Column: The grey still surrounds the taxability

Updated: Feb 24 2014, 08:27am hrs
The breakdown of the conciliation talks between Vodafone and the Indian government alludes to yet another opportunity for India to introspect on the aspersion cast on its image as a preferred investment destination among developing economies.

Foreign investors, India Inc and various stakeholders have been closely following the course of this 7-year-old dispute between the British telecom company Vodafone and the Indian tax department. The controversy arose upon Vodafones acquisition in 2007 of Hutchisons indirect interest in India, i.e. Hutchison Essar (held by way of a chain of downstream subsidiaries in British Virgin islands, Cayman islands and Mauritius). The Indian tax authorities asserted that since the transfer involved underlying Indian interests, Vodafone should have withheld/deducted taxes on the payment to Hutchison. Vodafone, of course, challenged this on the ground of lack of territorial nexus since there was no direct transfer of shares/interest in Hutchison Essar in India.

Vodafone went through an arduous and long drawn litigation and, finally, in January 2012, the Supreme Court of India favoured Vodafone and held that India had no jurisdiction to tax the transaction and Vodafone had no withholding tax obligation. The jubilance from this decision, however, was short lived. The Finance Act 2012 unfolded retrospective amendments to the income tax law provisions to nullify the verdict in the Vodafone case and tax the transfer of shares of a foreign company having substantial underlying interest in Indiapopularly known as indirect transfer of shares. These amendments have been positioned as clarifications to certain terms in the domestic tax law and, hence, have been made effective retrospectively.

Post these amendments, in June 2013, the Indian government and Vodafone decided to resolve the dispute through a conciliation process. However, based on the latest updates, it is expected that the Indian government will withdraw from the process in light of Vodafones demand to also include its transfer pricing disputes under the conciliation talks. This would mean that the Indian tax department will resume their tax demand of R20,000 crore (including interest and penalty) from Vodafone. The tax payout may impact Vodafones further investment plans in India, ongoing spectrum auction payments, etc.

The retrospective taxation of indirect transfers has significantly expanded the scope of taxation of non-residents in India in cases of cross-border transactions with an underlying Indian connection. Also, the wordings and scope of the relevant provisions are fraught with ambiguity and scope for wide interpretation. These developments have evoked fear in the investor community creating concerns over tax uncertainty regarding Indian investments, unclear and widely scoped tax provisions, disregard of jurisprudence by the legislature and possibility of Indian revenue authorities targeting open litigations of foreign companies in India.

Apart from the Vodafone fallout, taxation of indirect transfers would bring within in its sweep various similar cross-border deals. It would be interesting to know the fate of pending cases such as SAB Millers acquisition of various assets (including Indian assets) from the Australian Fosters group in 2006, Krafts acquisition of Cadbury in 2010 involving a small proportion of underlying Indian assets etc, under these amended provisions.

The retrospective taxation of indirect transfers led to representations by various stakeholders to the government for reconsideration of these proposals. An expert committee (Shome committee) was set up to analyse the amended provisions. In 2012, the committee in its draft report made certain recommendations such as applying the provisions dealing with indirect transfers prospectively. It also highlighted that where the government proceeds with retrospective application, then the withholding tax liability and interest and penalty should not be imposed on the parties. It also suggested defining the term substantially used in amended provisions as a threshold of 50% of the total value derived from assets of the company or entity from India. Other suggestions included allowing tax treaty benefits to the non-resident taxpayers, granting exemption to minority shareholders, transfer of shares of a foreign company under intra-group restructuring, PE investors etc. These recommendations indicate an approach to address concerns over the uncertainty and ambiguity arising from the retrospective provisions.

Also, a positive precedent laid down on the issue of indirect transfers as in the case of Sanofi Pasteur is reason for cheer for foreign investors. In the said case, the shares of an Indian subsidiary of a French company were indirectly sold to Sanofi Pasteur in France by two other French companies. The Andhra Pradesh High Court in this case held that capital gains resulting from offshore transaction between two foreign companies with an underlying Indian asset are not taxable under the India-France tax treaty and that the retrospective amendments would not override the beneficial tax treaty provisions.

A growing and developing economy like India, which is struggling with fiscal and current account deficits, should respect the need to recognise foreign investors as important stakeholders in its growth story. Frequent and retrospective changes in laws, which are ambiguous and wide in interpretation, will act as a deterrent for foreign investors looking at capitalising the growth potential in a market of over 1.2 billion people. The need of the hour is to have a simple and stable tax system, rid of complexities and wide interpretations, and a time-bound resolution mechanism. The government may consider clarifying the provisions and applicability of the indirect tax provisionscontemplating and incorporating the recommendations of the expert committee; initiatives such as coming up with FAQs which give clear directional guidance on taxability of indirect transfers etc, would be a welcome move to restore investor confidence.

Girish Vanvari

The author is co-head, tax, KPMG in India. This article is co-authored by

Nidhi Maheshwari, director, tax, KPMG in India