2. Executive Summary
• Vodafone International Holding (Vodafone NL) was issued an order by the Indian Tax
Authority assessing a capital gains tax alleged to have arisen on acquisition of
controlling interest in an Indian entity, Vodafone-Essar Ltd from Hutchison Essar
• The controlling interest was acquired by acquiring the shares of a foreign holding company
that indirectly held more than 50% of the shares of the Indian entity
• The Tax Authority has alleged that Vodafone NL failed to withhold Indian tax on the
payment of consideration made to Hutch for acquiring the controlling interest
• Vodafone NL filed a writ petition in the Bombay High Court (HC) against the Tax Authority‟s
order
• The HC commenced proceedings on the writ petition on 4 August 2010
• The main thrust of the arguments has been that the transaction was not designed to evade
Indian tax, transfer of shares of a company is different from transfer of underlying
assets of that company, situs of the shares that was transferred is not in India and the
Indian Tax Law (ITL) does not contain ‘look through’ provisions
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3. Facts and Background
• Vodafone International Holdings BV, based in Netherlands and controlled by Vodafone
UK, obtained the controlling interest and share of CGP Investments Holdings Ltd (CGP)
located in Cayman Island for a value of $11.01 billion from Hutchinson
Telecommunications International Ltd (HTIL), which had stake in Hutchinson Essar Ltd
(HEL) that handled the company's mobile operations in India
• HEL had its stake in CGP Holdings, from which Vodafone bought 52 per cent of HEL's
stake in 2007, thereby vesting controlling interest over them
• The Bombay High Court, on September 8, ruled that when the underlying assets of the
transaction between two or more offshore entities lies in India, it is subject to capital
gains tax under relevant Income Tax laws (ITL) in India
• The Court invoked the nexus rule wherein a state can tax by connecting a person sought
to be taxed with the jurisdiction, which seeks to tax (The treatment of the company as an
Assesse in Default (AID) under Section 201(1)of the Income Tax Act)
• The court came to the conclusion that Vodafone is liable to pay taxes at source (TDS)
• Vodafone has now appealed before the Supreme Court to revisit the judgement, which
makes them liable for a record amount of Rs 12,000 crores going to the tax authorities'
kitty
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5. Tax Authority‟s Contention
• The subject of the transaction is a composite transaction involving a transfer of rights in an
Indian company
• This resulted in an accrual or deemed accrual of income from a source of income in
India or from an asset in India or through the transfer of capital asset in India
• The transfer of shares of the Cayman Islands entity was a means to transfer the controlling
interest in India
• There was a presence of territorial nexus in India for the transaction carried out and
accordingly there was liability on Vodafone NL to withhold taxes
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6. Vodafone‟s Plea
• The provisions were not applicable to the current case and the primary obligation to
discharge the tax was with the payee (Hutchison Telecommunications International
Limited)
• Unless the payee had defaulted in making payment of taxes, on demand by the Revenue
authorities, tax could not be recovered from the payer
• The withholding tax provisions cannot have extra-territorial application i.e. cannot apply
in an offshore transaction involving two non residents in respect of a capital asset (i.e. shares)
and payment outside India
• The transaction is not chargeable to tax in India since it involves transfer of shares of a non-
resident company by one non-resident to another and is not a transfer of a capital asset
situated in India
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7. Transaction not designed to evade
tax, structure evolved over a period of
years
• Incorporation of a company in any jurisdiction is driven by several economic, political and
commercial factors so tax saving is not the sole objective in adopting a particular
structure
• Authenticity of the structure was explained by chronological events of liberalization of the
Indian economy, Foreign Direct Investment (FDI) policy, Hutch’s entry in different
telecom circles etc. leading to the acquisition of shares by Vodafone NL
• Merely because an entity is an investment company (with reference to Cayman Islands
entity) it could not be said that the particular company is designed to avoid tax and such
Indian exchange control regulations recognize such investment companies
• The structures were legally formulated, considering the commercial expediency and
economic realities, and the decision to purchase shares was also governed by commercial
expediency
• Indian operations are being carried out by the Indian entity and other operating companies
which are separate legal entities
• The corporate veil cannot be imposed unless there is proof that the transaction is sham and
designed to evade tax so a genuine transaction undertaken within permissible legal
framework cannot be called a sham transaction.
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8. Transfer of shares is different from
transfer of underlying assets
• The ITL specifically recognizes ‘shares’ as a capital asset
• Sale of shares results in transfer of bundle of rights viz., right to dividend, right to
vote, right to control etc and each right cannot be vivisected and taxed separately
• Through purchase of shares, Vodafone NL has acquired a right to control the Indian
business operations and not the ownership of the assets in India, which continues to
remain with the Indian entity
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9. Situs of shares transferred not in
ndia, no „look through‟ provisions in India
• As per the ITL, transfer of a capital asset is taxable in India if it is situated in India
• Situs of shares lies in the place where the share register is maintained and in the absence
of such share register being maintained, the situs lies at the place of incorporation of the
company, therefore, since the shares of the Cayman Islands entity are being transferred, it
cannot be taxed in India
• Rules of apportionment of sale consideration applies only if different jurisdictions claim right
of taxation under the source rule
• As there are no activities in India, the source rule and, consequently, rules of apportionment
would not be triggered
• Under certain ‘look through’ provisions, if the value of shares is derived from the value of
shares of an underlying asset (say, land) then the transaction is liable to tax even in the
country where the asset (land) is situated, even though the transferred asset (share) is
not situated in that country but the ITL do not have such provisions to tax the
transaction
• Vodafone NL had never objected that it had not acquired controlling interest over the Indian
operations. However, there being no transfer of Indian assets or change in ownership of
Indian business, the share sale transaction is not subject to tax in India
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10. No business connection in India
• As per the ITL, business connection means existence of business relations between a non-
resident and any other person, arising out of its business activities, which contributes
directly or indirectly to the earning of income in India
• The business connection test is applied while calculating the business income
and, hence, has no application in computing capital gains and in such cases the taxability of
income is restricted to business operations carried out in India
• Since, Hutch has neither any business presence nor carries out any business activities in
India the same cannot come within the ambit of taxation under the ITL
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11. No liability to withhold Indian tax on
payments between two non-residents
• The withholding tax provisions are applicable to any person who has certain territorial nexus
and, hence, is adequately connected to the Indian Territory, the person should be subjected to Indian
laws or should have a presence in India, Vodafone NL does not have any presence in India
• Connectivity with the Indian laws should be evaluated by considering the factors such as, party
to the contract is a resident of India, transactions is consummated in India or is governed by
Indian laws and the payment is made from/in India and none of these conditions are satisfied in
the fact of Vodafone NL
• The provisions of the ITL extend to whole of India and, therefore, it was never intended to cover
persons who did not have any presence in India
• Further, wherever it was felt necessary, the parliament has incorporated extra territorial
coverage in certain laws such as the foreign exchange law that applies to a branch, office or
agency outside India that is owned or controlled by person resident in India
• The logical intention in insertion of withholding tax provisions in respect of non-resident was to
ensure that taxes are gathered well before funds leave Indian shores as the Indian Government
would not be able to chase the non-resident for tax collection and enforcement later
• The intent in these provisions was never to obligate a non-resident, who does not have any
presence in India, but to comply with withholding tax provisions such as withholding of
taxes, depositing the same, filing returns, issuing certificates etc
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12. The High Court Decision
• It holded that the notice is legally tenable and thus dismisses the writ petition
• The following are the observations made by the High Court:
– Income was earned towards consideration for transfer of its business/economic interests
as a group
– The subject matter of the present transaction is nothing but transfer of interests, tangible
and intangible in Indian companies and not an innocuous acquisition of shares of a
Cayman Islands Company
– The interest in Telecom License is jointly held with the Essar Group along with the use
of Brand & Goodwill and non-compete rights given by HTIL and so there is a right to
enter into Telecom Business in India, with a premium for the controlling interest
– As there was admittedly a transfer of controlling interest in the Indian company, there
was an “extinguishment of rights” and “relinquishment” by the transfer or in the shares
of the Indian company which constituted a “transfer”
– The shares in the Cayman company were merely the mode or the vehicle to transfer the
assets situated in India
– The choice of the assesse in selecting a particular mode of transfer of such assets will
not alter or determine the nature or character of the asset
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13. The High Court Decision (Contd…)
– As the assesse (Vodafone) had wilfully failed to produce the primary/original agreement
and other prior and subsequent agreements/documents , so it was impossible to
appreciate the true nature of the transaction and the constitutional validity of Income-tax
provisions could not be gone into
– It is settled law that a writ cannot be entertained against a mere show-cause notice unless
the Court is satisfied that the show cause notice was totally unjustified in the eye of law
for absolute want of jurisdiction of the authority to even investigate into facts
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14. A look Beyond
• Chargeability to tax of an offshore transaction between non-residents:
– The Court has not made any observation on the chargeability of the said transaction to tax and
so it appears to acknowledge a distinction between the shares perse (held outside India) and the
underlying rights/interests/assets (based in India)
– It observes that the share transfer could be treated as mere mode for transfer of underlying
assets and so this appears to navigate against the accepted jurisprudence and seeks to impose
the corporate veil having far-reaching implications on transactions domestically and
internationally
– If the value is created significantly in India, there are merits in the Revenue‟s
perspective, however prior to seeking a levy of tax on such transactions, the legislature should
first make appropriate provisions in the tax laws
• While, the position of the Courts on the chargeability of tax is yet to be decided, this judgment
indicates the direction in which the legislature could move:
– Media reports suggest that notices to several companies are in the pipeline
– The revenue department is embroiled in a legal battle with US-based General Electric for its
60% stake sale in Genpact which were sold for $500 million in 2007.
– In yet another transaction, telecom major AT & T stake sale in Idea Cellular to the Tata
Industries in 2005 has also been sent a tax notice.
– Internationally, US private equity fund Lone Star has faced tax hurdles in Seoul, Korea over its
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15. A look Beyond (Contd…)
• As part of the corporate tax strategy, appropriate attention should be provided to:
– Use of jurisdictions with good treaty networks for implementing global investment
structures
– Clarity and consistency in disclosures and filings under other regulations and with
regulatory authorities
– Review of shareholder agreements to understand the references to key business rights, its
situs and its transferability
– Use of an indemnification clause for recourse to seller in case of tax liability
– Hygiene in corporate communications (particularly external media)
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