July 9, 2008
The Vodafone Tax Controversy
NDA Commentaries on Court Proceedings*
The Vodafone tax controversy
concerns a cross-border M&A transaction between
non-resident entities and its taxability in India. The
facts before the Bombay High Court are unique and
unprecedented, and the outcome could have a telling
impact on global mergers and acquisitions, indirectly
involving an Indian subsidiary. Nishith Desai Associates
brings you updates on the final hearings as and when
they develop in the courtroom. |
On July 8, 2008, Additional Solicitor General of
India, Senior Advocate Mr. Mohan Parasaran, counsel for the
Income-tax Department (“Revenue”),
continued his submissions with respect to the chargeability of
capital gains in light of the facts and circumstances of the
instant case. The counsel pointed out that Vodafone
International Holdings BV (“Vodafone”)
had made an application to the Foreign Investment Promotion
Board (“FIPB”). This, he submitted, indicated that Vodafone acquired a
controlling interest in Vodafone Essar Limited1
(“Vodafone India”).
It was further submitted that in the present transaction,
neither Section 195 nor the show cause notice can be construed
as extra territorial. The Revenue also contended that Vodafone
was rightly classified as an ‘Assessee in Default’ for its
failure to withhold tax from the consideration paid to Hutchison
Telecommunications International Limited (“HTIL”).
Finally, the counsel submitted that the retrospective amendments
to Section 191 and 201 are machinery provisions and were amended
to remedy the mischief, and hence wholly within constitutional
precincts.
Submissions on Chargeability
On the first proposition, on chargeability, the
counsel opened his arguments by stating that Section 5 of the
ITA contemplates twin basis of taxation, i.e. based on residence
under Section 5(1) and source of income in respect of non
residents under Section 5(2). Section 9 introduces a deeming
fiction by virtue of which income accruing or arising
directly or indirectly
through or from any business connection in India;
property situate in India; or asset or source of income in
India; or transfer of capital asset situate in India. Analyzing
the constituents of the said Section, the counsel submitted that
transfer of 67% of HTIL’s economic interest and controlling
stake in Vodafone India in favor of Vodafone is nothing but
transfer of capital asset in the form of shares of Vodafone
India, falling within Section 9. In support of the above
submissions, the counsel for the Revenue also relied on
judgments of various courts to substantiate that Section 9 must
be construed strictly in interpreting each of the four
constituents of the said provision. Further he also relied on
decisions to demonstrate that the definition of property
includes intangibles, i.e. controlling interest.
The counsel then referred to and relied on the
definitions of ‘Capital Asset’, ‘Transfer’ and ‘Assessee’ under
ITA. He contended that the definition of Capital Asset is an
inclusive definition to mean property of any kind whether or not
connected with business or profession. In this context he
emphasized on the fact that it is not merely the shares which
are transferred but intangible assets comprising a bundle of
rights and controlling interest in Vodafone India, in favor of
Vodafone, which lead to transfer of a capital asset situate in
India. Relying on the definition of ‘transfer’ under the ITA,
the counsel submitted that relinquishment of controlling
interest of HTIL in Vodafone India, in favor of Vodafone was
nothing but transfer to Vodafone, the capital asset situate in
India. Referring to the
definition of Assessee the learned counsel emphasized that the
said definition included Assessee in Default for the purposes of
Section 195 (failure to deduct withholding tax). In light of
this, he categorically submitted that the crux of the issue
which makes the transaction taxable under Section 9 was transfer
of intangible controlling interest (67%) of HTIL in Vodafone
India in favor of Vodafone and not the innocuous acquisition of
shares of CGP Investments (“CGP”)
i.e. the Cayman Islands Company.
At this juncture, Mr. Chagla appearing for Vodafone intervened to state
without prejudice that they do not dispute acquisition of
indirect control in Vodafone Essar in India but as judicial
precedents suggest transfer of controlling interest cannot be
construed as an asset in the first place and such transfer of
asset is merely incidental to the transfer of shares. He
indicated that he would further elaborate on this aspect in his
rejoinder (rebuttal), as the hearing continues on July 9, 2008.
On his second proposition regarding submissions
to FIPB the counsel for the Revenue pointed out that Vodafone
was different from shareholders of Vodafone. The ultimate
controlling entity as a result of the transfer of controlling
interest of HTIL in Vodafone India is Vodafone. The learned
counsel for the Revenue urged that in recent times of changing
corporate jurisprudence, the principles laid down by the classic
case of Solomon v/s. Solomon in terms of shareholder identity,
apply, but with modifications suited to today’s era.
At this juncture, Mr. Chagla intervened to submit
that there was no change whatsoever in the shareholding in Hutch
Essar pursuant to such transfer. The counsel for the Revenue
stated that HTIL had conducted a competitive auction for sale of
HTIL’s interest in Vodafone India. Vodafone participated in this
auction and agreed to pay USD 11.08 billion to acquire 67% of
controlling stake in Vodafone India. Reference was made to
certain correspondence / letters to FIPB by Vodafone to
demonstrate that by the ‘complex’ transaction, HTIL, transferred
a bundle of rights, both tangible and intangible along with
economic and controlling interest to Vodafone in Vodafone India.
The counsel strenuously urged that the transfer of CGP’s shares
was merely a medium, a vehicle to acquire controlling interest
in Vodafone India. In this context, he urged the Court to
consider that the shares of CGP so transferred were not even
considered in determining the enterprise value of Hutch Essar.
He further submitted that by transfer of 67% controlling stake
of HTIL in Vodafone India, Vodafone acquired the right to
appoint 8 directors and the Chairman in Vodafone India, by which
Vodafone actually acquired management control in the Indian
entity. Further, the counsel submitted that the intention of
Vodafone was to acquire a stake in Vodafone India by acquiring
shares of the CGP which was merely a vehicle to acquire
controlling interest in Vodafone India. Hence there was no need
whatsoever to invoke the doctrine of lifting corporate veil,
when the intention of the parties is manifestly evident.
Obligation to withhold
Tax
On the applicability of Section 195, counsel for
Revenue submitted that neither the said Section nor the show
cause notice issued to Vodafone for non compliance thereof can
be construed as extra territorial. In this context, he submitted
that under Section 1(2) of the ITA, the Act extends to the whole
of India, in contra distinction to part of India and not outside
India. According to the counsel for the Revenue a non resident
can be taxed in India if he falls within the scope of Section 9,
if the requirements there under are complied with. To this Mr.
Chagla, the counsel for Vodafone cautioned the Court to the
effect that this would lead to taxation of worldwide income in
India merely by virtue of some connection with India. The
counsel for the Revenue emphasized that Section 195 was a
provision laying down machinery to collect tax and ought to be
interpreted to give effect to the charging Section. He submitted
that once Section 9 is triggered as a consequence thereof the
machinery provision to collect the tax i.e. Section 195 comes
into play. The counsel for the Revenue strenuously argued that
the Court ought to give due credence to the internationally
accepted ‘Effects Doctrine’ which has its root in the US, on the
issue of territorial nexus with India. In this context, he
categorically submitted that it is not only the transaction but
the ultimate effect of the same, should determine the
taxability. He drew support from the provisions of the US Anti
Trust Law i.e. the Sherman Act to state that the principle of
substantial effect must be followed so long as the same is not
applied unilaterally. In light of the submissions advanced on
Section 195, he submitted that Vodafone was therefore liable to
deduct tax from the payments made to HTIL under Section 195,
failure of which rendered Vodafone to be an Assessee in default.
Retrospective Amendments
On the retrospective amendments to Section 191 and 201 he
submitted that the amendments were introduced with a view to
remedy the mischief and ensure that tax due and payable is not
evaded. He relied on several decisions of various courts to
contend that taxation statutes should be strictly construed and
the procedural provisions laying down the machinery to tax must
be so interpreted so
as to make the same workable and not otherwise. The counsel for
the Revenue would be continuing his submissions on the
retrospective amendments tomorrow after which Mr. Chagla would
rejoin to rebut the submissions made by the Revenue’s counsel.
The hearing concluded today i.e. on July 9, 2008.We
shall come back to you with our analysis of the today’s
developments in our final hotline, shortly.
______________________
1 Earlier known as Hutch Essar
Limited
* Previous commentaries:
June 27, 2008,
June 30, 2008
July 2, 2008,
July 8, 2008
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