Introduction > On 11 February 2007, Vodafone NL acquired 67% stake in Hutch Essar India (52% from HTIL &

call option for 15% stake from resident Indians) for US$ 11.1 billion The transaction was expected to realize an estimated before tax gain of US$ 9.6 billion to HTIL In this respect, conditional approval was granted by FIPB to Vodafone stipulating that there should be compliance and observance of applicable laws and regulations in India including tax obligations under Indian tax laws. Thereby, Hutchison International incorporated in Hongkong sold its SPV in Cayman Islands CGP Investments to Vodafone. Vodafone got controlling interest in Hutch Essar, India on account of share acquisition of CGP (situated outside India) from a non resident In connection with the transaction, the Indian tax authorities issued notice to Vodafone asking Vodafone as to why it should not be treated as an assessee in default for not withholding taxes on its payments to the Hutch Group. Subsequently, Vodafone filed a writ petition challenging the validity of the notice before the Bombay HC.

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Taxability of Capital gains

IT Departments' argument Capital asset: The acquisition of one share in CGP by Vodafone NL was a consequence of purchasing interest in the Indian telecom business which encompasses a bundle of rights in India and the transfer of share is incidental to all such rights. Business connection: FIPB approval was mandatory and was a condition precedent to the SPA which indicated that this transaction had nexus with India References made to India in the Share Purchase Agreement (SPA) Due diligence of Hutch Essar India was conducted by Ernst & Young Vodafones stand Taxation of capital gains based on economic nexus will quadruplicate taxation in various jurisdictions like Mauritius, Cayman Islands, Hongkong and India There are no specific look through provisions in Indian law to tax non residents for transactions held outside India. For example, look through provisions in certain countries tax capital gains on transfer of shares of companies owning immovable properties in that country FIPB approval was not for the acquisition of 52% and FIPB approval was obtained for the 15% stake in which call options were obtained from the Indian owners and the ownership of the

same is not transferred to Vodafone

Analysis The Bombay High Court while dismissing Vodafones plea has held that, there was apparently an extinguishment of rights and relinquishment by the transfer of controlling interest in the Indian company which constitutes a transfer It has also held that the shares in the Cayman company were merely the mode or the vehicle to transfer the assets situated in India The Supreme Court while dismissing Vodafones petition did not comment on the taxability of the transaction However, the Supreme Court has directed Vodafone to approach the revenue authorities for initially and then approach the High Court if the authorities answer the jurisdictional facts negatively

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It can also be viewed that the provisions of section 9 are wide enough and the look through provisions for transactions happening outside India involving capital assets situated in India are inbuilt in it

Judicial precedents Favouring Vodafone: Sale of shares an isolated transaction, not a business connection (R.D. Agarwal & Co 56 ITR 20(SC)) Against Vodafone: Controlling interest not a separate capital asset distinct from shares (Mahadeo Ram Kumar 166 ITR 477 (Cal)) IT department
By virtue of sale of shares of CGP, Vodafone indirectly acquired controlling interest in an Indian company and hence the transfer gave rise to capital gain taxable in India There is a business connection in India as FIPB approval was required

Law
Taxability of capital gains

Vodafone
No transfer or sale of shares/assets in India Therefore, capital gains not taxable in India No prior FIPB approval was required to acquire 52% and FIPB approval was obtained for the 15% stake in which call options were obtained and the ownership of the same is not transferred to Vodafone Taxable presence in India is required and sec 195 does not have extra-territorial jurisdiction.

IT law
Sec 9(1): Income deemed to accrue in India from any business connection in India or through transfer of capital asset in India Capital asset situated outside India and sale of shares is not an business connection Controlling interest not a separate capital asset distinct from shares

Withholding tax u/s sec 195

Show cause notice to Vodafone to show cause as to why Vodafone should not be treated as an assessee in default (AID) in respect of failure to deduct tax on the capital gain arising on such transfer Sec 195 applies to any person and Vodafone should have obtained NIL withholding tax certificate Notice issued to Hutch Essar, India to show cause as to why it should not be treated as representative assessee Hutch Essar is a representative assessee with respect to the withholding tax obligation of Vodafone, Netherlands

Sec 195 applicable only if income is taxable in India No mandatory requirement to obtain NIL withholding tax certificate if income not taxable in India Sec 201 amended by Finance Bill 2008 to cover failure to withhold tax in the scope of AID w.e.f 1 Jun 02

Representative assessee

Hutch Essar is not a party to the transaction and cannot be treated as a representative assessee Hutch Esaar has no transaction with non resident

Representative assessee shall have business connection with non resident; or A resident or non resident who has acquired a capital asset in India

Conclusion
The Supreme Court has held that the sale of the share of the Cayman Islands company did not trigger a tax liability in India, the investment structure was bona fide and needed to be respected, and there was no tax liability on Vodafone to withhold tax and deposit it in India. The judges stated that Indias tax laws did not have the necessary provision to look through the corporate structure in the absence of a fraud. This supports the earlier decision of the Supreme Court, when it upheld treaty planning via Mauritius and explicitly concluded that there was no reason to revisit the finding by reference to a larger bench of the Supreme Court. The Supreme Court has recognized the need and upheld the right of tax payers to genuine tax planning. One key aspect on which the decision of the Supreme Court overrides the decision of the Bombay high court is in relation to the unbundling of the consideration. The high court had stated that while the situs of the shares that were transacted was outside India and hence not taxable in India. However, the high court had ruled that the transaction documents indicated that there were a bundle of rights and entitlements that were transacted and their situs needed to be determined and consideration allocated for determination of tax in India. The Supreme Court held that merely because certain values were indicated in correspondences between parties, it did not mean the parties have agreed to bifurcate the transaction value into acquisition of different assets and rights. The Supreme Court held that the deal was a consolidated transaction. At stake for Vodafone was over $2 billion in potential tax liability and risk of tax penalties. This decision comes as a relief to Vodafone, and also to the wider investor community, many of whom were fearful of the tax consequences if the tax authorities had succeeded in their endeavour to tax income and gains arising outside India from transfer of shares that derive value from underlying shares and assets in India. The proposed direct taxes code will change the rules of the game hopefully with predetermined tax laws that provide such outcome in defined circumstances and with certainty, an attribute that the Supreme Court stated forcefully as an important criterion for tax laws to enable and encourage investors.