Taxation of Cross Borders Mergers & Acquisitions: Vodafone

Hutch Deal
Dr. Monica Singhania
Associate Professor
Faculty of Management Studies (FMS)
University of Delhi
Email: monica@fms.edu
Venugopal Dastaru
MBA Class of 2012
Faculty of Management Studies (FMS)
University of Delhi
Abstract
Any mergers and acquisitions activity is intricate in its dimensions and would be affected by a
plethora of laws and regulations depending on the stakeholders involved. Deal structuring from
a tax perspective is one of the critical factors for any business restructuring proposition, such
that the transaction is tax neutral or results in minimizing the tax implications. Such acquisitions
may be routed through direct investments or through an International Holding Company (IHC).
An IHC would be advantageous in case the promoter/company wishes to keep the cash flows
generated from overseas operations outside India for future growth needs. In case of direct
investments, the entire surplus amount would have to be repatriated to India and the same would
be subject to tax in India, thereby reducing the disposable income in the hands of the
promoter/company.
Income generated overseas could be repatriated to the Indian Company in the form of interest,
royalties, service or management fees, dividends, capital gains. Such income when repatriated to
the Indian Company by the IHC or to the IHC by the target company would attract double
taxation. Double taxation is a situation in which two or more taxes are paid for the same
income/transaction which arises because of the overlap between different countries tax laws and
jurisdictions. The liability is then mitigated or off settled by tax treaties between the two
countries. An ideal location for an IHC would be one with low/nil withholding tax on receipts,
on income streams and on subsequent re-distribution as passive income. Some of the
jurisdictions preferred for repatriating back to India include Mauritius, Cyprus, Singapore and
Netherlands, which have relatively better tax treaties with India.
Essentially the Vodafone Hutch deal involved transfer of shares of a non-resident Cayman
Islands based entity between two non-residents (Hutch and Vodafone). Apparently the
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transaction had no link with India and therefore the related parties to the transaction indeed
assumed and claimed that no tax on this deal is payable in India. But the Indian tax
authorities thought otherwise. The Indian tax authorities issued notice to Vodafone under
section 201 of the Indian Income Tax Act 1961 so as to show cause as to why it should not be
treated as an assessee in default since it (Vodafone) had failed to discharge its withholding
tax obligation with respect to tax on gains made by Hutch on the sale of shares to Vodafone.
In addition, the Indian tax authorities decided to treat Vodafone as an agent of Hutch under
section 163 of the Income Tax Act 1961 to recover the tax dues. On Vodafones challenge to
the notice, the Bombay High Court on December 3, 2008, approved the Indian tax authorities
jurisdiction to initiate investigation so as to determine whether the over $11 billion
Hutchison-Vodafone transaction was liable for capital gains tax in India. Finally on January
20, 2012, the Supreme Court ruled in favour of Vodafone. The Supreme Court disagreed with
the conclusions arrived at by the Bombay High Court that the sale of CGP share by HTIL to
Vodafone would amount to transfer of a capital asset within the meaning of Section 2(14) of
the Indian Income Tax Act and the rights and entitlements flow from FWAs, SHAs, Term
Sheet, loan assignments, brand license etc. form integral part of CGP share attracting capital
gains tax. Consequently, the demand of nearly Rs.12,000 crores by way of capital gains tax,
would amount to imposing capital punishment for capital investment since it lacks authority
of law and, therefore, stands quashed.
Keywords: Business restructuring, cross border transactions, tax haven, capital gains
I. Introduction
Mergers and acquisitions play a major role in the globalization process. Tax laws should better
accommodate cross border merger and acquisitions. In an endeavour to geographically expand
the utilization of their competitive advantages, merger and acquisitions allow the firms to do so
in a fast, effective and perhaps in an inexpensive manner.
Many countries have some tax rules that grant certain benefits to merger and acquisitions
transactions, usually allowing some deferral of the tax otherwise imposed on the owners of some
of the participating parties upon the transaction. On the other hand, once mergers and
acquisitions transactions cross borders, countries are much less enthusiastic to provide tax
benefits to the involved parties, understanding that, in some cases, relief of current taxation
practically means exemption since such countries may completely lose jurisdiction to tax the
transaction.
Cross-border merger and acquisitions, although presenting many of the same issues as domestic
deals, are usually more complex and rife with surprises and other pitfalls, more so when the
number of geographies involved in the transaction increases. The sheer range of concerns has
expanded as the speed and volume of international deals have increased. Domestic merger and
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acquisitions are, generally and on average, socially desirable transactions. In many countries,
they enjoy tax (deferral) preferences, but only to the extent to which they use stock to
compensate target corporations or their shareholders.
The legal framework for business consolidations in India consists of numerous statutory
provisions for tax concessions and tax neutrality for certain kinds of reorganizations and
consolidations. With India rapidly globalising, and the economy growing and showing positive
results, a sound tax policy is essential in this regard. Tax is an important business cost to be
considered while taking any business decision, particularly when competing with other global
players. The new direct tax code that the Government is planning to introduce, to replace the
current Income-tax Act, 1961, is expected to emphasise on transparency and taxpayer-
friendliness.
Any mergers and acquisitions activity is intricate in its dimensions and would be affected by a
plethora of laws and regulations depending on the stakeholders involved. Progressive
deregulation in sectors such as banking, insurance, power, aviation, housing and policy
rationalization in others like broadcasting, telecommunications and media, coupled with the
governments decision to exit non strategic areas through divestment/ disinvestment has further
triggered M&A activities in India. Further considering competition in the world market and
pressure on the top line and bottom line, Indian Companies are increasingly looking at mergers
and acquisitions as instruments for momentous growth and a critical tool of business strategy.
Deal structuring from a tax perspective is one of the critical factors for any business
restructuring proposition, such that the transaction is tax neutral or minimizing tax implications.
Such acquisitions may be routed through direct investments or through an International Holding
Company (IHC). An IHC would be advantageous in case the promoter/company wishes to keep
the cash flows generated from overseas operations outside India for future growth needs. In case
of direct investments, the entire surplus amount would have to be repatriated to India and the
same would be subject to tax in India, thereby reducing the disposable income in the hands of
the promoter/company.
Income generated overseas, could be repatriated to the Indian Company in the form of interest,
royalties, service or management fees, dividends, capital gains. Such income when repatriated to
the Indian Company by the IHC or to the IHC by the target company would attract double
taxation. Double taxation is a situation in which two or more taxes are paid for the same
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income/transaction which arises because of the overlap between different countries tax laws and
jurisdictions. The liability is then mitigated or off settled by tax treaties between the two
countries.
An ideal location for an IHC would be one with low/nil withholding tax on receipts, on income
streams and on subsequent re-distribution as passive income. Some of the jurisdictions preferred
for repatriating back to India include Mauritius, Cyprus, Singapore and Netherlands, which have
relatively better tax treaties with India.
The paper discusses about the taxation issues in cross border mergers & acquisitions in India. It
discusses about structuring the transactions. It also discusses about the taxation issues in sales of
shares and sale of assets. It also studies about the various laws governing the cross border
mergers & acquisitions. The paper takes VodafoneHutch deal as a special case to study the
taxation issues in cross border mergers and acquisitions. The paper proposes to showcase what
lies at the heart of this VodafoneHutch deal, the effect of taxation on such transactions, the way
forward of the deal, options for the parties involved, impact on future cross border M&A,
concept of tax haven, possible tax planning in such cases, tax treaty shopping how far legal
and ethical and the present tax law in India is in this regard.
II. Historical Background
Given the role that mergers and acquisitions play in globalization process, the Indian business
environment has indeed altered radically with the changes in the economic policy and with the
introduction of new institutional mechanisms. The industrial policy changes in 1991 ushered in
an era of liberal trade and transactions in industrial and financial sectors of the economy. In the
last two decades, India witnessed substantial rise in mergers and acquisitions activity in almost
all sectors of the economy. Indian industries underwent structural changes in the post-
liberalisation period wherein mergers and acquisitions were accepted as vital means of corporate
restructuring and redirecting capital towards efficient management. In a way, restructuring of
business became an integral part of the new economic paradigm. Restructuring and
reorganization became important as the controls and restrictions gave way to competition and
free trade. Restructuring usually involves major organisational changes such as shift in corporate
strategies to meet increased competition and rapidly changing market conditions.
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Regulatory Framework: The relevant laws that are to be implicated in a cross border mergers
and acquisitions in India are as under:
Companies Act, 1956: Cross border M&A, both the amalgamating company or companies and
the amalgamated (i.e. survivor) company are required to comply with the requirements specified
in Section 391-394 of the Companies Act, which, inter alia, require the approval of a High court
and of the Central government. Section 394 and 394A of the Act set forth the powers of the
High Court and provide for the court to give notice to the Central Government in connection
with amalgamation of companies.
Foreign Exchange Laws: The Foreign Direct Investment Policy of India needs to be followed
when any foreign company acquires an Indian company. FDI is completely prohibited in certain
sectors such as gambling and betting, lottery business, atomic energy, retail trading and
agricultural or plantation activities. The Foreign Investment policy of Government of India
along with the press notes and clarificatory circulars issued by the department of investment
policy and promotion, Foreign Exchange Management Act, 1999 (FEMA) and regulations made
there under, including circulars and notifications issued by the RBI from time to time, the
Securities and Exchange Board of India Act, 1992 and regulations made there under (SEBI
laws).
Income Tax Act, 1961: A number of important issues arise in structuring a cross-border merger
and acquisitions deal to ensure that tax liabilities and cost will be minimized for the acquiring
company. The first step is to explore leveraging local country operations for cash management
and repatriation advantages. Moreover, the companies should be looking at the availability of
asset-basis set up structures for tax purposes and keeping a keen eye on valuable tax attributes in
merger and acquisitions targets, including net operating losses, foreign tax credits and tax
holidays. As per the provisions of the Income Tax Act, capital gains tax would be levied on such
transactions when capital assets are transferred. From the definition of transfer, it is clear that if
merger, amalgamation, demerger or any sort of restructuring results in transfer of capital asset, it
would lead to a taxable event. As far as merger and acquisitions are concerned, the provisions of
Indian Income Tax Act, 1961 with respect to amalgamation (section 2(1B)), demerger (section
2(19AA)), securities transaction tax (STT), capital gains, slump sale, set off and carry forward
of losses, etc. need to be examined intricately to establish legitimate safeguards.
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Tax structure is important factor in mergers and acquisitions. Tax laws determine the desired tax
treatment of the transaction whether it is taxable or tax free. An ideal tax structure should be
such that it minimizes the tax leakage, such as tax withholding relating to cross border mergers
and acquisitions.
Proposed tax treatment under Direct Tax Code: It is to be noted that recently, the Finance
Minister has released the new Direct Tax Code which seeks to bring about a structural change in
the tax system currently governed by the Income- tax Act, 1961. Summarized below are the key
proposed provisions that are likely to have an impact on the mergers and acquisitions in India:
Currently, the definition of amalgamation covers only amalgamation between companies. It
is now proposed to include, subject to fulfilment of certain conditions, even amalgamation
amongst co-operative societies and amalgamation of sole proprietary concern and
unincorporated bodies (firm, association of persons and body of individuals) into a company
in this definition.
For amalgamation of companies to be tax neutral, in addition to existing conditions the Code
proposes that amalgamation should be in accordance with the provisions of the Companies
Act, 1956.
In case of demerger, resulting company can issue only equity shares (as against both equity
and preference shares as per existing provisions) as consideration to the shareholders of
demerged company, for the demerger to qualify as tax neutral demerger.
Irrespective of sectors (for instance manufacturing or service), the benefit of carry forward
and set off of losses of predecessor in the hands of successor Company is proposed to be
available to all the companies. As per existing provisions in view of definition of industrial
undertaking certain companies were not able to utilize the benefit of losses as a result of
amalgamation. Further, the Code provides for indefinite carry forward of business losses as
against restrictive limit of 8 years under existing provisions.
Profit from the slump sale of any undertaking is proposed to be taxed as a business income as
against capital gains income.
Code seeks to eliminate the distinction between long term and short term capital asset.
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Introduction of General Anti Avoidance Rule (GAAR) which empowers the Commissioner
of Income-tax (CIT) to declare an arrangement as impermissible if the same has been
entered into with the objective of obtaining tax benefit and which lacks commercial
substance.
Taxation of Mergers & Acquisitions: A Comparative Study
There have been many recent developments in the competition and taxation laws of various
countries. The tax is a deciding factor for any cross border reorganization and so all the
countries should try to have a favourable tax environment.
United States: The two primary relevant federal securities laws in US that has to be complied,
are the Securities Act of 1933 (the Securities Act) and the Securities Exchange Act of 1934
(the Exchange Act), including the rules and regulations promulgated by the Securities and
Exchange Commission (the SEC).
Internal Revenue Code of 1986, as amended (Code), is provided by the federal government, this
code provides for tax laws in US. Section 267 of their internal revenue code (IRC) exempt US
corporate entity in some cases relating to taxation aspect as far as mergers and acquisitions are
concerned.
Singapore: Income is taxed in Singapore in accordance with the provisions of the Income Tax
Act (Chapter 134) and the Economic Expansion Incentives (Relief from Income Tax) Act
(Chapter 86). Singapore has also signed a Comprehensive Economic Cooperation Agreement
(CECA) with India.
United Kingdom: Finance Act 2009 and Corporation Tax Act 2009 which are likely to have a
considerable impact on U.K. acquisition structuring. The existing Treasury consent regime
(whereby certain transactions involving a foreign body corporate may be unlawful without prior
consent) is replaced with a reporting requirement for large transactions from 1 July 2009. Minor
changes have been made to the U.K. controlled foreign company (CFC) rules from 1 July 2009
over a two-year transitional period.
European Union: European competition law is governed primarily by Articles 85 and 86 of the
Treaty Establishing the European Community. Article 85 is designed primarily to achieve the
same goal as the Sherman Act in U.S. legislation insofar as it prohibits all agreements and
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concerted practices that affect trade among E.U. members and which have as their main
objective the prevention, restriction or distortion of competition. Article 86 is designed to meet
the policy objectives of the Clayton Act in that it prohibits the abuse of a dominant market
position through unfair trading conditions, pricing, limiting production, tying and dumping.
So, India has followed the footsteps of the developed economy by tax reforms and other
regulatory developments. US, UK and Singapore seems to have a friendly environment for
mergers and acquisitions by Indian companies.
III. Literature Review
As per the Cross-border Transactions - an India Tax and Regulatory Update, issued on
January 1, 2009 by Deloitte, India has always been perceived as a difficult jurisdiction to do
business with. In spite of India having substantially opened the doors for foreign investment and
there being no lack of local entrepreneurial talent, the country still ranks low in terms of being a
preferred business destination.
The Taxation of Cross-Border Mergers and Acquisitions, issued by KPMG, discusses Limited
Liability Partnership Act and tax attributes of various assets and share purchases. It highlights
withholding taxes in various countries, deal structures and various tax liability structures under
acquisition or merger by various modes. It compared tax liability under asset purchases,
demerger, amalgamation, various corporate laws covering transfer taxes, IT laws and other
accounting principles.
In Vodafone International Holdings BV v. Union of India [(2008) 175 Taxmann 399 (Bom.
HC)], December 3, 2008, Hutchison Essar Ltd. (Hutch India), a company incorporated in
India, was a joint venture of the Hong Kong-based Hutchison Telecommunications International
Ltd (Hutch Hong Kong) and the India-based Essar Group. Hutch India was in the business of
providing telecommunication service in India. Hutch Hong Kong held 67% of the shares of
Hutch India through CGP Investments Holdings Ltd (the Cayman Islands SPV), an SPV
registered in Cayman Islands, and some other shareholders. As a result of this sale, capital
gains, estimated at $ 2 billion, accrued to the Cayman Islands SPV. Considered from the point of
view of jurisdictions, it is clear that the sale transaction took place between the Dutch SPV
(owned by a UK group) and the Cayman Islands SPV (owned by a Hong Kong company). The
ultimate effect however was the transfer of controlling shares of an Indian company.
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FDI in Telecom Sector in India
In Basic, Cellular Mobile, Paging and Value Added Service, and Global Mobile Personal
Communications by Satellite, Composite FDI permitted is 74% (49% under automatic route)
subject to grant of license from Department of Telecommunications subject to security and license
conditions.
FDI up to 74% (49% under automatic route) is also permitted for Radio Paging Service and
Internet Service Providers (ISP's)
FDI up to 100% permitted in respect Infrastructure Providers providing dark fibre (IP Category
I); Electronic Mail; and Voice Mail
This is subject to the conditions that such companies would divest 26% of their equity in favour of
Indian public in 5 years, if these companies were listed in other parts of the world. In telecom
manufacturing sector 100% FDI is permitted under automatic route. The Government has modified
method of calculation of Direct and Indirect Foreign Investment in sector with caps and have also
issued guidelines on downstream investment by Indian Companies. Inflow of FDI into Indias
telecom sector during April 2000 to February 2010 was about Rs. 405,460 million. Also, more than
8 per cent of the approved FDI in the country is related to the telecom sector.
3G & Broadband Wireless Services (BWA): The government has in a pioneering decision,
decided to auction 3G & BWA spectrum. The broad policy guidelines for 3G & BWA have already
been issued on 1stAugust 2008 and allotment of spectrum has been planned through simultaneously
ascending e-auction process by a specialized agency. New players would also be able to bid thus
leading to technology innovation, more competition, faster roll out and ultimately greater choice for
customers at competitive tariffs. The 3G will allow telecom companies to offer additional value
added services such as high resolution video and multimedia services in addition to voice, fax and
conventional data services with high data rate transmission capabilities. BWA will become a
predominant platform for broadband roll out services. It is also an effective tool for undertaking
social initiatives of the Government such as e-education, telemedicine, e-health and e-Governance.
Providing affordable broadband, especially to the suburban and rural communities is the next focus
area of the Department.
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BSNL & MTNL have already been allotted 3G & BWA spectrum with a view to ensuring early roll
out of 3G & WiMax services in the country. They will pay the same price for the spectrum as
discovered through the auction. While, Honourable Prime Minister launched the MTNLs 3G
mobile services on the inaugural function of India Telecom 2008 held on 11th December
2008, BSNL launched its countrywide 3G services from Chennai, in the southern Tamil Nadu state
on 22nd February 2009.
Mobile Number Portability (MNP): Mobile Number Portability (MNP) allows subscribers to
retain their existing telephone number when they switch from one access service provider to
another irrespective of mobile technology or from one technology to another of the same or any
other access service provider. The Government has announced the guidelines for Mobile
Number Portability (MNP) Service Licence in the country on 1st August 2008 and has issued a
separate Licence for MNP. The Department of Telecommunication (DoT) has already issued
licences to two global companies for implementing the service.
IV. Vodafone Hutch case
The acquisition of Hutchison Essar by Vodafone at an enterprise value of $19.3 billion
which comes to around $794 per share was one of the biggest cross border deals in the
booming Indian telecom market at that time. Vodafone won the 67% block on sale by
Hutch-Essar leaving behind Reliance Communication and a consortium led by Hindujas
as well. It paid around 10.9 billion dollars for the acquisition.
Profile of Co-parties
Owners: Vodafone: 67% Essar: 33%
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Vodafone Profile: Vodafone Group plc is a global telecommunications company headquartered
in Newbury, United Kingdom. It is the world's largest mobile telecommunications company
measured by revenues and the world's second-largest measured by subscribers, with around 332
million proportionate subscribers as at 30 September 2010. It operates networks in over 30
countries and has partner networks in over 40 additional countries. It owns 45% of Verizon
Wireless, the largest mobile telecommunications company in the United States measured by
subscribers.
Its primary listing is on the London Stock Exchange and it is a constituent of the FTSE 100
Index. It had a market capitalisation of approximately 92 billion as of November 2010, making
it the third largest company on the London Stock Exchange. It has a secondary listing on
NASDAQ.
Essar Profile: The Essar Group is a multinational conglomerate corporation in the sectors of
Steel, Energy, Power, Communications, Shipping Ports & Logistics as well as Construction
headquartered at Mumbai, India. The Group's annual revenues were over USD 15 billion in
financial year 2008-2009.
Essar began as a construction company in 1969 and diversified into manufacturing, services and
retail. Essar is managed by Shashi Ruia, Chairman Essar Group and Ravi Ruia, Vice Chairman
Essar Group.
Hutch Profile: Hutchison Whampoa Limited of Hong Kong is a Fortune 500 company and one
of the largest companies listed on the Hong Kong Stock Exchange. HWL is an international
corporation with a diverse array of holdings which includes the world's biggest port and
telecommunication operations in 14 countries and run under the 3 brand. Its business also
includes retail, property development and infrastructure. It belongs to the Cheung Kong Group
Vodafone-Essar: The case - Hutchison International, a non-resident seller and parent company
based in Hong Kong sold its stake in the foreign investment company CGP Investments
Holdings Ltd., registered in the Cayman Islands (which, in turn, held shares of Hutchison-Essar
- Indian operating company, through another Mauritius entity) to Vodafone, a Dutch non-
resident buyer. Vodafone Essar is owned by Vodafone 52%, Essar Group 33%, and other Indian
nationals, 15%. On February 11, 2007, Vodafone agreed to acquire the controlling interest of
67% held by Li Ka Shing Holdings in Hutch-Essar for US$11.1 billion, pipping Reliance
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Communications, Hinduja Group, and Essar Group, which is the owner of the remaining 33%.
The whole company was valued at USD 18.8 billion. The transaction closed on May 8, 2007.
The total is Vodafone Essar subscription is 106,347,368 subscribers i.e., 23.94% of the
total 444,295,711 subscribers.
Individual Investors: Individual large stake holders Analjit Singh and Asim Ghosh sold their
stakes to Vodafone in December 2009. Asim Ghosh, the former managing director of Vodafone
Essar, had 4.68 per cent stake in the company held through investment firm AG Mercantile, and
sold a part of it for about Rs 3.3 billion. Analjit Singh, who had a share of 7.58 per cent through
three companies, sold a part of his stake for over Rs 5 billion. After the sale, the stakes held by
Ghosh and Singh in Vodafone Essar will come down to 2.39 per cent and 3.87 per cent
respectively.
Vodafone Hutch deal Time Line
The time line for the Vodafone and Hutch deal is as follow:
2007/05/29 - Court sends notice to Vodafone and Hutch
2007/05/05 - Vodafone-Hutch deal gets Finance Minister's nod
2007/04/04 - Vodafone-Hutch deal: Decision likely at next FIPB meeting
2007/03/19 - FIPB to take up Vodafone proposal on Tuesday
2007/03/16 - Hutchison offers $415 m to Essar as `sign-on bonus'
2007/03/16 - Vodafone's Hutch deal in order: Kamal Nath
2007/03/15 - Essar, Vodafone reach agreement on jointly managing Hutch
2007/02/18 - What Vodafone will collect from the Hutch call
2007/02/15 - `Roses for Essar, telephony for masses'
2007/02/15 - Vodafone pledges $2-b investments
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2007/02/12 - Hutch: Vodafone top bidder with $19-b offer
2007/02/11 - Hindujas to partner Qatar Telecom, Altimo for Hutch
2007/02/10 - Hutch bidding goes to the wire
2007/01/11 - Vodafone offer in a few weeks
2007/01/09 - Vodafone starts due diligence of Hutch
2007/01/06 - Hutchison, Essar differ over right of refusal
2007/01/03 - Essar gets fund pledge worth $24 b for Hutch-Essar buy
2006/12/29 - Reliance Comm in race for Hutch-Essar
2006/12/23 - Vodafone joins race for Hutchison Essar stake
2006/12/21 - Vodafone may join race for Hutch
Taxation issue in Vodafone Hutch deal: The Indian Revenue authorities issued show cause
notice to Vodafone arguing that they had failed to discharge withholding tax obligation with
respect to tax on gains made by Hutch on sale of shares to Vodafone. Vodafone filed a writ
petition in the Mumbai High Court challenging the jurisdiction of the Revenue department.
The revenue department issued show-cause to Vodafone asking for an explanation as to
why Vodafone Essar (which was formerly Hutchison Essar) should not be treated as an
agent (representative assessee) of Hutchison International and asked Vodafone Essar to
pay $ 1.7 billion as capital gains tax.
Indian Income Tax department view: The whole controversy in the case of Vodafone is
about the taxability of transfer of share capital of the Indian entity. Generally, the transfer
of shares of a non-resident company to another non-resident is not subject to tax in India.
But the revenue department is of the view that this transfer represents transfer of
beneficial interest of the shares of the Indian company and, hence, it will be subject to
tax.
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The revenue authorities are of the view that as the valuation for the transfer includes
the valuation of the Indian entity also and as Vodafone has also appr oached the
Foreign Investment Promotion Board (FIPB) for its approval for the deal, Vodafone
has a business connection in India and, therefore, the transaction is subject to
capital gains tax in India.
Vodafone view: On the contrary, Vodafones argument is that there is no sale of
shares of the Indian company and what it had acquired is a company incorporated in
Cayman Islands which, in turn, holds the Indian entity. Hence, the transaction is not
subject to tax in India.
Vodafone argued that the deal was not taxable in India as the funds were paid outside India for
the purchase of shares in an offshore company that the tax liability should be borne by Hutch;
that Vodafone was not liable to withhold tax as the withholding rule in India applied only to
Indian residence that the recent amendment to the IT act of imposing a retrospective interest
penalty for withholding lapses was unconstitutional.
Now the taxmans argument was focused on proving that even though the Vodafone-Hutch deal
was offshore, it was taxable as the underlying asset was in India and so it pointed out that the
capital asset; that is the Hutch-Essar or now Vodafone-Essar joint venture is situated here and
was central to the valuation of the offshore shares; that through the sale of offshore shares,
Hutch had sold Vodafone valuable rights - in that the Indian asset including tag along rights,
management rights and the right to do business in India and that the offshore transaction had
resulted in Vodafone having operational control over that Indian asset. The Department also
argued that the withholding tax liability always existed and the amendment was just a
clarification.
Key questions before the High Court:
Whether the show cause notice issued by the Revenue authorities was without
Jurisdiction as Vodafone could not be said to be liable under section 201 of the
Income tax Act 1961 for not withholding tax?
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Whether the provisions relating withholding tax obligation under section 195 of
the Acts have extra territorial application and a non resident without presence in
India has an obligation to comply with it?
Whether the transaction per se resulted in income chargeable to tax in India?
Vodafones Petition and Arguments: Vodafones argument is that there is no sale of shares of
the Indian company and what it had acquired is a company incorporated in Cayman Islands
which in turn holds the Indian entity. Hence, the transaction is not subject to tax in India.
The petitions and arguments of Vodafone are as under:
It was not in default (under section 201) for not withholding tax as the law applied to
situations where tax had been withheld and not deposited. Hence, to impose an obligation
where no withholding had been made was unconstitutional. Giving a contextual
interpretation, person liable to withhold tax could not include a non resident having no
presence (in India), since such an interpretation would amount to treating unequals as
equal by imposing onerous compliance obligations as applicable to residents or non-
residents having a presence in India. The transfer was with respect to ownership of shares
in a foreign company and no capital asset in India. Further, change in controlling interest
in Indian companies was only incidental to change in foreign shareholding.
Vodafone also challenged the constitutional validity of retrospective amendments to
sections 191 and 201 of the Act, motivated to impose an obligation on payer to withhold
tax.
The transfer of the shares of CGP which was a capital asset situated outside India could not
result in any income chargeable to tax in India. A share in a company represents a bundle of
rights and its transfer results in a transfer of all the underlying rights. However, what were
transferred were only a share and not the individual rights.
When there is no look-through provisions under the Income Tax Act, 1961 ("the Act"), such a
provision cannot be read into the statute and the corporate veil cannot be lifted unless a tax fraud
is perpetrated. The Supreme Court ("SC") in the case of Azadi Bachao Andolan (2003) 263 ITR
706 has held that there was no tax consequence in India when the shares of one of the
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intermediate holding company in Mauritius were transferred. Similarly, there should not be a
tax consequence, even when an upstream holding company transfers its shares.
Analysis of the issue: HC ruling in Vodafone Case: The HC held that the series of transactions
in question has a significant nexus' with India. Since the essence of it was change in controlling
interest in HEL, it constituted a source of income in India. It held that the price paid by
Vodafone factored in, as part of the consideration, diverse rights and entitlements being
transferred as part of the composite transaction. Many of these entitlements were not relatable
to the transfer of the CGP share. It held that intrinsic to the transaction were transfer of other
rights and entitlements. Such rights and entitlements constitute capital assets' as per the
provisions of the Act.
The apportionment of consideration paid by Vodafone for a bundle of entitlements stated above
lies within the jurisdiction of the Indian Revenue. The Indian Revenue Authorities sought to
apportion income resulting to HTIL between what has accrued or arisen or what is deemed to
have accrue or arise as a result of a nexus with India and that which lies outside.
Subsequent to the HC ruling, the Revenue has raised a tax demand of Rs. 112,180 million on
Vodafone for failure to withhold taxes. Meanwhile, the appeal filed by Vodafone before the
Supreme Court was heard in November 2010.
Analysis of decision: This is a landmark ruling which throws light on principles of taxation of
cross-border transfers. The High Court's observation on the principle of proportionality' that a
portion of the income would be chargeable to tax is a significant one. The Court has also
observed that the other rights and entitlements, passed on as a part of the deal are separate assets
and can be regarded as capital assets', within the meaning of the Act. These observations seem
to indicate that transactions involving a simpler transfer of shares of a company outside India,
which has companies in its fold in India, would not be chargeable to tax in India. However, if
certain other rights and entitlements in India are transferred along with the transfer of shares,
there would be an incidence of tax in India.
This decision could certainly embolden the Revenue authorities to investigate offshore
transactions, which have a connection with India or cases where limited interest exists in India
and the demand raised by the Revenue authorities is a clear indication of things to come.
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The Dutch government, on behalf of Vodafone, has approached the Indian government for
settling a three-year-old dispute involving a tax claim of over Rs 11,000 crore. Netherlands has
written to India asking it to consider an alternate dispute resolution that will run parallel to the
ongoing court process through what is termed as a Mutual Agreement Procedure (MAP).
India would examine the request and take a decision in accordance with the provisions of the
India-Netherlands double tax avoidance agreement (DTAA). MAP is an alternate process of
dispute resolution, and is an option available to a taxpayer in addition to and concurrent with the
appellate process. However, under MAP, once the proceedings are initiated, it is possible to
obtain a stay on the tax demand provided one gives a bank guarantee.
This opens up the possibility of a settlement on the lines of what Vodafone clinched in the UK
earlier this year, when it agreed to pay 1.25 billion in taxes to settle a decade-long dispute
dating back to 2000 regarding its Luxembourg subsidiary.
Supreme Court of India Decision
The Supreme Court today ruled in favour of Vodafone in the $2 billion tax case saying capital
gains tax is not applicable to the telecom major. The apex court also said the Rs 2,500 crore
which Vodafone has already paid should be returned to Vodafone with interest. The decision
will be a big boost for cross-border mergers and acquisitions here. The Income tax departments
contention, if upheld, would have rendered standard transaction structures too risky forcing
foreign companies to weigh potentially new litigation and insurance costs. Nearly five years
after the Indian taxman issued the first notice to Vodafone international on September 2007 for
failure to withhold tax on payments made to Hutchison Telecom, Chief Justice of India SH
Kapadia and Justice KS Radhakrishnan pronounced their judgement.
The SC has ruled that the transaction is not taxable in India, and it has made the following
observations/ comments while pronouncing its ruling:
Presently, there are no look-through provisions in the Indian domestic tax law to tax
the transaction.
There is no extinguishment of property rights in India through the transfer of shares
between two foreign entities of shares in another foreign entity.
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Similarly, provisions which treat a person as an agent/representative of a foreign
entity for the purpose of levy and recovery of tax due from such a foreign entity is not
applicable in the absence of a nexus.
There is no conflict between the earlier decisions of the SC in Azadi Bachao Andolan,
and Mc Dowell. The SC in the case of Azadi (263 ITR 706), had held that an act
which is otherwise valid in law cannot be held as sham, merely on the basis of some
underlying motive supposedly resulting in some tax advantage. The SC in the case of
Mc Dowells (154 ITR 148), held that sanction cannot be accorded to a colourable
device.
The duration of the holding structure, timing of exit and continuity of business, are
important factors while evaluating as to whether the transaction as a whole is a sham.
Considering the factual matrix in the present scenario, the SC held that the transaction
is not a sham.
Withholding tax provisions in the Indian domestic tax law cannot apply to offshore
transactions
The Tax Authority has also been directed to refund the entire amount (US$ 0.5
billion) deposited by Vodafone as part payment towards the demand in early 2011
along with interest
Tax policy certainty crucial for national economic interest.
The decision of the SC is expected to be a milestone development in the taxation of
international transactions and on the judicial approach to tax avoidance. This case is, perhaps,
the first in the world where the issue of taxation on indirect transfer of shares is being
litigated before a countrys highest judicial forum. The principles emanating from this ruling
could therefore, have ramifications beyond India. It could also be of relevance in shaping
Indias tax policy on international taxation and tax avoidance in the future.
V. Summary & Concluding remarks
Indian tax laws are complex and possibly are in the process of getting more complicated by the
day in terms of regular annual amendments and judicial decisions which continuously revise the
judicial interpretations in the light of changing business environment. The growing importance
19
of the Indian economy and the increasing demands for resources has given the government the
confidence to tax offshore deals wherever possible. In the case of transactions involving large
capital sums, it would be advisable for the concerned parties to approach the Authority for
Advance Rulings (AAR) which would freeze the tax treatment for a particular transaction in the
case of a non resident. This would avoid the kind of pitfalls that Vodafone finds itself in.
This would also have a major impact on deals with a country with which India does not have a
Double Taxation Avoidance Agreement (DTAA). The major legal battles such as the Vodafone
dispute which essentially determine the fate of a large chunk of Foreign Direct Investments into
India and is in this context much awaited. The challenge lies in balancing the interest of the
investors and the revenue authorities. The new direct tax code that the Government is planning
to introduce so as to replace the current Income-tax Act, 1961 (the IT Act), is expected to
emphasize on transparency and taxpayer-friendliness.
At present, the dispute resolution mechanism in India moves slowly. Assessment proceedings
continue for more than two years from the date of filing of the tax return. Thereafter, the two
appellate levels take approximately two to seven years to dispose of an appeal. If the dispute still
continues, on a question of law, the matter gets referred to the High Court and the Supreme
Court which generally takes very long. This is worrying the Indian corporate sector as it takes a
lot of management time and effort. There is a need to expedite the litigation procedure. There
should be a limitation period on disposal of appeals as well.
Amendments brought about by the Finance Act, 2008 would have a major impact on transfer of
shares overseas, especially in a case where the seller of the shares is a resident (as per tax laws)
of a country with which India does not have a Double Taxation Avoidance Agreement (DTAA).
The amendment also brings the investors from countries like the US and UK within the tax net
in India, since Indias DTAA with such countries provide for taxation of capital gains in
accordance with the domestic tax laws of India. In this way, there is an urgent need to speed up
the system and bring more clarity in rules and amendments.
References
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K.R. Girish and Himanshu Patel, KPMG, Deals: India wants more taxes from cross-border
M&A, February 19, 2008, International Tax Review.
Government widens scope of anti-abuse provisions in I-T Act by Abhineet Kumar & Sidhartha,
March 4, 2010, Mumbai.
India issues advance ruling on capital gains tax implications of an intra group share transfer
by Ernst &Young.
Taxation of Cross Border Mergers and Acquisitions, 2010 Edition, KPMG United States
available on http://kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/Documents/Tax-
MA-2010/MA_Cross-Border_2010_India.pdf
Cross-border mergers and acquisitions - Addressing the taxation issues from an Indian
perspective, Gaurav Goel.
Economic Times, Times of India, Mint web pages for various news and updates
Cross Border Business Reorganization: Indian Law Implications, Aniket Singhania & Vaibhav
Shukla.
Corporate Mergers & Acquisitions, Gurminder Kaur, 2005.
Direct Taxes Law & Practice, 2011, Dr. Vinod K. Singhania and Dr. Kapil Singhania, Taxmann
Publications, India.
Vodafone Hutch Supreme Court ruling