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DR.

RAM MANOHAR LOHIYA NATIONAL LAW UNIVERSITY
LUCKNOW

SEMESTER V
(2015-16)
INTERPRETATION OF STATUTES

PROJECT ON

FROM MCDOWELL TO VODAFONE: THE FINE LINE BETWEEN TAX
EVASION AND TAX PLANNING

SUBMITTED BY –

S UBMITTED TO

GARIMA PARAKH
HUSSAIN

M RS. SAMREEN

A.B.LLB (H ON) SEMESTER IV (LAW) ROLL NO. 57 A SST. PROFESSOR .

And my classmates for their constant support. Gurdeep Singh Sir and Dean (Academics).ACKNOWLEDGEMENT I would like to extend my sincere thanks to My teacher and my mentor Mrs. Professor C. Dr. Samreen Hussain for giving me this wonderful opportunity to work on this project and for his able guidance and advice. My seniors for sharing their valuable tips. .M. Jariwala for their encouragement and Enthusiasm. Vice Chancellor.

CONCLUSION…………………………………………………………………….1] Brief facts and judgment of the case…………………………………………………....1] Tax avoidance by large corporations………………………………………………….8 [3. MCDOWELL V.……11 .8 [3.. TAX PLANNING AND EVASION………………………………………………………2 [1...1 2.2] Rules for interpretation of taxing statutes: When tax avoidance becomes evasion……………………………………………………………………………………….TABLE OF CONTENTS 1.1] Brief facts and judgment of the case………………………………………………….2] Detailed analysis of tax evasion with respect to income tax provisions………………9 [3.7 4..6 [2. UOI: CASE ANALYSIS……. COMM TAX OFFICER: CASE ANALYSIS………………………….3] Extension of McDowell’s principle of purposive construction………………………10 5.2 [1.4 3.6 [2... INTRODUCTION………………………………………………………………………. VODAFONE INTERNATIONAL HOLDINGS LTD V...2] Decision in Azadi Bachao Andolan case and the conflict…………………………….

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Therefore. In other words. which maybe argued to be in contravention of the literal rule principle that when the law is clear and unambiguous the meaning that is most apparent from its reading is to be given effect even though it may lead to misfortune and injustice.INTRODUCTION The rue in McDowell & Co. and colourable devices cannot be part of tax planning. Azadi Bachao Andolan3 the court observed that it cannot be read as leading to a conclusion that all tax planning is illegal. Union of India 2. 3 (2004) 10 SCC 1. v. When the argument was raised before the Supreme Court with regard to the reading of the McDowell decision in the case of Union of India v. The ‘substance over form’ test should be applied only once it 1 AIR 1986 SC 649. the fundamental question is where to draw the line between legitimate tax planning and tax avoidance within the framework of the law. However. the court accorded a purposive interpretation to the unambiguous law. Judicial pronouncements after McDowell have only increased the confusion as to what is permissible in the determination of tax liability through the transactions entered into by the assessee. and whether what the court sought to accomplish and what it actually did. It further observed that every citizen has an obligation to pay taxes without resorting to subterfuges. it also held that the legal effect of a transaction cannot hide the substance of that transaction. 1 | Page . 2 (2012) 6 SCC 613. The contention raised by McDowell in the case was that it is open to everyone to arrange his/her affairs in a legitimate manner so as to reduce the tax burden to a minimum and does not constitute tax evasion. Commercial Tax Officer 1 has been the source of significant controversy in the area of tax governance. Although the facts and issues in the case are completely different from McDowell. While on one hand it may seem to have changed the face of tax jurisprudence. The court held that tax planning may be legitimate as long as it is within the framework of the law. the issue that is of concern here is that of interpretation of taxing statutes. some detractors and writers are of a different opinion that it is a mere judicial aberration in the otherwise clear and reasonable exposition of fiscal principles by the Supreme Court. This conflict was sought to be resolved in the case of Vodafone International Holdings v. Ltd. illegitimate or impermissible and there is no conflict between the Supreme Court’s decisions in the McDowell and the Azadi Bachao Andolan case.

Merely because at the time of exit. systematic and orderly manner. But this matter was absolutely settled in Vodafone Holdings that Azadi Bachao is not in conflict with McDowell. deductions and reliefs available under the statute as may be applicable to his/her case. the Supreme Court after reviewing various judgments of the House of Lords in England.has been established through the facts that the impugned transaction is a sham and a front for the illegal purpose of tax evasion. Every taxpayer is expected to voluntarily make disclosures of his incomes and tax liabilities through legal compliance. has reiterated that the Westminster principle (will also be discussed in the final draft of the project) is the cornerstone of law and every tax-payer is entitled to arrange his affairs so as to reduce the tax liability. In other words. capital gains tax becomes not payable would not make the entire “share sale” (investment) a sham or a tax avoidant. The fact that the motive for a transaction is to avoid taxes does not invalidate it unless a particular enactment so provides. TAX PLANNING AND EVASION The word ‘tax planning’ connotes the exercise carried out by the taxpayer to meet his tax obligations in a proper.1] Tax avoidance by large corporations 2 | Page . but also unethical and immoral. Every strategic foreign investment coming into India should be looked at in a holistic manner. This project aims at analyzing the same and ascertaining whether there exists scope for further debate. When a tax payer deliberately or consciously does not furnish material particulars or furnishes inaccurate or false information to defraud the State. it violates legal provisions and is termed as ‘tax evasion’. availing all permissible exemptions. [1. In delivering the judgment. It is not only illegal. In all the above cases the Court was referring to the appropriate line of analysis to be adopted while determining the legality of a transaction. Planning does not necessarily mean reduction in tax liability but is also aimed at avoiding controversies and consequential litigations. tax evasion means illegally hiding income or concealing the particulars of income or concealing the particular source or sources of income or in manipulating the accounts so as to inflate the expenditure and other outgoings with a view to illegally reduce the burden of taxation. The decision in Azadi Bachao case was incongruent with both McDowell and Vodafone in as much as it categorically restored the right of the tax-payer to mitigate taxes by all legitimate means.

a way can be found around any law with diligence. It therefore comes as no surprise that Starbucks sources its UK coffee from its wholesale trading subsidiary in Switzerland. which serves a two-fold purpose – one. CTO4 the Supreme Court observed – “Tax Planning may be legitimate provided it is within the framework of law. Principles of Statutory Interpretation (10th edn. Corporations and enterprises exploit the loop holes in taxation statutes to legally evade tax and such actions cannot be termed to be violative of the law prima facie since it does not expressly identify it as such. Switzerland is the centre of the world coffee trading business due to the fact that it charges a lowly rate of 12% on trading profits.6 For instance. particularly when effective rates of tax diminish significantly. Ltd. 3 | Page . and there is nothing to be read in through implication.com/news/business-20580545> accessed 23 September 2015.” It is a well established principle that if a person sought to be taxed comes within the letter of the law. The most common method of tax evasion is changing the jurisdiction. Wadhwa and Company 2006) 745. v. In a taxing statute. What makes matters even more difficult to resolve is the competition among such tax jurisdictions to attract multinationals – the lower and more liberal the 4 AIR 1986 SC 649. here. they save huge amounts on tax and two. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.In the case of McDowell Co. he must be taxed.bbc. 5 G P Singh. the words are clear enough. ‘Corporate Tax Avoidance: How do companies do it?’ BBC News (4 December 2012) <http://www. 5 However. tax authorities internationally consider aggressive tax planning schemes by taxpayers to erode the tax base unnaturally. there is no place for intention. Business clusters develop in those countries where the tax regime is liberal. Legitimate tax avoidance has been accepted by the Supreme Court such that taxpayers have a right to arrange their affairs in such a manner so as to pay the least tax possible. becomes the bane for enforcement authorities since such exigency was not foreseen. Literality. however great the hardship may appear to the judicial mind to be. given the time. 6 Laurence Knight. However. Colourable devises cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. presumption or equity. business clusters can usually provide the necessary expertise required to operate.

Wadhwa and Company 2006) 775. Registrar of Probates10 ‘evasion’ has been considered to hold two meanings – one. 8 G P Singh. with the idea of tax evasion can also incorporate a company off-shore. There have been allegations against Google. thereby circumventing the ‘place of establishment’ rule 7. does not cease in the 7 Income Tax Act 1961. interpretation of the statutes by way of case laws is of considerable importance. Vodafone Holdings etc. then TRC can be ignored. Another issue with regard to tax evasion is overpricing through transfer pricing to shift larger share of profits to low tax jurisdictions. which suggests an under-hand dealing to avoid that to which the Act applies and two. and then create a WOS in Mauritius and after obtaining a TRC may invest in India. [1. a mere intentional avoidance of something to which the Act does not apply. Large amounts. therefore. of indulging in blatant tax evasion. but once it is established that such an investment is black money or capital that is hidden. can be routed back to India using TRC as a defence. tax avoidance or tax evasion. it is nothing but circular movement of capital known as Round Tripping. s 6(3). since the transaction is fraudulent and against national interest. Amazon. 9 (1881) 8 QBD 125. While determining whether a particular transaction constitutes as tax management. in A. v. An Indian Company. But this principle has no application where what is done is actually the thing prohibited. recently. A transaction which by the acts done is of the nature of a trading transaction and is genuine and not sham. say in a Tax Haven. Noyes9 and Lord Hobhouse in Simms v. Apple. 8 Grove J.tax regulations. the larger the number of large corporations who flock there.2] Rules for interpretation of taxing statutes: When tax avoidance becomes evasion It is well established that penal and taxing statutes are not to be extended by analogy to cover acts and situations not within the words of the statute or any doctrine of substance of the matter. Principles of Statutory Interpretation (10th edn. G. under the cloak or colour of a different transaction not prohibited by the statute. 10 (1900) AC 323. 4 | Page .

The new approach laid down in W.12 The principle laid down in the case of IRC v. while considering a device to avoid tax. the proper way to construe a taxing statute. T. but whether the transaction is a device to avoid tax. 14 (1981) 1 All ER 865 (HL). Ramsay Ltd v. IRC14 has been adopted by the Indian jurisdiction through the case of McDowell & Co. Dawson16.” The conditions for application of this new approach were laid down in Furniss v. In our view. Ltd v. These are – 1. 13 (1936) AC 1 (HL). Duke of Westminster13 that one has to see only the legal nature of the transaction and not the substance of the matter. will be inapplicable in case of a series of transactions or a composite transaction completed for the purpose of tax avoidance. CTO15 where it was observed that – “We must recognize that there is behind taxation laws as much moral sanction as behind any other welfare legislation and it is a pretence to say that avoidance of taxation is not unethical and that it stands on no less moral plane than honest payment of taxation. 15 (1985) 3 SCC 230. even if real and not a sham cannot be regarded as a concern in the nature of trade. 16 (1984) 1 All ER 530. merely because those taking part in it have their eyes fixed on the fiscal advantage of avoiding income tax. is not to ask whether the provisions should be construed literally or liberally. 12 Bishop v Finsbury Securities Ltd (1966) 3 All ER 105 (HL).11 But a wholly artificial scheme remote from the trade planned with the purpose of tax avoidance. nor whether the transaction is not unreal and not prohibited by law. There must be a preordained series of transactions or a composite transaction 11 Griffiths v J P Harrisan Ltd (1962) 1 All ER 909 (HL).absence of a statutory provision providing otherwise to be an adventure or concern in the nature of ‘trade’. 5 | Page .

to determine whether the enactment will cover the said transaction or not. In other words. Considering the entire series of transactions as a whole is the most important part of the process since the true effect of the transaction can be gleaned from this. 18 (1988) 3 All ER 495 (HL). the relevant enactment must be construed to ascertain its meaning. The transaction should have had no other purpose except tax avoidance. COMM TAX OFFICER: CASE ANALYSIS [2. and finally the enactment as construed must be applied to the true legal effect of such transactions. 3. it is rendered inapplicable in cases where the Ramsay principle or the new approach has application. 4.1] Brief facts and judgment of the case 17 ibid. Dawson17 were further explicitly delineated in Craven v. There must be steps inserted which have no commercial purpose except for avoidance/deferment of tax liability. 2. 6 | Page . White18 1. The preordained transactions took place. first. then the series of transactions in question should be analysed. Though the Westminster principle is not dead and can still be applied. MCDOWELL V. The tax saving transaction had no independent life since there was no likelihood of the series of transactions not taking place as planned. The pre-ordained series of transactions must have been done so when the tax saving transaction was entered into. The conditions laid down in Furniss v. regarded as a whole to ascertain its true legal effect.2.

Excise duty though paid by the purchaser to meet the liability of the manufacturer.” [2. the amount of excise duty paid by its buyers to the Excise Department. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. Under the governing law it was includible in the turnover of the manufacturer of liquor. as mentioned. The assessee continued to sell liquor in this manner and paid sales tax under the A. is a part of the consideration for the sale and is includible in the turnover of the manufacturer. it was stage-managed not to be part of the assessee’s trade.2] Decision in Azadi Bachao Andolan case and the conflict 7 | Page . Held: The fact that excise duty does not go into the common till of the manufacturer (assessee) to become a part of the circulating capital. The assessee devised a way not to pay tax on turnover inclusive of duty paid by the liquor purchasers. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. The assessee appealed to the Supreme Court.Purchasers of Indian liquors for obtaining distillery passes paid excise duty under Excise Rules. and (ii) under this system the transactions of such payments were not made to figure in the assessee’s books of accounts. The Supreme Court. However. Tax planning may be legitimate provided it is within the framework of law. famously observed – “Tax Planning may be legitimate provided it is within the framework of law. include the amount of the excise duty. Sales Tax Act on the turnover returned by him which did not.P. The assessee challenged that view but the High Court agreed with the Assessing Authority. The strategy was the conjoint product of two facts: (i) under an agreed strategy the purchasers had to discharge the manufacture’s liability. The excise duty paid on his behalf was integral to the consideration for the sale of liquor. the Assessing Authority took the view and held that the assessee had failed to include in its turnover. A Division Bench of the Supreme Court examined the excise laws as well as the sales tax laws. In terms of the law the manufacturer was liable to pay excise duty on the manufacture of liquor. is not the decisive test for determining whether such duty constitutes the seller’s turnover. Colorable devises cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. while making a distinction between tax avoidance and tax planning in this case. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. The purchaser has paid the tax on behalf of the manufacturer.

8 | Page . the AAR did not view the arrangement as a tax avoidance scheme. the Indian Supreme Court held that treaty shopping is a legitimate exercise of tax planning and AIML cannot be denied benefits of the Mauritius Treaty in the absence of express treaty provisions limiting such benefits. J. unless the same falls in the category of colourable device. 20 (1968) 67 ITR 11 (SC). in the 19 AIR 1986 SC 649. his wishes in the manner to do any trade. which is clearly not the intention of the judges in the former. Considering that the shares were held by AIML for a considerable period of time and are proposed to be sold at fair market value. The court in McDowell21 nowhere said that every action or inaction on the part of the taxpayer which results in reduction of the tax liability to which he may be subjected in future. Such misinterpretation led to the decision in the latter case that the tax payer has an overriding right to mitigate tax payable. by legitimate means and should not be scrutinized. is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act. 23 (1968) 67 ITR 11 (SC). The principle enunciated in the above case has not affected the freedom of the citizen to the act in a manner according to his requirements. 22 ibid. where it supposes all transactions to be scrutinized under the substance over form test. In the Azadi Bachao Andolan20 case. the benefits of the Treaty for residents of Mauritius subject to there being a valid tax residency certificate issue by the Mauritian Government were validated. the Supreme Court held that colourable devices and subterfuges do not constitute legitimate tax planning. these are clearly only in the context of artificial and colourable devices. makes a number of observations regarding the need to depart from the Westminster principle and tax avoidance.In the McDowell19 case. 21 ibid. Therefore. 24 Although Chinnappa Reddy. Reading McDowell. within the framework of law. activity or planning his affairs with circumspection. What differentiates Azadi Bachao from McDowell is the perception of the ambit and reach of judicial role. But the interpretation of McDowell22 in Azadi Bacaho23 tends towards the extreme.

this instance has set a rare example wherein the Indian tax authorities have gone to length to interpret the existing tax laws.nishithdesai. 1961 clarifying that an offshore capital asset would be considered to have a situs in India if it 24 Ashish Sodhani and Shreya Rao. there is no conflict between McDowell and Azadi Bachao. While we have heard about lifting the ‘corporate veil’. This is a landmark case. A tax free corporate reorganization should not per se constitute a colourable device. Held: The Supreme Court delivered a judgment in favour of Vodafone. The alleged purpose of this transaction was to acquire 67% controlling interest in HEL. [3. subject to relaxation of FDI Norms. 9 | Page .manner indicated hereinabove. in cases of treaty shopping and/or tax avoidance. 6 July 2013) <http://www. ‘Landmark International Tax Cases decided by Indian Judiciary Summary’ (Nishith Desai. Another issue in question in this case was the validity of Azadi Bachao case when contrasting it with McDowell case which explains as to how in certain circumstances tax avoidance should be brought within the tax net. 25 Vodafone International Holdings v UOI (2012) 6 SCC 613. a company resident for tax purposes in the Cayman Islands. acquired the entire share capital of CGP Investments Holdings Ltd (CGP).25 VODAFONE INTERNATIONAL HOLDINGS V. UOI: CASE ANALYSIS The Vodafone tax case throws an interesting question on the taxability of a non resident company acquiring shares of a resident company through an indirect route. stating inter alia that no Indian tax was required to be withheld on a transfer of offshore assets between two non-residents.1] Brief facts and judgment of the case Vodafone International Holdings BV (VIH).com/fileadmin/user_upload/pdfs/Research %20Articles/Landmark%20International%20Tax. to bring a global company like Vodafone to its tax ambit. 2012 introduced Explanation 5 to Section 9 (1) (i) of the Income-tax Act. The Finance Act. a company resident for tax purposes in the Netherlands. as it is for the first time that the tax departments have sought to tax a company through a mechanism of tracing the source of acquisition. which held 52% shares in Hindustan Essar Ltd (HEL) as well as options to acquire a further 15% shareholding interest in HEL.pdf> accessed 25 September 2015.

indirect transfers cannot be covered under this provision. this argument was rejected by the court as an incorrect reading of S. Therefore. in certain cases where the executive decision-making of the subsidiary company has become fully subordinate to the parent company. the executive board of the subsidiary has become a mere puppet in the hands of the parent company. income accruing or arising to a non-resident outside India on transfer of a capital asset situate in India is fictionally deemed to accrue or arise in India. becomes taxable in India. then all income derived even indirectly from such transfer. The income in question in this case is ‘transfer of a capital asset situate in India’ for which the elements of transfer. 26 Thus. However. Whether a transaction is used principally as a colourable device for the distribution of earnings. and situation of such asset in India must be satisfied to be taxable. a legal fiction has limited scope and cannot be expanded by giving purposive interpretation particularly if the result of such interpretation is to transform the concept of chargeability which is also there in Section 9(1) (i). 1961. However. so much so that. even though abroad. notwithstanding the location of the parent company. It is in the above cases that the principle of lifting the corporate veil or the doctrine of substance over form or the concept of beneficial ownership or the 26 Income tax Act 1961. The income dealt with in each of the sub-clauses are to be read separate from each other and the satisfaction of requirements of others cannot be sought with respect to one. [3. a visible change occurs in the rule of residence stated above.2] Detailed analysis of tax evasion with respect to income tax provisions It is a well-settled principle that all corporate entities have separate existence irrespective of them being the parent or the holding company and shall be taxed as per their respective places of residence. The amendment is currently retroactively applicable from 1961. s 9 (1) (i). This is the main purpose behind enactment of Section 9(1)(i) of the Act. However. existence of a capital asset. profits and gains is determined by a review of all the facts and circumstances surrounding the transaction. 10 | P a g e .substantially derived its value – directly or indirectly – from assets situated in India. It was argued by the revenue authorities that if transfer of a capital asset situate in India happens “in consequence of” something which has taken place overseas (including transfer of a capital asset). which income is made liable to be taxed by reason of Section 5(2)(b) of the Act. Vodafone argued that the entire transaction had taken place overseas and India had no jurisdiction to tax the same. particularly when one reads Section 9(1)(i) with Section 5(2) (b) of the Act. In the instant case. 9 of the Income Tax Act.

has observed as follows after referring to a number of English decisions laying down various principles – “Tax planning may be legitimate provided it is within the framework of law. has opined while agreeing with the judgment of Mishra. implying that revenue officials cannot tax without statutory support and every tax payer is entitled to arrange his affairs so that his taxes shall be as low as possible and that he is not bound to choose that pattern which will replenish the treasury. J.27 The corporate business purpose of a transaction is evidence of the fact that the impugned transaction is not undertaken as a colourable or artificial device. The stronger the evidence of a device. [3. 28 (1999) 8 SCC 667.concept of alter ego arises. that – “The principle of Westminster has been given a decent burial in England. the stronger the corporate business purpose must exist to overcome the evidence of a device. Sate of MP28 a five judge bench of the Supreme Court stated that the subject is not to be taxed by inference or analogy. the argument of the revenue authorities that the ratio of McDowell is contrary to that of Azadi Bachao Andolan was rejected by the court in the case of Vodafone Holdings Ltd and 27 Vodafone International Holdings v UOI (2012) 6 SCC 613. where the term tax avoidance originated. 11 | P a g e . J. but only by the plain words of a statute applicable to the facts and circumstances of each case. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that is honourable to avoid the payment of tax by resorting to dubious methods. Mishra. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. The judicial attitude towards tax avoidance has changed and the Courts are now concerning themselves not merely with the genuineness of a transaction. Therefore.” Reddy. but with the intended effect of it for fiscal purposes.3] Extension of McDowell’s principle of purposive construction In Vodafone Holdings.” In the case of Mathuram Agarwal v. J. the court upheld the validity of the judgment in McDowell and rejected the misconstrued reading of the same in Azai Bachao.

Hence. the revenue authorities may invoke the ‘substance over form’ principle or ‘piercing the corporate veil’ test only after it is able to establish on the basis of the facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidant. Ramsay lays down that the principle of statutory interpretation rather than an over-arching anti-avoidance doctrine imposed upon tax laws. CONCLUSION The principle of purposive construction adopted in McDowell has been repeatedly upheld in subsequent cases. 12 | P a g e . despite the confusion that arose from the decision in Azadi Bachao Andolan. This was dispelled by the judgment in Vodafone. fiscal nullity can be resorted to the revenue authorities. purposive construction adopted in McDowell still holds good and has been adopted in the present case as well. While the Westminster principle states that – “Given that a document or transaction is genuine. Similarly. the substance over form rule is being preferred by tax authorities who are adopting an aggressive approach towards tax avoidance to safeguard tax collection in the face of weakening world economies and stiff international competition. However. which can adversely affect the corporate entities. and therefore is only a reading of the Westminster case in proper context by which ‘device’ which was colourable in nature had to be ignored as fiscal nullity. if the interposition of a holding company has been proved to have no commercial substance. In other words.reopening of the case was rejected. it has been observed in Vodafone that in the application of a judicial anti-avoidance rule. This is the limitation delineated for the application of substance over form principle and the final holding of this case upheld the form over substance rule. Though form over substance is the rule where the provision is so clear as to leave no room for ambiguity. the court cannot go behind it to some supposed underlying substance”. every transaction cannot be looked at from the purpose of tax deferment/evasion and must be presumed to be legitimate and holistic unless proved otherwise. The facts of the two cases were quite different and dealt with different aspects of tax avoidance and tax evasion due to which such confusion arose. But this new rule is a fresh approach to interpret taxation statutes which usually do not admit a priori principles of interpretation will make it tougher of illegitimate evasions to subsist. The Supreme Court must lay down guidelines for application of this new approach to prevent arbitrariness from creeping into tax collection mechanisms and protect legitimate transactions from unwarranted scrutiny.