TAX MANAGEMENT

EFFECTS OF VODAFONE CASE ON MERGER AND

ACQUISITIONS

Submitted by:-
Tanmay Gangwar (091202064)

Submitted to:

Mr.Bharatish Ballal
Background and facts of the case
Vodafone International BV (“Vodafone”), a Dutch resident company acquired interest of
Hutchison Telecommunications International Limited (“Hutch”) (a company registered in the
Cayman Islands) in CGP Investments (Holdings) Ltd (“CGP Investments”) also registered in
Cayman Islands. CGP investments, through a host of intermediate companies, held a 67
percent equity interest in Hutchison Essar Limited (“HEL”), an Indian telecom company. 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.
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( “Act”) for not withholding tax ?
• Whether the provisions relating withholding tax obligation under section 195 of the
Act 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?

Vodafone’s Petition and Arguments

• 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. Tax is the
primary obligation of the payee. Unless the payee had defaulted in making payment of
taxes, on demand by the Revenue authorities, tax could not be recovered from the
payer.
• Giving a contextual interpretation, “person” liable to withhold tax (in section 195)
could not include a non resident having no presence (in India), since such an
interpretation would amount to treating unequal’s 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 not a
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.

VERDICT

In a landmark ruling the Bombay High court said Vodafone Group Plc is liable for an
estimated $2.6 billion in taxes for its 2007 acquisition of one of India's largest mobile phone
companies.

The American principle of Doctrine of Effects was referred to by the court. According to this
doctrine, any country may impose liabilities, even upon persons not within its allegiance, for
conduct outside its borders that has consequences within its borders which the country
represents.”

Vodafone ‘s argument that its international company had merely acquired a Cayman Islands
company which in turn held shares in the Indian company was not accepted by the court
which said it found this argument too simplistic. It held that Vodafone’s basic objective
appeared to be acquisition of a business interest in India.

What also went in favour of the Revenue Department was its argument that Vodafone’s
transaction could not have been a mere acquisition of shares overseas as it was conditional
upon approval of Indian regulatory authorities like the Foreign Investment Promotion Board.

The Revenue Department also cited statements made by the Chief Executive Officer of
Vodafone, the company’s annual reports and the interest acquired by Vodafone in joint
venture with Essar, in the telecom licenses issued by the Department of Telecommunications.
IMPLICATIONS OF VODAFONE CASE

Impact on cross-border transactions:

This ruling seems to suggest a fundamentally different approach to taxation of transactions

where there is a transfer of controlling interest in India regardless of the fact that such transfer
is effected by way of sale of shares of an overseas company. This will create a degree of
uncertainty in respect of similar transactions , which have already taken place and where the
revenue department will make an attempt to take support of the Bombay High Court
judgement to tax those transactions. Having said this, in cases which can be distinguished on
facts and especially in those situations where there is no transfer of business or other valuable
commercial rights in India it will still be possible to argue against taxation arising in India.
For example, where there is not an outright sale of business in India but a large interest in the
Indian company is indirectly transferred through shares of a foreign company, the earlier
position should prevail i.e., sale of a foreign company not being subject to tax in India.

Direct Taxes Code 2010 (DTC):

DTC which will come into effect on April 1, 2012 specifically spells out the conditions
under which indirect transfer will be subject to tax in India. The tax policy direction seems to
be to tax only those transactions where there is sale of substantial business interests in the
Indian company and not where there is either portfolio sale or a sale of a block of shares not
resulting in outright sale of the business in India. India has thus joined China , amongst other
countries, in attempting to tax indirect transfers and to this extent cross-border transactions
will need to factor in the current view of Revenue as well as proposed changes in the DTC so
as not to be caught by surprise at a later stage.

IMPACT ON FDI’s

The Vodafone case, in turn, could apply the brakes on cross-border deal-making in the
country. According to the United Nations Conference on Trade and Development (Unctad),
India was all set to become the No. 2 destination for foreign direct investment (FDI) -- the
major component of which is M&A -- by December 2012, pushing the U.S. down to the No.
4 place in the process. That could be at risk now.

SEVERAL LEGAL ISSUES ARISE FROM THE CASE:

(i) Whether a non-resident seller (Vodafone International) is liable to tax in India on sale of
shares of the foreign SPV?

(ii) Is a non-resident purchaser (HTIL) liable for deduction of tax on purchase of shares of the
foreign SPV while making payment to the non-resident seller?
(iii) Whether an Indian company can be treated as ‘agent’ of the non-resident purchaser and
held liable for deduction of tax?

(iv) Can the law impose tax retrospectively?

IMPACT ON M&A

• The Vodafone issue has been around for the past three years most M&A transactions
[since then] have been very careful in structuring the deals. It is not that people will
drop an M&A deal if India is involved.

• The return expectation is now going to be higher. This is because there is a higher tax
risk weightage which will be assigned to India as a tax jurisdiction. But this is also
going to give more clarity on how the Indian government is going to tax such deals.
Therefore, while you may ascribe a higher risk weightage because there is going to be
higher tax, there will no uncertainty.

• In a 200-page order delivered on September 8, the Bombay High Court ruled that the
Vodafone-Hutchison deal is taxable in India. But the implications are wider, experts
point out. The court has stated that the purchase of shares of a foreign company by
one non-resident from another non-resident attracts Indian tax if the object is to
acquire the Indian assets held by the foreign company.

• The key issue in case of Vodafone is not the stated law but the substantive nature of
the transaction and the growing tendency of tax authorities worldwide to disregard
structures not having commercial substance.
Conclusion:

The high court ruling came as foreign firms show renewed interest in acquiring Indian
companies, lured by growth prospects in the world’s second-fastest growing major economy.
But the decision may prompt overseas firms to be more cautious about plans to enter India
through acquisitions.
“This will make the deals costlier for strategic buyers and private equity firms,” said
Jagannadham Thunuguntla, equity head of SMC Capital.
“Investors who are planning to enter into India hoping there will be no tax liability will think
twice.”
Vodafone, fighting a tax bill in India from its 2007 purchase of Hutchison Whampoa Ltd’s
mobile business in the country, had filed an appeal with the court in June challenging the tax
department’s jurisdiction over the bill.
The Supreme Court on 27th September 2010 refused to offer any immediate relief to
Vodafone, which has challenged the Bombay High Court order allowing the government to
tax the company's USD 11billion deal with Hutch. The tax department had raised a demand
for Rs. 12,000 crore as tax on the 2007 deal. While refusing to stay the high court order, the
apex court issued notices to the tax authorities directing them to decide within four weeks the
liabilities of Vodafone.

• The Vodafone case is being keenly followed in other countries that still don't have their
legal position clear.
• The case may lead to diversion of FDI’s and further cross border deal from INDIA to
other countries leading a loss to economy as a hole.

• The image of India would be impacted in global scenario as of now the Indian
government is now recognized as someone who is laying down the rules for source
taxation.