A

Project Report
On
CASE STUDY OF MERGER OF VODAFONE AND HUTCHINSON

Submitted towards the partial fulfillment of

3rd Semester of M.B.A. (Insurance)
Degree course, for the subject

MERGERS AND ACQUISITIONS

Submitted by: Submitted to:

Samudra Singh & Bhana Ram Tak Dr. U.R.Daga
M.B.A. (Insurance) Faculty of Management
3rd Semester National Law University
Roll no. 233 & 223

NATIONAL LAW UNIVERSITY, JODHPUR

2010
INTRODUCTION

In an increasingly open global economy, where old prejudices against foreign ‘predators’ and old
fears of economic colonization have been replaced by a hunger for capital, Mergers and
Acquisitions (M&A) are welcome everywhere.

In human aspects of M&As we used a not-too-original distinction between mergers, acquisitions

and joint ventures. M&As represented a ‘marriage’, while joint ventures meant ‘cohabiting’.
Although mergers and acquisitions are generally treated as if they are one and the same thing,
they are legally different transactions. In an acquisition, one company buys sufficient numbers of
shares as to gain control of the other—the acquired company. Acquisitions may be welcomed by
the acquired company or they may be vigorously contested.

There are several alternative methods of consolidation with each method having its own
strengths and weaknesses, depending on the given situation. However, the most commonly
adopted method of consolidation by firms has been through M&As. Though both mergers and
acquisitions lead to two formerly independent firms becoming a commonly controlled entity,
there are subtle differences between the two. While acquisition refers to acquiring control of one
corporation by another, merger is a particular type of acquisition that results in a combination of
both the assets and liabilities of acquired and acquiring firms. In a merger, only one organization
survives and the other goes out of existence. There are also ways to acquire a firm other than a
merger such as stock acquisition or asset acquisition

The Vodafone-Hutch deal is one of the largest M&A deal executed by overseas firm in Indian
subcontinent. Today Vodafone business in India has been successfully integrated into the group
and now has over 44 million customers, with over 50 per cent pro forma revenue growth.
Revenues increased by 50 per cent during the year driven by rapid expansion of the customer
base with an average of 1.5 million net additions per month since acquisition

In today’s volatile market, where major M&A deals are showing negative growth or companies
are looking for Government Bailout money, Vodafone acquisition of hutch is a major contributor
to its revenue .While India’s revenues grew by 29.6 percent other APAC countries posted far
lower growths at 10 percent in Egypt, 7 percent in Australia and 3 percent in New Zealand at
constant exchange rates. This Report covers the various aspects of M&A along with insights on
Vodafone Merger.

HISTORY:

Hutchison-Essar
Year and Events

1994 Hutchison Max Telecom Limited (HMTL), a joint venture between Hutchison and Max,
wins the licence to provide cellular services in Mumbai. C. Sivasankaran sells 51% stake in
Delhi’s Sterlings Cellular to Essar group.

1995 HMTL launches mobile services in India under the Max Touch brand name.

1996 Swisscom sells 49% stake in Essar Cellphone to Hutchison.

1998 Max’s Analjit Singh sells 41% stake in Hutchison Max to Hutchison Hong Kong.

2000 (Jan) Hutchison acquires a 49 per cent stake in Sterling Cellular in the Delhi circle from
Swisscom, an Essar Group company. A few weeks later, the Orange brand name replaces Max
Touch in Mumbai.

2000 (July) Hutchison and Kotak together acquire a 100 per cent stake in Usha Martin Telekom
in Kolkata circle.

2000 (Sep) Hutchison acquires a 49 per cent stake in Fascel, which operates in Gujarat, from
Shinawatra.

2001 Hutchison puts in the bid to provide cellular licences in Chennai, Andhra Pradesh,
Karnataka and Maharashtra. It wins all except Maharashtra.

2003 Essar Teleholdings sells its operations in Rajasthan, Uttar Pradesh (East) and Haryana to
Hutchison Essar. Essar was running these operations through group company, Aircel Diglink
India Ltd. Hutchison acquires licence to provide cellular services in Punjab. This is bought from
Escotel.
2004 Essar picks France Telecom’s 9.9% stake in BPL Communications. Hutchison
Telecommunications International Ltd (HTIL) gets listed on the Hong Kong and New York stock
exchanges. Launches services in Punjab, West Bengal and Uttar Pradesh (West). Also receives
approval from the regulators to consolidate its operations in India.

2005 Hutchison Essar consolidates its various mobile companies in India to create a single entity.
A little later, Hutchison Essar signs agreements with the Essar Group to acquire BPL
Communications and Essar Spacetel. During the same year, Hutch becomes a national brand.
Essar Teleholdings buys Max Telecom Ventures 3.16% stake in Hutchison Essar for Rs. 657
crore. Egyptian cellular service provider, Orascom, acquires a 19.3 per cent stake in HTIL.

2006 Kotak sells 8.33% stake to Analjit Singh for Rs 1019 crore. HTIL acquires a 5.11 stake
from the Hindujas to increase its direct and indirect stake in Hutchison-Essar to 67 per cent.
Essar holds the balance 33 per cent. Hutchison-Essar receives the letter of intent (LoI) from the
government to provide cellular services in six more circles. Hutchison wants to exit.

In February 2007 Vodafone announced officially its acquisition of 67% of Hutch-Essar for
$11.08 billion defeating the rival bidder Reliance Communications.

FACTS OF THE CASE

In 2007, Vodafone Group bought the Indian telecom assets of Hong Kong's Hutchison
Telecommunications International Ltd. It paid US$11 billion for a 67% stake in Hutchison Essar.
The latter was the operating company in India for what is now the third-largest operator with 111
million users. Vodafone was the buyer. Hutchison, the seller, made huge capital gains. Yet since
then, Vodafone has been battling it out in the courts against the Indian Income Tax (IT)
department, which has saddled it with a US$2.1 billion tax claim. Hutchison, which pocketed the
capital gains, is nowhere in the picture.

The transaction was executed through a Hutchinson company located in the Cayman Islands
Round 1: began in September 2007, when the Tax Department issued a show cause notice to
Vodafone that said Vodafone was liable to pay withholding tax on the purchase amount.
Round 2: Vodafone filed a writ at the Bombay High Court disputing the tax department's
jurisdiction in an overseas transaction. But the petition was dismissed and Vodafone then
appealed to the Supreme Court marking the third round of hostilities.
In January 2009, the Supreme Court sent the case back to the Tax Department to decide on the
jurisdiction issue.
Hutchison held call options over companies controlled by Asim Ghosh and Analjit Singh as also
over SMMS Investments Pvt. Ltd. aggregating to approximately 15% of the shareholding of
HEL. The benefit of these options enured in favour of a corporate entity called 3 Global Services
Private Ltd., a company registered under the Companies' Act, 1956.
Many important documents relevant to the deal have never been made public, so it is unclear if
the tax claim is a result of Vodafone's overlooking a key issue or overconfidence. In such
transactions, the buyer is supposed to deduct tax at source (or withholding tax) and pay that to
the government. This is a transaction involving foreign companies and the seller can easily
disappear once the money is in the bank. The buyer, on the other hand, has the Indian assets and,
in a worst case scenario, those can be attached if there is any default.

VODAFONE

Vodafone is a mobile network operator with its headquarters in Newbury, Berkshire, England,
UK. It is the largest mobile telecommunications network company in the world by turnover and
has a market value of about £75 billion (August 2008). Vodafone currently has operations in 25
countries and partner networks in a further 42 countries. The name Vodafone comes from Voice
data fone, chosen by the company to “reflect the provision of voice and data services over mobile
phones.

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 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.
As of Nov 2008 Vodafone Essar has 58764164 or 23.57% of total 249349436 GSM mobile
connections in India. Vodafone India’s share in the mobile phone operator market rose to 18
percent.

HUTCH-ESSAR

Hutch Essar was a leading Indian telecommunications mobile operator with 23.3 million
customers at 31 December 2006, representing a 16.4% national market share. Hutch Essar
operates in 16 circles and has licenses in an additional six circles. In the year to 31 December
2005, Hutch Essar reported revenue of US$1,282 million, EBITDA of US$415 million, and
operating profit of US$313 million. In the six months to 30 June 2006, Hutch Essar reported
revenue of US$908 million, EBITDA of US$297 million, and operating profit of US$226
million.

Up until January 2006, Hutch Essar had licenses in 13 circles, of which nine have 900 MHz
spectrum. In January 2006, Hutch Essar acquired BPL, thereby adding three circles, each
operating with 900 MHz spectrum. In October 2006, Hutch Essar acquired Spacetel, adding six
further licenses, with operations planned to be launched during 2007.

Reasons for Hutch Sale

There are two main reasons which are responsible for Li Ka-shing to leave India. They are
•Hutch-Essar: Mutual Distrust.

•A right time to quit Indian operations to finance other operations Li Ka-Shing was the 10th
richest man globally in 2006, is known as a businessman who spots an opportunity early, invests
in it and exits at a neat premium. It is only after he exits that the rush begins. In the early 1990s,
he sold his stake in Star TV to Rupert Murdoch for $825 million. The Hutch Essar deal has
netted him a neat $8.48 billion. What could he do with that money? Li is a major player in the
ports and retail businesses. Getting access to the ports business in India is difficult, thanks to
being from China. However, with retail being the new mantra in India, Li could be looking at a
third entry. His retail outfits include Watson’s and PARKnSHOP. While Watsons operates 7,700
stores in 37 countries, PARKnSHOP is a supermarket chain.
Industry sources say that several incidents revealed the deepening rift between Hutch and Essar.
They say that as telecom valuations in India started rising, Essar tried to increase its stake in the
joint venture. However, in December 2005, Orascom of Egypt bought a 19.3 per cent stake in
Hutchison Whampoa. This indirectly gave it control of 12.93 per cent stake in Hutchison Essar.
The stake sale decision was reportedly taken without Essar’s knowledge and strained its relations
with Hutchison. Following this Essar approached the Department of Telecommunications on this
sale saying that Hutchison Whampoa’s equity sale to Orascom may have an impact on national
security as Orascom has a stake in Pakistan’s Mobilink. Subsequently, say sources, Essar
sounded out some private equity investors about buying out Hutchison’s equity holding in
Hutchison Essar.

What followed was the tussle between Essar and Hutch over BPL’s Mumbai circle. Sources say
that the decision to split the merger of BPL Communication into Hutchison Essar may also have
been prompted by the potential of the Mumbai circle. (BPL’s mobile operations included BPL
Cellular, which had licences for Maharashtra, Tamil Nadu and Kerala, and BPL Mobile, which
had the licence for Mumbai. BPL Cellular was merged with Hutchison Essar earlier this year.)

FINANCING THE DEAL

VODAFONE’S successful bid for Hutchison’s 67 per cent stake in Hutch Essar may have been
driven by its compulsions to enter the high-growth Indian market, but what clinched the deal for
the UK-based company was the enormous booty of cash at its disposal.
Analysts estimate that Vodafone was probably the least leveraged of all the bidders and this
helped them bid aggressively. It already has $5 billion from the sale of its Japanese unit for $15
billion last year (the remaining $10 billion is expected to go back to shareholders). It will also get
$1.62 billion cash from its 5.6 per cent stake sale in Bharti. This $6.62 billion may go towards
funding the $11.1-billion price tag for the 67 per cent stake.
In addition, Vodafone has free cash reserves (for the first six months of 2006) in excess of $3
billion. It has also sold its 25 per cent stake in Swisscom Mobile and exited Belgium. Therefore,
the debt component in the deal is likely to be low, according to an analyst.
Unconfirmed sources say that Reliance Communications was wary of raising too much debt,
which may have acted as a deterrent. Whether the UK-based telco overpaid is another question.
Investment bankers in India, too, have underlined Vodafone’s advantage, thanks to its access to
cash and its capability to strike the least leveraged deal.

SYNERGIES CLAIMED

• Vodafone gets access to the fastest growing mobile phone market in the world that is expected
to touch 500 million subscribers by 2010.

• Cellular penetration in rural India is below 2%, but 67% of India’s population lives in rural
India.
• Hutchison-Essar is not just the #4 player, but also one of the better-run companies with higher
average revenue per subscribers.

• 3G is set to take off in India, allowing data and video to ride on cellular networks. Vodafone
already offers 3G elsewhere in the world.

• India is key to Vodafone strengthening its presence in Asia, a region seen as the big telecom
story.

IMMEDIATE CHALLENGES

Hutch is going to be a tough battle ahead as the world’s largest mobile operator (by revenues)
tries to woo the price-conscious Indian consumer. Vodafone is targeting 100 million Indian
subscribers in three years (Hutch has 24.41 million at present). That’s half its current subscriber
base across 27 countries.

But getting there means adding between 1.5 million and 2 million subscribers every month.
While Hutch has been adding around 1 million subscribers a month, market leader Bharti has
been adding 1.75 million. Vodafone needs to exceed Bharti’s net subscriber additions to be the
leader in three years. Second, it needs to tap rural India in a big way. Vodafone has earmarked an
investment of $2 billion over the next couple of years to strengthen its presence here. The
agreement with Bharti fits in perfectly to tap the hinterland

.Realising the importance of familiarity with the terrain, Sarin has opted to retain Asim Ghosh as
the man to head the venture. Once the board approves it, Ghosh will formally take charge. After
all, that’s what he has been doing as Hutchison’s key lieutenant over the past few years.
However, even before it gets to that, Vodafone has to ensure that the Essar Group, the 33 per
cent partner in the venture, does not go to court on its entry. To insure against such a possibility,
Vodafone has reserved the right to abandon the acquisition of the stake if litigation is launched.
Summing these challenges we have: -

• The cellular telephony is extremely competitive, and India has one of the lowest ARPUs in the
world. Besides, ARPU growth is slowing.

• It has an uneasy equation with Essar, which is one-third partner in Hutch-Essar. That could be a
source of problem.

• The Vodafone brand is relatively unknown in the Indian market. Besides the brand will cost
money and take time.

• Telecom valuations are at a high and this could mean it is years Vodafone recovers its multi-
billion dollar investment.

• Its big competitors are home-grown majors, who can manage the ‘environment’ better.

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?

Scope of Taxable Income of a Non-resident:

Pursuant to Section 5(2) of the Act, the taxable income of a non-resident includes income
“received or deemed to be received in India” and income that “accrues or arises or deemed to
accrue or arise in India”. However, it does not include income that accrues or arises or is deemed
to accrue or arise outside India. Pursuant to Section 9 (1) of the Act, income is deemed to accrue
or arise in India if such income is due to transfer of an asset situated in India or through or from
business connection in India.

Pursuant to Section 195 of the Act every person paying any sum, which is chargeable to tax in
India to a non-resident must deduct income-tax at source at the time of payment or credit. The
liability to deduct tax applies to non-residents as well as residents. The IT Department has argued
that this transfer represents a transfer of beneficial interest in the shares of the Indian company
and hence, any gain arising from it would attract tax in India.

In the case of transfer of shares in an Indian company by companies established in certain

countries such as Mauritius, Cyprus and Singapore withholding tax on capital gains is not liable
to be levied in India pursuant to the relevant DTAA.

CGP (the company that was sold to Vodafone) was a Cayman company and there is no India-
Cayman DTAA. It is an interesting question as to whether the sale of Mauritius SPV would
attract a similar tax notice or whether a Mauritius intermediate SPV interposed between the
Cayman SPV and the Indian subsidiary would act as a successful blocker entity.

Who is an Agent?

According to Section 160(1) of the Act, ‘agent’ of the non-resident is ‘representative assessee’,
and Section 161 discusses the liability of representative assessee. Section 163 defines agent to
include a person who has a business connection with the non-resident.

Passing of Laws Retrospectively:

In the 1975 Hindustan Machine Tools case, the Supreme Court held that the legislature could
pass laws retrospectively, with the exception that this power could be challenged if the law was
discriminatory. This same principle was reaffirmed in 1997 in Arooran Sugars Ltd case, where
the Supreme Court that if the law does not discriminate, it may be retrospective.

This is perhaps the first time tax authorities are attempting to tax a transaction between two
foreign companies involving transfer of an Indian asset. If the tax liability is established, it could
result in a tax liability of approximately $1.7 billion. Investors will be keeping a close eye on the
upcoming Mumbai High Court verdict. Either way, the next battle may be fought in the Supreme
Court.

Hutch Vodafone Merger – An Issue of Tax Planning Under Income Tax Act,
1961

It is a landmark case that will severely impact the Mergers & Acquisitions (M&A) landscape in
India. No matter which way it goes, the Vodafone versus IT department tax case will have an
indelible impact on the M&A landscape of India. Last year British Telecom giant Vodafone paid
Hong Kong based Hutchison International over USD 11 billion to buy Hutchison’s 67% stake in
Indian telecom company Hutchison Essar. The transaction was done through the sale and
purchase of shares of CGP, a Mauritius based company that owned that 67% stake in Hutch
Essar. Since the deal was offshore, neither party thought it was taxable in India. But the tax
department disagreed. It claimed that capital gains tax most people paid on the transaction and
that tax should have been deducted by Vodafone whilst paying Hutch. The matter went to court
and was heard over by the court. 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 taxman’s 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.

The tax officers are saying that Hutch is taxable on the profit they made from the sale - that is
one aspect. The second aspect is that Vodafone as a payer was liable to deduct tax at source
because they paid income to Hutch. Those are the two different issues. The case was mainly
about the second issue where the Vodafone was liable or not and in principle; it is possible that
the department is right on the first and yet not right on the second.

JUDGEMENTS

The facts clearly establish that it would be simplistic to assume that the entire transaction
between HTIL and VIH BV was fulfilled merely upon the transfer of a single share of CGP in
the Cayman Islands. The commercial and business understanding between the parties postulated
that what was being transferred from HTIL to VIH BV was the controlling interest in HEL.
HTIL had through its investments in HEL carried on operations in India which HTIL in its
annual report of 2007 represented to be the Indian mobile telecommunication operations. The
transaction between HTIL and VIH BV was structured so as to achieve the object of
discontinuing the operations of HTIL in relation to the Indian mobile telecommunication
operations by transferring the rights and entitlements of HTIL to VIH BV. HEL was at all times
intended to be the target company and a transfer of the controlling interest in HEL was the
purpose which was achieved by the transaction. Ernst and Young who carried out a due diligence
of the telecommunications business carried on by HEL and its subsidiaries have made the
following disclosure in its report: -
"The target structure now also includes a Cayman company, CGP Investments (Holdings)
Limited. CGP Investments (Holdings) Limited was not originally within the target group. After
our due diligence had commenced the seller proposed that CGP Investments (Holdings) Limited
should be added to the target group and made available certain limited information about the
company. Although we have reviewed this information, it is not sufficient for us to be able to
comment on any tax risks associated with the company." (Emphasis supplied).
The due diligence report emphasizes that the object and intent of the parties was to achieve the
transfer of control over HEL and the transfer of the solitary share of CGP, a Cayman Islands
company was put into place at the behest of HTIL, subsequently as a mode of effectuating the
goal.
The true nature of the transaction as it emerges from the transactional documents is that the
transfer of the solitary share of the Cayman Islands company reflected only a part of the
arrangement put into place by the parties in achieving the object of transferring control of HEL to
VIH BV. HTIL had put into place, during the period when it was in control of HEL, a complex
structure including the financing of Indian companies which in turn had holdings directly or
indirectly in HEL. In consideration call and put options were created and the benefit of those
options had to be transferred to the purchaser as an integral part of the transfer of control over
HEL. Hence, it is from that perspective that the framework agreements pertaining to the Analjit
Singh and Asim Ghosh group of companies and IDFC have to be perceived. These were
agreements with Indian companies and the transaction between HTIL and VIH BV takes due
account of the benefit of those agreements.
The price paid by VIH BV to HTIL of US $ 11.01 Billion factored in, as part of the
consideration, diverse rights and entitlements that were being transferred to VIH BV. Many of
these entitlements were not relatable to the transfer of the CGP share. Indeed, if the transfer of
the solitary share of CGP could have effectuated the purpose it was not necessary for the parties
to enter into a complex structure of business documentation. The transactional documents are not
merely incidental or consequential to the transfer of the CGP share, but recognized independently
the rights and entitlements of HTIL in relation to the Indian business which were being
transferred to VIH BV.
We began the record of submissions by adverting to the contention of the Petitioner that if any of
the shares held by the Mauritian companies were sold in India, there would be no liability to
capital gains tax because of the Convention on the Avoidance of Double Taxation between India
and Mauritius. The crux of the submission is that the entire transaction in the case is subsumed in
the transfer of a share of an upstream overseas company which exercised control over Mauritian
companies. As we have noted earlier, it is simplistic to assume that all that the transaction
involved was the transfer of one share of an upstream overseas company which was in a position
to exercise control over a Mauritian company. The transaction between VIH BV and HTIL was a
composite transaction which covered a complex web of structures and arrangements, not
referable to the transfer of one share of an upstream overseas company alone. The transfer of that
one share alone would not have been sufficient to consummate the transaction. The transaction
documents are adequate in themselves to establish the untenability of the Petitioner's
submissions.
The submission of VIH BV that the transaction involves merely a sale of a share of a foreign
company from one non- resident company to another cannot be accepted. The edifice of the
submission has been built around the theory that the share of CGP, a company situated in the
Cayman Islands was a capital asset situated outside India and all that was transferred was that
which was attached to and emanated from the solitary share. It was on this hypothesis that it was
urged that the rights and entitlements which flow out of the holding of a share cannot be
dissected from the ownership of the share. The purpose of the discussion earlier has been to
establish the fallacy in the submission. The transfer of the CGP share was not adequate in itself
to achieve the object of consummating the transaction between HTIL and VIH BV. Intrinsic to
the transaction was a transfer of other rights and entitlements. These rights and entitlements
constitute in themselves capital assets within the meaning of Section 2(14) which expression is
defined to mean property of any kind held by an assessee.
Under Section 5(2) the total income of a non-resident includes all income from whatever source
derived which (a) is received or is deemed to be received in India or (b) accrues or arises or is
deemed to accrue or arise to him in India. Parliament has designedly used the words "all income
from whatever source derived". These are words of width and amplitude. Clause (i) of Section 9
explains the ambit of incomes which shall be deemed to accrue or arise in India. Parliament has
designedly postulated that all income accruing or arising whether directly or indirectly, (a)
through or from any business connection in India or (b) through or from any property in India; or
(c) through or from any asset or source of income in India or (d) through the transfer of a capital
asset situate in India would be deemed to accrue or arise in India. Where an asset or source of
income is situated in India or where the capital asset is situated in India, all income which
accrues or arises directly or indirectly through or from it shall be treated as income which is
deemed to accrue or arise in India.
VIH BVs disclosure to the FIPB is indicative of the fact that the consideration that was paid to
HTIL in the amount of US $ 11.01 Billion was for the acquisition of a panoply of entitlements
including a control premium, use and rights to the Hutch brand in India, a non-compete
agreement with the Hutch group, the value of non-voting non convertible preference shares,
various loan obligations and the entitlement to acquire subject to Indian foreign investment rules,
a further 15% indirect interest in HEL.
The manner in which the consideration should be apportioned is not something which can be
determined at this stage. Apportionment lies within the jurisdiction of the Assessing Officer
during the course of the assessment proceedings. Undoubtedly it would be for the Assessing
Officer to apportion the income which has resulted to HTIL between that which has accrued or
arisen or what is deemed to have accrued or arisen as a result of a nexus within the Indian taxing
jurisdiction and that which lies outside. Such an enquiry would lie outside the realm of the
present proceedings. But once this Court comes to the conclusion that the transaction between
HTIL and VIH BV had a sufficient nexus with Indian fiscal jurisdiction, the issue of jurisdiction
would have to be answered by holding that the Indian tax authorities acted within their
jurisdiction in issuing a notice to show cause to the Petitioner for not deducting tax at source.
In assessing the true nature and character of a transaction, the label which parties may ascribe to
the transaction is not determinative of its character. The nature of the transaction has to be
ascertained from the covenants of the contract and from the surrounding circumstances. In
National Cement Mines Industries Ltd. vs. C. I. T., (1961) 42 ITR 69 1961 Indlaw SC 95 Mr.
Justice J.C. Shah speaking for the Supreme Court emphasized the principles of interpretation to
be adopted by the Court in construing a commercial transaction :
"But in assessing the true character of the receipt for the purpose of the Income-tax Act, inability
to ascribe to the transaction a definite category is of little consequence. It is not the nature of the
receipt under the general law but in commerce that is material. It is often difficult to distinguish
whether an agreement is for payment of a debt by installments or for making annual payments in
the nature of income. The court has, on an appraisal of all the facts, to assess whether a
transaction is commercial in character yielding income or is one in consideration of parting with
property for repayment of capital in installments. No single test of universal application can be
discovered for solution of the problem. The name which the parties may give to the transaction
which is the source of the receipt and the characterization of the receipt by them are of little
moment, and the true nature and character of the transaction have to be ascertained from the
covenants of the contract in the light of the surrounding circumstances."
The Bombay high court has affirmed the tax department’s jurisdiction to proceed against
Vodafone Group Plc. However, it has not determined whether any part of the payment made by
Vodafone is actually chargeable to tax in India. The court had granted a stay on the department
from raising a tax demand to allow time for an appeal to be filed by Vodafone before the
Supreme Court, which has now been made.

The decision accepts the principle that income earned by a non-resident from an offshore
transaction cannot be taxed in India unless the assets transferred have sufficient nexus with the
territory of India. With respect to transfer of capital assets by a non-resident, it is necessary that
the legal situs (a legal term meaning site) of the assets is in India. Considering that the
transaction between Vodafone and Hutchison only involved the transfer of specific non-India
based assets such as shares of a foreign company and certain loan entitlements, it should
ordinarily not give rise to any income that is taxable in India.

To briefly summarize the facts, in February 2007, a sale and purchase agreement was entered
into between Vodafone International Holdings BV, Netherlands, and Hutchison
Telecommunications International Ltd (HTIL), Cayman Islands, for acquisition of the entire
share capital of CGP Investments (Holdings) Ltd, another company based in the Cayman Islands.
CGP Investments directly and indirectly held offshore companies that owned a 67% interest in
the Indian operating company, Hutch Essar Ltd (HEL). The agreement between Vodafone and
HTIL also involved assignment of certain inter-company loans which were owed by CGP
Investments and its Mauritian subsidiary to various Hutchison group companies.

Based on various transaction documents, Foreign Investment Promotion Board (FIPB)

disclosures and due diligence reports, the tax department has tried to argue that the subject matter
of the transaction was a transfer of 67% interest in the Indian operating company, HEL, and a
number of other rights such as its Indian telecom licence, the right to use the Hutch brand,
management rights in the Indian company, joint venture interests and inter-company loan
obligations. According to the department, this creates sufficient nexus for it to exercise
jurisdiction to proceed against Vodafone.
While accepting the tax department’s jurisdiction to initiate proceedings, the Bombay high court
noted that the acquisition of the offshore Cayman entity by Vodafone was a composite
transaction and the numerous agreements between the various parties captured certain rights and
entitlements in relation to the Indian operating company. On this basis, the court held that the
department would have to apportion that part of the payment made by Vodafone which related to
assets that were situated in India.

The high court has also emphasized that, for tax purposes, one should only look at the form of
the transaction and not its substance as long as it is not a sham or a colorable device. This
principle was laid down by the Supreme Court in the Azadi Bachao Andolan case. The high
court clarified that taxpayers can legitimately plan their economic affairs within the four corners
of law even if the object was to lawfully mitigate the incidence of tax.

The high court also reiterated the common law principle that a share is a distinct capital asset in
its own right. The business and assets of a corporation are not the business and assets of its
shareholders and the acquisition of shares of a parent company would not lead to any transfer of
interests in its underlying subsidiary companies. The court observed in very clear terms that a
controlling interest which a shareholder acquires is incidental to the holding of shares and does
not have a separate existence distinct from the shareholding.

On applying these principles to Vodafone’s facts, it is difficult to understand how the high court
accepted the tax department’s jurisdiction to initiate proceedings in relation to an offshore
transaction of this nature. Even if such jurisdiction does exist, it is likely that little or no part of
the consideration paid by Vodafone may be considered taxable in India.

The form of the transaction only contemplated transfer of certain offshore loan entitlements and
shareholding in the Cayman entity which is legally distinct from the underlying controlling
interest in the Indian operating company. The other rights and interests vested with various
downstream subsidiary companies and it may not be possible to suggest that these were
transferred in law. Another issue is that it would be very difficult to quantify the cost of
acquisition of the various rights identified by the tax department.

Further, under principles of private international law, the legal situs of many of these rights
cannot be said to lie in India and, hence, there may not be sufficient nexus for the transaction to
be taxed in India. These legal aspects are likely to have a crucial bearing on the final outcome of
the case.

This time, the Income Tax department has launched a 3 pronged attack against Vodafone. The
first offensive is one that harks back to the first show cause notice of 2007.
Then and now - the tax department holds Vodafone as an assessee in default for not making its
withholding tax payments on time. The department insists that whether an income is chargeable
or not, withholding tax must be paid. Now this argument has been tested in court quite frequently
this past year.
Speaking of tax liability, that brings me to the most important aspect of this case - the one
regarding jurisdiction. The tax department claims it is the actions of Vodafone itself that gives it
grounds to claim jurisdiction over the Vodafone-Hutch transaction. This change in brand, filings
with the FIPB, due diligence of Hutch, a sale purchase agreement centered around Hutch, and
disclosures to the stock exchanges. The Tax Department claims all these actions by Vodafone
prove that the subject matter of the transaction with Hutch was an Indian asset, even if the
transaction was done offshore.
The Bombay High Court has attempted a difficult distinction. On the one hand are the actual
shares (in the Vodafone case, just one share of Cayman Island registered CGP Investments
Holdings was transferred). This is not taxable. Balanced against this are the assets, brand value,
goodwill and other intangibles owned by the company in India. This is taxable. The problem is to
figure out how much it is worth. The court has passed the buck on this and left the valuation
exercise to the IT assessing officer. The court has also bounced the ball back to the Supreme
Court. It has barred action by the taxation authorities for eight weeks, while Vodafone files an
appeal. The company didn't take that long; it went to the Supreme Court on September 14. "The
appeal challenges the recent High Court judgment on the issue of jurisdiction. Vodafone remains
convinced that there is no tax to pay on the Hutchison transaction and we will continue to defend
this position vigorously,"
REFERENCES: -
http://taxguru.in/news/display/103/Tax%20officials%20scrutinising%20cross-border%20merger/

www.legalserviceindia.com/.../l363-Hutch-Vodafone-Merger-–-An-Issue-Of-Tax-Planning.html

www.totaltele.com/view.aspx?ID=457987

365businessdays.blogspot.com/.../vodafone-tax-case-verdict-victory-for.html

bombayhighcourt.nic.in/data/judgements/2010/OSWP130810

http://www.nishithdesai.com/nda-news/Vodafone VS Tax Department Round 4

knowledge.wharton.upenn.edu/india/article.cfm?articleid=4529