20 January 2012

EY Tax Alert
The Vodafone case: SC rules transfer of shares of a foreign
company that indirectly held underlying Indian assets not
taxable

Executive summary

This Tax Alert summarizes the decision of the Supreme

Court of India (SC) in the case of Vodafone
International Holdings B.V. (Vodafone NL) [SLP (C) No.
26529 of 2010] wherein the issue before the SC was
whether the Tax Authority had jurisdiction under the
Indian Tax Laws (ITL) to tax the gains arising to a
foreign company from transfer of shares of a foreign
holding company, which indirectly held underlying
Indian assets (indirect transfer).
While setting aside the decision of the Bombay High
Court (HC) which had held that the Tax Authority had
jurisdiction to tax the transaction, the SC, in a

landmark judgment, held that the indirect transfer,

would not be taxable in India. Further, the SC accepted
that tax planning within the framework of law is
permissible, unless the planning is a sham or a
colorable device. In any event, the onus is on the Tax
Authority to establish that a transaction is a sham.
The source rule provisions under the ITL needs to be
strictly construed and, accordingly, in the absence of a
look through provision, an indirect transfer would not
be taxable in India. The situs of the capital asset, being
shares, would be situated where the company is
incorporated and where the register of members is
maintained. The withholding tax provisions under the
ITL will not apply when there is an offshore transaction
between two non-residents; accordingly, such
provisions would not have an extra territorial
operation. The SC also observed that the inclusion of
an anti-abuse provision under the statute/tax treaty is
a matter of national economic policy and, in the
absence of the same, it cannot be implied.

assignment of loan interests. Thereafter, HTIL

announced that Vodafone NL had acquired the
controlling interest in HEL.

Facts and background

In 1992, the Hong Kong based, Hutchison Group
acquired interest in an Indian telecom business
through a joint venture (JV) company. Hutchison
Telecommunications International (Cayman)
Holdings Ltd. (HTIL) held shares of CGP
Investments (Holdings) Ltd. (CGP Investments), a
holding company, based in Cayman Island.
Through CGP Investments and the various
Mauritius entities, HTIL held 67% in the Hutch
Essar Ltd. (HEL) an Indian JV company. Thus,
through CGP Investments, the Hutch Group, held,
directly and indirectly, controlling interest in HEL.
In December 2006, HTIL issued a press
statement, stating that it had been approached by
various potentially interested parties regarding a
possible sale of its equity interests in HEL, which
was carrying on telecom operations in India.
Vodafone NL, a Dutch entity, made a bid to
acquire share capital of CGP Investments and,
consequently, in February 2007, entered into an
agreement for acquisition of the Indian interests
of HTIL. Prior to this, Vodafone had entered into a
JV with Bharti Airtel (Airtel), an Indian company,
which was also engaged in providing similar
services as that of HEL. Subsequently, an
agreement for Sale and Purchase of Share and
Loans (SPA) was entered into between HTIL and
Vodafone NL under which HTIL agreed to procure
and transfer the entire issued share capital of CGP
Investments, held by a group company
incorporated in the British Virgin Island, free from
all encumbrances together with all rights
attaching or accruing, and together with

EY Tax Alert

Vodafone NL informed Essar Group (the other

stake-holder in HEL) about the acquisition of the
entire holding from HTIL. Thereafter, Vodafone NL
also applied to the Foreign Investment Promotion
Board (FIPB) (Indian foreign investment
regulatory authority) and sought approval for
direct acquisition of 52% in HEL. However, it was
aptly clarified before the FIPB that as the
transaction was offshore, between two nonresidents, the approval was merely taken for
noting purposes and was not mandatory.
Thereafter, FIPB enquired as to the basis on which
Vodafone NL had paid the consideration for 67%
in HEL when in actual, only 52% stake was
acquired to which Vodafone NL responded that it
had acquired 52% only, however, the additional
consideration paid was on account of acquiring
additional assets such as the control premium,
use and rights to the Hutch brand in India, noncompete agreement with Hutch Group, value of
non-voting non-convertible preference shares,
various loan obligations, call option which enabled
Vodafone NL to additionally acquire 15% stake in
HEL. Subsequently, FIPB accorded approval and,
accordingly, Vodafone NL made the payment of
consideration to HTIL for acquiring the entire
share capital of CGP Investments, as per the
instructions of the Hutch Group.

The entire structure has been depicted below for

easy reference.

In connection with the transaction, the Tax

Authority issued a notice to Vodafone NL
enquiring as to why Vodafone NL should not be
treated as a taxpayer-in-default for not
withholding taxes on its payments to HTIL.
Subsequently, Vodafone NL filed a writ petition
before the HC, challenging the validity of the
notice. The HC, while dismissing the petition filed,
held that the said transaction would be subject to
the scrutiny of the Tax Authority for the reason
that the dominant purpose of the transaction was
to acquire the controlling interest in HEL and,
accordingly, the notice issued, prima facie, could
not be termed erroneous. Further, as the HC was
not in possession of the relevant agreements, it
was unable to decide the true nature of the
transaction and concluded that it was not in a
position to deliberate on the taxability of the
transaction, including the jurisdictional issue.
[Kindly refer the Ernst & Young tax alert dated 5
December 2008 for detailed comments]. Pursuant
to the order of the HC, Vodafone NL filed a special
leave petition (SLP) before the SC. The SC,
however, dismissed the SLP and held that the
jurisdictional issue would have to be examined by
the Tax Authority as a preliminary issue [Kindly
refer Ernst & Young Tax Alert dated 29 January
2009 for detailed comments].

Pursuant to the SC observation, the Tax Authority

asserted that it had jurisdiction to tax the
transaction and considering the fact that
Vodafone NL had failed to withhold tax under the
provisions of the ITL, it was treated as a taxpayerin-default. Aggrieved, Vodafone NL challenged
this order before the HC by way of a writ petition.
While dismissing the petition, the HC held that the

Shareholders

Listed in
Hong
Kong &
New York

British
Virgin
Islands

Cayman
Islands

HTIL
(Cayman
Islands)

SPA

Vodafone
Plc

UK

HTI (BVI)
Holding
s Ltd

CGP

Transfer of
CGP shares
to Vodafone
NL

Vodafone
NL

Netherlands

India
Mauritius

8 entities

HEL

IND Subs

EY Tax Alert

Tax Authority had jurisdiction to tax the

transaction. [Kindly refer Ernst & Young Tax Alert
dated 9 September 2010 for detailed comments].

Aggrieved, Vodafone NL approached the SC on

the issue of taxability of the transaction. The SC
also permitted AT&T US as interveners, being
aggrieved from the order of the HC in the case of
Aditya Birla Nuvo Ltd. [Kindly refer Ernst &Young
Tax Alert dated16 July 2011 for detailed
comments]. The proceedings took place over a
period of 28 days during the months from August
to October 2011. [Kindly refer Ernst & Young Tax
Alert dated 24 October 2010 for detailed
comments].

SCs ruling on principles

Tax avoidance, SC decision in Azadi not in conflict
with McDowell

The Tax Authority had contended that the

decision of the SC in the case of Azadi Bachao
Andolan [263 ITR 706] so far as tax avoidance was
concerned, would need to be overruled as it had
departed from the principles laid down in the case
of McDowell [154 ITR 148] where one of the judges
had given a separate ruling on the issue and other
judges had concurred with it.

The majority ruling in McDowell had clearly held

that tax planning was legitimate, provided that it
was within the framework of law and that
colorable devices could not be a part of tax
planning. The separate ruling by the fifth judge
was in relation to tax evasion through colorable

devices by resorting to dubious methods and

subterfuges. It is nowhere mentioned that tax
planning is illegitimate or impermissible and,
moreover, the fifth judge himself agreed with the
majority ruling.

that the Tax Authority should apply the look at

test to ascertain its true legal nature. Genuine tax
planning is not to be abandoned.

As per the Westminster principle, emerging from

the House of Lords decision in the case of CIR v
Duke of Westminster [1935 All E.R. 259], a
taxpayer can arrange his affairs so as to reduce
the liability of tax and the fact that the motive for
a transaction is to avoid tax does no invalidate it
unless a particular enactment so provides.

Applying the Westminster principle, the Tax

Authority cannot tax a subject without a specific
provision to 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.

There is no conflict between McDowell ruling and

Azadi ruling, and no consideration by a larger
bench on the same is required.

However, the Ramsay doctrine, emerging from a

later decision of the House of Lords in the case of
WT Ramsay [1981 1 All E.R. 865], was a new
Separate entity approach and look at principle
approach to artificial tax avoidance schemes,
wherein, a subject could be taxed only if there was It is well recognized in both corporate and tax laws
a clear intendment and the intendment has to be
that a company is treated as separate person
ascertained on clear principles and the courts
distinct from its shareholders. Companies and
could not approach the issue on a mere literal
other entities are viewed as economic entities
interpretation.
with legal independence vis--vis their
shareholders.
The Ramsay ruling did not discard the
Westminster ruling, but read it in the proper
If the controlling foreign enterprise makes an
context as per which a device, which was
indirect transfer through abuse of organization
colorable in nature, had to be ignored as a fiscal
form without any reasonable business purpose
nullity. Thus, the Ramsay ruling lays down the
resulting in tax avoidance or avoidance of
principle of statutory interpretation, rather than
withholding tax, then the Tax Authority may
an over-arching anti-avoidance doctrine imposed
disregard the form of arrangement, reupon tax laws.
characterize the equity transfer according to
economic substance, and impose tax on the
In Craven v White [1988 3 All E.R. 495], it was
foreign enterprise.
held by the House of Lords that the Tax Authority
cannot start with the question as to whether the
However, the burden is on the Tax Authority to
transaction is a tax deferment/saving device, but
allege and establish abuse, where there is a tax

EY Tax Alert

avoidance in the creation and/or use of abusive

business purpose must exist to overcome
holding structures. The Tax Authority may invoke
evidence of there being a tax device.
the anti-avoidance rules such as the substance
over form principle or piercing the corporate veil Source rules in the ITL is not a look through
test only after it is able to establish that the
provision
impugned transaction is sham or tax avoidant.
The source rules in the ITL deem certain incomes
Thus, if the Tax Authority establishes that in a
to accrue or arise in India under certain
holding structure, an entity that has no
circumstances. The essential condition for
commercial/business substance and has been
triggering capital gains taxation under these
interposed only to avoid tax, then in such cases,
source rules is that the capital asset must be
applying the test of fiscal nullity, the Tax
situated in India. In this regard the charge of
Authority may disregard such inter-positioning.
capital gains requires the existence of all three of
However, this has to be done at the threshold.
the following elements: (i) transfer; (ii) existence
of a capital asset; and (iii) situation of such asset
Every strategic foreign direct investment coming
in India. Thus, for a foreign enterprise, income
to India should be looked at in a holistic manner
from capital gains accruing or arising outside
by the Tax Authority. In doing so the following
India would be fictionally deemed to accrue or
factors are important and need to be considered:
arise in India, when the capital asset is situated in
a) Participation in investment
India.
b) Duration of time period for which the holding
structure exists
It was contended by the Tax Authority that this is
c) The period of business operation in India
a look through provision which would even cover
d) Generation of taxable revenues in India
indirect transfer of capital assets. A legal fiction
e) Timing of exit and continuity of business on
has limited scope and cannot be expanded by
exit
giving it a purposive interpretation particularly
when it would transform the concept of
In this regard, the Tax Authority must ascertain
chargeability under the ITL. If the contention of
the legal nature of the transaction, and while
the Tax Authority is accepted and the transfer of
doing so, the look at principle needs to be
shares of foreign company holding shares in an
applied, wherein the entire transactions as a
Indian company is regarded as transfer of shares
whole needs to be looked at, without dissecting it.
of the Indian company, it would amount to
changing the content and ambit of the source
The corporate business purpose of the transaction
rules in the ITL.
would be proof that the impugned transaction is
not a colorable/artificial device and a strong
The source rule in the ITL, with respect to a
capital asset, requires that the asset which is

EY Tax Alert

being transferred be situated in India. If the term

indirect is also read into the provision, it would
render the above requirement nugatory.

The words directly or indirectly in the source

rules would go only with the term income and
not with the term transfer of a capital asset.

Further, the proposed Direct Taxes Code Bill of

2009 and 2010 (which is expected to replace the
present ITL), expressly provide for taxation of
indirect transfers. These proposals show that in
the existing provisions under the ITL, the word
indirect cannot be read on the basis of a
purposive construction. The question of providing
a look through or limitation on benefits (LOB)
provision in the statute or in the treaty, is a
matter of policy, and needs to be expressly
provided by way of a specific legislation to tax
such transactions.

SCs ruling on HutchVodafone transaction

India-Mauritius tax treaty (DTAA) and Azadi Bachao
Andolan (supra)

[1]

The LOB and look through provisions cannot be

read into a DTAA. In the absence of an LOB clause
and an administrative circular[1] [which recognizes
DTAA benefits based on a Tax Residency
Certificate (TRC)] and the TRC, the Tax Authority
cannot, at the time of sale/exit/disinvestment,
Circular 789 of 2000

deny capital gains benefits arising to a Mauritius

resident, by stating that foreign investment is only
routed through Mauritius.

However, the Tax Authority would not be

precluded from denying DTAA benefits in case it is
established that a Mauritius company is without
any commercial substance, or is interposed with a
view to avoid tax. The Tax Authority can disregard
such devices and take into account the real
transaction between the parties, and subject it to
tax. For example, the TRC does not prevent
enquiry into a tax fraud, where an overseas entity
is used by an Indian resident for round-tripping or
any other illegal activities, and for determining
the role of the Mauritius entity in the entire
transaction.

In such kinds of abusive structures, legislative

measures have to be taken to plug the loopholes.
All the same, a genuine corporate structure set up
for purely commercial purpose, and which
indulges in genuine investment, has to be
recognized.

The TRC can be accepted as conclusive evidence

for accepting the status of residents and the
beneficial ownership, for applying the DTAA.
However, it may be ignored if the DTAA is used for
the fraudulent purpose of tax evasion.

CGP Investments and its interposition

Parties are free to choose whatever lawful

arrangement which will suit their business and
commercial purpose, but the true nature of the
transaction can be ascertained only by looking at

the legal arrangement actually entered in to and

carried out.

incorporated and where its shares can be

transferred.

One of the tests to examine the genuineness of

the structure is the timing test i.e., the timing of

the incorporation of the entities or transfer of the
shares etc. Structures created for genuine
business reasons are those which are generally
created or acquired when investment is first
made, or further made at the time of
consolidation.

Considering that the transfer of CGP Investments

shares was recorded in Cayman Islands, where the
register of members of CGP Investments is
maintained, it could not be accepted that the situs
of the Cayman Islands company shares was where
the underlying assets were situated (India).

It cannot be said that HTIL or Vodafone NL, was a

fly by night operator or short time investor, as
the HTIL operated from 1994 and only in 2007
Transfer of controlling interest
was the divestment made. If the look at test
(supra) is applied and not the dissecting
A controlling interest is an incident of ownership
approach, then the extinguishment took place
of shares of the company and is not an identifiable
because of transfer of CGP Investments share and
or distinct capital asset independent of holding of
not by virtue of various clauses in the SPA
shares. Transfer of the CGP Investments share
(wherein the rights of the HEL-controlling interest
automatically results in a host of consequences
were factored in).
including transfer of controlling interest, and that
controlling interest as such, cannot be dissected
Therefore, sale of CGP Investments share, for
from CGP Investments share without a specific
exiting from the Indian telecom sector, cannot be
legislative intervention.
considered as a pre-ordained transaction, with no
commercial purpose other than tax avoidance.
Accordingly, this controlling interest cannot be
Sale of CGP Investments share was a genuine
dissected so as to percolate and be treated as
business transaction and not a fraudulent or
transfer of controlling interest of the downstream
dubious method to avoid capital gains tax.
entities, and ultimately to that of HEL.

Situs of shares (CGP Investments)

Therefore, situs of CGP Investments is situated in

Cayman Islands, and on transfer in Cayman
Islands, the situs would not shift to India.

The legal principle on which situs of an asset, such

as share of a company, is determined, is well
settled. As per Indian Company Law, situs of

shares would be where the company is

EY Tax Alert

Controlling interest, which stood transferred to

Vodafone NL from HTIL accompanies the CGP
Investments share, and cannot be dissected.
The present case concerned a sale of shares and
not an asset sale. When a transaction involves

transfer of shares lock, stock and barrel, it cannot Miscellaneous points

be broken down into individual components,
assets or rights.
Call and put options are contractual rights, and in
the absence of a statutory stipulation, they
Applicability of withholding tax and representative
cannot be considered as capital assets; at best
taxpayer provisions
they may be regarded as potential shares, till they
are exercised.
Withholding tax provisions would apply only if
payments are made from a resident to another
The shareholders agreement (SHA) is a private
non-resident, and not between two non-residents
contract between shareholders, while Articles of
situated outside India.
Association (AoA) of a company is a public
document. The essential purpose of the SHA is to
In the present case, the transaction was the
make provisions for proper and effective internal
transfer of a capital asset between two nonmanagement of the company. Provisions of the
resident entities, through a contract executed
SHA may also go contrary to the provisions of the
outside India, and it was entered into on a
AoA, in which event, the provisions of the AoA
principal-to-principal basis. The consideration was
would govern, and not the provisions of the SHA.
also paid outside India. The SC ruling in the case
of Eli Lily [(2009) 15 SCC 1], [Kindly refer to EY
Being a private document, the SHA binds the
Tax Alert dated 31 March 2009 for detailed
parties thereof and not the remaining
comments], was distinguished on the ground that
shareholders in the company; however, the SHA
services were rendered in India by the employees,
cannot go contrary to the AOA. Provisions like
and a portion of salary was received from an
right of first refusal, tag along rights, call option,
entity situated in India.
put option, which find place in a SHA may regulate
the rights between the parties which are purely
Therefore, there is no liability to withhold tax,
contractual, and those rights will have efficacy
which gets triggered only when there is income
only in the course of ownership of shares by the
chargeable to tax in India. Vodafone Groups
parties.
earlier investment in Airtel cannot be regarded as
a presence in India to bring Vodafone NL under
the jurisdiction of the ITL.

Vodafone NL cannot be regarded as a

representative taxpayer on behalf of the nonresident which requires that income should have
deemed to accrue in India, as there is no transfer
of capital asset situated in India.

Comments

company, the same would trigger taxable capital gains

under the ITL. However, there have not been
precedents in the past where Tax Authority has
attempted to tax capital gains arising on transfer of
shares of a foreign holding company of an Indian
subsidiary on the basis that such transfer involves an
indirect transfer of the underlying Indian assets. The
ruling of the SC would set a binding precedent for
other similar transactions, as well for those
transactions which are currently being investigated by
the Tax Authority or are in various stages of litigation.
An issue that was extensively argued before the SC
was on the concept of tax avoidance and an attempt
was made by the Tax Authority to dilute the principle
laid down in the SCs Azadi Bachao ruling on an alleged
ground that the said ruling was inconsistent with the
decision of the larger bench of the SC in the
McDowells case. The SC has clarified that there is no
conflict in the decisions and has sought to reiterate
that while tax planning is legitimate, structures that
are subterfuges or colorable devices, need not be
respected for tax purposes.
The ruling also acknowledges that use of holding
companies and investment structures as well as use of
offshore financial centers, can often be driven by
business/commercial purpose and the use of these
elements in international structures, does not imply
tax avoidance.

One of the concerns expressed by several foreign

investors in the context of the Vodafone case is the
Cross-border acquisition of Indian companies has been uncertainty created by the approach of the Tax
a focus of the Tax Authority over the last couple of
Authority. The SC order echoes these concerns of the
years. It is fairly well-established that if the acquisition investor community. The SC has observed that
involved a direct transfer of shares of an Indian
certainty and stability form the basic foundation of any

EY Tax Alert

fiscal system and they are integral to the rule of law.

One would hope that the Government gives due
consideration to these observations while framing its
tax policy and legislative proposals.
The decision of the SC is 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 was 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 India's tax policy on international
taxation and tax avoidance in the future.

EY Tax Alert

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