IMPACT OF VODAFONE TAX CASE ON MERGERS AND ACQUISITION IN INDIA

Tax Management

Shalma 091202043
Suneeta 091202114
Supriya 09102030
Srinivasan 091202062
Abhishek 0912020
The recent notice for a potential $2 billion tax claim, issued by the Indian income-tax authorities
is about Vodafone’s purchase of stake of Hutchison Telecom International (HTIL) in Hutchison
Essar. The controversy that it has stirred is about the taxability of such transfers. In this case, it
appears that HTIL (the non-resident seller and parent company) sold its stake in the foreign
investment company, which in turn held shares of Hutchison Essar (the Indian company), to
Vodafone (the non-resident purchaser).

The Income-Tax Act, 1961 specifies the scope of taxable income of a non-resident. As per
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”. It does not include income that accrues or arises or is deemed to accrue or arise outside
India.
Taxability on the basis of asset located in India is spoken of in Section 9(1)(i). It says that
income is deemed to accrue or arise in India if it is from transfer of an asset situated in India or
through or from business connection in India and, hence, liable to tax in India.

In the case under discussion, the transfer is of shares of investment company situated outside
India and, as such, should not be liable to tax in India. However, the income-tax authorities
seem to be taking a view that this transfer effectively represents transfer of the beneficial interest
in the shares of the underlying Indian company and, hence, it would attract tax in India.

The fact that Hutchison and Vodafone had to take approval from the Indian authorities such as
the FIPB (Foreign Investment Promotion Board), as the underlying asset is in India, has
compounded the issue. This seems to be a clear case of tax authorities attempting to lift the
corporate veil, an extreme measure generally taken in cases of fraud and legal violation.

In the case of investment from certain countries such as Mauritius, Cyprus and Singapore,
capital gains are not liable to tax in India under the DTAAs (double taxation avoidance
agreements). However, it appears that in the instant case, the non-resident seller of shares is a
Hong Kong-based company. As India does not have any DTAA with Hong Kong, no treaty
benefit could be availed of.

Section 195 of the I-T Act casts an obligation on a person responsible for paying any sum —
which is chargeable to tax in India — to a non-resident to deduct income-tax at source at the time
of payment or credit. It is well established that the liability to deduct tax applies to non-residents
as well as residents. Thus, in our view, a non-resident purchaser (that is, the payer) is liable to
deduct the tax at source if the transaction is liable to tax in India. Liability for deduction of tax
is, therefore, on the transferee company.

According to Section 160(1) of the I-T 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. In our view, it is
difficult to consider the Indian company as an agent, merely because it is a subsidiary of the non-
resident.
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 11 billion 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.

Impact on Mergers and Acquisition in India:-

"India is a booming economy,’ 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.
As most of the assets of the Vodafone company are in India, it seems reasonable to us that the
Indian government should be able to tax them. The Vodafone issue has been around for the past
three years, since then most M&A transactions have been very careful in structuring the deals. It
is not that people will drop an M&A deal if India is involved. But 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 authority. 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.