NATIONAL LAW INSTITUTE UNIVERSITY, BHOPAL

TRIMESTER XI

INTERPRETATION OF STATUTES- 2

TOPIC
FROM MCDOWELL TO VODAFONE: INTERPRETATION OF TAX LAW
IN CASES

SUBMITTED BY – SUBMITTED TO

PRASUN TIWARI ASSOC. PROF. KAVITA SINGH

ROLL NO. – 2016 B.A.LL.B 15

 ACKNOWLEDGEMENT

I would like to extend my sincere thanks to

My teacher and my mentor Assoc. Prof. Kavita Singh for giving me this
wonderful opportunity to work on this project and for his able guidance and
advice, I tаke this opportunity to thаnk everyone who helped me out in
completing this project work directly or indirectly, without whose guidance and
support, it would have been quite difficult to complete this project.

2
 TABLE OF CONTENTS

Table of Contents

INTRODUCTION............................................................................................................................5

TAX PLANNING AND EVASION................................................................................................7

[1.1] Tax avoidance by large corporations.......................................................................................8

[1.2] Rules for interpretation of taxing statutes: When tax avoidance becomes evasion...............10

MCDOWELL V. COMM TAX OFFICER: CASE ANALYSIS...................................................12

[2.1] Brief facts and judgment of the case......................................................................................12

[2.2] Decision in Azadi Bachao Andolan case and the conflict.....................................................14

VODAFONE INTERNATIONAL HOLDINGS V. UOI: CASE ANALYSIS.............................15

[3.1] Brief facts and judgment of the case......................................................................................15

[3.2] Detailed analysis of tax evasion with respect to income tax provisions................................17

[3.3] Extension of McDowell’s principle of purposive construction.............................................18

CONCLUSION..............................................................................................................................19

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 INTRODUCTION
Street at McDowell & Co. In the field of tax governance, Ltd. v. Commercial Tax Officer has been
the subject of major controversy. Although, on the one hand, the face of tax jurisprudence may
seem to have changed, some detractors and writers are of a different opinion that the otherwise
simple and rational presentation of fiscal principles by the Supreme Court is a mere judicial
aberration. Only doubt as to what is appropriate in the assessment of tax liability by the transactions
entered into by the assessee has been increased by judicial pronouncements after McDowell. The
central question, therefore, is where to draw the line between the law 's legitimate tax preparation
and tax evasion, and whether or not what the court tried to do and what it actually did.
The point raised by McDowell in the case was that it is open to all to coordinate their affairs in a
lawful way to mitigate the tax burden and does not constitute tax evasion. The court held that as
long as it is within the scope of the law, tax planning can be valid. It also held, however, that the
legal impact of a transaction was not capable of concealing the content of that transaction and that
colour devices should not be part of tax planning. It also found that every person has an obligation
to pay taxes without resorting to subterfuges. In other words , the court gave the unambiguous law
a purposeful interpretation, which can be argued to be contrary to the concept of the literal rule
that the sense that is most obvious from its reading is to be given effect when the law is plain and
unambiguous, even though it may lead to misfortune and injustice. In the case of Vodafone
International Holdings v. Union of India1, this dispute was supposed to be solved.
Although the facts and concerns in the case are entirely different from McDowell, the topic that is of
interest here is that of tax law interpretation. When the argument was presented before the Supreme
Court regarding the reading of the McDowell decision in the Union of India v. Azadi Bachao Andolan
case, the court found that it could not be interpreted as leading to the conclusion that all tax planning
was unconstitutional, unlawful or impermissible and that there was no dispute between the McDowell
and Azadi Bachao Andola decisions of the Supreme Court. Only after it has been proven by the
evidence that the disputed transaction is a scam and a front for the illegal intent of tax evasion should
the 'substance over form' test be applied. It is important to look at any strategic foreign investment
coming to India in a holistic manner. Simply since capital gains tax is not payable at the time of exit,
the whole "share sale" (investment) will not be a scam or tax avoidance.

In the Azadi Bachao case , the decision was inconsistent with both McDowell and Vodafone, to the
degree that it categorically restored the taxpayer's right to reduce taxes through all valid means. But
at Vodafone Holdings, this matter was completely resolved that Azadi Bachao was not in dispute
with McDowell. After studying the various judgments of the House of Lords in England, the
1
(2012) 6 SCC 613
4|Page
Supreme Court reiterated in delivering the judgement that the Westminster principle (which will
also be addressed in the final draught of the project) is the foundation of the law and that all
taxpayers are entitled to coordinate their affairs in order to minimise tax liability. The fact that the
purpose for a transaction is to escape taxes does not invalidate it unless it is provided for by a clear
enactment. In both of the cases referred to above, the Court referred to the required line of
reasoning to be followed to determine the validity of the transaction. This project aims at analyzing
the same and ascertaining whether there exists scope for further debate.

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TAX PLANNING AND EVASION

The term 'tax planning' applies to the taxpayer's practise of correctly, consistently and orderly
meeting his tax responsibilities, making use of all allowable exemptions , deductions and reliefs
available under the law as may be appropriate to his / her situation. Planning does not simply mean
reducing tax liability, but it also helps to reduce conflict and lawsuits as a result. Via legal
enforcement, every taxpayer is required to voluntarily report his income and tax liabilities. If a tax
payer does not knowingly or knowingly provide truthful information or provide incorrect or false
information to defraud the State, it violates legal rules and is referred to as 'tax evasion'. In other
words, tax evasion means unlawful concealment of income or concealment of income data or
concealment of a single source or source of income or manipulation of accounts in order to inflate
expenditure and other outgoings with a view to illegally reduce the burden of taxation. It is not only
illegal, but also unethical and immoral.

6|Page
 [1.1] Tax avoidance by large corporations

In the case of McDowell Co. Ltd. v. CTO2 the Supreme Court observed –

“Tax Planning may be legitimate provided it is within the framework of law. 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. It is the obligation of every
citizen to pay the taxes honestly without resorting to subterfuges.”

It is a well-established concept that if a person seeking to be taxed falls within the limits of the law,
he must be taxed, however great the hardship might seem to the judicial mind to be. There is no
space for motive, inference or justice in a taxing statute, and there is nothing to be interpreted by
implication; the terms are sufficiently plain. A way around any law can be found, however, with
patience, given the time. In order to legally circumvent taxes, companies and businesses manipulate
the loop holes in tax laws and such acts can not be deemed to be prima facie violations of the law as
it does not specifically define it as such. Since such a condition was not foreseen, literality, here,
becomes the ban for enforcement authorities. The Supreme Court has acknowledged permissible tax
evasion in such a way that taxpayers have the right to organise their affairs in such a manner as to
pay the least possible tax.
However, tax authorities internationally consider taxpayers' aggressive tax planning schemes to
erode the tax base unnaturally, particularly when effective tax rates are dramatically decreasing.
Changing the jurisdiction is the most common form of tax evasion. In those countries where the tax
regime is liberal, which serves a two-fold purpose, business clusters develop: one, they save huge
amounts of tax and two, business clusters can typically have the required expertise to work. For
example, due to the fact that it charges a low rate of 12 percent on trading income, Switzerland is
the core of the global coffee trading market. Therefore, it comes as no surprise that Starbucks is
importing its UK coffee from its Swiss wholesale trading subsidiary.
The competition among such tax jurisdictions to attract multinationals, the lower and more liberal the
tax regulations, the greater the number of large companies that flock there, makes matters even more
difficult to resolve. An Indian company may also incorporate an off-shore company with the principle
of tax evasion, say in a Tax Haven, and then create a WOS in Mauritius and may invest in India after
obtaining a TRC. Therefore, large amounts can be diverted back to India using TRC as a shield, but
once it is identified that such an investment is black money or secret capital, the circular movement of
capital known as Round Tripping is nothing but; then TRC can be ignored because the transaction is
illegal and against national interest.
2
AIR 1986 SC 649
7|Page
 Another issue with regard to tax evasion is overpricing through transfer pricing to shift larger share
of profits to low tax jurisdictions, thereby circumventing the ‘place of establishment’ rule 3. There
have been allegations against Google, Apple, Amazon, Vodafone Holdings etc, recently, of
indulging in blatant tax evasion. While determining whether a particular transaction constitutes as
tax management, tax avoidance or tax evasion, interpretation of the statutes by way of case laws is
of considerable importance.

3
Income Tax Act 1961, s 6(3).
8|Page
 [1.2] Rules for interpretation of taxing statutes: When tax avoidance becomes evasion

It is well founded that it is not to be applied by comparison to criminal and taxing laws to include
acts and circumstances not under the parameters of the law or some theory of substance of the
matter. But this concept does not apply where what is done is actually the thing forbidden, not
forbidden by the law under the cloak or colour of another transaction.8 Grove J. And in A. G. In
Simms v. Registrar of Probates 'evasion' v. Noyes and Lord Hobhouse is considered to have two
definitions, one that means an underhand dealing to prevent that of which the Act applies and two, a
mere deliberate avoidance of anything to which the Act does not apply.
A transaction that is real and not sham by the actions performed is of the essence of a trading
transaction and does not cease to be an adventure or concern in the course of 'trade' in the absence of a
legislative provision, simply because those who engage in it have their eyes set on the fiscal benefit of
avoiding income tax. However, a wholly artificial device that is distant from trade intended for the
purpose of tax avoidance, even if it is genuine and not a fake, can not be treated as a problem with
regard to the essence of trade. In the case of IRC v. Duke of Westminster, the concept that one must
see only the legal essence of the transaction and not the content of the matter is not valid in the event
of a sequence of transactions or a hybrid transaction concluded for tax avoidance purposes. The new
strategy laid down in W. The Indian jurisdiction has adopted T. Ramsay Ltd v. IRC in the McDowell
& Co. case. Ltd v. CTO, where it was noted 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. In our view, the proper way to
construe a taxing statute, while considering a device to avoid tax, is not to ask whether the
provisions should be construed literally or liberally, nor whether the transaction is not unreal and
not prohibited by law, but whether the transaction is a device to avoid tax.”

The conditions for application of this new approach were laid down in Furniss v. Dawson4. These
are –
1. A preordained sequence of transactions or a composite transaction must occur.

2. Steps must be inserted that have no commercial intent, except for tax liability avoidance /
deferment.

Though the Westminster principle is not dead and can still be applied, it is rendered inapplicable in
cases where the Ramsay principle or the new approach has application. The conditions laid down in
Furniss v. Dawson -

4
(1984) 1 All ER 530.
9|Page
1. This must have been done by the pre-ordained sequence of
transactions when the tax saving transaction was entered into.

2. Besides just tax avoidance, the transaction should have had no

other intent.

3. Since there was no possibility of a sequence of transactions not

taking place since expected, the tax saving transaction had no
independent existence.

4. Preordained transactions have been carried out.

In other words, first, In order to ascertain its purpose, the applicable enactment must be construed;
then the sequence of transactions in question must be examined, taken as a whole in order to
determine their true legal impact; and finally, the legislation as defined must be applied to the true
legal effect of such transactions in order to decide whether or not the transaction will be protected
by that legislation. 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.

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 MCDOWELL V. COMM TAX OFFICER: CASE ANALYSIS

[2.1] Brief facts and judgment of the case

Purchasers of Indian liquors pay excise duty under Excise Laws to receive distillery passes. It was
included in the turnover of the liquor producer under the applicable legislation. Excise tax, when
charged by the customer to comply with the manufacturer 's responsibility, is part of the sales
consideration and is included in the manufacturer's turnover. The tax was paid by the customer on
behalf of the producer. With respect to the statute, the producer was responsible for paying the excise
duty on the production of liquor. For the selling of liquor, the excise tax paid on his behalf was an
important part of the consideration. The policy was the combined result of two factors: I the
purchasers had to discharge the manufacturer's liability under a negotiated policy; and (ii) the
transactions of such purchases were not included in the assessee's account books under this system; it
was handled on stage not to be part of the assessee 's trade.
Under that way, the assessee continued to sell liquor and paid sales tax under the A.P. The Sales Tax
Act on the turnover returned by him, which did not include the excise duty number, as reported. The
assessee invented a way not to pay turnover tax, including the duty paid by the purchasers of the
liquor. The Assessing Authority, however, took the view that the assessee had failed to include, in its
turnover, the amount of excise duty paid to the Excise Department by its purchasers. The assessee
questioned this view, but the Evaluating Authority agreed with the High Court. The assessee filed an
appeal to the Supreme Court. The excise laws as well as the sales tax laws were checked by a Supreme
Court Division Bench.
Held: The fact that the excise duty does not form part of the circulating capital within the general
till of the producer (assessee) does not constitute a definitive test for deciding if such duty
constitutes the turnover of the seller. Tax planning, if it is within the legal structure, can be valid.
Colourable devices should not be part of tax preparation and it is incorrect to promote or perpetuate
the illusion that by resorting to questionable methods, avoiding the payment of tax is honourable. It
is the responsibility of every person to honestly pay taxes without resorting to subterfuges.

The Supreme Court, while making a distinction between tax avoidance and tax planning in this
case, famously observed –

“Tax Planning may be legitimate provided it is within the framework of law. Colorable devises
cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is

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honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every
citizen to pay the taxes honestly without resorting to subterfuges.”

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 [2.2] Decision in Azadi Bachao Andolan case and the conflict
The Supreme Court ruled in the McDowell case that colorable devices and subterfuges do not
constitute valid tax planning. In the case of Azadi Bachao Andolan, the Indian Supreme Court held
that treaty shopping was a valid exercise of tax planning and that, in the absence of explicit treaty
clauses restricting such benefits, AIML could not be denied the benefits of the Mauritius Treaty.
Considering that the shares were owned for a significant period of time by AIML and are proposed
to be sold at fair market value, the arrangement was not considered by the AAR as a tax avoidance
scheme. The advantages of the Treaty have therefore been confirmed for citizens of Mauritius who
are entitled to a valid tax residency certificate provided by the Government of Mauritius. The
understanding of the nature and nature of the judicial position is what separates Azadi Bachao from
McDowell. The McDowell court has never clarified that any action or omission on the part of the
taxpayer resulting in a reduction of the tax liability to which the taxpayer may be subjected in the
future must be regarded with suspicion and viewed as a tax avoidance mechanism irrespective of the
validity or validity of the act. The principle set out in the foregoing case has not affected the right of
the citizen to behave in the manner prescribed by him, in the manner in which he wishes to carry out
any business, operation or preparation of his affairs with circumspection, within the scope of the law,
unless it falls within the category of colourful devices. But the interpretation of McDowell in Azadi
Bacaho tends towards the extreme, where it supposes all transactions to be scrutinized under the
substance over form test, which is clearly not the intention of the judges in the former. 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.

While Reddy's Chinnappa, J. There are a variety of findings on the need to deviate from the concept
of Westminster and tax evasion, which are obviously only in the form of artificial and colourful
devices. Reading McDowell, there is no disagreement between McDowell and Azadi Bachao.25

in the manner suggested above in cases of treaty shopping and/or tax avoidance.

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 VODAFONE INTERNATIONAL HOLDINGS V. UOI: CASE ANALYSIS

The Vodafone tax case poses an important question about the taxability of a non-resident corporation
purchasing, via an indirect path, the shares of a resident company. This is a landmark case, as the tax
departments have, for the first time, tried to tax a corporation through a method to trace the source of
the acquisition. Although we have heard of lifting the 'corporate veil,' this example has set a rare
example in which the Indian tax authorities have gone to the extent of manipulating the current tax
laws to bring a multinational corporation such as Vodafone into its tax setting.
[3.1] Brief facts and judgment of the case

Vodafone International Holdings BV (VIH), a company resident for tax purposes in the Netherlands,
has purchased the entire share capital of CGP Investments Holdings Ltd (CGP), a company resident
for tax purposes in the Cayman Islands, which holds a 52% interest in Hindustan Essar Ltd (HEL) and
rights to acquire a further 15% interest in HEL, subject to FDI relaxation. The suspected goal of this
deal was to obtain a controlling interest of 67% in HEL. Another question at issue in this case was the
relevance of the case of Azadi Bachao as opposed to the case of McDowell, which describes how tax
evasion can be brought into the tax net in such situations.
Held: The Supreme Court delivered a judgement in favour of Vodafone, stating, inter alia, that no
Indian tax on the transfer of offshore assets between two non-residents was needed to be withheld.
A corporate reorganisation free of tax does not constitute a colourful device per se.

The Finance Act, 2012 introduced Explanation 5 to Section 9 (1) (i) of the Income-tax Act, 1961
clarifying that an offshore capital asset would be considered to have a situs in India if it

24 Ashish Sodhani and Shreya Rao, ‘Landmark International Tax Cases decided by Indian Judiciary -
Summary’ (Nishith Desai, 6 July 2013)
<http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research
%20Articles/Landmark%20International%20Tax.pdf> accessed 25 September 2015.
25 Vodafone International Holdings v UOI (2012) 6 SCC 613.

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 substantially derived its value – directly or indirectly – from assets situated in India. The
amendment is currently retroactively applicable from 1961. 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), then all income derived even indirectly
from such transfer, even though abroad, becomes taxable in India. This claim, however, was
dismissed as an incorrect reading of S by the court. 9 of the Act on Income Tax, 1961. The revenue
dealt with in each of the sub-clauses must be read separately from each other, and it is not possible
to attempt the fulfilment of others' requirements with respect to one. In this case, the revenue in
question is 'the transfer of a capital asset situated in India,' for which it is appropriate to satisfy the
elements of the transfer, the presence of a capital asset, and the condition of that asset in India in
order to be taxable. Thus, the income accruing or arising from the transfer of a capital asset located
in India to a non-resident outside India is fictitiously considered to accrue or occur in India, the
income of which is liable to be taxed under Section 5(2)(b) of the Act. This is the key intention
behind Section 9(1)(i) of the Act 's enactment.

A legal fiction, however, has limited scope and can not be extended by providing a purposeful interpretation,
especially if the effect of such an interpretation is to turn the definition of chargeability that already exists in
Section 9(1)(i), particularly when Section 9(1)(i) and Section 5(2)(b) of the Act are referred to. Therefore,
under this clause, indirect transactions can not be covered.
[3.2] 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, notwithstanding the location of the parent company. However, in certain cases where the
executive decision-making of the subsidiary company has become fully subordinate to the parent
company, so much so that, the executive board of the subsidiary has become a mere puppet in the
hands of the parent company, a visible change occurs in the rule of residence stated above. In the
instant case, Vodafone argued that the entire transaction had taken place overseas and India had no
jurisdiction to tax the same. A analysis of all the facts and circumstances surrounding the
transaction decides whether a transaction is used solely as a colourable instrument for the allocation
of revenues, benefits and gains. The theory of raising the corporate veil or the doctrine of content
over appearance or the concept of beneficial ownership or the concept of alter ego emerges in the
above cases. The corporate business intent of a transaction is proof that the transaction at issue is
not carried out as a colourful or artificial device. In order to resolve the evidence of a device, the
greater the evidence of a device, the better the corporate business intent must exist.
 [3.3] Extension of McDowell’s principle of purposive construction

In Vodafone Holdings, the court upheld the validity of the judgment in McDowell and rejected the
misconstrued reading of the same in Azai Bachao. Mishra, J. 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. 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. It is the obligation of
every citizen to pay the taxes honestly without resorting to subterfuges.”

Reddy, J. has opined while agreeing with the judgment of Mishra, J. that –

“The principle of Westminster has been given a decent burial in England, where the term tax
avoidance originated. The judicial attitude towards tax avoidance has changed and the Courts are
now concerning themselves not merely with the genuineness of a transaction, but with the intended
effect of it for fiscal purposes.”

In the case of Mathuram Agarwal v. Sate of MP5 a five judge bench of the Supreme Court held that
the subject-matter is not to be taxed by implication or comparison, but only by the plain words of a
statute applicable to the facts and circumstances in each case, which means that, without legislative
assistance, revenue officials may not tax and that every taxpayer is entitled to arrange his affairs in
such a way that his taxes are as low as possible and that he is not obliged to follow that pattern.
Therefore, in the case of Vodafone Holdings Ltd, the claim of the revenue authorities that the
McDowell ratio is contrary to that of Azadi Bachao Andolan has been dismissed by the court and
the reopening of the case has been denied. Therefore, the purposeful construction adopted at
McDowell is still nice and has also been adopted in the present case.

5
(1999) 8 SCC 667
 CONCLUSION

The principle of purposive construction adopted in McDowell has been repeatedly upheld in
subsequent cases, despite the confusion that arose from the decision in Azadi Bachao Andolan. 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. This was dispelled by the judgment in Vodafone. While
the Westminster principle states that – “Given that a document or transaction is genuine, the court
cannot go behind it to some supposed underlying substance”, Ramsay notes that instead of an over-
arching anti-avoidance doctrine based on tax laws, the concept of statutory interpretation is
therefore just a reading of the Westminster case in the proper sense under which the 'kit' that was
colourful in nature had to be disregarded as fiscal nullity. Similarly, Vodafone has observed that the
revenue authorities may invoke the principle of 'substance over form' or 'piercing the corporate veil'
in the application of a judicial anti-avoidance rule only after it is able to decide on the basis of the
facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax
avoidant. In other words, if the interposition of a holding company has been proved to have no
commercial substance, fiscal nullity can be resorted to the revenue authorities. However, 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. 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 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. 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, which can adversely
affect the corporate entities.