New Law College

Internal Assignment Submission –

INTERPRETATION OF STATUTES

Mayank Sharma
FYLLB, Div. A
Roll No. 051
Contents
D E C L A R A T I O N ................................................................................. Error! Bookmark not defined.
CHAPTER I................................................................................................................................................ 2
INTRODUCTION AND REASERCH METHEDOLOGY : ................................................................................ 2
Synopsis: ............................................................................................................................................. 2
Introduction ......................................................................................................................................... 2
Research Methodology ....................................................................................................................... 3
Aims and objectives: ....................................................................................................................... 3
Scope and limitations: ..................................................................................................................... 4
Hypothesis: ..................................................................................................................................... 4
Statement of Problem:..................................................................................................................... 4
Mode of Writing ............................................................................................................................. 5
Mode of Citation ............................................................................................................................. 5
Chapter II................................................................................................................................................. 6
CONSIDERATIONS GUIDING THE INTERPRETATION OF TAX STATUTES.................................................. 6
I. The classical rule: Strict construction of taxing statutes ............................................................. 6
II. Dilutions to the Principle of Strict Construction ......................................................................... 8
A shift to purposive construction? .................................................................................................. 8
Chapter III.............................................................................................................................................. 14
Vodafone Saga and its Critical Analysis ................................................................................................ 14
Chapter IV ............................................................................................................................................. 16
Conclusion ............................................................................................................................................. 16
 CHAPTER I

INTRODUCTION AND REASERCH METHEDOLOGY :

Synopsis:

Introduction
In this paper, the researcher studies the ancient maxim that taxing statutes have to be construed
strictly with special reference of Vodafone judgment. Beginning with a discussion of the
classical rule, the researcher moves on to focus on the various dilutions to the rule of strict
construction and comment on the same. These include a shift to purposive construction,
external aids, machinery provisions, exemptions and evasions. The purpose is to gather a sense
of what could be driving the judiciary to dilute the rule of strict construction and the
implications of the same.

Tax avoidance through artificial devices — holding companies, subsidiaries, treaty shopping
and selling valuable properties indirectly by entering into a maze of framework agreements —
has become a very lucrative industry today.

A large part of the income of the ‘Big 5' accountancy and consultancy firms derives from tax
avoidance schemes which flourish in the name of tax planning. Their legality has agitated
courts in India and abroad for a long time. In 1985, a 5-judge bench of the Supreme Court in
the McDowell case settled the question decisively, observing:

“In that very country where the phrase ‘tax avoidance' originated, the judicial attitude towards
[it] has changed and the smile, cynical or even affectionate though it might have been at one
time, has now frozen into a deep frown. The courts are now concerning themselves not merely
with the genuineness of a transaction, but with [its] intended effect for fiscal purposes. No one
can now get away with a tax avoidance project with the mere statement that there is nothing
illegal about it. In our view, the proper way to construe a taxing statute, while considering a
device to avoid tax is … to ask … whether the transaction is a device to avoid tax, and whether
the transaction is such that the judicial process may accord its approval to it.”

“It is neither fair not desirable to expect the legislature to … take care of every device and
scheme to avoid taxation,” the ruling added. “It is up to the Court … to determine the nature
of the new and sophisticated legal devices to avoid tax ... expose [them] for what they really
are and refuse to give judicial benediction.”
‘Legitimate tax planning'

Despite such a clear pronouncement, recent judgments of smaller Supreme Court benches have
gone back to calling artificial tax avoidance devices “legitimate tax planning”.

Though the Income Tax Act obliges even non-residents to pay tax on incomes earned in India,
many foreign institutional investors avoided paying taxes citing the Double Taxation Treaty
with Mauritius. This treaty says a company will be taxed only in the country where it is
domiciled. All these FIIs, though based in other countries and operating exclusively in India,
claimed Mauritian domicile by virtue of being registered there under the Mauritius Offshore
Business Activities Act (MOBA). Companies registered under MOBA are not allowed to
acquire property, invest or conduct business in Mauritius.

Yet these ‘Post Box Companies' claimed to be domiciled there and the I-T department allowed
them to get away with claiming the benefits of the treaty for many years. Given the benign
attitude of the Indian tax authorities and the fact that there was no capital gains tax and virtually
no tax at all on these companies in Mauritius, most FIIs and most of the foreign investment in
India, by 2000, came to be routed through Mauritius.

The party finally ended when a proactive tax officer tried to stop this blatant evasion. Relying
on McDowell, he lifted the corporate veil of MOBA companies to determine their place of
management and actual place of residence. Since this happened to be in different countries in
Europe or North America, the relevant Double Tax Avoidance treaty became the one between
India and that country. All these treaties provided for capital gains to be taxed where the gains
had accrued. Since the gains accrued in India, he levied capital gains tax on these FIIs.

.Research Methodology

Aims and objectives:

The aim of this project is to look at the Vodafone judgement passed by the honourable Supreme
Court and its consequences. Thereby analyzing the various concepts in Taxation Law such as
Tax avoidance, Capital Gain etc and the way it has been dealt to incur the liabilities.

 To understand the concept of tax avoidance.

 Taxing statutes have to be construed strictly
  To analyze that just because the operating company pays taxes in India, can the investor
company be exempted from Capital gains tax.
 To examine the various impacts caused by tax haven concept.
 To determine the impact of the judgment with special reference to FDI.

Scope and limitations:

In this paper, the researcher studies the ancient maxim that taxing statutes have to be construed
strictly. Beginning with a discussion of the classical rule, the researcher moves on to focus on
the various dilutions to the rule of strict construction and comment on the same. These include
a shift to purposive construction, external aids, machinery provisions, exemptions and
evasions. The purpose is to gather a sense of what could be driving the judiciary to dilute the
rule of strict construction and the implications of the same.

Also, the project limits itself to studying of the Vodafone judgement by the Honourable
Supreme Court. It even observes the tax laws under Income tax Act 1961.

The researcher’s study was even limited by his understanding as there could be some basic
observations which he might have failed to put forward in the project due to limited
understanding of the subject.

Hypothesis:

1. Taxing statutes have to be construed strictly.

2. A normal view would be that if one non-resident sells shares of a foreign company to
another non-resident of India; and the transaction takes place outside India, there can
be no tax on the same.

3. In Vodafone case, clearly a series of tax havens and SPVs (Special Purpose Vehicle)
have been used to avoid Indian Taxes.
Statement of Problem:

Department’s view – in brief: Department’s claim, in essence was: CGP is a nullity, a sham
entity. Transfer of CGP’s shares has no substance. The parties to the transfer themselves
laid bare the real transaction – that of sale of HEL stake. Real transfer is: The transfer of
substantial interest (67% stake) in HEL. This controlling shareholding has its situs in
India. Since the transferred asset is situated in India, the capital gains arising on the same is
liable to tax in India. VIH was therefore required to deduct tax at source.

Honourable Supreme Court has given a ruling that – only the legal transaction –sale of CGP
share - is to be considered. By selling CGP share, the seller may have transferred its interests
in HEL. However, Indian interest arises due to sale of CGP share. It does not arise out of the
SPA (which recorded the real facts). All the arguments of the revenue were rejected.

Crux of the matter: Should one simply consider the legal form of the transaction (i.e., sale of
one share in CGP); or should one consider real form - the entire set of facts as stated
by the parties themselves in the SPA and various other correspondences? Is the case fit
for considering “Substance over Form”? Is the case fit for lifting the Corporate Veil?

Mode of Writing
A descriptive and analytical method of writing has been followed.

Mode of Citation
A uniform mode of Citation has been followed.
 Chapter II

CONSIDERATIONS GUIDING THE INTERPRETATION OF TAX STATUTES

I. The classical rule: Strict construction of taxing statutes

The classical rule with regard to the construction of taxing statutes is that they should be strictly
construed. It is a well-established rule that can be traced to common law in England and has
been imported into the Indian legal system as well.1

A person should not be taxed unless there are clear words indicating that purpose. Every statute
must be read “according to the natural construction of its words”.2 In a taxing statute, it is only
what is clearly said that needs to be looked at. Considerations guiding the interpretation of
taxing statutes cannot include equity or presumptions. Nothing must be read in or implied. In
the interpretation of taxing statutes, the language of the statute is the only thing that can be
fairly looked at.3 This has been the classical approach towards the interpretation of tax statutes
as followed in England as well as in India.

The rationale for the strict construction of taxing statutes lies in the fact that they impose
pecuniary burdens. Therefore, in some sense, they operate as penalties. It is on the basis of this
that clear and unambiguous language is required in order to make out a charge of tax.4

This rule of strict construction is also known as the Duke of Westminster principle, being
named after its famous exposition in the case of IRC v. The Duke of Westminster5. In this case,
the respondent i.e. Duke of Westminster, covenanted to pay his gardener an yearly sum for a
period of seven years without prejudice to the remuneration received by the gardener for his
services. The Duke then sought to deduct such payments in order to ascertain his total taxable
income for surtax. The Revenue i.e. Appellant however sought to show these payments as
payments of salary or wages and impose tax thereon. In this case, the court rejected the
argument that in the construction of taxing statutes, it must ignore the legal position and instead
focus on “the substance of the matter”. The court observed that every person is entitled to
arrange his affairs in such a manner that the burden of tax that falls upon him be as low as

1
G.P. Singh, PRINCIPLES OF STATUTORY INTERPRETATION, 815 (12th edn., 2010).
2
In re Micklethwait, (1885) 11 Ex 452 (Court of Exchequer Chamber); Tennant v. Smith, [1892] A.C. 150 (House
of Lords).
3
Cape Brandy Syndicate v. Inland Revenue Commissioners, [1921] 1 K.B. 64 (King’s Bench Division).
4
P.B. Maxwell, INTERPRETATION OF STATUTES, 256 (12th edn., 1962).
5
The Commissioners of Inland Revenue v. The Duke of Westminster, [1936] A.C. 1 (House of Lords).
legally permissible. The doctrine of “substance of the matter” cannot be used to impose a
greater liability on the person. It is the true nature of the legal obligation and nothing else that
is the substance. On this basis, the court dismissed the appeal.6

As mentioned before, this line of reasoning has found resonance in India too. The Supreme
Court of India has reiterated the position that it is a maxim of tax law that tax is not to be
imposed on a person unless the words of the taxing statute are unambiguous.7 The Supreme
Court has observed that the strict letter of the law is to be considered in determining tax liability
and not other things such as the spirit of the statute or the substance of the law. If the Court is
satisfied that a case falls within the provisions, then a tax can be imposed. However, if a
situation does not fall within the “four corners of the provisions of the taxing statute”, no tax
can be imposed. Inference, analogy and probing of legislative intent in order to get to the
substance of the matter are not permitted in the interpretation of tax statutes.8

A taxing statute has three components: the subject of the tax, the person liable to pay tax and
the rate at which tax is to be paid. In the case of ambiguity regarding any of these three
ingredients in a taxing statute, there is no tax in law. Unless the legislature does not modify the
defect, no tax can be imposed as per law. This is because taxing statutes need to be strictly
construed.9

Another principle of statutory interpretation that is seen with respect to taxing statutes is that
the courts must favour the assessee in case there is ambiguity and two or more reasonable
interpretations of the taxing provisions exist.10

Thus, in this section, it has been seen that the judiciary has stressed on the requirement of clear
and unambiguous language in order to impose a tax upon an individual. This strict rule of has
governed the interpretation of tax statutes. However, from the latter half of the previous
century, several dilutions to this strict rule have been seen. In the following sections of this
paper, the researcher seeks to discuss these detours from the straight route laid down by the
rule of strict construction

6
The Commissioners of Inland Revenue v. The Duke of Westminster, [1936] A.C. 1 (House of Lords).
7
Mathuram Agrawal v. The State of Madhya Pradesh, AIR 2000 SC 109 (Supreme Court of India).
8
A.V. Fernandez v. State of Kerala, AIR 1957 SC 657 (Supreme Court of India).
9
Mathuram Agrawal v. The State of Madhya Pradesh, AIR 2000 SC 109 (Supreme Court of India).
10
CIT v. Karamchand Premchand Ltd., AIR 1960 SC 1175 (Supreme Court of India).
 II. Dilutions to the Principle of Strict Construction

A shift to purposive construction?

As has been noted above, the strict rule of construction has been subject to some dilution,
especially since the latter half of the previous century.

A good example of this was seen in the decision of the Supreme Court in CCE v. ACER India
Ltd.11. The main question in the case revolved around whether the value of operational software
could be deducted from the total value of computers supplied to customers in the calculation
of the amount of central excise payable as duty. In this background, an entire section of the
judgment was directed towards the principles guiding the interpretation of taxing statutes. The
Supreme Court noted that the imposition of tax is a constitutional function. It referred to the
strict construction that needs to be given to taxing statutes. It also observed that the doctrine of
“substance of the matter” had been rejected. However, the court noted several other
considerations to be made in the interpretation of taxing statutes that fall outside the four
corners of the language of the statute.12

In the eyes of the researcher, many of these signify a departure from the strict rule of
interpretation. Some of these had their basis in previous judgments whereas some others
seemed to be pronounced by the court for the first time. To begin with, the Court noted that
existing market practice must be a consideration behind the interpretation of taxing statutes.
Similarly, the court also noted that public policy could be a guiding factor in the interpretation
and application of taxing statutes. 13

The court also noted that the statute must not be interpreted in such a manner that it leads to
the wide scale evasion of duty. An interpretation based on this dictum can have significantly
different results in practice from those seen earlier based upon the strict rule of interpretation.
While, in this case, the dictum was motivated by the desire to prevent consumers of computer
products from having to face the burden of excess duty imposed on the respondent, its
ramifications on other types of cases involving taxation can be quite telling. The researcher
opines that this would go far in tilting the balance of power in favour of the Revenue.14

11
Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of
India).
12
Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of
India).
13
Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of
India).
14
Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of
India).
Most importantly, the Supreme Court made observations expressly providing that the rule of
strict construction was not to be always applied in the interpretation of tax statutes. The
Supreme Court noted that the principle of strict construction may not be adhered to in case the
statutory construction can reasonably have only one meaning. The court went on to substantiate
this by the statement that the principle of purposive construction will be adhered to in case the
literal meaning results in absurdity. The Supreme Court here explicitly provided that purposive
construction could be given precedence over literal meaning in the case of absurdity and that
this maxim is applicable even in the case of taxing statutes.15 This is reflective of the shift in
favour of purposive construction, at least in some cases, even in the interpretation of taxing
statutes. This is extremely significant because this allows the courts to go beyond the four
corners of the statute in order to determine “legislative purpose” in a manner that was not
allowed hitherto. This is an extremely controversial and significant shift which leaves open a
wide range of conclusions open with respect to the interpretation of tax statutes. It might be
argued that it purposive construction would only come into operation in case literal
construction leads to absurd results. Yet, even this must be seen to be significant. The following
paragraph illustrates a case where this difference has been seen.

In the case of CWS v. CIT16, the Court delved into provisions of the Income Tax Act, 1961
revolving around the imposition of tax on the appellant, which was the assessee company, with
regard to expenditure on the company’s assets used by its employees either partly or wholly
for their own benefit. A plain reading of the statute would have meant that liability could not
be imposed. However, the court went ahead to uphold the assessment of the Revenue on the
basis of a reading of the statute along with legislative intent to tax. The court compared the
impugned provision with analogous provisions in previous and successive versions of the
Income Tax Act and concluded that the assessee must be held liable for tax in accordance with
its reading of Parliamentary intention. The Court stated that non-taxation here would be a result
that would be incongruous, discriminatory and most importantly, absurd. The court opined that
though literal construction was the general rule in the interpretation of tax statutes, it could not
be adhered to in case the result was incongruous, discriminatory or absurd. It stated that
interpretation of statutes could not be a mechanical exercise. It held that the object of all
interpretation was to give effect to the object of the enactment with regard to the language used.
In this manner, the Supreme Court went ahead to affirm the taxation of the assessee company

15
Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of
India).
16
C.W.S. (India) Ltd. v. Commissioner of Income Tax, JT 1994 (3) SC 116 (Supreme Court of India).
i.e. the appellant in spite of the fact that literal interpretation would have led to a contrary result
of non-taxation.17

It is submitted that while such decisions of the Supreme Court might seem as the right step in
order to ensure that the ends of justice are met in a particular case, they also create a large
enough window of opportunity allowing for some unnecessary judicial flexibility that could
negatively impact the interpretation of tax statutes when they operate as precedents. Grandiose
declarations embracing purposive construction and privileging it over strict construction can
lead to unintended consequences. The problem would lie not in ascertaining the existence of
absurdity. Like most cases, the problem would lie in ascertaining legislative intent and the
purpose of the statute. The researcher feels that the availability of such interpretive capacity in
the hands of the judiciary could lead to a strengthening of the position of the Revenue as against
the assessee and seriously impact the interests of the assessee in this manner.

The following sections highlight certain other dilutions to the rule of strict construction.

a. The usage of external aids

It has been seen that courts have employed certain external aids in the interpretation of taxing
provisions. In doing so, they have gone beyond the four corners of the language of the statute
and have thereby diluted the rule of strict construction.

For example, in the case of Nawn Estates v. CIT18, the Supreme Court was called upon to
interpret the term ‘investment’ as found in the Income Tax Act, 1922. This term had not been
defined by the statute. The Supreme Court considered various external aids in coming to the
conclusion that the appellant was to be brought within the purview of the tax on the basis that
it was an ‘investment company’. The Court considered the legislative history of the Income
Tax Act 1922, right from its amendment in 1955. It also considered the legislative history of
the Income Tax Act, 1961. The Supreme Court also sought to substantiate its position on the
understanding of ‘investment’ in common business parlance. Significantly, the Court even
went on to recognise that English authorities can be useful guides in the interpretation of
analogous provisions, fundamental concepts and general principles “unaffected by the
specialties of the English Income Tax Statutes”. Again, it is reiterated that while the Court may
have concluded rightly in the case, the acceptance of such a broad variety of external aids to

17
C.W.S. (India) Ltd. v. Commissioner of Income Tax, JT 1994 (3) SC 116 (Supreme Court of India).
18
Nawn Estates (P) Ltd. v. C.I.T, West Bengal (1977) 1 SCC 7 (Supreme Court of Indi a).
construction can lead to some vulnerability of the rule of strict construction. The researcher is
especially concerned with the idea of usage of analogous English provisions in the
interpretation of Indian counterparts. It must be understood that taxing environments and policy
considerations in the two countries are different. Therefore, the researcher opines that
importing an English understanding of specific taxing provisions to the Indian scenario will
lead to more questions than the solutions it provides. Extreme caution needs to be exercised by
the interpreting authority in this regard.

b. Exemptions

An area of considerable disagreement in the construction of taxing statutes has been that of
exemptions. An exemption is an exception from the general obligation to pay taxes.19 There
are two opinions on the matter of construction of exemptions in case of ambiguity. According
to one view, an exemption must be liberally construed so as to benefit the assessee from then
operation of the duty. The other view is that exemptions tend to increase the burden on the
general burden of taxpayers, and for this reason, they must be strictly construed against the
assessee.20

There is no presumption with regard to the application of exemption. The person claiming the
exemption has to establish that he is entitled to it as per the language of the taxing enactment.21

An example of the liberal interpretation of exemptions was seen in CCE v. NE Tobacco

Company22. The question was whether the unit or factory established by the respondent in a
certain Export Promotion Industrial Park could be given the status of a ‘new industrial unit’ so
as to avail an exemption. The Supreme Court held that an exemption notification must be
liberally construed in favour of the respondent. It therefore dismissed the appeal.23 However,
it must be mentioned that there are various authorities in opposition to this view, including
various other judgments of the Supreme Court.

An illustration is the case of Orissa State Warehousing Corporation v. CIT24. In this case, the
appellant sought to benefit from an exemption on the basis of Section 10(29) of the Income

19
A.B. Kafatiya, INTERPRETATION OF STATUTES, 293 (2008).
20
Singh, supra note 1, at 839 and 840.
21
Commissioner of Income Tax v. Ramakrishna Deo, AIR 1959 SC 239 (Supreme Court of India).
22
Commissioner of Central Excise v. North- Eastern Tobacco Company, AIR 2003 SC 616 (Supreme Court of
India).
23
Commissioner of Central Excise v. North- Eastern Tobacco Company, AIR 2003 SC 616 (Supreme Court of
India).
24
Orissa State Warehousing Corporation v. Commissioner of Income Tax, AIR 1999 SC 1388 (Supreme Court
of India).
Tax Act, 1961. The appellant argued that liberal interpretation must be given to income derived
from “letting out of godowns or warehouses for storage, processing or facilitating the
marketing” so as to include interest derived on fixed deposits. The Supreme Court observed
that exemptions are an exception to the general rule that a taxing statute must be construed in
favour of the assessee in case of ambiguity. The Court, dismissing the appeal, held that
entitlement for exemptions should not be read with any wider connotation or latitude to the
taxpayer. This case was an example of the literal approach to construction of exemptions.25

Therefore, it can be concluded that authorities exist in support of both liberal as well as literal
interpretation of exemption provisions in statutes.

However, where there is a beneficient object, such as increased production or incentives to co-
operatives, exemption provisions are to be liberally construed. In the case of CIT v. Straw
Board Manufacturing26, the Supreme Court employed liberal interpretation to strawboard
within the expression ‘paper and pulp’ so as to enable the respondent to benefit from
concessions for the furtherance of industrial activity.27

The researcher opines that the observations of the Supreme Court in UoI v Wood
Papers28provides a part of the solution in resolving the conflicting methods of interpretation of
exemptions. The Court noted that the applicability of an exemption needs to be strictly viewed
keeping in mind legislative intent, inequitable burden on taxpayers and augmentation of
revenue. However, once doubt about applicability is removed, and it is ascertained that the
assessee was meant to be entitled, and then a liberal construction is appropriate. Therefore,
strict and liberal constructions are to be invoked at different stages of interpretation of an
exemption provision.29

The researcher is in agreement with this reading by the Supreme Court.

c. Machinery provisions

It has been held by the Supreme Court that a fiscal statute must be strictly construed only with
regard to taxing provisions such as charging provisions and not to machinery provisions. A

25
Orissa State Warehousing Corporation v. Commissioner of Income Tax, AIR 1999 SC 1388 (Supreme Court
of India).
26
Commissioner of Income Tax, Amritsar v. Straw Board Manufacturing Co. Ltd., AIR 1989 SC 1490
(Supreme Court of India).
27
Commissioner of Income Tax, Amritsar v. Straw Board Manufacturing Co. Ltd., AIR 1989 SC 1490
(Supreme Court of India).
28
Union of India v. M/S Wood Papers Ltd., AIR 1991 SC 2049 (Supreme Court of India).
29
Union of India v. M/S Wood Papers Ltd., AIR 1991 SC 2049 (Supreme Court of India).
machinery section should be so construed so as to effectuate liability.30 The researcher agrees
with this line of reasoning. As long as the subject, assessee and the rate of tax are clear,
procedural aspects like the machinery for enforcement must not allow one to escape the
clutches of taxation.

d. Evasion of tax

A significant departure from the Westminster principle was seen in the decision of the House
of Lords in Ramsay v. IRC31. In this case, the taxpayer company sought to reduce its capital
gains tax through a series of transactions that would create artificial capital losses. Each of
these losses would seem “genuine” as per the Westminster principle. But taken on the whole,
the effect was that the company would escape tax liability. The court held that it could not
stand still in the face of increasingly sophisticated devices of tax avoidance. It had to view the
scheme as a whole and not step by step. Holding that the court could not apply the Westminster
principle for sham transactions, the appeal was dismissed.32

The above decision significantly formed the backbone of the decision of the Constitution Bench
of the Supreme Court in McDowell v. CTO33 (“McDowell”). The Supreme Court dramatically
held that the Westminster principle had been buried in England and that India should also
dissociate itself from the principle. The court stated that intended effect of a transaction for
fiscal purposes had to be considered in determining tax liability and that no one could get away
with a tax avoidance project merely by stating that nothing was illegal about it. The court was
motivated by various ill-effects of tax avoidance such as loss of revenue, piling up of black
money, burden on remaining taxpayers, inequity of advice available to the Revenue and the
skillful avoider. The Court also observed that tax avoidance was unethical in a welfare state.
The court held that the construction of a scheme of tax avoidance was neither liberal nor literal.
Rather, the question is whether a transaction is a device to avoid tax and whether the judiciary
can accord approval to it. The Court had to take stock of new and sophisticated legal devices
and relate it to existing legislation with the help of “emerging” techniques of interpretation.34

This above case was notably criticized by the Supreme Court itself in Union of India v. Azadi
Bachao Andolan35. The Court here referred to various authorities to support its proposition that

30
CIT Central, Calcutta v. National Taj Traders, AIR 1980 SC 485 (Supreme Court of India).
31
W.T. Ramsay v. Inland Revenue Commissioners, [1982] A.C. 300 (House of Lords).
32
W.T. Ramsay v. Inland Revenue Commissioners, [1982] A.C. 300 (House of Lords).
33
McDowell and Co. v. Commercial Tax Officer, AIR 1986 SC 649 (Supreme Court of India).
34
McDowell and Co. v. Commercial Tax Officer, AIR 1986 SC 649 (Supreme Court of India).
35
Union of India v. Azadi Bachao Andolan, AIR 2004 SC 1107 (Supreme Court of India).
the Westminster principle was dead. However, it incorrectly held that the concurring judgment
in the McDowell case was not reflective of the majority. The researcher opines that it was also
wrong in placing reliance on another Constitution Bench decision of the Supreme Court that
came after McDowell i.e. Mathuram Agrawal v. State of MP36 since this latter decision was not
pronounced in the context of tax avoidance schemes.

It is thus the researcher’s opinion that the McDowell case has indeed succeeded in modifying
the Westminster principle at least in the context of tax avoidance schemes, and has provided a
qualification to the rule of strict construction to that extent. While this is a theoretical anomaly,
it has been practically necessitated so as to prevent large scale losses to the revenue through
intricately designed schemes. It has led to the strengthening of the position of the Revenue vis-
à-vis the assessee.

Yet, the researcher argues that this qualification has made the task of interpretation very
complex. It becomes tough to delineate acceptable tax planning from unacceptable tax
avoidance. Moreover, an inquiry into the motives of either the legislature or the assessee is
always going to be fraught with danger. The wisdom of this step must be doubted, at least from
the point of view of statutory interpretation.

Chapter III

Vodafone Saga and its Critical Analysis

Department’s view – in brief: Department’s claim, in essence was: CGP is a nullity, a sham
entity. Transfer of CGP’s shares has no substance. The parties to the transfer themselves
laid bare the real transaction – that of sale of HEL stake. Real transfer is: The transfer of
substantial interest (67% stake) in HEL. This controlling shareholding has its situs in
India. Since the transferred asset is situated in India, the capital gains arising on the same is
liable to tax in India. VIH was therefore required to deduct tax at source.

Honourable Supreme Court has given a ruling that – only the legal transaction –sale of CGP
share - is to be considered. By selling CGP share, the seller may have transferred its interests
in HEL. However, Indian interest arises due to sale of CGP share. It does not arise out of the
SPA (which recorded the real facts). All the arguments of the revenue were rejected.

36
Mathuram Agrawal v. The State of Madhya Pradesh, AIR 2000 SC 109 (Supreme Court of India).
Crux of the matter: Should one simply consider the legal form of the transaction (i.e., sale of
one share in CGP); or should one consider real form - the entire set of facts as stated
by the parties themselves in the SPA and various other correspondences? Is the case fit
for considering “Substance over Form”? Is the case fit for lifting the Corporate Veil?
Critical Analysis

Vodafone's argument was that it did not pay directly for an asset located in India. It paid for
acquiring the controlling interest in a Cayman Islands-based holding company. The transaction
was between two non-resident companies. The Supreme Court applied several well-established
principles of tax jurisprudence in deciding the case in favour of Vodafone. The doctrine of
form over substance, the source rule, the law relating to direct and indirect transfers, the concept
of business assets, and the anti-abuse rules were all gone into in the 276-page judgment. Did
the deal amount to questionable tax planning or tax avoidance device? The Supreme Court
gave a firm ‘no' as the answer to this question. In its opinion, use of holding companies and the
investment structure and also the use of offshore financial entities can be driven in certain cases
by business and commercial purposes.

The use of such devices will not imply tax avoidance. Taxpayers are free to arrange their affairs
to minimise tax within the framework of tax laws. There is a distinction between legitimate tax
minimisation and abusive tax avoidance. The Court upheld the law laid down in the Azadi
Bachao case and also distinguished the Mcdowell ruling.

The Supreme Court has ruled that the case concerned mere sale of shares simplicity and there
was no sale of assets. It was only by acquiring the shares of CGP that Vodafone got an indirect
control over several kinds of companies in the group structure of Hutchison. True, sale of shares
of a foreign company is not subject to tax in India. But what about other rights acquired by
Vodafone by virtue of this complex transaction? What about control premium because of the
67 per cent acquisition?

What about the non-compete agreement? What about the brand licences, operating licences,
customer base, etc.? According to the Supreme Court, these rights were acquired only as a
consequence of the transfer of shares in CGP. The transaction cannot be dissected and the
payment cannot be split into compartments. There was no anti-avoidance provision in the
Indian law. The Court made the distinction between the look-to principle and the look-through
principle. In the absence of anti-avoidance provisions in the law, it is not possible to invoke the
theory of see through.

A major consideration that prevailed with the Supreme Court was that the complicated
structures were put in place long before acquisition of the relevant shares. It rejected the
Bombay High Court's view that applying the proportionality theory, a part of the transaction
must be brought to tax. It concluded that the deal should be viewed as a consolidated transaction
based on economic nexus. “Applying the ‘look at' test in order to ascertain the true nature and
character of the transaction, we hold, that the offshore transaction herein is a bona
fide structured FDI investment into India which fell outside India's territorial tax jurisdictions,
hence not taxable.” This was not a sham transaction. Nor was it meant to avoid tax.

Chapter IV

Conclusion

In the eyes of the researcher, the various dilutions to the rule of strict construction are reflective
of judicial recognition of the fact that the legislature is possibly missing a few steps in its
attempt to grapple with fast paced economic developments. This is visibly seen in the case of
tax evasions. The rate of growth of the nature and functions of the Revenue is far outstripped
by the growth of the creatures and activities subject to taxation. The strict rule of construction
was inspired by a need to balance the powers of the individual against the State and prevent
the State from penalizing the individual unnecessarily. However, economic developments have
shifted the balance against the State and in favour of companies, who have at their disposal
considerable resources and tax expertise. It is no surprise then that most of the dilutions, such
as purposive construction and evasion seem to favour the Revenue. The few constructions that
favour the assessee, such as liberal construction of exemptions, also have underlying economic
objectives such as promotion of industrialization as their basis.

However, the researcher is of the opinion that the judiciary has invited some trouble on itself
by creating dilutions to the rule of strict construction. It has opened up avenues for arguments
based on legislative intent and “real nature” of transactions in cases involving taxation. The
researcher believes that the judiciary will resolve this conflict, more often than not, by
favouring the Revenue, in keeping with the reasons for the creation of dilutions.
The brunt of this change, however, shall be borne by the weaker of the taxpayers. Neither do
they have the wherewithal to come up with intricate arguments to reduce their tax burden nor
does judicial attitude seem to be in their favour.

In order that the interests of these weaker sections are protected, the researcher hopes that the
dilutions to the rule of strict construction be viewed with great caution. From a theoretical point
of view too, the researcher is of the opinion that the dilutions represent a definite compromise
and that they will lead to various problems in statutory interpretation. While the rule of strict
construction still holds a dominant position in the interpretation of taxing statutes, there can be
no doubt that the departures from the rule have struck its effectiveness in a manner that the
implications will be substantial.