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A Project Report On CASE STUDY OF MERGER OF VODAFONE AND HUTCHINSON Submitted towards the partial fulfillment of 3rd Semester

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


Submitted by: Samudra Singh & Bhana Ram Tak M.B.A. (Insurance) 3rd Semester Roll no. 233 & 223

Submitted to: Dr. U.R.Daga Faculty of Management National Law University


In an increasingly open global economy, where old prejudices against foreign predators and old fears of economic colonization have been replaced by a hunger for capital, Mergers and Acquisitions (M&A) are welcome everywhere. In human aspects of M&As we used a not-too-original distinction between mergers, acquisitions and joint ventures. M&As represented a marriage, while joint ventures meant cohabiting. Although mergers and acquisitions are generally treated as if they are one and the same thing, they are legally different transactions. In an acquisition, one company buys sufficient numbers of shares as to gain control of the otherthe acquired company. Acquisitions may be welcomed by the acquired company or they may be vigorously contested. There are several alternative methods of consolidation with each method having its own strengths and weaknesses, depending on the given situation. However, the most commonly adopted method of consolidation by firms has been through M&As. Though both mergers and acquisitions lead to two formerly independent firms becoming a commonly controlled entity, there are subtle differences between the two. While acquisition refers to acquiring control of one corporation by another, merger is a particular type of acquisition that results in a combination of both the assets and liabilities of acquired and acquiring firms. In a merger, only one organization survives and the other goes out of existence. There are also ways to acquire a firm other than a merger such as stock acquisition or asset acquisition The Vodafone-Hutch deal is one of the largest M&A deal executed by overseas firm in Indian subcontinent. Today Vodafone business in India has been successfully integrated into the group and now has over 44 million customers, with over 50 per cent pro forma revenue growth. Revenues increased by 50 per cent during the year driven by rapid expansion of the customer base with an average of 1.5 million net additions per month since acquisition In todays volatile market, where major M&A deals are showing negative growth or companies are looking for Government Bailout money, Vodafone acquisition of hutch is a major contributor to its revenue .While Indias revenues grew by 29.6 percent other APAC countries posted far lower growths at 10 percent in Egypt, 7 percent in Australia and 3 percent in New Zealand at

constant exchange rates. This Report covers the various aspects of M&A along with insights on Vodafone Merger.

Hutchison-Essar Year and Events 1994 Hutchison Max Telecom Limited (HMTL), a joint venture between Hutchison and Max, wins the licence to provide cellular services in Mumbai. C. Sivasankaran sells 51% stake in Delhis Sterlings Cellular to Essar group. 1995 HMTL launches mobile services in India under the Max Touch brand name. 1996 Swisscom sells 49% stake in Essar Cellphone to Hutchison. 1998 Maxs Analjit Singh sells 41% stake in Hutchison Max to Hutchison Hong Kong. 2000 (Jan) Hutchison acquires a 49 per cent stake in Sterling Cellular in the Delhi circle from Swisscom, an Essar Group company. A few weeks later, the Orange brand name replaces Max Touch in Mumbai. 2000 (July) Hutchison and Kotak together acquire a 100 per cent stake in Usha Martin Telekom in Kolkata circle. 2000 (Sep) Hutchison acquires a 49 per cent stake in Fascel, which operates in Gujarat, from Shinawatra. 2001 Hutchison puts in the bid to provide cellular licences in Chennai, Andhra Pradesh, Karnataka and Maharashtra. It wins all except Maharashtra. 2003 Essar Teleholdings sells its operations in Rajasthan, Uttar Pradesh (East) and Haryana to Hutchison Essar. Essar was running these operations through group company, Aircel Diglink India Ltd. Hutchison acquires licence to provide cellular services in Punjab. This is bought from Escotel.

2004 Essar picks France Telecoms 9.9% stake in BPL Communications. Hutchison Telecommunications International Ltd (HTIL) gets listed on the Hong Kong and New York stock exchanges. Launches services in Punjab, West Bengal and Uttar Pradesh (West). Also receives approval from the regulators to consolidate its operations in India. 2005 Hutchison Essar consolidates its various mobile companies in India to create a single entity. A little later, Hutchison Essar signs agreements with the Essar Group to acquire BPL Communications and Essar Spacetel. During the same year, Hutch becomes a national brand. Essar Teleholdings buys Max Telecom Ventures 3.16% stake in Hutchison Essar for Rs. 657 crore. Egyptian cellular service provider, Orascom, acquires a 19.3 per cent stake in HTIL. 2006 Kotak sells 8.33% stake to Analjit Singh for Rs 1019 crore. HTIL acquires a 5.11 stake from the Hindujas to increase its direct and indirect stake in Hutchison-Essar to 67 per cent. Essar holds the balance 33 per cent. Hutchison-Essar receives the letter of intent (LoI) from the government to provide cellular services in six more circles. Hutchison wants to exit. In February 2007 Vodafone announced officially its acquisition of 67% of Hutch-Essar for $11.08 billion defeating the rival bidder Reliance Communications.


In 2007, Vodafone Group bought the Indian telecom assets of Hong Kong's Hutchison Telecommunications International Ltd. It paid US$11 billion for a 67% stake in Hutchison Essar. The latter was the operating company in India for what is now the third-largest operator with 111 million users. Vodafone was the buyer. Hutchison, the seller, made huge capital gains. Yet since then, Vodafone has been battling it out in the courts against the Indian Income Tax (IT) department, which has saddled it with a US$2.1 billion tax claim. Hutchison, which pocketed the capital gains, is nowhere in the picture. The transaction was executed through a Hutchinson company located in the Cayman Islands Round 1: began in September 2007, when the Tax Department issued a show cause notice to Vodafone that said Vodafone was liable to pay withholding tax on the purchase amount.

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

Vodafone is a mobile network operator with its headquarters in Newbury, Berkshire, England, UK. It is the largest mobile telecommunications network company in the world by turnover and has a market value of about 75 billion (August 2008). Vodafone currently has operations in 25 countries and partner networks in a further 42 countries. The name Vodafone comes from Voice data fone, chosen by the company to reflect the provision of voice and data services over mobile phones. Vodafone Essar is owned by Vodafone 52%, Essar Group 33%, and other Indian nationals, 15%. On February 11, 2007, Vodafone agreed to acquire the controlling interest of 67% held by Li Ka Shing Holdings in Hutch-Essar for US$11.1 billion, pipping Reliance Communications, Hinduja Group, and Essar Group, which is the owner of the remaining 33%. The whole company was valued at USD 18.8 billion. The transaction closed on May 8, 2007.

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

Hutch Essar was a leading Indian telecommunications mobile operator with 23.3 million customers at 31 December 2006, representing a 16.4% national market share. Hutch Essar operates in 16 circles and has licenses in an additional six circles. In the year to 31 December 2005, Hutch Essar reported revenue of US$1,282 million, EBITDA of US$415 million, and operating profit of US$313 million. In the six months to 30 June 2006, Hutch Essar reported revenue of US$908 million, EBITDA of US$297 million, and operating profit of US$226 million. Up until January 2006, Hutch Essar had licenses in 13 circles, of which nine have 900 MHz spectrum. In January 2006, Hutch Essar acquired BPL, thereby adding three circles, each operating with 900 MHz spectrum. In October 2006, Hutch Essar acquired Spacetel, adding six further licenses, with operations planned to be launched during 2007.

Reasons for Hutch Sale

There are two main reasons which are responsible for Li Ka-shing to leave India. They are Hutch-Essar: Mutual Distrust. A right time to quit Indian operations to finance other operations Li Ka-Shing was the 10th richest man globally in 2006, is known as a businessman who spots an opportunity early, invests in it and exits at a neat premium. It is only after he exits that the rush begins. In the early 1990s, he sold his stake in Star TV to Rupert Murdoch for $825 million. The Hutch Essar deal has netted him a neat $8.48 billion. What could he do with that money? Li is a major player in the ports and retail businesses. Getting access to the ports business in India is difficult, thanks to being from China. However, with retail being the new mantra in India, Li could be looking at a third entry. His retail outfits include Watsons and PARKnSHOP. While Watsons operates 7,700 stores in 37 countries, PARKnSHOP is a supermarket chain.

Industry sources say that several incidents revealed the deepening rift between Hutch and Essar. They say that as telecom valuations in India started rising, Essar tried to increase its stake in the joint venture. However, in December 2005, Orascom of Egypt bought a 19.3 per cent stake in Hutchison Whampoa. This indirectly gave it control of 12.93 per cent stake in Hutchison Essar. The stake sale decision was reportedly taken without Essars knowledge and strained its relations with Hutchison. Following this Essar approached the Department of Telecommunications on this sale saying that Hutchison Whampoas equity sale to Orascom may have an impact on national security as Orascom has a stake in Pakistans Mobilink. Subsequently, say sources, Essar sounded out some private equity investors about buying out Hutchisons equity holding in Hutchison Essar. What followed was the tussle between Essar and Hutch over BPLs Mumbai circle. Sources say that the decision to split the merger of BPL Communication into Hutchison Essar may also have been prompted by the potential of the Mumbai circle. (BPLs mobile operations included BPL Cellular, which had licences for Maharashtra, Tamil Nadu and Kerala, and BPL Mobile, which had the licence for Mumbai. BPL Cellular was merged with Hutchison Essar earlier this year.)


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

Investment bankers in India, too, have underlined Vodafones advantage, thanks to its access to cash and its capability to strike the least leveraged deal.

Vodafone gets access to the fastest growing mobile phone market in the world that is expected to touch 500 million subscribers by 2010. Cellular penetration in rural India is below 2%, but 67% of Indias population lives in rural India. Hutchison-Essar is not just the #4 player, but also one of the better-run companies with higher average revenue per subscribers. 3G is set to take off in India, allowing data and video to ride on cellular networks. Vodafone already offers 3G elsewhere in the world. India is key to Vodafone strengthening its presence in Asia, a region seen as the big telecom story.

Hutch is going to be a tough battle ahead as the worlds largest mobile operator (by revenues) tries to woo the price-conscious Indian consumer. Vodafone is targeting 100 million Indian subscribers in three years (Hutch has 24.41 million at present). Thats half its current subscriber base across 27 countries. But getting there means adding between 1.5 million and 2 million subscribers every month. While Hutch has been adding around 1 million subscribers a month, market leader Bharti has been adding 1.75 million. Vodafone needs to exceed Bhartis net subscriber additions to be the leader in three years. Second, it needs to tap rural India in a big way. Vodafone has earmarked an investment of $2 billion over the next couple of years to strengthen its presence here. The agreement with Bharti fits in perfectly to tap the hinterland .Realising the importance of familiarity with the terrain, Sarin has opted to retain Asim Ghosh as the man to head the venture. Once the board approves it, Ghosh will formally take charge. After

all, thats what he has been doing as Hutchisons key lieutenant over the past few years. However, even before it gets to that, Vodafone has to ensure that the Essar Group, the 33 per cent partner in the venture, does not go to court on its entry. To insure against such a possibility, Vodafone has reserved the right to abandon the acquisition of the stake if litigation is launched. Summing these challenges we have: The cellular telephony is extremely competitive, and India has one of the lowest ARPUs in the world. Besides, ARPU growth is slowing. It has an uneasy equation with Essar, which is one-third partner in Hutch-Essar. That could be a source of problem. The Vodafone brand is relatively unknown in the Indian market. Besides the brand will cost money and take time. Telecom valuations are at a high and this could mean it is years Vodafone recovers its multibillion dollar investment. Its big competitors are home-grown majors, who can manage the environment better.

Several legal issues arise from the case:

(i) Whether a non-resident seller (Vodafone International) is liable to tax in India on sale of shares of the foreign SPV? (ii) Is a non-resident purchaser (HTIL) liable for deduction of tax on purchase of shares of the foreign SPV while making payment to the non-resident seller? (iii) Whether an Indian company can be treated as agent of the non-resident purchaser and held liable for deduction of tax? (iv) Can the law impose tax retrospectively?

Scope of Taxable Income of a Non-resident: Pursuant to Section 5(2) of the Act, the taxable income of a non-resident includes income received or deemed to be received in India and income that accrues or arises or deemed to accrue or arise in India. However, it does not include income that accrues or arises or is deemed to accrue or arise outside India. Pursuant to Section 9 (1) of the Act, income is deemed to accrue or arise in India if such income is due to transfer of an asset situated in India or through or from business connection in India. Pursuant to Section 195 of the Act every person paying any sum, which is chargeable to tax in India to a non-resident must deduct income-tax at source at the time of payment or credit. The liability to deduct tax applies to non-residents as well as residents. The IT Department has argued that this transfer represents a transfer of beneficial interest in the shares of the Indian company and hence, any gain arising from it would attract tax in India. In the case of transfer of shares in an Indian company by companies established in certain countries such as Mauritius, Cyprus and Singapore withholding tax on capital gains is not liable to be levied in India pursuant to the relevant DTAA. CGP (the company that was sold to Vodafone) was a Cayman company and there is no IndiaCayman DTAA. It is an interesting question as to whether the sale of Mauritius SPV would attract a similar tax notice or whether a Mauritius intermediate SPV interposed between the Cayman SPV and the Indian subsidiary would act as a successful blocker entity. Who is an Agent? According to Section 160(1) of the Act, agent of the non-resident is representative assessee, and Section 161 discusses the liability of representative assessee. Section 163 defines agent to include a person who has a business connection with the non-resident. Passing of Laws Retrospectively: In the 1975 Hindustan Machine Tools case, the Supreme Court held that the legislature could pass laws retrospectively, with the exception that this power could be challenged if the law was

discriminatory. This same principle was reaffirmed in 1997 in Arooran Sugars Ltd case, where the Supreme Court that if the law does not discriminate, it may be retrospective. This is perhaps the first time tax authorities are attempting to tax a transaction between two foreign companies involving transfer of an Indian asset. If the tax liability is established, it could result in a tax liability of approximately $1.7 billion. Investors will be keeping a close eye on the upcoming Mumbai High Court verdict. Either way, the next battle may be fought in the Supreme Court.

Hutch Vodafone Merger An Issue of Tax Planning Under Income Tax Act, 1961
It is a landmark case that will severely impact the Mergers & Acquisitions (M&A) landscape in India. No matter which way it goes, the Vodafone versus IT department tax case will have an indelible impact on the M&A landscape of India. Last year British Telecom giant Vodafone paid Hong Kong based Hutchison International over USD 11 billion to buy Hutchisons 67% stake in Indian telecom company Hutchison Essar. The transaction was done through the sale and purchase of shares of CGP, a Mauritius based company that owned that 67% stake in Hutch Essar. Since the deal was offshore, neither party thought it was taxable in India. But the tax department disagreed. It claimed that capital gains tax most people paid on the transaction and that tax should have been deducted by Vodafone whilst paying Hutch. The matter went to court and was heard over by the court. Vodafone argued that the deal was not taxable in India as the funds were paid outside India for the purchase of shares in an offshore company that the tax liability should be borne by Hutch; that Vodafone was not liable to withhold tax as the withholding rule in India applied only to Indian residence that the recent amendment to the IT act of imposing a retrospective interest penalty for withholding lapses was unconstitutional. Now the taxmans argument was focused on proving that even though the Vodafone-Hutch deal was offshore, it was taxable as the underlying asset was in India and so it pointed out that the capital asset; that is the Hutch-Essar or now Vodafone-Essar joint venture is situated here and was central to the valuation of the offshore shares; that through the sale of offshore shares, Hutch had sold Vodafone valuable rights - in that the Indian asset including tag along rights,

management rights and the right to do business in India and that the offshore transaction had resulted in Vodafone having operational control over that Indian asset. The Department also argued that the withholding tax liability always existed and the amendment was just a clarification. The tax officers are saying that Hutch is taxable on the profit they made from the sale - that is one aspect. The second aspect is that Vodafone as a payer was liable to deduct tax at source because they paid income to Hutch. Those are the two different issues. The case was mainly about the second issue where the Vodafone was liable or not and in principle; it is possible that the department is right on the first and yet not right on the second.

The facts clearly establish that it would be simplistic to assume that the entire transaction between HTIL and VIH BV was fulfilled merely upon the transfer of a single share of CGP in the Cayman Islands. The commercial and business understanding between the parties postulated that what was being transferred from HTIL to VIH BV was the controlling interest in HEL. HTIL had through its investments in HEL carried on operations in India which HTIL in its annual report of 2007 represented to be the Indian mobile telecommunication operations. The transaction between HTIL and VIH BV was structured so as to achieve the object of discontinuing the operations of HTIL in relation to the Indian mobile telecommunication operations by transferring the rights and entitlements of HTIL to VIH BV. HEL was at all times intended to be the target company and a transfer of the controlling interest in HEL was the purpose which was achieved by the transaction. Ernst and Young who carried out a due diligence of the telecommunications business carried on by HEL and its subsidiaries have made the following disclosure in its report: "The target structure now also includes a Cayman company, CGP Investments (Holdings) Limited. CGP Investments (Holdings) Limited was not originally within the target group. After our due diligence had commenced the seller proposed that CGP Investments (Holdings) Limited should be added to the target group and made available certain limited information about the

company. Although we have reviewed this information, it is not sufficient for us to be able to comment on any tax risks associated with the company." (Emphasis supplied). The due diligence report emphasizes that the object and intent of the parties was to achieve the transfer of control over HEL and the transfer of the solitary share of CGP, a Cayman Islands company was put into place at the behest of HTIL, subsequently as a mode of effectuating the goal. The true nature of the transaction as it emerges from the transactional documents is that the transfer of the solitary share of the Cayman Islands company reflected only a part of the arrangement put into place by the parties in achieving the object of transferring control of HEL to VIH BV. HTIL had put into place, during the period when it was in control of HEL, a complex structure including the financing of Indian companies which in turn had holdings directly or indirectly in HEL. In consideration call and put options were created and the benefit of those options had to be transferred to the purchaser as an integral part of the transfer of control over HEL. Hence, it is from that perspective that the framework agreements pertaining to the Analjit Singh and Asim Ghosh group of companies and IDFC have to be perceived. These were agreements with Indian companies and the transaction between HTIL and VIH BV takes due account of the benefit of those agreements. The price paid by VIH BV to HTIL of US $ 11.01 Billion factored in, as part of the consideration, diverse rights and entitlements that were being transferred to VIH BV. Many of these entitlements were not relatable to the transfer of the CGP share. Indeed, if the transfer of the solitary share of CGP could have effectuated the purpose it was not necessary for the parties to enter into a complex structure of business documentation. The transactional documents are not merely incidental or consequential to the transfer of the CGP share, but recognized independently the rights and entitlements of HTIL in relation to the Indian business which were being transferred to VIH BV. We began the record of submissions by adverting to the contention of the Petitioner that if any of the shares held by the Mauritian companies were sold in India, there would be no liability to capital gains tax because of the Convention on the Avoidance of Double Taxation between India and Mauritius. The crux of the submission is that the entire transaction in the case is subsumed in the transfer of a share of an upstream overseas company which exercised control over Mauritian companies. As we have noted earlier, it is simplistic to assume that all that the transaction

involved was the transfer of one share of an upstream overseas company which was in a position to exercise control over a Mauritian company. The transaction between VIH BV and HTIL was a composite transaction which covered a complex web of structures and arrangements, not referable to the transfer of one share of an upstream overseas company alone. The transfer of that one share alone would not have been sufficient to consummate the transaction. The transaction documents are adequate in themselves to establish the untenability of the Petitioner's submissions. The submission of VIH BV that the transaction involves merely a sale of a share of a foreign company from one non- resident company to another cannot be accepted. The edifice of the submission has been built around the theory that the share of CGP, a company situated in the Cayman Islands was a capital asset situated outside India and all that was transferred was that which was attached to and emanated from the solitary share. It was on this hypothesis that it was urged that the rights and entitlements which flow out of the holding of a share cannot be dissected from the ownership of the share. The purpose of the discussion earlier has been to establish the fallacy in the submission. The transfer of the CGP share was not adequate in itself to achieve the object of consummating the transaction between HTIL and VIH BV. Intrinsic to the transaction was a transfer of other rights and entitlements. These rights and entitlements constitute in themselves capital assets within the meaning of Section 2(14) which expression is defined to mean property of any kind held by an assessee. Under Section 5(2) the total income of a non-resident includes all income from whatever source derived which (a) is received or is deemed to be received in India or (b) accrues or arises or is deemed to accrue or arise to him in India. Parliament has designedly used the words "all income from whatever source derived". These are words of width and amplitude. Clause (i) of Section 9 explains the ambit of incomes which shall be deemed to accrue or arise in India. Parliament has designedly postulated that all income accruing or arising whether directly or indirectly, (a) through or from any business connection in India or (b) through or from any property in India; or (c) through or from any asset or source of income in India or (d) through the transfer of a capital asset situate in India would be deemed to accrue or arise in India. Where an asset or source of income is situated in India or where the capital asset is situated in India, all income which accrues or arises directly or indirectly through or from it shall be treated as income which is deemed to accrue or arise in India.

VIH BVs disclosure to the FIPB is indicative of the fact that the consideration that was paid to HTIL in the amount of US $ 11.01 Billion was for the acquisition of a panoply of entitlements including a control premium, use and rights to the Hutch brand in India, a non-compete agreement with the Hutch group, the value of non-voting non convertible preference shares, various loan obligations and the entitlement to acquire subject to Indian foreign investment rules, a further 15% indirect interest in HEL. The manner in which the consideration should be apportioned is not something which can be determined at this stage. Apportionment lies within the jurisdiction of the Assessing Officer during the course of the assessment proceedings. Undoubtedly it would be for the Assessing Officer to apportion the income which has resulted to HTIL between that which has accrued or arisen or what is deemed to have accrued or arisen as a result of a nexus within the Indian taxing jurisdiction and that which lies outside. Such an enquiry would lie outside the realm of the present proceedings. But once this Court comes to the conclusion that the transaction between HTIL and VIH BV had a sufficient nexus with Indian fiscal jurisdiction, the issue of jurisdiction would have to be answered by holding that the Indian tax authorities acted within their jurisdiction in issuing a notice to show cause to the Petitioner for not deducting tax at source. In assessing the true nature and character of a transaction, the label which parties may ascribe to the transaction is not determinative of its character. The nature of the transaction has to be ascertained from the covenants of the contract and from the surrounding circumstances. In National Cement Mines Industries Ltd. vs. C. I. T., (1961) 42 ITR 69 1961 Indlaw SC 95 Mr. Justice J.C. Shah speaking for the Supreme Court emphasized the principles of interpretation to be adopted by the Court in construing a commercial transaction : "But in assessing the true character of the receipt for the purpose of the Income-tax Act, inability to ascribe to the transaction a definite category is of little consequence. It is not the nature of the receipt under the general law but in commerce that is material. It is often difficult to distinguish whether an agreement is for payment of a debt by installments or for making annual payments in the nature of income. The court has, on an appraisal of all the facts, to assess whether a transaction is commercial in character yielding income or is one in consideration of parting with property for repayment of capital in installments. No single test of universal application can be discovered for solution of the problem. The name which the parties may give to the transaction which is the source of the receipt and the characterization of the receipt by them are of little

moment, and the true nature and character of the transaction have to be ascertained from the covenants of the contract in the light of the surrounding circumstances." The Bombay high court has affirmed the tax departments jurisdiction to proceed against Vodafone Group Plc. However, it has not determined whether any part of the payment made by Vodafone is actually chargeable to tax in India. The court had granted a stay on the department from raising a tax demand to allow time for an appeal to be filed by Vodafone before the Supreme Court, which has now been made. The decision accepts the principle that income earned by a non-resident from an offshore transaction cannot be taxed in India unless the assets transferred have sufficient nexus with the territory of India. With respect to transfer of capital assets by a non-resident, it is necessary that the legal situs (a legal term meaning site) of the assets is in India. Considering that the transaction between Vodafone and Hutchison only involved the transfer of specific non-India based assets such as shares of a foreign company and certain loan entitlements, it should ordinarily not give rise to any income that is taxable in India. To briefly summarize the facts, in February 2007, a sale and purchase agreement was entered into between Vodafone International Holdings BV, Netherlands, and Hutchison Telecommunications International Ltd (HTIL), Cayman Islands, for acquisition of the entire share capital of CGP Investments (Holdings) Ltd, another company based in the Cayman Islands. CGP Investments directly and indirectly held offshore companies that owned a 67% interest in the Indian operating company, Hutch Essar Ltd (HEL). The agreement between Vodafone and HTIL also involved assignment of certain inter-company loans which were owed by CGP Investments and its Mauritian subsidiary to various Hutchison group companies. Based on various transaction documents, Foreign Investment Promotion Board (FIPB) disclosures and due diligence reports, the tax department has tried to argue that the subject matter of the transaction was a transfer of 67% interest in the Indian operating company, HEL, and a number of other rights such as its Indian telecom licence, the right to use the Hutch brand, management rights in the Indian company, joint venture interests and inter-company loan obligations. According to the department, this creates sufficient nexus for it to exercise jurisdiction to proceed against Vodafone.

While accepting the tax departments jurisdiction to initiate proceedings, the Bombay high court noted that the acquisition of the offshore Cayman entity by Vodafone was a composite transaction and the numerous agreements between the various parties captured certain rights and entitlements in relation to the Indian operating company. On this basis, the court held that the department would have to apportion that part of the payment made by Vodafone which related to assets that were situated in India. The high court has also emphasized that, for tax purposes, one should only look at the form of the transaction and not its substance as long as it is not a sham or a colorable device. This principle was laid down by the Supreme Court in the Azadi Bachao Andolan case. The high court clarified that taxpayers can legitimately plan their economic affairs within the four corners of law even if the object was to lawfully mitigate the incidence of tax. The high court also reiterated the common law principle that a share is a distinct capital asset in its own right. The business and assets of a corporation are not the business and assets of its shareholders and the acquisition of shares of a parent company would not lead to any transfer of interests in its underlying subsidiary companies. The court observed in very clear terms that a controlling interest which a shareholder acquires is incidental to the holding of shares and does not have a separate existence distinct from the shareholding. On applying these principles to Vodafones facts, it is difficult to understand how the high court accepted the tax departments jurisdiction to initiate proceedings in relation to an offshore transaction of this nature. Even if such jurisdiction does exist, it is likely that little or no part of the consideration paid by Vodafone may be considered taxable in India. The form of the transaction only contemplated transfer of certain offshore loan entitlements and shareholding in the Cayman entity which is legally distinct from the underlying controlling interest in the Indian operating company. The other rights and interests vested with various downstream subsidiary companies and it may not be possible to suggest that these were transferred in law. Another issue is that it would be very difficult to quantify the cost of acquisition of the various rights identified by the tax department. Further, under principles of private international law, the legal situs of many of these rights cannot be said to lie in India and, hence, there may not be sufficient nexus for the transaction to

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

REFERENCES: VS Tax Department Round 4