Vodafone tax case

Analysis of key issues

Background
Hutchison International, Hongkong (HTIL) CGP Investments, Cayman Islands
Sale of CGP shares

Vodafone, Netherlands

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Intermediate Co., Mauritius

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Hutch Essar, India

On 11 February 2007, Vodafone NL acquired 67% stake in Hutch Essar India (52% from HTIL & call option for 15% stake from resident Indians) for US$ 11.1 billion The transaction was expected to realize an estimated before tax gain of US$ 9.6 billion to HTIL In this respect, conditional approval was granted by FIPB to Vodafone stipulating that there should be compliance and observance of applicable laws and regulations in India including tax obligations under Indian tax laws.

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Thereby, Hutchison International incorporated in Hongkong sold its SPV in Cayman Islands CGP Investments to Vodafone. Vodafone got controlling interest in Hutch Essar, India on account of share acquisition of CGP (situated outside India) from a non resident In connection with the transaction, the Indian tax authorities issued notice to Vodafone asking Vodafone as to why it should not be treated as an assessee in default for not withholding taxes on its payments to the Hutch Group. Subsequently, Vodafone filed a writ petition challenging the validity of the notice before the Bombay HC.

The legal battle

Key tax issues under challenge
Taxability of capital gains Whether sale of shares of a foreign company between two non residents will result in capital gains tax in India Withholding tax Whether provisions of s.195 apply to nonresident acquirer of shares for withholding tax on payment Representative assessee Can Indian subsidiary be regarded as a representative assessee of the non resident seller

Event milestones
February 2007 December 2008 January 2009 May 2010 July 2010 Current status Acquisition of Hutch Essar by Vodafone Bombay HC decision dismissing Vodafone's plea Supreme Court dismisses SLP filed by Vodafone IT Department has issued showcause notice with its final order Vodafone moves Bombay HC against the IT Department order Hearing is completed in Bombay HC on Aug 18, 2010 and the judgement is reserved

Taxability of Capital gains

LEGAL BASIS Sec 9(1): Income is deemed to accrue or arise in India; Through transfer of capital asset situated in India; or Through or from any business connection in India

IT Departments' argument
Capital asset: The acquisition of one share in CGP by Vodafone NL was a consequence of purchasing interest in the Indian telecom business which encompasses a bundle of rights in India and the transfer of share is incidental to all such rights. Business connection: FIPB approval was mandatory and was a condition precedent to the SPA which indicated that this transaction had nexus with India References made to India in the Share Purchase Agreement (SPA) Due diligence of Hutch Essar India was conducted by Ernst & Young Taxation of capital gains based on economic nexus will quadruplicate taxation in various jurisdictions like Mauritius, Cayman Islands, Hongkong and India There are no specific look through provisions in Indian law to tax non residents for transactions held outside India. For example, look through provisions in certain countries tax capital gains on transfer of shares of companies owning immovable properties in that country FIPB approval was not for the acquisition of 52% and FIPB approval was obtained for the 15% stake in which call options were obtained from the Indian owners and the ownership of the same is not transferred to Vodafone

Vodafones stand

Taxability of Capital gains

Analysis
The Bombay High Court while dismissing Vodafones plea has held that, there was apparently an extinguishment of rights and relinquishment by the transfer of controlling interest in the Indian company which constitutes a transfer It has also held that the shares in the Cayman company were merely the mode or the vehicle to transfer the assets situated in India The Supreme Court while dismissing Vodafones petition did not comment on the taxability of the transaction However, the Supreme Court has directed Vodafone to approach the revenue authorities for initially and then approach the High Court if the authorities answer the jurisdictional facts negatively It can also be viewed that the provisions of section 9 are wide enough and the look through provisions for transactions happening outside India involving capital assets situated in India are inbuilt in it

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Judicial precedents
Favouring Vodafone: Sale of shares an isolated transaction, not a business connection (R.D. Agarwal & Co 56 ITR 20(SC)) Against Vodafone: Controlling interest not a separate capital asset distinct from shares (Mahadeo Ram Kumar 166 ITR 477 (Cal))

Protection under Treaties

> > As viewed by some experts, the issue of taxability of capital gains in India may not have arisen if the shares held by the Intermediate Co. (Mauritius ) in Hutch Essar is transferred to Vodafone In this case the DTAA between India and Mauritius would have come in to force whereby the capital gains will be taxable in Mauritius (on basis of the Supreme Court decision in Azadi Bachao Andolans case)

Key considerations for protection under treaties

> Every intermediary holding company needs to pass the substance test and establish its independence and authority to claim itself as the beneficial owner of the investments The Supreme Court in Azadi Bachao Andolans case, had held that the design of tax avoidance itself is not objectionable if it is within the framework of law and is not prohibited by law and that lifting of the 'corporate veil' is not permissible to deny the benefits of a tax treaty. Therefore, it appears that investments into India through treaty network may not be faced with many hurdles in claiming beneficial ownership and corresponding treaty benefits provided it is a legal transaction and passes the substance test Instances of substance test are obtaining Tax Resident Certificate (TRC) in Mauritius, criteria in Indo-Singapore treaty for US$ 200,000 expense and other such conditions prescribed under the local laws of the respective foreign country

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Withholding of tax Section 195

LEGAL BASIS Sec 195: Any person responsible for paying any sum to a nonresident which is chargeable to tax, shall deduct tax thereon

IT Departments argument
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The term any person in section 195 shall include non-residents.

The intention of section 195 is to cast an obligation to deduct taxes on the person who is within the ambit of the Indian law to deduct taxes from the income of the person who is not within the ambit of the Indian law (i.e. non-resident) The duty to deduct taxes can be cast only on someone who has a presence in India. If the IT Departments' argument is accepted it will lead to a scenario in which section 195 will have extra-territorial application where even persons having no territorial nexus with India (i.e. non resident) will be bound by the provisions. However, there are conflicting views given by the courts on this aspect The Supreme Court has mentioned that Vodafone is fully safeguarded under Section 195(2), 195(3) and Section 197 of the Act. i.e.it can recover the tax from the Seller Sec 201 was amended by Finance Bill 2008 to cover failure to withhold tax in the scope of AID with retrospective effect from 1st June 2002 Prior to this only if a person who has deducted tax and has not remitted it is considered as an AID

Vodafones stand

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Analysis

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Assessee in default (AID)

Representative assessee
> Representative assessee includes any person : who has any business connection with the non resident who has acquired a capital asset in India Normally a representative assessee can only be a person in India. In this case, since the seller was a non-resident, HTIL was not liable to capital gains tax. Therefore, IT department issued notice to the Vodafone NL treating it as assessee in default for not withholding tax and Hutch Essar India treating it as a Representative assessee i.e. agent of Hutchison International However, in this case as no capital asset is acquired in India the extra territorial application has to be analyzed

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Summary of key issues

Issue Taxability of capital gains IT Department By virtue of sale of shares of CGP, Vodafone indirectly acquired controlling interest in an Indian company and hence the transfer gave rise to capital gain taxable in India There is a business connection in India as FIPB approval was required Vodafone No transfer or sale of shares/assets in India Therefore, capital gains not taxable in India No prior FIPB approval was required to acquire 52% and FIPB approval was obtained for the 15% stake in which call options were obtained and the ownership of the same is not transferred to Vodafone Taxable presence in India is required and sec 195 does not have extra-territorial jurisdiction. Legal analysis Sec 9(1): Income deemed to accrue in India from any business connection in India or through transfer of capital asset in India Capital asset situated outside India and sale of shares is not an business connection Controlling interest not a separate capital asset distinct from shares Sec 195 applicable only if income is taxable in India No mandatory requirement to obtain NIL withholding tax certificate if income not taxable in India Sec 201 amended by Finance Bill 2008 to cover failure to withhold tax in the scope of AID w.e.f 1 Jun 02 Representative assessee shall have business connection with non resident; or A resident or non resident who has acquired a capital asset in India

Withholding tax u/s sec 195

Show cause notice to Vodafone to show cause as to why Vodafone should not be treated as an assessee in default (AID) in respect of failure to deduct tax on the capital gain arising on such transfer Sec 195 applies to any person and Vodafone should have obtained NIL withholding tax certificate Notice issued to Hutch Essar, India to show cause as to why it should not be treated as representative assessee Hutch Essar is a representative assessee with respect to the withholding tax obligation of Vodafone, Netherlands

Representative assessee

Hutch Essar is not a party to the transaction and cannot be treated as a representative assessee Hutch Esaar has no transaction with non resident