Vodafone Hutchison Essar tax case

By:
Md. Mohafiz Khan
CUJ/I/2013/IMBA/022
7th Semester
Introduction
The acquisition of Hutchison Essar by Vodafone at an enterprise value of $19.3 billion which comes
to around $794 per share was one of the biggest cross border deals in the booming Indian telecom
market at that time. Vodafone won the 67% block on sale by Hutch-Essar leaving behind Reliance
Communication and a consortium led by Hindujas as well. It paid around 10.9 billion dollars for the
acquisition.

Profile of Co-parties
Owners: Vodafone: 67% Essar: 33%

Vodafone Profile: Vodafone Group plc is a global telecommunications company headquartered in

Newbury, United Kingdom. It is the world's largest mobile telecommunications company
measured by revenues and the world's second-largest measured by subscribers, with around 332
million proportionate subscribers as at 30 September 2010. It operates networks in over 30 countries
and has partner networks in over 40 additional countries. It owns 45% of Verizon Wireless, the
largest mobile telecommunications company in the United States measured by subscribers.
Its primary listing is on the London Stock Exchange and it is a constituent of the FTSE 100
Index. It had a market capitalization of approximately 92 billion as of November 2010, making
It the third largest company on the London Stock Exchange. It has a secondary listing on
NASDAQ.

Mission
We will be the communications leader in an increasingly connected world.
Vision
Our vision is to lead the industry in responding to public concerns regarding mobile phones, masts
and health by demonstrating leading edge practices and encouraging others to follow.

Essar Profile: The Essar Group is a multinational conglomerate corporation in the sectors of Steel,
Energy, Power, Communications, Shipping Ports & Logistics as well as Construction Headquartered
at Mumbai, India. The Group's annual revenues were over USD 15 billion in financial year 2008-
2009.
Essar began as a construction company in 1969 and diversified into manufacturing, services and
retail. Essar is managed by Shashi Ruia, Chairman Essar Group and Ravi Ruia, Vice Chairman,
Essar Group.
Vision
We will be a respected global entrepreneur, through the power of positive action.
Mission
We are committed to innovative growth, through our personal passion, reinforced by a
professional mindset, creating value for all those we touch.
Hutch Profile: Hutchison Whampoa Limited of Hong Kong is a Fortune 500 company and one of the
largest companies listed on the Hong Kong Stock Exchange. HWL is an international corporation
with a diverse array of holdings which includes the world's biggest port and telecommunication
operations in 14 countries and run under the 3 brand. Its business also includes retail, property
development and infrastructure. It belongs to the Cheung Kong Group.
We provide the power of digital communication, enabling everyone to improve their lives, build societies
and secure a better future for all.

Mission-We exist to help our customers get the full benefit of being connected. Our success is
measured by how passionately they promote us.
Vision-Our vision to empower societies is a clear call to action. We bring vital infrastructure, new
services and products that stimulate progress, change and improvement.

Objective of the study

To understand the case of Vodafone Hutch taxation in India.

Vodafone-Essar: The case - Hutchison International, a non-resident seller and parent company
based in Hong Kong sold its stake in the foreign investment company CGP Investments Holdings
Ltd., registered in the Cayman Islands (which, in turn, held shares of Hutchison-Essar- Indian
operating company, through another Mauritius entity) to Vodafone, a Dutch nonresident buyer.
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.
The total is Vodafone Essar subscription is 106,347,368 subscribers i.e., 23.94% of the total
444,295,711 subscribers.
Individual Investors: Individual large stake holders Analjit Singh and Asim Ghosh sold their stakes
to Vodafone in December 2009. Asim Ghosh, the former managing director of Vodafone Essar, had
4.68 per cent stake in the company held through investment firm AG Mercantile, and sold a part of it
for about Rs 3.3 billion. Analjit Singh, who had a share of 7.58 per cent through three companies,
sold a part of his stake for over Rs 5 billion. After the sale, the stakes held by Ghosh and Singh in
Vodafone Essar will come down to 2.39 per cent and 3.87 per cent respectively.

Vodafone Hutch deal Time Line

The time line for the Vodafone and Hutch deal is as follow:

2007/05/29 - Court sends notice to Vodafone and Hutch

2007/05/05 - Vodafone-Hutch deal gets Finance Minister's nod

2007/04/04 - Vodafone-Hutch deal: Decision likely at next FIPB meeting

2007/03/19 - FIPB to take up Vodafone proposal on Tuesday

2007/03/16 - Hutchison offers $415 m to Essar as `sign-on bonus'

2007/03/16 - Vodafone's Hutch deal in order: Kamal Nath

2007/03/15 - Essar, Vodafone reach agreement on jointly managing Hutch

2007/02/18 - What Vodafone will collect from the Hutch call

2007/02/15 - `Roses for Essar, telephony for masses'

2007/02/15 - Vodafone pledges $2-b investments

2007/02/12 - Hutch: Vodafone top bidder with $19-b offer

2007/02/11 - Hindujas to partner Qatar Telecom, Altimo for Hutch

2007/02/10 - Hutch bidding goes to the wire

2007/01/11 - Vodafone offer in a few weeks

2007/01/09 - Vodafone starts due diligence of Hutch

2007/01/06 - Hutchison, Essar differ over right of refusal

2007/01/03 - Essar gets fund pledge worth $24 b for Hutch-Essar buy

2006/12/29 - Reliance Comm in race for Hutch-Essar

2006/12/23 - Vodafone joins race for Hutchison Essar stake

2006/12/21 - Vodafone may join race for Hutch

Taxation issue in Vodafone Hutch deal: The Indian Revenue authorities issued show cause
notice to Vodafone arguing that they had failed to discharge withholding tax obligation with respect to
tax on gains made by Hutch on sale of shares to Vodafone. Vodafone filed a writ petition in the
Mumbai High Court challenging the jurisdiction of the Revenue department. The revenue department
issued show-cause to Vodafone asking for an explanation as to why Vodafone Essar (which was
formerly Hutchison Essar) should not be treated as an agent (representative assesse) of Hutchison
International and asked Vodafone Essar to pay $ 1.7 billion as capital gains tax.

Indian Income Tax department view: The whole controversy in the case of Vodafone is about the
taxability of transfer of share capital of the Indian entity. Generally, the transfer of shares of a non-
resident company to another non-resident is not subject to tax in India.
But the revenue department is of the view that this transfer represents transfer of beneficial interest
of the shares of the Indian company and, hence, it will be subject to tax.
The revenue authorities are of the view that as the valuation for the transfer includes the valuation of
the Indian entity also and as Vodafone has also approached the
Foreign Investment Promotion Board (FIPB) for its approval for the deal, Vodafone has a business
connection in India and, therefore, the transaction is subject to capital gains tax in India.

Vodafone view: On the contrary, Vodafones argument is that there is no sale of shares of the
Indian company and what it had acquired is a company incorporated in
Cayman Islands which, in turn, holds the Indian entity. Hence, the transaction is not subject to tax in
India.
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.

Key questions before the High Court:

Whether the show cause notice issued by the Revenue authorities was without
Jurisdiction as Vodafone could not be said to be liable under section 201 of the
Income tax Act 1961 for not withholding tax?

Whether the provisions relating withholding tax obligation under section 195 of the Acts have
extra territorial application and a non-resident without presence in
India has an obligation to comply with it?

Whether the transaction per se resulted in income chargeable to tax in India?

Vodafones Petition and Arguments: Vodafones argument is that there is no sale of shares of the
Indian company and what it had acquired is a company incorporated in Cayman Islands which in
turn holds the Indian entity. Hence, the transaction is not subject to tax in India.

The petitions and arguments of Vodafone are as under:

It was not in default (under section 201) for not withholding tax as the law applied to situations where
tax had been withheld and not deposited. Hence, to impose an obligation where no withholding had
been made was unconstitutional. Giving a contextual interpretation, person liable to withhold tax
could not include a non-resident having no presence (in India), since such an interpretation would
amount to treating unequals as equal by imposing onerous compliance obligations as applicable to
residents or nonresidents having a presence in India. The transfer was with respect to ownership of
shares in a foreign company and no capital asset in India. Further, change in controlling interest in
Indian companies was only incidental to change in foreign shareholding.
Vodafone also challenged the constitutional validity of retrospective amendments to sections 191
and 201 of the Act, motivated to impose an obligation on payer to withhold tax.
The transfer of the shares of CGP which was a capital asset situated outside India could not result in
any income chargeable to tax in India. A share in a company represents a bundle of rights and its
transfer results in a transfer of all the underlying rights. However, what were transferred were only a
share and not the individual rights.
When there is no look-through provisions under the Income Tax Act, 1961 ("the Act"), such a
provision cannot be read into the statute and the corporate veil cannot be lifted unless a tax fraud is
perpetrated. The Supreme Court ("SC") in the case of Azadi Bachao Andolan (2003) 263 ITR
706 has held that there was no tax consequence in India when the shares of one of the intermediate
holding company in Mauritius were transferred. Similarly, there should not be a tax consequence,
even when an upstream holding company transfers its shares.

Analysis of the issue: HC ruling in Vodafone Case: The HC held that the series of transactions in
question has a significant nexus' with India. Since the essence of it was change in controlling
interest in HEL, it constituted a source of income in India. It held that the price paid by
Vodafone factored in, as part of the consideration, diverse rights and entitlements being transferred
as part of the composite transaction. Many of these entitlements were not relatable to the transfer of
the CGP share. It held that intrinsic to the transaction were transfer of other rights and entitlements.
Such rights and entitlements constitute capital assets' as per the provisions of the Act.
The apportionment of consideration paid by Vodafone for a bundle of entitlements stated above lies
within the jurisdiction of the Indian Revenue. The Indian Revenue Authorities sought to apportion
income resulting to HTIL between what has accrued or arisen or what is deemed to have accrue or
arise as a result of a nexus with India and that which lies outside.
Subsequent to the HC ruling, the Revenue has raised a tax demand of Rs.112,180 million on
Vodafone for failure to withhold taxes. Meanwhile, the appeal filed by Vodafone before the Supreme
Court was heard in November 2010.

Analysis of decision: This is a landmark ruling which throws light on principles of taxation of cross-
border transfers. The High Court's observation on the principle of proportionality' that a portion of the
income would be chargeable to tax is a significant one. The Court has also observed that the other
rights and entitlements, passed on as a part of the deal are separate assets and can be regarded as
capital assets', within the meaning of the Act. These observations seem to indicate that transactions
involving a simpler transfer of shares of a company outside India, which has companies in its fold in
India, would not be chargeable to tax in India. However, if certain other rights and entitlements in
India are transferred along with the transfer of shares, there would be an incidence of tax in India.
This decision could certainly embolden the Revenue authorities to investigate offshore transactions,
which have a connection with India or cases where limited interest exists in India and the demand
raised by the Revenue authorities is a clear indication of things to come.

The Dutch government, on behalf of Vodafone, has approached the Indian government for settling a
three-year-old dispute involving a tax claim of over Rs.11,000 crore. Netherlands has written to India
asking it to consider an alternate dispute resolution that will run parallel to the ongoing court process
through what is termed as a Mutual Agreement Procedure (MAP).
India would examine the request and take a decision in accordance with the provisions of the
India-Netherlands double tax avoidance agreement (DTAA). MAP is an alternate process of dispute
resolution, and is an option available to a taxpayer in addition to and concurrent with the appellate
process. However, under MAP, once the proceedings are initiated, it is possible to obtain a stay on
the tax demand provided one gives a bank guarantee.
This opens up the possibility of a settlement on the lines of what Vodafone clinched in the UK earlier
this year, when it agreed to pay 1.25 billion in taxes to settle a decade-long dispute dating back to
2000 regarding its Luxembourg subsidiary.

Supreme Court of India Decision

The Supreme Court today ruled in favour of Vodafone in the $2 billion tax case saying capital gains
tax is not applicable to the telecom major. The apex court also said the Rs.2,500 crore which
Vodafone has already paid should be returned to Vodafone with interest. The decision will be a big
boost for cross-border mergers and acquisitions here. The Income tax departments contention, if
upheld, would have rendered standard transaction structures too risky forcing foreign companies to
weigh potentially new litigation and insurance costs. Nearly five years after the Indian taxman issued
the first notice to Vodafone international on September 2007 for failure to withhold tax on payments
made to Hutchison Telecom, Chief Justice of India SH Kapadia and Justice KS Radhakrishnan
pronounced their judgement.
The SC has ruled that the transaction is not taxable in India, and it has made the following
observations/ comments while pronouncing its ruling:
Presently, there are no look-through provisions in the Indian domestic tax law to tax the
transaction.
There is no extinguishment of property rights in India through the transfer of shares between two
foreign entities of shares in another foreign entity.
Similarly, provisions which treat a person as an agent/representative of a foreign entity for the
purpose of levy and recovery of tax due from such a foreign entity is not applicable in the absence of
a nexus.
There is no conflict between the earlier decisions of the SC in Azadi Bachao Andolan,and Mc
Dowell. The SC in the case of Azadi (263 ITR 706), had held that an act which is otherwise valid in
law cannot be held as sham, merely on the basis of some underlying motive supposedly resulting in
some tax advantage. The SC in the case of Mc Dowells (154 ITR 148), held that sanction cannot be
accorded to a colourable device.
The duration of the holding structure, timing of exit and continuity of business, are important
factors while evaluating as to whether the transaction as a whole is a sham.
Considering the factual matrix in the present scenario, the SC held that the transactions not a sham.
Withholding tax provisions in the Indian domestic tax law cannot apply to offshore transactions
The Tax Authority has also been directed to refund the entire amount (US$ 0.5 billion) deposited
by Vodafone as part payment towards the demand in early 2011 along with interest
Tax policy certainty crucial for national economic interest.
The decision of the SC is expected to be a milestone development in the taxation of international
transactions and on the judicial approach to tax avoidance. This case is, perhaps, the first in the
world where the issue of taxation on indirect transfer of shares is being litigated before a countrys
highest judicial forum. The principles emanating from this ruling could therefore, have ramifications
beyond India. It could also be of relevance in shaping Indias tax policy on international taxation and
tax avoidance in the future.

V. Summary & Concluding remarks

Indian tax laws are complex and possibly are in the process of getting more complicated by the day
in terms of regular annual amendments and judicial decisions which continuously revise the judicial
interpretations in the light of changing business environment. The growing importance of the Indian
economy and the increasing demands for resources has given the government the confidence to tax
offshore deals wherever possible. In the case of transactions involving large capital sums, it would
be advisable for the concerned parties to approach the Authority for Advance Rulings (AAR) which
would freeze the tax treatment for a particular transaction in the case of a non-resident. This would
avoid the kind of pitfalls that Vodafone finds itself in.
This would also have a major impact on deals with a country with which India does not have a
Double Taxation Avoidance Agreement (DTAA). The major legal battles such as the Vodafone
dispute which essentially determine the fate of a large chunk of Foreign Direct Investments into
India and is in this context much awaited. The challenge lies in balancing the interest of the investors
and the revenue authorities. The new direct tax code that the Government is planning to introduce so
as to replace the current Income-tax Act, 1961 (the IT Act), is expected to emphasize on
transparency and taxpayer-friendliness.
At present, the dispute resolution mechanism in India moves slowly. Assessment proceedings
continue for more than two years from the date of filing of the tax return. Thereafter, the two
appellate levels take approximately two to seven years to dispose of an appeal. If the dispute still
continues, on a question of law, the matter gets referred to the High Court and the Supreme
Court which generally takes very long. This is worrying the Indian corporate sector as it takes a lot of
management time and effort. There is a need to expedite the litigation procedure. There should be a
limitation period on disposal of appeals as well.
Amendments brought about by the Finance Act, 2008 would have a major impact on transfer of
shares overseas, especially in a case where the seller of the shares is a resident (as per tax laws) of
a country with which India does not have a Double Taxation Avoidance Agreement (DTAA).
The amendment also brings the investors from countries like the US and UK within the tax net in
India, since Indias DTAA with such countries provide for taxation of capital gains in accordance with
the domestic tax laws of India. In this way, there is an urgent need to speed up the system and bring
more clarity in rules and amendments.