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India
Tax
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International tax Alert

Vodafone Ruling
Volume: ITX/ 25 /2010
8 September 2010

Bombay High Court decides against Vodafone’s plea

In this issue:
Facts in brief
Key contentions of Vodafone
Key contentions of the Indian tax authorities
Ruling of the Bombay High Court
Contacts

Facts in brief

 Vodafone International Holdings B.V. (“Vodafone”) was issued a notice by the Indian tax
authorities in the context of non-compliance of Indian withholding tax obligations (vis-à-vis the
acquisition of shares of a non-resident Hutchison Group entity (“HG”) outside India).

 The primary allegation of the Indian tax authorities was that though the shares transferred
belonged to a non-resident entity and the share transfer had taken place outside India (from one
non-resident to another), what effectively exchanged hands pursuant to the transaction was the
“controlling interest” in Hutchison Essar Limited (“HEL”), which was held indirectly by HG.

HEL was the flagship company which held the telecom business of the Hutchison Group in India.

 Vodafone filed a writ petition before the Bombay High Court against the said notice. The
Bombay High Court rejected the writ petition and made a prima facie observation that the
transaction under consideration may be liable to tax in India since the underlying intent of the
transaction was to transfer “controlling interest” in HEL from HG to Vodafone.

 Aggrieved by the above, Vodafone filed a special leave petition before the Supreme Court. The

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 Supreme Court dismissed the special leave petition and directed the Indian tax authorities to
examine the limited question as to whether they have sufficient territorial jurisdiction to levy tax
on the transaction under consideration.

Further, the Supreme Court also provided relief to Vodafone by directing that in case the order
passed by the Indian tax authorities is against Vodafone, it could directly approach the Bombay
High Court for quick adjudication (i.e. it would not be required to go through the elaborate
procedure of first approaching the appellate commissioner and income tax appellate tribunal
before appealing to the Bombay High Court).

 In response to the Supreme Court’s direction and post completion of a detailed scrutiny, the
Indian tax authorities passed a voluminous order adjudicating that they had territorial jurisdiction
to tax the transaction under consideration. Further, they also held that the transaction was
taxable in India and Vodafone was an “assessee in default” for not having complied with its
withholding tax obligations.

 Based on the relief granted by the Supreme Court, Vodafone directly approached the Bombay
High Court against the said order of the Indian tax authorities.

 A brief summary of the key contentions put forth by Vodafone and the Indian tax authorities and
the resultant verdict of the Bombay High Court is as follows -

Key contentions by Vodafone

 Since the transfer is of a capital asset situated outside India, the gains arising there from should
not be liable to tax in India in the hands of the non-resident seller entity.
 The Income Tax Act, 1961 (“ITA”) does not have any “look through” provisions. The same
cannot be enforced through judicial interpretation.
 The observation of the Indian tax authorities that pursuant to the transaction under
consideration, the benefit of the telecom licence stood transferred to Vodafone is grossly
misconceived. Under the Telecom policy of India, a telecom licence can only be held by an
Indian company and there was no transfer, direct or indirect, of any such licence.
 The Foreign Investment Promotion Board (“FIPB”) Approval was a routine process required to
be complied with pursuant to Press Note 1. This mundane requirement does not shift the situs
of the shares to India.
 The Indian withholding tax provisions under section 195 of the ITA do not apply to offshore
entities making offshore payments. Further, section 195 of the ITA could be triggered only if it
can be established that the payment under consideration is of “a sum chargeable under the
ITA”.
 In a case such as the present, where the payment has no element which could be made liable
to tax in India and the payer does not withhold any tax and the Indian tax authorities thereafter
make a demand of tax which allegedly should have been withheld under Section 195 of the ITA,
it is open to the payer to contend that its action was justified on the ground that there was no
sum chargeable to tax under the provisions of the ITA. Such an issue if raised has to be
decided and not only on a prima facie basis.

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Key contentions of the Indian tax authorities

 The transaction constituted a transfer of composite and bundle of rights held by HG in HEL
(Vodafone had simply stepped into the shoes of HG). The subject matter of transfer was not the
shares of the Cayman Islands company but assets situated in India.
 HG had necessarily to adopt several steps to consummate the transaction of transferring all its
rights in HEL in India, which were independent of the transfer of the share of the Cayman
Islands company.
 HG received income from the disinvestment of its rights and interest in HEL. This was brought
out in its appropriation of income as a “transaction special dividend” to its shareholders.
 “Controlling interest” in a company can be obtained by independent agreements de hors
shareholding.
 Several valuable rights (which are property rights and capital assets) were relinquished in
favour of Vodafone. These rights would constitute an asset of a capital nature which is situated
in India.
 The provisions under the ITA are of wide amplitude and a comparison with the OECD system of
taxation may not be appropriate.
 “Capital asset” is widely defined to mean property of any kind held by the assessee. This would
include rights and interests which are capable of being owned and transferred.
 Though an acquisition of an interest in a joint venture would not amount to an acquisition of an
asset, the acquisition of a bundle of rights amounted to acquisition of “property”. HG could
transfer its “controlling interest” in HEL only on extinguishing it rights in HEL.
 A disinvestment of its right, title or interest preceded disinvestment of “controlling interest”. It
would be too simplistic to assume that what was transferred was only a share and that all other
rights were incidental to the transfer. Further, the particular mode of transfer would not be
determinative of the nature of the asset and would not alter or determine the situs, nature or
character of the asset. Accordingly, HG relinquished it asset, namely its interest in HEL, so as to
fall within the ambit of “transfer” as defined under section 2(47) of the ITA.
 The “accrual” or “arising” of any income indicates some origin of income and this has to be
determined on a cumulative basis depending on the facts of the case. The entire income which
HG derived had its “source” in India and hence “accrued” or “arose” in India.
 In respect of the liability to deduct tax, the expression “person” as provided in section 195 of the
ITA could be applied to a non-resident. Further the provisions would apply to all payments
which wholly or partly represent “a sum chargeable to tax” and once the income is chargeable,
the nexus will exist both with regard to payee and the payer. Since the transaction under
consideration had a substantial nexus, it would result in an obligation being cast on Vodafone to
deduct tax at source under section 195 of the ITA.

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 Ruling of the Bombay High Court

 From the Hutchison Group’s perspective, it had carried on “Indian mobile telecommunications
operations” which was being discontinued as a result of the transaction.
 A review of various relevant term sheets, sale purchase agreement, tax deed covenant, brand
license agreement, loan assignment agreements, due diligence report, etc. clearly established
that it would be simplistic to assume that the entire transaction between HG Group and
Vodafone was fulfilled merely upon the transfer of a single share of a Cayman Islands company.
 The true nature of the transaction as it emerges from the transactional documents is that the
transfer of a solitary share of the Cayman Islands company reflected only a part of the
arrangement put into place by the parties towards achieving the object of transferring “control”
of HEL to Vodafone.
 The transactional documents are not merely incidental or consequential to the transfer of the
share of the Cayman Islands company but recognize independently the rights and entitlements
of HG in relation to the Indian business which were being transferred to Vodafone.
 The transfer of the share of the Cayman Islands company was not adequate in itself to achieve
the object of consummating the transaction between HG and Vodafone. 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) of the ITA (which
expression is defined to mean “property of any kind held by an assessee”).
 Vodafone’s disclosure to the FIPB is indicative of the fact that the consideration that was paid to
HG 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 a further 15% indirect interest in HEL.

The Bombay High Court has however refrained from adjudicating on the methodology pursuant
to which the total consideration should be apportioned towards each of the above.

 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.
 From the perspective of income tax law, what is relevant is the place from which or the source
from which the profits or gains have generated or have accrued or arisen to the seller. The
income accrued and arose and was derived as a consequence of divestment of HG’s interest in
India. If there was no divestment or relinquishment of such interest in India, there was no
occasion for the income to arise. The real taxable event is the divestment of HG’s interests
(which comprises of various facets or components including the transfer of interests in different
group entities).
 Once the territorial nexus is established, the provisions of section 195 of the ITA would operate.
Even though the revenue laws of a country may not be enforceable in another country, that
does not imply that the courts of a country shall not enforce the law against the residents of
another country within their own territories.

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  “Chargeability” and “enforceability” are distinct legal conceptions. A mere difficulty in compliance
or in enforcement is not a ground to avoid observance. In the present case, the transaction in
question had a significant nexus with India. The essence of the transaction was a change in the
“controlling interest” in HEL which constituted a “source of income” in India. The transaction
between the parties covered within its sweep, diverse rights and entitlements. Vodafone, by the
diverse agreements that it entered into, has a nexus with Indian jurisdiction. In these
circumstances, the proceedings which have been initiated by the Indian tax authorities
cannot be held to lack jurisdiction.
 The constitutional validity of the amendment to section 201 of the ITA was not adjudicated upon
since it was not applied by the Indian tax authorities while invoking the territorial jurisdiction.
 Further, the Bombay High Court has held that it is open to Vodafone to agitate before the
Indian tax authorities that it had reasonable cause and a genuine belief to the effect that
it was not liable to deduct tax at source and accordingly, no penal liability could be
fastened upon it.

Source: Writ Petition No.1325 of 2010 decided by the Bombay High Court as available on
itatonline.org

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