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One of the most controversial economic issues in the last five years was the tax dispute between Vodafone and the tax department. The case originated after the revenue's (tax department) notice to Vodafone that the company has to pay a capital gains tax of nearly Rs 11000 crores from its purchase of Hutchison Essar Telecom Company from Hutch. The entire dispute centered on the question that whether an indirect transfer of property located in India can be taxed under the relevant section 9(1) (i) of the Income-tax Act. The section instructs imposition of capital gains tax when the capital assets are transferred directly from one company to another.

Indirect transfer means when the shares of a company is transferred, the underlying asset is also transferred to the buyer.

At the final stage of the dispute, the Supreme Court verdict came that tax department doesn't have the right to tax the deal. This is because the relevant income tax Act (Section 9 (i) (i)) doesn't instruct tax authorities when capital asset (machinery building etc.) lying in India is transferred indirectly by transferring the shares by foreign companies abroad. Both Vodafone and Hutch were foreign companies and they made deal in another foreign company which held 67% of shares of Hutchison Essar India Limited. Hence Vodafone need not pay tax for the said deal.

• Issues:

- Taxability over Capital Gains on an overseas transaction between 2 foreign companies (having non-residential status in India) of sale of investments comprising of shares of an Indian Company;
- Withholding Tax obligations of the Non Resident Buyer ( Vodafone International Holdings BV) while making payment of lump sum consideration to Non Resident Seller ( Hutchison International Holdings Ltd)

• Facts of the Case

- Vodafone International Holdings BV, Netherlands ('VIH') entered into a Share Purchase Agreement with Hutchison Telecom, Cayman Islands for purchasing equity shares of its subsidiaries CGP, Cayman Islands

- CGP in turn, directly and indirectly, owned ~52% share capital of Indian Company named as Hutchison Essar Limited ('HEL'). The acquisition meant VIH acquired control over CGP and subsidiaries, including HEL

- The Revenue Authorities held that the gains were taxable in India as there was transfer of controlling stake / business situated in India and accordingly alleged failure on part of VIH to withhold tax on gains arising to HTIL on the transfer of shares of CGP

• Vodafone judgment synopsis (by the Hon'ble SC of India) which set aside the Bombay HC order that WHT and interest and penalties of Rs 11,000 Cr are leviable on Vodafone International Holdings BV, Netherlands.

- The transaction for transfer of shares of a Foreign Company (though directly or indirectly holds shares of an Indian Company) between two non-residents on principal to principal basis abroad cannot be deemed as 'Transfer of Capital Asset' situated in India and accordingly, cannot result into levy of capital gains tax in India.

- The provisions of Section 9 of Act will be attracted only when capital asset is located / situated in India.

- The transaction should not be structured in a manner for avoidance of income tax. The investment structure should be examined and seen in a holistic manner.

- The lump sum consideration for purchase of an entire investment cannot be allocated or dissected in order to calculate the value of specific rights and entitlements.

- The withholding tax obligations in India would arise only when such income is taxable in India

Vodafone judgment synopsis (by the Hon'ble HC of Bombay) which upheld the Revenue's contention that Vodafone was liable for tax deduction at source (TDS) under the Income Tax Act.

- 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.

- 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. The Petitioner 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 Income Tax Authorities cannot be held to lack jurisdiction.

- The issue of jurisdiction for the reasons already noted earlier, has been correctly decided.

• Vodafone judgment - Retrospective Amendments in Finance Act 2012

- Explanation 4 has been inserted in section 9(1) (i), w.e.f. A.Y. 1962-63 to clarify that the expression 'through' (used in section 9(1) (i) in relation to any asset or source of income in India) shall mean and include and shall be deemed to have always meant and included 'by means of', 'in consequence of' or 'by reason of'

- Explanation 5 has been inserted in section 9(1) (i), w.e.f. A. Y. 1962-63 to clarify that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.

- Consequent to insertion of above explanations, the following explanations have also been added to clarify the meaning of (a) 'capital asset' given in section 2(14), (b) 'transfer' given in section 2(47) and (c) to widen the scope of section 195(1).

Multinationals that own property situated in India pay taxes to the Indian government on a transfer of that property if such a transfer has resulted in a gain, termed a 'capital gain'.

The key factor here is that the property being transferred is situated in India; otherwise, the Indian government would have no jurisdiction to tax the transfer of property. Globally, countries do not tax capital gains unless there is some nexus with the country, such as the fact that the transferor is a resident of the taxing country or the fact that the property is situated in the taxing country.

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Category Income Tax, Other Articles by - Ramadurai Chandrasekaran 



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