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VODAFONE: REVIEW NEEDED AT THE TOUCHSTONE OF MCDOWLL 5-JUDGE JUDGMENT

In recent history of taxation the case of Vodafone International Holdings would always occupy a prominent place as the law laid down now would continue to hold their sway in most of the judgments that will be pronounced henceforth. The judgment rendered by the Supreme Court has begun to draw criticism from leading luminaries in the field and even public interest litigation has been preferred recently challenging its proprietary as the CJI it is alleged happens to be an interested party and had vested interest as his own son was in the employ of E&Y who were the consultants to the company. The judgment has come in for criticism from a senior advocate Prashant Bhushan in the leading daily “The Hindu” of 23rd of February, 2012.

In this case Hutchison Group, Hong Kong (UK) first invested into telecom business in India in 1992. It invested in an Indian joint venture vehicle by name HTML (Hutchison Max Telecom Ltd.). HTML was later renamed HEL. HEL was an Indian company in which shares were acquired by Hutchison group of companies through a structural arrangement of holding and subsidiary companies incorporated in various foreign countries particularly in Mauritius-Hutchison Telecom International Limited (HTIL) which was incorporated in Cayman Island. HTIL and its downstream companies held interest in mobile telecommunication business in several countries including India. CGP was a hundred percent subsidiary of HTIL incorporated in Cayman Island as an exempted company and it had a controlling interest in HEL. Appellants VIH- Vodafone International Holding BV was a resident for tax purposes in Netherlands. A SPA (Sale Purchase Agreement) was entered into between appellant and HTMIL under which HTIL agreed to transfer to appellants its entire issued capital in CGP and thereby entire interest of HTIL in HEL was transferred to VIH the appellants. 

The High Court held that VIH on purchase of CGP got indirect interest in HEL and controlling right in certain indirect holding companies in HEL, controlling rights through shareholder agreements which included right to appoint directors in certain indirect holding companies of HEL, rights to use Hutch brand in India, non-compete agreement with Hutch brand in India etc., which all constituted a capital asset within the meaning of section 2(14). High Court further held that tax department had jurisdiction to initiate proceedings under section 201 for failure by VIH to deduct tax on payments made by it to HTIL for acquisition of such indirect transfers of capital assets. But the Apex Court did not confer with the views expressed by the High Court and held that it is a transaction between two non residents and the splitting of the agreement for various rights cannot be made and even the subject of transfer of CGP another non-resident company is outside the territorial jurisdiction of Indian tax authorities for the purpose of S. 9(1)(i) of the Income Tax Act, 1961 in taxing such offshore transactions.

In view of the above facts the section 9 (1)(i) has to be read further by us which is under:         

Section 9(1)(i) of the Income-tax Act, 1961 (hereinafter referred to as "the Act") reads as under:

"9. Income deemed to accrue or arise in India.-(1)The following incomes shall be deemed to accrue or arise in India:

(i)  all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.

The vexing issue that has been decided in favour of the Vodafone by the Supreme Court was:

1. Whether the transaction could be termed as indirect transfer of a capital asset in India for applicability of Section 9(1)(i) and capital gain arising from such transaction could be exigible to tax in India under the Income Tax Act, 1961

2. Whether the department can tax the capital gains arising from sale of shares of the foreign subsidiary on the basis that that the foreign subsidiary which is not a tax resident in India hold underlying Indian assets?  

3. Whether word indirectly used in section 9 would cover indirect transfers of capital assets that are situated in India.

4. Whether Section 9 contains a look through provision? The term "look through" is used in tax matters to mean an entity’s legal form is ignored and tax effect comes directly on the owners.

5. Where does lie the situs of shares of a foreign subsidiary company?

The Supreme Court held that the words “indirect transfer” cannot be read in to S.9 as the same applies to the transfers of capital assets situated in India. The transfer should be of an asset in respect of which it may be possible to compute capital gains under the Act. The words directly or indirectly go with the income and not with the assets’ transfer.

The DTC Bill, 2010 itself has proposed the taxing income from transfer of shares of a foreign company by a non resident in specified circumstances. These circumstances take note of a situation where any time during twelve months preceding the transfer the fair market value of the assets in India owned directly or indirectly by the company represent at least fifty percent of the fair market value of all assets owned by the company. Therefore, DTC Bill 2010 takes in to account taxation of offshore share transactions and such purposive construction cannot be read into S.9(1)(i) to bring in to tax the indirect transfer and the section is not a look through provision. A comparison was also made in respect of S.64 dealing with indirect transfers and income arising therefrom with the provision of S.9(1)(i) and the intention of the legislature does not seem to be the one that is comprised in S.64(7) or (8). SC also referred to its judgment in the Ishikawajma-Harima Heavy Industries Ltd’s case. Thus situs cannot be shifted from one country to another in the absence of express provision in S.9 which has no look through mechanism.        

Under the Indian Companies Act, 1956, the situs of the shares would be where the company is incorporated and where its shares can be transferred. In the present case, it has been asserted by appellants that the transfer of the CGP share (upstream foreign subsidiary’s share) was recorded in the Cayman Islands, where the register of members of the CGP is maintained. This assertion has neither been rebutted in the impugned order of the Department dated 31-05-2010 nor traversed in the pleadings filed by the Revenue nor controverted. In the circumstances, the arguments of the Revenue that the situs of the CGP share was situated in the place (India) where the underlying assets stood situated cannot be accepted. [S.H. Kapadia, CJI]

In any view, "look through provision" will not shift the situs of an asset from one country to another. Shifting of situs can be done only by express legislation [K.S. Radhakrishnan, J]

The very fact that the transaction involves the transfer of exclusive ownership rights which are countable as capital asset even though through a maze of interwoven transactions which had the dominant purpose to acquire a valuable right in India in respect of telecom business along with other rights under SPA entered to by the appellants to camouflage the real one and secure immunization from taxation(being the dominant purpose) coming under the garb of splitting up can be made equitable with the device which is of a dubious nature with sole and underlying  purpose to avoid tax as one to be found in McDowell on different set of facts but with a strong motive to adopt colourable piece of device to avoid tax. The whole set of interwoven transactions had always had the business connection in India even though entered in non tax jurisdiction and one related to the exercise of those rights in India.

The capital asset is said to be situated at a place where it is situated and as such the rights are existing and exercisable in Indian territories. The concept of share sale need not to be read in to find out the location of capital assets and their vesting and exercising of a paramount right in India.

There is a very thin line of distinction between avoidance and evasion of tax and sometimes the avoidance of tax with the intention to dodge the tax authorities could be held to lead to evasion. The phenomenon of tax gap is the result of such transactions which deny the rightful to tax at the right place and jurisdiction. The decision has rendered the proponents of FDI on cloud nine but the huge tax loss with such a device is the cry of tax famished country India. If one has to ponder what for the whole exercise conducted then the answer is none other than the avoidance of tax in India in respect of a valuable right of colossal measure.

Now coming to what the Supreme Court has stated earlier in McDowell case long back in 1985 by five judge bench settling the question with full affirmation while observing as under:

“In that very country where the phrase ‘tax avoidance’ originated, the judicial attitude towards it has changed…… The courts are now concerning themselves not merely with the genuineness of a transaction, but with its intended effect for fiscal purposes. No one can get away with a tax avoidance project with the mere statement that there is nothing illegal about it. In our view the proper way to construe a taxing statute, while considering a device to avoid tax is… to ask… whether the transaction is a device to avoid tax and whether the transaction is such that the judicial process may accord its approval to it.”

“It is neither fair nor desirable to expect the legislature to…..take care of every device and scheme to avoid taxation,” the ruling added.

“It is up to the court … to determine the nature of new and sophisticated device to avoid tax…to expose them for what they really are and refuse to give judicial benediction.”

The ratio of above judgment five judges and with SC’s views cited above state in an unambiguous way what the current judgment of Vodafone looks lacking rather legitimizing the device. The review file by the Union appears to be correct if it pleads accordingly as the Cayman status is but a post box address and no real corporate activities are carried which too should have been culled as these are merely shell companies like those based in Mauritius which took the benefit under CBDT circular based on residency certificate which was quashed by Delhi HC but SC called it a legitimate tax planning ignoring the five judge judgment of a larger bench. HTIL sold its 67% to Vodafone International in respect of its holding in HEL-Hutch Essar Ltd (an Indian company) and both the companies stated so in about their share and interest in Indian company for specified consideration.

The five bench judgment must rule over the three bench judgment now delivered which the Union of India must contest to set the matter right both in respect of Azadi Bachao Andolan and Vodafone International case by constituting larger bench as it has set at naught the previous judgment of SC in a significant manner which should form the crux for review.

China in circumspect had been very cautious as it taxes indirect transfers of a capital asset situated in China by bringing the legislative amendment in 2009 and bringing in a look through provision.    

V.K.KALIA

FCA DISA-ICAI     

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Category Income Tax, Other Articles by - Vijay Kalia 



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