Vodafone wins arbitration against India in retrospective tax case

The telecom major Vodafone won a long-pending case against the Indian government in an international court over Rs. 22,000 crore in a retrospective tax dispute. Let's take a look at what happened:

Facts of the Case:

The main companies involved were as under:

HEL was an Indian Company in which CGP (Mauritius) was holding 67% shares and Essar holding the remaining 33 % shares. CGP was a 100% subsidiary of HTIL (Hong Kong). A Share Purchase Agreement (SPA) was signed between the Non-resident Companies on 11.2.2007 between VIH and HTIL, whereby HTIL agreed to procure the sale of CGP shares.

Issue Involved:

Whether the transfer of shares between two foreign companies, resulting in the extinguishment of controlling interest in the Indian Company held by a foreign company to another foreign company, amounted to the transfer of capital assets in India and as such chargeable to tax in India.

Analysis of the Case:

Assessee's view:

If one non-resident sells shares of a foreign company to another non-resident of India; and the transaction took place outside India, there can be no tax on the same.

Department's view:

CGP is a sham entity incorporated in Cayman Islands Mauritius which is known as a Tax Haven. The transfer of CGP's shares has no substance. The real transfer is the transfer of substantial interest (67% stake) in HEL (Indian Company). This controlling shareholding has its situs in India. Since the transferred asset is situated in India, the capital gains arising on the same are liable to tax in India. VIH was therefore required to deduct tax at source u/s 195.

Supreme Court Verdict:

The Supreme Court had analyzed section 9(1)(i) and held that it consists of three elements, namely, transfer, the existence of a capital asset, and the situation of capital asset in India which must co-exist for an income to accrue or arise in India.

The court held that section 9(1)(i) of the ITA does not cover indirect transfers and that the words “directly or indirectly” used in section 163 read with section 9(1)(i) go with the income and not with the transfer of a capital asset. The court also held that Section 195, cannot be applied to a non-resident payer and thus VIH cannot be held liable for deduction of tax at source from the payment made to HTIL. Also since there is no income there is no question of TDS being applicable.

The court ruled in favor of VIH and held that the offshore transaction is a participated investment and not a sham or tax avoidant.

However, the government amended its law retrospectively to enable it to tax any gain on the transfer of shares in a non-Indian company which derives substantial value from underlying Indian assets. Thus, the liability was back on VIH.

International Arbitration Tribunal :

The Company was served in 2016, with a demand notice of Rs. 22,100 crore including interest. The international arbitration tribunal in The Hague ruled that India's imposition of tax liability on Vodafone, as well as interest and penalties, were in a breach of an investment treaty agreement between India and the Netherlands. Further ruled that the government should cease dues from Vodafone and should bear partial legal costs borne by VIH.