Vodafone Vs Asst Dirctor of Income Tax

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Well... It is interesting to see the proceedings of the case!

Taxability of Vodaphone on acquiring stake in Huchison-Essar in India

                                                By: Surendra Bhargava

Introduction:

Vodafone International Holdings B.V (Vodafone), Netherlands

acquired 100 percent shares in CGP (Holdings) Limited

(CGP) based in Cayman Island for USD 11.2 billion from

Hutchinson Telecommunications International Limited (HTIL)

based in HongKong. CGP held 67 percent shares in Hutchison Essar Limited (HEL), an

Indian entity through Intermediate Holding Companies (IHCs) based in Mauritius. HEL was a joint venture between Hutchinson group (foreign

investor) with the Essar group (Indian partner). HEL had, earlier, obtained

telecom licences to provide cellular telephony in different circles in

India.

Income tax department issued a show cause notice to Vodafone to

explain why tax was not deducted at source while making payment

to HTIL. Vodafone filed a writ petition in the Bombay High Court

challenging the said notice on several grounds.

Scope of write up:

1.2 We consider in this write up one ground that the transfer of shares does not give rise to income ‘chargeable to tax’in India. Vodaphone’s contentions were:

Vodaphone’s contentions:

· Under Section 9(1)(i)  income inter alia

accruing or arising ‘through the transfer of a capital asset situate in

India’ is deemed to accrue or arise in India.

· The transaction in the present case is the transfer of shares of a nonresident

company and is therefore, not a transfer of a capital asset

situated in India.

· The share capital in question is the share capital of CGP. The share

capital of the company would be situate at the place of its registered

office i.e. the Cayman Islands.

· The controlling interest in HEL is not

an asset separate and distinct from the shares but is an incidence

arising from the holding of a particular number of shares in CGP. It

is by virtue of the acquisition of the share capital of CGP that

Vodafone has acquired control of CGP directly and of HEL

indirectly.

· Controlling interest is only an incidence of shareholding and cannot

have an independent existence.

· There is an indirect acquisition of the controlling interest in HEL.

The same has however been achieved by acquiring control of CGP

by virtue of the acquisition of its share capital outside India. So, no

capital asset was transferred within India.

· There is nothing in Indian law to warrant the assumption that a

shareholder who buys shares of a company buys any interest in the

property of the said company, which is a juristic person entirely

distinct from the shareholders.

· The expression ‘directly or indirectly’ in section 9 of the Act relates

to income accruing or arising in India and not to the transfer of a

capital asset situated in India.

· If no business operations are carried out in India, any income

accruing or arising abroad through or from a business connection in

India cannot be deemed to accrue or arise in India even though there

is a business connection in India and income is arising from such

connection. Therefore, the income is not chargeable to tax in India.

1.3 The department’s contentions were the following:

Department’s contentions:

· The income (capital gains) of HTIL is deemed to have accrued or

arisen in India and therefore, it fell within the ambit of

Section 9.

· HTIL, earned income from the transfer of its

business/economic interests, in favour of Vodafone.

· The transaction between Vodafone and

HTIL is nothing but transfer of interests, tangible and intangible, in

Indian companies of the Hutch Group in favour of Vodafone and not

an acquisition of shares of CGP.

· The transfer, involves the transfer of a bundle of interests in various

entities viz. interest in telecom license, use of brand and goodwill,

non-compete rights, right to enter into telecom business in India,

control premium etc and is not just a transfer of only the shares of CGP and

which was not even considered in the Enterprise value of HEL.

· The acquisition of interest in a Quasi-Partnership/Joint Venture,

itself amounts to acquisition of a capital asset.

· Vodafone itself has have not disputed that the transaction involves

transfer of controlling interest. A divestment or

extinguishment of right, title or interest must necessarily precede the

divestment of the controlling interest and it would be impossible to

dissociate one from the other and any divestment by one of any

interest of such value in shares would

amount to acquisition of enduring benefit to the other,

resulting in acquisition of a capital asset in India.

· The transaction also results not only in extinguishment of HTIL’s

rights in HEL but relinquishment of its asset viz., its interest in the

Hutchinson - Essar Group, so as to fall within the ambit of transfer

as defined in Section 2(47) of the Act.

· The object of the transaction in the present case was also to enable

Vodafone to successfully pierce the Indian mobile market to enlarge

its global presence.

· The interest which Vodafone has acquired in India should be

construed as a capital asset inasmuch as Vodafone has not only

become the successor in interest in that Joint Venture to HTIL, but

also has acquired a beneficial interest in the license granted by the

Department of Telecommunications in India to its group companies,

(now become as Vodafone Essar Limited)

· Vodafone, by its various

declarations made it apparent that the purpose of their

acquiring shares in CGP was to acquire the controlling interest of 67

percent in HEL.

· The court ought to give credence to the ‘Effects Doctrine prevalent

is USA’.

· The very purpose of entering into agreements is to acquire the

controlling interest which one foreign company held in the Indian

company, by other foreign company. This being the dominant

purpose of the transaction, the transaction would certainly be subject

to municipal laws of India, including the Act.

· Shares in themselves may be an asset but in some cases, like the

present one, shares may be merely a mode or a vehicle to transfer

some other asset(s).

High court’s decision:

1.4 The High Court held

-that the totality of the circumstances indicated that the tax authorities

have made out a strong prima facie case that the transaction was one

of transfer of a capital asset situate in India. It would be too simplistic

to hold that, Vodafone had merely acquired

shares of an unknown  company, CGP. The Court’s reasons  were:

· Vodafone made it apparent that the purpose of their

acquiring the shares in CGP was to acquire the controlling interest

of 67 per cent in HEL.

· Vodafone has itself admitted that HTIL has transferred their 67 per

cent interests in HEL qua their shareholders, qua the regulatory

authorities in India (FIPB), qua the statutory authorities in USA and

Hong Kong and it has also admitted acquiring 67 per cent held by

HTIL in HEL. A different stand apparently cannot be taken before

the tax authorities in India.

· through the acquisition of shares of CGP, Vodafone has

acquired controlling interests in the Indian Joint Venture

and other interests and intangible rights situate in India. The shares

were prima facie merely a vehicle to acquire these assets.

· The dominant purpose of the transaction of sale / purchase of shares

in CGP was to acquire the controlling interest of CGP in the Indian

company. The transaction would therefore certainly be subject to

Municipal laws of India, including the Income tax law.

1.5 The court did not refer to the concerned provision in section 9(1)(i) in detail, which we propose to do here.

Analysis:                     

2.1 Under section 9(1) of the Income tax Act (Act), 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.

2.2 The above clause speaks of the income which shall be deemed to accrue or arise in India to mean income accruing or arising whether directly or indirectly (1) through or from any business connection in India or (2) through or from any property in India, or (3) through or from any asset in India or (4) through or from any source of income in India, or (5) through the transfer of a capital asset situate in India.

2.3 We will consider, here, income accruing or arising whether directly or indirectly  (1) through or from any source of income  in India or (2) through the transfer of a capital asset situate in India and apply it to transfer of shares by a non-resident to another non-resident, in a company incorporated abroad, the foreign company holding shares in the Indian company .

2.4 The question to be examined is on the following facts: 1) shares transferred are held in the foreign company; 2) Transfer is by one non-resident to another non-resident; 3) foreign company held shares in the Indian company; 4) Indian company has property, asset, source of income and capital asset in India; 5) foreign company does not directly hold any property, asset, source of income and capital asset in India.   

View’s of author :

3.1 Kanga, Palkhiwala & Vyas explains these clauses in ‘The law & practice of income tax’ 9^th ed at pp 368:

Under this clause, which reproduces a part of s 42(1) of the 1922 act, income is deemed to accrue in India if it accrues, directly or indirectly : through

or from any

(i)business connection in India;

(ii) property in India;

(iii) asset or source of income in India;

(iv) money lent at interest and brought into India in cash; in kind*; or

(v) the transfer of a capital asset situated in India.

(*deleted w.e.f 1^st June, 1976) 

There is nothing in this clause to exclude from its scope any of the heads of income mentioned in s 14 of the Act.

Pp 369:       

      This clause performs 2 functions:

(i)                 It deems the above 5 categories of income to accrue in India. The deeming provisions of this clause:

(a)   Apply to residents and non-residents alike; and 

(b)   Has no application where income actually accrues in India or is received in India.

Both these points have been noted above in dealing with this section generally.

(ii)               it specifies the categories of income in respect of which a vicarious liability is imposed by ss 160 and 161 on an agent to be assessed in respect of a non-resident’s income. In performing this function, the clause:

(a)   applies to the income of non-residents alone; and

(b)   specifies the categories of income in respect of which the agent is vicariously liable even if the income actually accrues in India or is received in India.

3.2 The learned author’s view is that a) phrase ‘directly or indirectly’ qualitfies to all 5 categories of income; b) clause also applies to non-residents; c) clause applies to capital gain accruing or arising directly or indirectly on transfer of capital asset situate in India or income accruing or arising, directly or indirectly  through or from any

 (i) property in India;

(i) asset or source of income in India;

Capital asset:

3.3 ‘asset’ is not defined under the Act. However, ‘block of assets’ is defined in section 2(11) to mean ‘a group of assets falling within a class of assets comprising-(a) tangible assets,…; b) intangible assets, being know how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature,…

3.4 ‘capital asset’ is defined in section 2(14) to mean ‘property of any kind held by an assessee, whether or not connected with his business.., but does not include-

(only relevant part has been quoted for the sake of brevity)

3.5 Under Explanation 3 of section 32(1) ‘assets’ and ‘block of assets’ shall mean:

(a) tangible assets,…; b) intangible assets, being know how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature,…

3.6 Thus, ‘assets’ and ‘capital assets’ have the same meaning, under the Act.

3.7 In Dipti Kumar Basu v. CWT [1976] 105 ITR 450 (Cal), the Court held that, unless the context otherwise indicates, the word ‘asset’ must include property of every descripttion.

3.8 Thus, the words, ‘assets’, ‘capital assets’ and ‘property’ mean the same thing under the Act, as interpreted by the courts.

3.9 The phrase ‘any other business or commercial rights of similar nature’, in section 2(11), defining the ‘asset’, has not been defined. We may refer to section 55(1)(b)(1), which, while giving definition of ‘cost of improvement’ states that ‘capital asset being goodwill of a business’. Clause 2(a) of this section, defining ‘cost of acquisition’ again states ‘capital asset, being goodwill of a business’. Thus, goodwill is a capital asset. For other ‘business or commercial rights’, we may refer to section 55(2)(a), which states:

In relation to a capital asset, being goodwill of business or right to mark or brand name associated with a business or right to manufacture, produce or process any article or thing or right to carry on any business, tenancy rights, stage carriage permits or loom hours.

Directly or indirectly:

4.1 HEL has various assets, capital assets or property in India, tangible and intangible, interest in telecom license, use of brand and goodwill,

non-compete rights, right to enter into telecom business in India,

control premium etc. Shareholders, in CGP, own these assets, through the intermediate holding companies (IHCs) based in Mauritius. The capital assets were held, directly or indirectly by HTIL. The phrase ‘directly or indirectly’ has not been defined in the Act. Protocol to Indo-Japanese double taxation avoidance agreement, defines it:

“6. With reference to paragraph 1 of article 7 of the Convention, it is understood that by using the term ‘directly or indirectly attributable to the permanent establishment’, profits arising from transactions in which the permanent establishment has been involved shall be regarded as attributable to the permanent establishment to the extent appropriate to the part played by the permanent establishment in those transactions. It is also understood that profits shall be regarded as attributable to the permanent establishment to the above-mentioned extent, even when the contract or order relating to the sale or provision of goods or services in question is made or placed directly with the overseas head office of the enterprise rather than with the permanent establishment.”

4.2 Supreme court in the case of  Ishikawajma-Harima Heavy Industries Ltd  v.

Director of Income-tax [2007] 158 taxman 259 (sc) held that ‘Paragraph 6 of the Protocol to the DTAA is not applicable, because, for the profits to be ‘attributable directly or indirectly’, the permanent establishment must be involved in the activity giving rise to the profits’.

4.3 Although the above definition of ‘directly or indirectly’ is not all fours with the facts of our case, but it gives an indication, how to find out, whether capital gain to the non-resident shareholders could be attributed to the assets, capital assets and property in India. From the protocol, one can say that the income, by way of capital gain, from the sale of shares of the foreign company, accrues or arises, directly or indirectly (1) through or from any source of income  in India or (2) through the transfer of a capital asset situate in India.

Source of income in India:

5.1Whether gain from the transfer of shares, could be said to be,‘ through or from any source of income in India’? We may refer to the decision in Caltex (India) Ltd v CIT (1952) 21 ITR 278 (Bom): Caltex, incorporated outside India, sold its products in India. Caltex paid dividends to its 100% holding company. Dividends was assessed in the hands of holding company, treating Caltex, as statutory agent. The court held:

a.      The profits made by Caltex and the dividend declared by it out of such profits were from the self same source.

b.      Dividend declared were income, profits or gains arising directly from the source of income in British India within the meaning of the third head of section 42(1) of 1922 Act, namely, income, profits or gains arising directly or indirectly through any asset  or source of income in British India.

5.2 In CIT v Lady Kanchanbai (1970) 77 ITR 123(SC), the Supreme court quoted with approval, an observation of the Privy council as follows(p 126):

            ‘In Rhodesai Metals Ltd v CIT (1941) 9 ITR (suppl) 45(PC), the judicial committee observed that ‘source’ means not a legal concept but which a practical man would regard as a real source of income. There is hardly any room for doubt, nor was it contended otherwise-that the business of the assessee in Madhya Bharat constituted a separate source or sources’.       

Situs of income:

5.3. Tests for determining situs of income were laid down by the Rajasthan High Court, in the case of Mansinghka Bros Pyt Ltd v CIT (1984) 147 ITR 361, as under:

The place of accrual of income is the place where the right to receive that income arises, with the corresponding liability to make the payment of the same. In money lending transactions there may be several factors which may have different territorial connections. These factors may be

a.       as to the place where an agreement verbal or written to advance the loan is entered into;

b.       the place where the money is actually lent;

c.       the place where the money is used;

d.       the place where entries thereof are made; and

e.       the place where the money, including interest, is agreed to be paid.

In order to determine the situs of accrual of interest, these and several other factors may enter into consideration.  

5.4 In the present case, the source of income of the shareholders in the foreign company is the operations of the subsidiary company in India. The gain of non-resident shareholders, on sale of shares in the holding company, accrues or arises in India. Thus, the capital gain has source in India.  Such income would be deemed to accrue or arise in India, since it accrues, directly or indirectly through from any source of income in India.

Through or from:

6.1 There is difference in the two phrases discussed above, (1) through or from any asset or source of income in India or (2) through the transfer of a capital asset situate in India. Later phrase does not involve the word ‘from’. The meaning of these two words has been explained as under:  

www. Languagelab.com

"From" would mean you got the answer directly from your friend. Your friend gave you the answer.

Using "through" would indicate that your friend arranged for you to receive the answer (and therefore you probably received the answer from someone else).

6.2 What it means that the word ‘from’=directly and ‘through’=indirectly. Assuming the words ‘directly or indirectly’ do not qualify these two phrases, ‘through or from’, itself may fill the void.

6.3 Use of both the words in the first phrase, any source of income in India, indicates that income from underlying asset or source of income in India of the Indian subsidiary would be covered by this phrase.

6.4 The second phrase uses only the word ‘through’. It means   income accruing or arising whether indirectly would be covered by this word. Thus, capital gain accruing or arising through the transfer of shares of Indian subsidiary would be covered by this phrase.

6.5 We do not propose here to discuss the ‘Effects Doctrine prevalent in USA’. However, the use of words ‘directly or indirectly’ and ‘through or from’ seem to be equivalent to this doctrine.

Apportionment of capital gain:

7.1 We may deal here with one more aspect raised by Vodaphone that, if no business operations are carried out in India, any income

accruing or arising abroad through or from a business connection in

India cannot be deemed to accrue or arise in India even though there

is a business connection in India and income is arising from such

connection. Therefore, the income is not chargeable to tax in India.

7.2 The above contention is based on Explanation (1) below section 9(1)(i), reproduced below:

(a) in the case of a business of which all operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India.

7.3 We discussed above clause (i). Its components are:

(i)business connection in India;

(ii) property in India;

(iii) asset or source of income in India; 

(iv) the transfer of a capital asset situated in India.

7.4 The above explanation does state to apply to the whole clause, but it seems to apply only to the income from business connection. This will be apparent from the word ‘operations’ used in the explanation. 

Conclusion:

8. Prima facie, the High court’ view seems justified in confirming correctness of the department sending the notice to the Vodaphone. Taxability would depend upon studying details of relationship of various entities and of the transactions.

V.V. gud knowledge Gain!

Thanks yaar

 thanks surendra bhargava

very nice update.

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