Vodafone's $2bn tax case Summary of Supreme Court Proceedings
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In February, 2007 Vodafone (through its Netherlands entity) entered into an agreement with Hutchison Telecommunications International Limited, Cayman Islands (‘HTIL’), for acquisition of 66.9848% equity and interests in the Indian telecom business of Hutchison Essar Ltd. (hereinafter referred to as ‘HEL’). The total value of the transaction was $ 11.206 billion.
Purchase of 100% shareholding in CGP by Vodafone, for $ 11 bn
100% subsidiary
66.98% stake held directly and indirectly
The IT Department alleged that Vodafone (Netherlands), the buyer, had failed to deduct Indian tax on the payment of consideration made to HTIL and a show cause notice was issued to Vodafone BV in September 2007 for failure to withhold tax. Bombay High Court, in September 2010, dismissing the writ petition filed by Vodafone, held that share transfer had a significant nexus with India. HC also held that “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 (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 Income Tax Authorities cannot be held to lack jurisdiction.” Accordingly, Bombay High Court has held that the share transfer by Cayman entity is liable to tax in India. The total tax impact of the transaction is over Rs 11,000 cr.
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Vodafone has filed an appeal before the Supreme Court against Bombay High Court decision. A 3 judge bench of Supreme Court led by Chief Justice SH Kapadia, began hearings in Vodafone case from August 3 rd, 2011. Vodafone Counsel, Former Solicitor General Harish Salve has argued for 17 days over 7 weeks. Solicitor General Rohinton Nariman, argued on behalf of the Income-tax department for 6 days. Taxsutra.com has been covering daily proceedings at Supreme Court since last 2 months. This summary has been prepared to provide an overview of the key arguments presented by Vodafone and Income-tax Department before the Supreme Court (upto September 29th, 2011). The hearings are likely to get over by October end. To read the blow by blow account of each day’s proceedings, kindly visit Taxsutra.com
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Summary of arguments by Vodafone counsel Harish Salve ‘Situs’ of CGP shares outside India and not taxable under Sec 9 Sec 9 (1)(i) allows taxation of income deemed to accrue or arise in India through the transfer of a capital asset 'situated in India’. It is abundantly clear from the provision that the capital asset ought to be 'situated in India’. Letter of law should be strictly construed and hence, transfer of a capital asset (in HutchVodafone case, Cayman Island company’s shares) situated outside India, falls outside the ambit of Sec 9(1)(i). Source of income lies where the transaction is effected and not where the economic interest lies. IT Department was proceeding on a 'moving theory of nexus' on the basis that the economic interest and underlying assets were in India. How a share is valued is irrelevant for determining the situs and therefore the location of the gains on its transfer. Without an express legislation or a look through provision, an offshore share transfer between Vodafone and Hutch cannot be taxed. Controlling interest cannot be transferred de-hors shares Control flows from acquisition of shares and hence it is the legal transaction that ought to be seen. A shareholder doesn't have any separate rights, other than those flowing through shares. The only transaction in the Hutch-Vodafone deal, was the transfer of a Cayman Island company's share. HTIL, as a shareholder transferred “control” in CGP shares and not HEL. Thus, there was no separate transfer of controlling interest situated in India, by Hutch to Vodafone. The Share Purchase Agreements (SPA) and Framework Agreements are 'irrelevant' in deciding whether the transaction is taxable in India. Other than the CGP share, no asset was transferred which would be taxable in India. Can't disrespect 'form' unless Azadi Bachao revisited; Can't tax Vodafone transaction on ‘Economic reality theory’ As long as the transaction is bonafide and not a colourable device, it must be taxed only in ‘form’. Structuring based on corporate identity is recognized by Indian law and unless the tests of lifting corporate veil are satisfied, tax has to be levied on the basis of corporate structuring. Company structure cannot not be disregarded unless it is a sham. Where a structure was already in place for many years, shift of taxing jurisdiction by itself at the time of exit, cannot be the basis to lift corporate veil. Direct sale by Mauritius Company of HEL shares would not have attracted tax in India. Reliance was also placed on the decision of Supreme Court in the case of Azadi Bachao (263 ITR 706). It was submitted that unless the court revisited the ratio laid down in Azadi Bachao, form ought to be respected. Since there was no motive to evade tax, Revenue authorities are precluded from making further enquiry into upstream structure. To lift the corporate veil in a structure, ‘timing and stage’ of the transaction are very important and not ‘motive’ to save taxes. Where there are two options for undertaking a transaction, an option which saves taxes would be allowed if such option is permissible under the law and the transaction is otherwise genuine. •
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Sec 195 applies only if 'presence' in India, argues Vodafone 'Any person' in Sec 195 should be construed sensibly, i.e. it should be restricted to payers who have a presence in India, else the enforcement would be impossible. Salve submitted that Sec 195 would apply only if the veil was lifted. Cayman Island a ‘tax neutral’ jurisdiction Cayman Island falls in the Offshore Financial Centre (OFC) category and is not a tax haven. Cayman Island was added to the deal structure as a ‘tax neutral’ jurisdiction and not for tax avoidance. FIPB permission not mandatory FIPB permission was not mandatory to the Hutch Vodafone deal, as it was an off-shore transaction. But Vodafone, being a large corporation, did not want to take a chance and hence merely 'intimated' FIPB about the deal. Opinions from tax experts Opinions from tax experts from different countries were cited to demonstrate how the Vodafone-Hutch transaction would have been dealt with under their respective tax laws and would not have been taxable.
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List of key decision cited by Vodafone Chunnilal B Mehta (1938) 6 ITR 521 Craven v White [1989] A.C. 398
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(PC) Seth Pushalal Mansinghka (P.) Ltd
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(1967) 66 ITR 159 (SC) Assam Consolidated Tea Estates 167
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Bacha F.Guzdar vs. CIT [(1955) 25
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Comp Cases 1 UK court decisions [1925 Appeal
ITR 215
Cases (Privy Council), 1930 AIR (Privy Council) 10, 1942 Appeal Cases 541, 1927 Chancery Division 107, 1957 AIR 312, 1897 Chancery
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National & Grindlays Bank Ltd 72 ITR
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121 Anglo India Jute Mills 129 ITR 352 Azadi Bachao Andolan (263 ITR 706)
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Lamesa Holdings BV [1997] 785 FCA
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Division 911] Chiranjit Lal Chowdhuri (1950 SCR
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869) Ramsay v IRC ([1981] STC 174) Furniss v Dawson [1984] 1 All E.R.
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530 Prevost Car Inc. v. The Queen,[2009]
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F.C.J. No. 241
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Summary of arguments by Income-tax department counsel and Solicitor General Rohinton Nariman The crux of the submissions by Solicitor General Nariman, arguing on behalf of the Income-tax department, before the Supreme Court was as below 1. By construing the SPA (between Hutch and Vodafone) as it stands, along with interpretation of background facts and subsequent interpreting statements by both parties, the transaction be viewed as 'extinguishment of HTIL's property rights in India. One would then conclude that the share was merely a 'mode' to transfer capital assets in India. 2. The entire structure be looked at as an 'artificial tax avoidance scheme', wherein CGP was 'shoved' into the structure at the last minute. 3. If the above 2 arguments failed, then SC adopt the Bombay HC approach, that the CGP share passed outside India but there were other valuable rights which had passed through the SPA. 4. If everything failed and the court accepted Vodafone's argument that the transaction was 'nothing but the share,’ it would still fall within the 'widest' net cast by Sec 9. These arguments were explained in great detail by Solicitor General Nariman over 6 days.
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Business common sense of SPA should prevail Explaining various clauses of the Share Purchase Agreement (SPA), it was argued that there was much more than the sale of a solitary CGP share by Hutch to Vodafone. The function of the SPA was to pass direct, indirect equity and other rights relating to HEL. Based on a reference to the settlement agreement between Hutchison and Essar, where HTIL purportedly told Essar in its private negotiations that they were selling direct and indirect equity holdings, loans, other interests and rights in and relating to HEL, it was argued that something other than CGP share was sold. CGP share sale an 'artificial tax avoidance scheme' The original idea of the parties was to sell shares in Indian company Hutchison Essar (HEL), directly. But, CGP share had been introduced at last minute to artificially remove HTIL from Indian territory. Since HTIL wanted to declare a special dividend out of the $11bn payment, HTIL would have 'pocketed' the gains and not the Mauritius entities. As the payee (HTIL) was not the legal owner of shares, the benefit under India-Mauritius treaty would not have been available. CGP was fished out of this legal structure as an 'artificial tax avoidance scheme contrivance.’ The three critical factors in Vodafone case leading to the conclusion of structure being an artificial tax avoidance scheme: 1. The background facts being different from words used in agreement. 2. The SPA showing that the commercial substance was different than the nomenclature employed by parties. 3. Subsequent interpreting statements by parties. Ramsay, Azadi, McDowell debate The Solicitor General extensively relied on the 'Ramsay Doctrine' (a decision from UK Supreme Court), which according to him, laid down that if the business purpose, as opposed to effect, is to artificially avoid tax, then that step should be ignored. Solicitor General Nariman urged the Court to overrule the ratio laid down in Azadi Bachao. He stated that “Azadi Bachao was wrongly decided...Justice Chinnappa Reddy's views in McDowell were not his own views (but that of the 5 judge bench).” Nariman ©
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questioned as to how a 2 judge bench in Azadi could contradict a 5 judge bench in McDowell and stated that Azadi judgement goes to an extreme. He did however concede that a middle path was probably the 'correct' path.
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Sec 9 itself is a look through and it should be given a wide interpretation The term ‘property’ as per the definition of capital asset, has a wide ambit and includes 'Rights in Properties'. Reading this provision with Sec 9, it can be concluded that HTIL had extinguished its property rights in HEL. Sec 9 is a wide provision and its object is to tax any non-resident who has a source in India. The Solicitor General urged the bench not to look at Sec 9(1) in isolation. The words 'situated in India ' (with reference to transfer of capital asset appearing in Sec 9) should not be construed literally but construed 'purposively ' to mean that it must be traceable to a source in India. Sec 195 applicable as Vodafone had presence in India Sec 195 refers to the term “person”, which is widely defined u/s 2 to include even a foreign company. Even otherwise, Vodafone had presence in India on account of its shareholding & JV with Indian telecom company Bharti Airtel. Therefore, on the date of payment to Hutch, Sec 195 was applicable to the UK based telecom giant. Key Cases cited by Income Tax Department McDowell (154 ITR 148)
National Insurance Co. (1978 ) 113 ITR
Azadi Bachao (263 ITR 706) Ramsay ([1981] STC 174)
37(Cal) Laxmi Insurance Co. (1971) 80 ITR 575 Barclays Mercantile Business Finance Ltd v
'A Holdings ApS ' (8 ITLR)
Mawson [2005] 1 AC 684 Scottish Provident Institution [2004] 1 WLR
National Cement Mines Industries
3172 Furness v. Dawson [1984] 1 All E.R. 530
Ltd. 3 SCR 502 Sohan Lal Naraindas (1971) 3 SCR
Renusagar Power Co AIR [1988 SC]
319 The Godhra Electricity Co. (1975) 1
New Horizons Ltd [1995 SCC (1) 478]
SCC 199 Motor And General Stores (P.) 1967
Duke of Westminster [1936] AC 1
SCR (3) 876 B. M. Kharwar. [1969] 1 S.C.R. 651 Craven v White [1989] A.C. 398 Tower MCashback [2011] 2 W.L.R.
Fisher's Executors [1926] AC 395 (HL) Bank Of Chettinad Ltd (1940) 8 ITR 522 (PC) Nathu Ram Agarwal [1999] 8 SCO 667
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