Vodafone findings and way forward in similar cases

The Supreme Court of India recently delivered a path-breaking judgment in the case of Vodafone International Holdings BV v UOI, holding that indirect transfer of shares of an Indian entity between two non-residents is not taxable in India. The decision has brought relief to all those who are invested or looking to invest in India, or who have exited India with open tax issues.

Brief facts

Hutchison Telecommunications International, Hong Kong (Hutchison HK), held 67% of the shares of Hutchison Essar, India, indirectly through CGP Investments Holdings, Cayman Islands. Hutchison HK’s stake in CGP was acquired by Vodafone, UK, through Vodafone International Holdings BV (Vodafone), a Netherlands-based special purpose vehicle (SPV). As a result of this sale, capital gains, estimated at US$11 billion, accrued to CGP.

The Indian tax authorities (ITA), being of the view that the transaction would give rise to capital gains chargeable to tax in India, held that Vodafone was under an obligation to withhold tax at source when paying for the purchase. Vodafone maintained that the transaction was between two non-residents outside India and not chargeable to tax in India.

[ihc-hide-content ihc_mb_type=”show” ihc_mb_who=”3″ ihc_mb_template=”2″ ]

Critical aspects of decision

The Supreme Court held that shares are located where a company is incorporated and where its shares can be transferred. The situs cannot be determined by the location of the company’s underlying assets.

A gain to a non-resident arising from the transfer of shares of a foreign holding company which indirectly holds underlying Indian assets is not taxable in India. The ITA has no jurisdiction under the Income Tax Act, 1961, to tax the gains arising to a non-resident from such an indirect transfer by applying the “look through” principles in a deeming fiction created under the act.

The withholding tax provisions under the act do not apply to an offshore transaction between two non-residents – such provisions do not have extra-territorial operation. SPVs and holding companies are recognized in corporate as well as tax laws; a subsidiary and its parent are distinct taxpayers. Tax planning within the framework of law is permissible.

The onus is on the ITA to establish that a transaction is a sham or a colourable device. The ITA has to discharge this obligation based on the following guiding factors: (1) duration of the holding structure; (2) the period of business operations in India; (3) generation of taxable revenue in India during the period of business operations in India; (4) the timing of exit; (5) the continuity of business on such exit.

Impact on ongoing litigation

To determine the judgment’s impact on similar transactions between two non-residents, a detailed impact analysis of the Vodafone decision needs to be done, to determine the similarities or dissimilarities in facts. For transfers of shares of a company in a country with which India has a tax treaty, the tax position needs to be evaluated. Further, companies will have to justify their intention of “investment to participate” to the ITA. The Supreme Court has provided guidance which should be helpful for this.

To determine the way forward in an ongoing litigation, it will be necessary to consider the stage at which the litigation has reached. Based on the stage of the litigation, one of the following courses of action could be considered: (1) filing a revision or review petition against an order passed by a court; (2) filing a rectification petition under section 154 of the act against an order passed by the ITA (submitting that a Supreme Court order becomes the law of the land and therefore an order passed by the ITA treating a transaction as liable to tax is a mistake apparent from records); (3) filing a petition under article 265 of the constitution of India against an order demanding tax under section 195 read with section 201 (submitting that the tax is being demanded without the authority of law); (4) claiming a refund of tax under the provisions of the act or under a writ petition; (5) filing a special leave petition before the Supreme Court under article 136 of the constitution.

Conclusion

The intent of the Supreme Court’s decision was to provide clarity on India’s tax law and certainty of tax and legal interpretation, so as to facilitate investments into India. The decision is a key development in the interpretation of domestic and international tax aspects, including in respect of the judicial approach to tax avoidance in India. Although this is a landmark judgment, one will have to wait and watch the reaction of the ITA, which is likely to bring an amendment to the law.

[/ihc-hide-content]

Pranay Bhatia is an associate partner and Abhay Pitale is a senior associate at Economic Laws Practice. ELP is a full-service law firm with offices in Mumbai, New Delhi, Pune and Ahmedabad.