Lift The Corporate Veil Says Karnataka HC!

Lifting the corporate veil for checking tax avoidance -

A precursor to the new tax law!

By: Vipul Jhaveri, Partner, Deloitte Haskins & Sells

The volatile M&A market has everything to talk about when it comes to India- be it the huge deal flow, high volume of deals or tax authorities attempt to get their share of the pie on global deals. The Karnataka High Court in a recent judgment has indicated that tax authorities can lift the corporate veil to determine the facts of a transaction with a view to ascertain whether there is any avoidance of tax.

From the facts available, Richter Holdings Limited (RHL) a Cypriot company and West Globe Limited (WGL) a Mauritian company purchased all shares of Finsider International Company Limited (FICL) a UK company from Early Guard Limited (EGL) another UK company. FICL held 51% shares of Sesa Goa Limited (SGL), an Indian Company.

The Indian tax department issued a notice to RHL calling upon RHL to show cause as to why this transaction will not trigger withholding tax obligation. RHL filed a writ petition in Karnataka High Court challenging the said notice.

A similar controversy is currently pending and being litigated in the case of a transaction entered into by Vodafone where the tax authorities are alleging a similar withholding tax obligation on Vodafone.

In the current case RHL argued that the transfer of shares did not amount to acquisition of immovable property or controlling the management of the Indian company and it was only an incident to owning the shares of a company which flows out of the holding of shares.

The tax department on the other hand was of the view that the transfer of shares constituted transfer of capital asset and hence a withholding tax obligation had arisen in the hands of RHL.

The Karnataka High Court disposed the writ petition and held that since the agreement produced in the Court did not throw any significant light on the transaction, the tax authorities should do a further fact finding exercise, for which the corporate veil can also be lifted.

This decision goes a step ahead of the Vodafone by permitting corporate veil to be pierced.

The concept of lifting of corporate veil is increasingly applied byrevenue authorities globally. The Income-tax Act, 1961 (ITA), as it stands today, does not have explicit provisions for "looking through" the transactions. However, the proposed Direct Taxes Code (DTC) has General Anti Avoidance Rules (GAAR) provisions embedded in it which is essentially based on the principle of lifting of the corporate veil.

Further, transactions involving indirect transfer of controlling stake are not specifically covered under the ITA, however the same find place in the proposed DTC. While, the intention of the legislature to tax such transactions is clear, the implications under the current income tax law become critical for completed transactions and existing structures. Notices alleging liability to tax on such indirect transfers have already been issued to Sanofi, Tata, Vedanta, SABmiller, Cadbury etc. and appear to be a growing trend.

The changed approach of the tax department and the consequent uncertainty of taxation is creating apprehensions in the minds of the investors. Tax risks are increasingly being discussed at the time of concluding deals and are a cause of great concern. In the meantime, deal makers are opting for mechanisms like escrow accounts, insurance policy, etc. to conclude transactions already in pipeline.

However the prevailing tax uncertainty coupled with aggressive tax approach adopted by revenue authorities does not augur well for new investments into India. The actual impact of aggressive tax policies on inbound investment will need assessment and perhaps a relook, given the huge investment needs particularly in infrastructure sector.

As one moves ahead, the next hurdle to be crossed is the mechanism and basis of computing gains arising as a result of the transaction being taxable in India. This is going to be the next bout of litigation in case the tax authorities view is eventually upheld by the Courts.