Vodafone: Expectations from Marathon SC Hearing!

By: Daksha Baxi, Executive Director, Khaitan & Co

The Indian Supreme Court held a marathon hearing in the case of Vodafone and the decision of the Court is expected any time soon.  

The brief facts of the case are that Vodafone BV, a Dutch company of the UK based Vodafone Group bought one share from Hutchison International, a Cayman Islands company, of another Cayman Islands company (CGP) at a consideration of USD 11.1 billion. The only asset that CGP held were the shares in several subsidiaries in Mauritius which in turn held an aggregate of 67% shares in the Indian telecom company- Hutchison Essar Limited. Hutchison International realised a substantial capital gain on this sale. The Indian tax department sought to tax this gain in India. It argued that since the value that CGP derived was due to the value of the business of the Indian telecom company, the same should fall within the tax net in India. In such a case, they also claimed that Vodafone, which is the purchaser, was required under the Indian law to deduct the Indian capital gains tax at the time of paying the purchase consideration to Hutchison International. The Indian tax department held Vodafone as being in default of Indian income tax law provisions.

Vodafone approached Bombay High Court, claiming that since the transaction involved transfer of a share - being a capital asset - of a Cayman Islands company- situated outside India,  the gains realized by the seller cannot attract capital gains tax in India and that the Indian tax authorities do not have jurisdiction over Vodafone to require it to deduct the Indian capital gains tax. The Bombay High Court, however held that while there is no question of segregating "controlling interest" from the ownership of sufficient number or percentage of shares carrying voting rights by virtue of which controlling interest is derived by the shareholder, in the particular facts of this case, the consideration paid was a composite consideration towards acquisition of the share of CGP and various other valuable rights and entitlements in India. Accordingly the HC directed the tax authorities to apportion that part of the total consideration which was relatable to the rights and assets situated in India. The Bombay HC did not explicitly comment on lifting of corporate veil. It also did not view the transaction as a sham. However, taking a holistic and commercial view of the entire matter it held that the 'source of income' was indeed in India and therefore it attracted taxability in India.

One of the peculiar facts in this case is that the transferor company is located in Cayman Islands, with which India does not have a tax treaty. Where there is no tax treaty, the taxation of a non resident is determined in accordance with the provisions of the Income Tax Act, 1961 (ITA). Section 9(1)(i) of the ITA provides that where a non resident receives income which is derived in the manner described as follows : "all income accruing or arising, whether directly or indirectly, though 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.", then such income is deemed to have its source in India and is taxable in the hands of the non resident.

This does seem very wide and if the words "directly or indirectly" are interpreted to mean direct or indirect source from the various situations provided in this clause, then it would seem that Hutchison International did have a source in India since the capital gains arose to it through capital asset situated indirectly in India. This provision has not been invoked before and the courts have not had opportunity to interpret and apply this provision. Plain and simple application of this provision is likely to lead to a very anomalous and aggressive view where any international transaction involving any asset located in India, whether significant or small, could attract Indian capital gains tax. There is however no mechanism or rules provided for the computation of capital gains or income attributed to India in such circumstances. It would remain to be seen if such an interpretation was indeed intended by the legislature when this provision was enacted 50 years ago. Unfortunately, though the Bombay HC referred to this provision, it did not conclude on its applicability to the facts of this case. We know that the Supreme Court has debated this section and we hope that the decision will elaborate on its applicability and interpretation.

The proposed Direct Tax Code does bring some clarity in this regard by providing that where a foreign company derives income from transfer of shares or interest of another foreign company, the said income would not be deemed to have its source in India unless the fair market value of the assets owned directly or indirectly by the company represent at least 50% of the fair market value of the assets of the company.  This at least brings certainty. It may be argued whether the 50% threshold is reasonable or not, but at least it would not bring all and any transaction involving indirect holding of Indian asset under the Indian tax net.

India is poised at the economic scenario where not only it needs fundamental policy reforms and streamlining of procedural and regulatory aspects of doing business here, it also needs to remove this most gnawing tax uncertainty which can be achieved without the need of a larger consensus and acceptability. 

One hopes and expects that the honourable Supreme Court will certainly deal with these issues at length in their ruling and provide an answer which will put uncertainties to rest.