Vodafone: Judgment Day @ Bombay HC

Nifty BSE | NSE 31/05/12 Are Mutual Funds betting on Nifty?

In a massive setback to Vodafone, the Bombay High Court today ruled against the telecom company and in favour of the Income Tax department in the Rs 12,000 crore tax liability case. The Bombay High Court has said that the I-T department has the jurisdiction to proceed against Vodafone.

In an interview with CNBC-TV18's Harsha Subramaniam and Menaka Doshi, Harish Salve, Senior Counsel, Vodafone and Mukesh Butani, Partner, BMR Advisors gave their perspective on the Bombay High Court ruling.

Below is a verbatim transcript. Also watch the accompanying video.

Q: How do you interpret this judgement and which part of this judgement are you going to be challenging? Which part do you think has gone in your favour?

Salve: I have not analyzed it in great detail because I have just got the copy of the judgement a couple of hours back. As I read it, the court has upheld its jurisdiction. And the jurisdiction is because if anything at all is taxable in India then there is jurisdiction.

What they have said is as far as the first phase is concerned namely the transfer of the shares, they have accepted all our submissions. The transfer of a control pursuant to a share transfer doesn't result in transfer of a capital asset. That knocks out the CGP transfer.

What the court seems to have been impressed is by the government's argument that all along Vodafone said that 66% equity interest is being transferred. The CGP share accounts for 42% direct and at best some balance indirect. There is still the 15% bit which remains.

Now two important findings of the court are the transfer of contractual rights in India. The contractual rights in India are a capital asset and the transfer of those contractual rights in India has some value and that has to be apportioned and taxed in India.

And it has referred in this context to the Analjit Singh and the Asim Ghosh transactions. They have not accepted the Vodafone contention that these are pure options contracts, they said these are valuable rights. Even if they are options, options are themselves valuable rights And these option rights are situated in India.

The court has not accepted the theory that they moved by themselves. They've said that there were fresh agreements entered into. And therefore as I read the judgement it says those rights with Indian partners which have been transferred pursuant to contracts are taxable in India.

Q: The contractual rights that you were referring to are exactly the rights on the basis of which the court has established nexus with India and hence taxability and Vodafone in its statement says it is seeking legal advice to challenge this part of the judgment. On what ground would you be challenging this part of the judgment considering that the Bombay High Court has already held that these contractual rights do form capital and hence are taxable in India, the gains or the losses?

Salve: You realise in an appeal considering that the Bombay High Court has held is why we go and appeal to a superior court. So it is not that because the Bombay High Court has held we cannot challenge. We challenge the Bombay High Court judgment, exactly on the grounds that they have wrongly held that these contractual rights were assigned.

Q: That is the specific aspect of the judgment that you hope to challenge in the Supreme Court, the contractual rights which establish a nexus with India?

Salve: It was Vodafone's case that these contractual rights were pre-existing rights with a downstream company below CGP. They moved in any event and therefore transfer of this contractual rights was no part of the consideration. The High Court has said no these rights moved apart from the transfer of shares. So this limited wrangle is what in my perception as at present advice is what we will take to the Supreme Court.

Q: What do you make of the fact that Vodafone intends to challenge this one aspect of the judgement which in fact establishes the nexus with India?

Butani: I would imagine that besides challenging this aspect of the judgement what is important also is whether the bundle of rights which the Bombay High Court has held to be an asset whether that indeed is an asset and whether that's chargeable to tax in India.

Surprisingly the High Court after coming to the conclusion that there is a jurisdiction that the department has and all these rights could be held to be assets located in India, it has not gone into the issue of determining the liability for withholding tax. It has just devoted a few sentences towards the end.

So that part of the judgement was also little bit came as a surprise to me as to why didn't the High Court after determining the question of jurisdiction come to a conclusion because one of the important aspects that Vodafone was challenging is that Section 201 was amended with a view to fasten the liability on the principle sum of withholding tax primarily keeping in mind the Vodafone transaction and that retrospective amendment was also challenged on the grounds of constitutionality. So the High Court has not gone into that issue.

Q: The judgement actually goes ahead and talks about the fact that the transaction involves merely a sale of a share of a foreign company from one non resident to another and therefore this cannot be accepted. Doesn't that in a sense reject the basic premise?

Salve: No it doesn't. You have to read the whole judgment, it doesn't. It very clearly accepts and says that is not where it ends and there are other contractual transfers. If you read the judgment carefully it is very clear because the public representation was 66%. And they say the shares don't account for 66%.

Repeatedly the High Court says 66%. Therefore the suggestion that 66% got transferred by CGP share is not good enough. 66% involves contracts, those contracts are in India. But two third of the judgement deals and accepts Vodafone's case and rejects the department's case that where the share transfer results in a shift of the controlling interest in India then the tax will lie in India. That entire part of the judgment is very clear on the law.

Q: How complicated is this apportionment aspect going to get?

Salve: According to us, that's what I am saying, this is very complex. The High Court as Mukesh Butani rightly points out has raised a theoretical proposition and left it at that, fair enough. That's how it works. But to ascribe a value and to dissect the consideration is going to be a problem. But the total value of the option is 15% out of 66%. Now some value is ascribed because it's not that the 15% shares are transferred. It's only an option to those 15% shares out of the 66%.

So there has to be some sort of exercise. The department also pitched its case basically on the fundamental premise of transfer of control. That part has gone in our favour. In fact the High Court says that your argument was that Mauritius companies, suppose they had sold the Indian company shares nothing would have been taxable, how can it be taxed. The Court says you are right except that here there is something more than share transfer, it is a contractual transfer.

Q: How does this progress from here onwards considering that there is a stay within the time which you can appeal to the Supreme Court and thereafter the assessing officer will be at freedom to try and raise some sort of tax amount with respect to this apportionment?

Salve: First of all, the income tax department had already suggested in the end of the notice that entire amount is taxable. The court has expressedly said you have to apportion. So one thing is clear the whole amount is not taxable.

Now undoubtedly the department may try and say that look we ascribe 99% to these contracts or whatever. All that is academic for the reason that this is such an important question of law that this is bound to land up in the Supreme Court either which way and when it is before the Supreme Court the whole matter will be argued right there.

Q: We were through the course of the this evening wondering if this decision or this judgement by the Bombay High Court would impact similar such transactions. But it seems to me that if they are basing their nexus on contractual rights that went along with the actual share transfer which in a sense by itself is not taxable then can this judgment really be a precedent or benchmark for other M&A cases considering that several other transactions would be structured differently?

Butani: Plain M&A transactions which are as a result of simple transfer of shares at an offshore level can be distinguished from the Vodafone decision because as you correctly pointed out that the entire decision is dependent on a bundle of rights.

Salve: You would rely on Vodafone, you would not distinguish Vodafone, you would say I am in first part of Vodafone, where they've held the share transfer.

Butani: So if you rely on Vodafone on simple transaction it actually goes to your benefit. To your point earlier about department raising a demand my reading of the order suggests that the High Court has said that the department can proceed with the proceedings but it cannot raise a final order within a period of eight weeks. So I would imagine that that is sufficient time enough to file a petition in the Supreme Court and seek a stay of order in so far as the recovery proceedings are concerned.

Q: Going ahead, as far as this case is concerned, now there is a possibility of a likely demand notice being issued from the CBDT. Would you be waiting for the demand notice from the CBDT which is expected or go to the Supreme Court after the demand notice is received by you?

Salve: None of this has been analyzed by us because as all the clients are in Bombay. They are coming tomorrow. We will sit over the weekend, we will analyze the judgement and see where it goes from here.

Q: When you are talking about apportionment, the High Court judgement of today clearly says that apportionment lies in the realm of the assessing officer of the income tax department. Can we then safely infer that the High Court is saying that the quantum of tax deducted at source is now to be totally decided by the income tax department and that's why they have stayed away from it?

Salve: No, please understand the context in which the comment is made. Under the income tax law, under the TDS provisions, tax deducted at source provisions, where the entire income is not taxable then which part of it is taxable for tax deduction at source purposes has to be determined by the income tax department. So that is the exercise of apportionment.