Vodafone: Caught In A Whirlpool?

We started the year with a Vodafone judgment and the government’s spent all year trying to undo that Supreme Court (SC) judgment. First the review, then the retroactive amendments and now an effort to get a larger bench to relook at the Vodafone decision! To make sense of this, I need to tell you about another case.
 
In 2007 a Vodafone Essar subsidiary Vodafone Essar Gujarat decided to hive off Rs 15,000 crore of telecom infrastructure assets to sister concern Vodafone Essar Infrastructure; a company whose paid up capital was Rs 5 lakh. The transfer was under Sections 391 to 394 of the Companies Act, 1956, but the Income Tax Department objected to the de-merger scheme on grounds of tax evasion. In 2009 the Gujarat High Court agreed that the transaction had no commercial substance, it was a conduit to evade taxes. On appeal the Division Bench ruled otherwise. In doing so the Division Bench relied on the Supreme Court’s Vodafone decision. 
 
Revenue appealed that decision in the Supreme Court and has also filed an affidavit asking for the Supreme Court’s Vodafone and Azadi Bachao judgments to be overruled as they are in conflict with the McDowell judgment passed by a larger bench of 5 SC judges.
 
Mohan Parasaran, Additional Solicitor General, SC to ‘The Firm’
“The issue as to whether the structures created by the Gujarat entity were actually nearly on paper or were substance or not, is a point that is involved & that was actually considered in Vodafone. Vodafone gave its own interpretation of McDowells, even though the argument of the government was that there was a conflict between Azadi & McDowells; even at that point. But the 3 Judge bench harmonized McDowells and Azadi saying that there was no conflict. Now the government wants Vodafone to be referred to a larger bench on this aspect. This will be a limited aspect but Section 9 aspect is going to arise in future cases. Suppose this issue is referred to a larger bench - that will actually strengthen the arms of the government in actually referring the main matter- seeking for reference in the main matter to a larger bench, which involves interpretation of Section 9. They passed retrospective amendment only as clarificatory. Therefore the government wants its stand to be vindicated once again and possibly on that count, they will actually insist for the matter being referred to a larger bench."
 
Doshi: So now, we may be faced with the prospect of a 7 judge bench relooking at Vodafone & Azadi Bachao! To answer the Whys, Whats and Now Whats, I am joined by Senior Counsel Arvind Datar and S R Wadhwa, Former Chief Commissioner Income Tax and Advocate.
 
Doshi: You just heard Mr Parasaran lay out the grounds for that government affidavit. Do you agree with those grants, do you believe that they can be successful?
 
Datar: I personally feel that you should look at it with two angles. First of all, is it proper to ask for a review and secondly, is it necessary? As far as the Vodafone judgment is concerned, the government filed a review, it got dismissed. Then all the decisions, which were in favor of the assessee, all the legal principles have been overruled retrospectively from 1961 and now the only thing that remains is the reconciliation of McDowell’s and Azadi. On the question of propriety, it is not proper to refer these decisions to larger bench. Now you got McDowell’s from 5, you go to 7 and then you go on to 9- that is a larger question. So in my opinion, it has been repeatedly pointed out by the SC that certainty and clarity is most important and you should not keep on referring judgments to larger benches merely because there is a different point of view.

Secondly, on the necessity of it, I feel there is no need to refer it to a larger bench because having lost the review, this is an indirect attempt to ask the court to reopen the entire question. Frankly, if you read McDowell’s, the majority of McDowell’s says that if the tax planning is not a colorable device, not something dubious, not something subterfuge then it is perfectly permissible- that is the view of 4 judges. Justice Chinnappa Reddy says a device to avoid tax should be discouraged. Now the whole controversy can be summarized in two sentences- if the tax planning is not a colorable device, it is permissible. If the tax planning is colorable, it is not permissible. That is the view of McDowell’s. That is what Azadi also reiterates and that is what Vodafone says. What the government seeks to do is they want to get back to the extreme position of a few stray sentences of Justice Chinnappa Reddy’s judgment whereby any planning, whatsoever, will be disallowed by the department and that is what they were doing for so many years till Azadi came along. So in my opinion it is wholly unnecessary and it will set a very bad precedent. You had general anti-avoidance rule (GAAR), which was so horrendous, it had to be abandoned and now if they are going to go back to this; it is going to be very unfortunate. If at all the SC decides to refer to it, I think it will be better that we first decide whether McDowell is right or not. I am of the view that many of the points mentioned in Chinnappa Reddy’s judgment of McDowell are totally unsustainable.
 
Wadhwa: Let us see what was the issue in the McDowell’s is. It was the case of interpreting portions of the excise law as to whose legal liability it is to deposit the excise duty so that for the purpose of sales tax could the sales duty be added. There in that context, Justice Chinnappa Reddy did not write a dissenting judgment, he wrote a separate judgment both these- majority view and Mr Chinnappa Reddy’s review - was that wherever there is a colorable device, which has got no commercial value that can be regarded. Otherwise, tax planning per se is perfectly legitimate.
 
Doshi: What you are saying does not sit exactly with this stance of the government and the affidavit they filed earlier this week because they have gone on to court quoting Justice Reddy’s comment from within that judgment and that quote seems to imply that any transaction which is a device to avoid tax is not a permissible transaction. VODAFONE: IN REVERSE GEAR! Revenue Affidavit: Dec 2012
‘It is submitted that the judgments of this Hon’ble Court in Vodafone International Holdings BV v. Union of India (2012) and Union of India v. Azadi Bachao and Another (2004) require to be overruled, as they are in conflict with the decision of a Constitution Bench of 5 Judges of this Hon’ble Court in M/s. McDowell and Company v. Commercial Tax Officer (1985).’
Wadhwa: Is that the ratio of the judgment?
 
Doshi: That seems to be the interpretation of the revenue, do you agree with revenue’s interpretation?
 
Wadhwa: I do not agree with the government’s point of view. Moreover Azadi Bachao was rendered several years ago and in the interest of certainty, SC has itself said that judgments rendered several years ago should not be likely upset.
 
Doshi: Is revenue trying to overturn or hoping to overturn all of what Azadi Bachao decided on or is it just the explanation and the portions that relate to the interpretation of the McDowell’s judgment?
 
Datar: I find the revenue’s stand rather baffling particularly in a light of Mr Parasaran’s comments. If it is their plea that the Chinnappa Reddy view in McDowell’s should be restored, if you take that extreme view, then you land up in a position where any contract which results in the slightest reduction of tax is a device that has to be ignored. If you come to that very absurd position, then we are in a lot of trouble. If, as Mr Wadhwa put it, and all of us agree that nobody is canvassing for the view that a colorable device should be permitted. That is a given. Nobody is even arguing that something colorable should be permitted- Vodafone does not say so, Azadi does not say so, McDowell does not say so. All have commonly agreed that anything which is dubious or colorable should not be permitted.
 
Doshi: All are not commonly agreed because revenue seems to believe that it is not just the aspect of colorable device but all of the commentary of Justice Chinnappa Reddy on tax planning that the majority agreed with and hence should stand as the combined decision of McDowell’s and therefore the most important decision because that was determined by a 5 Judge bench?
 
Datar: The majority refers to tax planning in just one paragraph. In fact it is ironical that this judgment which has given so much trouble to assessees for the last 27 years, there was no issue of tax planning and tax evasion at all. It was a simple sales tax case where the entire observation of Justice Reddy were unnecessary. But that is history now. Majority uses the word colorable device and the minority – the concurring view of Justice Chinnappa Reddy- keeps on using the word device. Device itself has got an odious connotation, it means something which means colorable, it means something which is dubious. So if you read it in that way, I do not see what is the objective of the revenue in referring to a larger bench, what are they going to achieve? Do they want to say that any tax planning is bad?
 
Doshi: I want to ask you this though but both of you have made the point that for the last several years- over two decades now- this issue of colorable device, what the McDowell’s judgment lay out has been one that revenue has agitated upon in several different cases. Can I ask you this question- is it maybe time to put this whole matter at rest and maybe hence a 7 judge bench is probably the only way to go about it because for once and for all, we can get some sort of final determination on what is permissible, what is not permissible or am I being too hopeful? Could it be the case that after a 7 judge bench, if revenue is not happy with that decision, they may ask for a 9 judge bench and this matter would prolong indefinitely?
 
Datar: You cannot rule out the possibility of 9 judge bench coming later but the way it is going, maybe it is worthwhile going to 7 judge bench so that the entire thing is laid to rest at least for the time being and it is very rare that a 7 judge bench decision is then reversed by a 9 judge bench. Let the SC decide once and for all what is tax planning, what is the device, what is colorable and let them lay down test completely so that there is complete clarity and certainty.
 
Wadhwa: I would agree with Mr Datar, let the issue be clarified once and for all so that the ghost of what is colorable device and what is tax planning, Chinnappa Reddy’s judgment, the scope of it, all should be laid to rest for once and for all.
 
Datar: If it is referred to a 7 judge bench and if the 7 judge bench does not hear the matter quickly then you are going to have a prolonged period of uncertainty. For example the issue of entry tax before the 9 judge bench is now pending for more than two years. That has not yet been taken up. So if you are going to refer it to 7 judge bench and if the 7 judge bench is going to be taken up for hearing after 12-15 months ,then just look at the uncertainty.
 
Doshi: That is exactly connected to my last question which is what is the commercial implication of all of this?
 
Datar: As Mr Parasaran said, they just do not want to refer to this McDowell’s-Azadi controversy but want to go into Section 9, clarificatory amendments and the entire legal gamut of issues then we are in for a process of a very long drawn litigation. As I mentioned earlier, the government will get far more taxes if it accepts Vodafone gracefully and moves on rather than keeps on churning it by retrospective amendments and constant references. We will lose far more money, far more investments and far more confidence will be lost among the industry if you are going to keep on making the law uncertain and unstable. So I think in the long run commercially also it is better if the government drops its plan to refer to a 7 judge bench, accepts Vodafone gracefully and leave it to the retrospective amendment- that will be far better for all of us. ------------- For Readers’ Reference Revenue says Majority agreed with J. Reddy on this
‘In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it.”
McDowell: J Reddy wrote separate judgment commenting on tax planning & colourable devices
Revenue: Majority agreed with all of J. Reddy’s views
Azadi/Vodafone: Majority agreed with J. Reddy’s views on colourable devices Reasons Why Revenue Wants Azadi & Vodafone Overruled 1. In Azadi, 2 judge bench (wrongly) took the view that J. Reddy’s views were only his own
2. In Vodafone, 3 judge bench took same erroneous view as Azadi in holding J Reddy’s view as his own
3. Vodafone bench said Revenue argued that Azadi ignored Mathuram Agrawal. But Revenue argued to the contrary
4. Vodafone bench held Ramsay had not discarded Westminister. Whereas Mcdowell bench held to the contrary. 3 judge bench can’t hold view contrary to 5 judge bench
5. Vodafone bench omitted to mention that J. Reddy’s opinion was a ‘detailed’ opinion. McDowell 5 judge bench has noted it as a ‘detailed’ opinion
6. In Vodafone, concurring view of J. Radhakrishnan is contrary to McDowell. McDowell did not accept doctrine in A. Raman
7. In Vodafone, J Radhakrishnan’s concurring view wrongly held J. Reddy’s view as a supplement to J. Ranganath Misra’s view
8. In Vodafone, J. Radhakrishnan’s concurring judgment was wrong to hold J. Reddy’s views as incorrect