Vodafone vs. Union of India -An analysis of the Judgment
The last decade has viewed the tremendous growth in the Mergers and Acquisitions and it also witnessed the growth in legal disputes regarding tax to be paid on capital gains arising out of such matters. This presentation takes specific example of the Vodafone dispute regarding the payment of capital gain tax on transfer of the controlling interest in an Indian company from one foreign company to another.
The presentation will open itself while describing the dispute that arose in case of Vodafone vs. Union of India, hereinafter referred to as the Vodafone case. In this case of indirect acquisition, where a non resident Hong Kong based company Hutchision international telecom ltd hereinafter referred to as HTIL has transferred to another nonresident U K based company Vodafone Plc hereinafter referred to as Vodafone an indirect controlling interest in its Indian company Hutch Essar Limited hereinafter referred to as Telco.
The question arose on such transfer that whether transfer of an Indian entity by one nonresident company to another will arise an incident of Capital Gain Taxation in India or not.
The Income Tax Department issued a show cause notice to Vodafone to explain why tax was not withheld on payments to be made on the above mentioned transaction. In reply to the notice Vodafone had put forward the following points for not being liable to pay capital gain tax in India. Firstly the transaction was effected between two nonresident companies outside India, by a contract executed outside India in Cayman Islands and the consideration so required was also paid outside India. Thus, it claimed that the transaction took place between offshore entities and was outside India’s jurisdiction to tax. It also contended that the tax liability arises for HTIL as the seller. Vodafone also claimed itself not to be liable to withhold tax as according to the Income Tax Act the withholding rule applies only to residents in India.
The tax authority’s arguments were focused on proving that even though the deal was offshore, the transaction was not merely a transfer of a single share but a composite of rights and entitlements of local assets making the transaction taxable in India and contended the following:
· The underlying asset i.e. the joint venture, as asset of capital nature, was situated in India and was central to the valuation of shares;
· It was through the transfer of offshore shares, HTIL sold its rights in the Indian asset including tag along rights, managements rights, goodwill, brand and the right to do business in India;
· The offshore transfer resulted in Vodafone having operational control over the Indian asset and Vodafone also entered into separate agreements with the Indian entities to conduct business in India.
The aspect of whether a transaction between 2 non-residents can be taxed in India was dealt in detail by the Bombay High Court. The High Court held that the jurisdiction of a State to tax a non-resident is based on the nexus connecting the person sought to be taxed with the jurisdiction which seeks to tax. The question as to whether the sum paid to a non-resident or a foreign company pursuant to a transaction is chargeable to tax is determined by Sections 5(2), 9(1) and 195 of the Act.
Section 5(2) enunciates that the income of a non-resident from whatever source derived is included in the total income if
i. it is received in India;
ii. deemed to be received in India;
iii. accrues in India;
iv. deemed to accrue in India;
v. arises in India; or
vi. deemed to arise in India.
Section 9(1) explains the circumstances in which income is deemed to accrue or arise in India and includes all income accruing or arising in India, whether directly or indirectly
a) through or from any business connection in India; or
b) through or from any property in Section 195 provides for deduction for tax at source upon a payment to a non-resident or foreign company India; or
c) through or from any asset or source of income in India; or
d) Through the transfer of a capital asset situated in India.
As such, where an asset or source of income is situated in India or where the capital asset is situated in India, all income which accrues or arises, directly or indirectly, through or from it shall be treated as income which is deemed to accrue or arise in India.
The HC noted that the transaction and the agreements executed between the parties indicated that the parties were aware of the composite nature of the transaction and did not limit itself to acquiring one share in CGP but also
a) the various assets and liabilities of CGP including a 52% stake in HEL; and
b) Stake in control premium, use and rights to the Hutch brand and a non-compete agreement.
The HC held that the present case the Court held that the essence of the transaction was a change in controlling interest in HEL which constituted a source of income in India. The income accrued in India is chargeable to tax under Section 5(2) of the Act. Further, the HC held that given a sufficient territorial connection and nexus, such person’s global income, proportionate to the income chargeable in India, would attract the provisions of Section 195. Effectively, the HC held that in view of the application of Section 5(2), Vodafone was under a statutory obligation to deduct income tax at source under Section 195 of the Act. It, however, left the tax authorities to decide how to apportion the income that has accrued to HTIL as a result of the “nexus with the Indian jurisdiction.
The judgment was one of its kinds and is considered to be a landmark judgment in the sphere of tax on capital gains accrued on indirect acquisition. The decision will result in foreign investors more cautious approach when investing in India. Tax structures will have to be more straightforward and investments will have to be routed through treaty jurisdictions having more robust substance requirements.
The multinational enterprises hold their operational subsidiaries through a complicated string of holding companies. Depending upon the facts it will be difficult for them to reorganize their holdings in a manner in which transactions at a global level does not become chargeable to tax in India.
While the Bombay High Court’s ruling does seem to suggest that the authorities have a jurisdiction to tax on an alleged offshore transaction, it appears that the conclusion was based having regards to the specific legal arrangements put in place effectuating the transaction. The ruling does not seem to propose a general principle for all off shore share transactions which indirectly involves Indian assets.
# Vodafone v. Union of India, Page 162, Paragraph 125
# Section 195 provides for deduction for tax at source upon a payment to a non-resident or foreign company
# Vodafone v. Union of India, Page 193, Paragraph 144
# Ibid, Page 192, Paragraph 144
# Ibid, Page 183, Paragraph 139
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