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New Delhi, Jan. 20: India’s biggest tax claim against a corporate entity – a potential tab for Rs 11,000 crore ($ 2.2 billion) against the UK-based Vodafone Group with the prospect of larding it with huge penalties at a later stage – has been tossed into a judicial dustbin.
The Supreme Court announced the stunning verdict today, overturning a ruling by Bombay High Court that had upheld the tax authorities right to pursue a Dutch subsidiary of Vodafone Plc for failing to deduct the amount while making a $11.08-billion payment in May 2007 to Hutchison Telecommunications International Ltd, a wholly-owned Cayman Island subsidiary of Hong Kong-based tycoon Li Kashing’s Hutchison Whampoa.
Vodafone International Holdings BV of the Netherlands had acquired the entire share capital of CGP Investments (Holdings) Ltd, based in the Cayman Islands. CGP Investments held a 67 per cent stake in Hutchison Essar through several layers of overseas and Indian entities.
The unexpected verdict was immediately touted as a landmark judgment that would restore the faith of foreign investors in India’s judicial system and inject an element of certainty in India’s notoriously whimsical process of taxation.
US-based Kraft’s global acquisition of chocolate maker Cadbury, a $150-million Idea Cellular AT&T-deal, SABMiller’s purchase of 100 per cent stake in Foster’s India, and General Electric’s $500 million sale of its majority stake in BPO outfit Genpact have been under the taxman’s scanner and could potentially benefit from this ruling.
A three-judge bench headed by Chief Justice of India S.H. Kapadia said the offshore transaction, which gave Vodafone Group a controlling 67 per cent stake in Hutchison Essar (now Vodafone Essar), was “bona fide” and labelled it as a “structured foreign direct investment into India”. Vodafone Essar is the country’s third biggest mobile telephony player.
Justices Swatantar Kumar and K.S. Radhakrishnan were the other two judges.
“The offshore transaction evidences participative investment… not a sham or tax avoidant pre-ordained transaction. It is between a Cayman Islands company and a company incorporated in the Netherlands. The subject matter was the transfer of a company incorporated in Cayman Islands. Consequently, Indian tax authorities had no territorial tax jurisdiction to tax the offshore transaction,” the bench ruled.
The bench also directed the tax department to refund the Rs 2,500 crore that Vodafone – the world’s largest mobile telephony company by revenues – had deposited with the court registry while pursuing its legal challenge. The government had encashed the amount and will now have to return it with 4 per cent interest within two months.
The tax authorities can file an appeal against the ruling but it was not immediately clear whether they would do so.
It is learnt that the Central Board of Direct Taxes has formed a 10-member panel that will study the implications of the judgment.
Finance minister Pranab Mukherjee went into a huddle with law minister Salman Khurshid, sparking speculation that the government could amend its tax laws once again with attention focusing on the probable inclusion of an Effects Doctrine – like in the US -- that would empower the state to levy taxes against persons not residing within the territory of the state as long as some “real link” could be established between it and the proposed taxpayer. It was not clear whether this would have retrospective effect.
In February 2008 – about 10 months after the Vodafone-Hutchison deal was sealed – the government had amended the tax laws retrospectively making it mandatory for a company to withhold or deduct tax under Section 194 for payouts made to entities that could escape the tax net. And if it failed to do so, it would be treated as an “assessee in default” who could run the risk of being slapped with severe penalties.
In October 2010, the income tax department asked Vodafone to pay Rs 11,217 crore by way of tax and interest. Vodafone contested the tab on two counts: first, that there was no basis for levying the tax on an overseas stake sale, and second, the calculation itself.
A month later, it deposited Rs 2,500 crore with the Supreme Court and also provided a bank guarantee for Rs 8500 crore pending final adjudication of the case. But on March 23, 2011, the tax authorities served another notice asking Vodafone to explain why it should not be liable to pay penalties amounting to 100 per cent of the tax payable.
“Vodafone has maintained consistently throughout the legal proceedings that this transaction was not taxable and we are pleased with today’s judgment in the Supreme Court,” the London-based company said in a statement.
While ruling in favour of Vodafone, the apex court made an impassioned plea for strong governance and stability in fiscal laws to attract overseas investors.
“FDI flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to the rule of law. Certainty and stability form the basic foundation of any fiscal system,” the judges said.
“Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner,” the bench said. “Investors should know where they stand. It also helps the tax administration in enforcing the provisions of taxing laws.”
Vodafone has consistently argued that if any tax had to be paid at all, it ought to have been collected from the seller i.e. the Hutchison group.
The revenue authorities claimed that if the transfer of a capital asset situated in India happened as a consequence of something that had taken place overseas (including transfer of a capital asset), then all income derived even indirectly from such a transfer would becomes taxable in India.
They argued that the control of Hutchison Essar had passed to Vodafone as a result of the transfer of the CGP share outside India and would therefore attract the provisions of Section 9 of the Income Tax Act. However, the top court rejected this contention.
The court said that Section 9(1)(i) did not cover indirect transfer of capital assets/property situated in India. It only applied to transfers of a capital asset situated in India.
In a separate but concurrent judgment, Justice Radhakrishnan likened the demand of almost Rs 12,000 crore by way of capital gains tax to “imposing capital punishment for capital investment since it lacks authority of law”.
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