New Delhi, Oct. 9: The Vodafone tax case appears to be inching towards resolution after a five-year, acrimonious court wrangle and an audacious attempt by the government to undermine an adverse Supreme Court verdict through an amendment in tax laws that was dated back by 60 years.
The government today placed in the public domain a report that a committee headed by taxation expert Parthasarathi Shome had submitted last week.
For starters, the committee advised the government to “avoid introducing fundamental changes in tax provisions without consultations and thus not anticipated by the taxpayer”.
But the bulk of the 86-page report dealt with the extraordinary situation that arose in the 2012 budget after then finance minister Pranab Mukherjee proposed to amend a tax law from April 1, 1962.
It was a thinly disguised attempt to gouge out $2.2 billion in taxes from Vodafone Plc, the world’s second largest mobile-phone operator, after the Supreme Court had ruled in January that it was not liable to pay the levy.
The tax demand sprang from Vodafone’s buyout of a 67 per cent stake in mobile telephony player Hutchison Max (since renamed as Vodafone India) through a $11.2-billion deal in April 2007 with Hong Kong-based Hutchison Whampoa.
The deal had been struck between a Dutch subsidiary of Vodafone and two Hutchison entities registered on the Cayman Islands and the British Virgin Islands — seemingly outside India’s tax jurisdiction.
The relentless manner in which the government hounded Vodafone to fork out a tax that Hutchison should really have paid, if it was legitimate, had cast a long shadow on India’s reputation as an investment destination that protects the rights of foreign investors and is fair in its tax treatment.
The committee said “retrospective application of tax law should occur in exceptional or rarest of rare cases” and only to correct apparent mistakes or anomalies in existing laws, or “to ‘protect’ the tax base from highly abusive tax planning schemes that have the main purpose of avoiding tax”.
Although the Shome committee generally frowned on the idea of retrospective taxes, it gave the government some wiggle room in deciding the fate of the Vodafone tax case. It said that if the government opted to impose retrospective taxation on indirect transfer of assets, it should not levy a penalty as well by declaring the entity an “assessee in default”.
The government had threatened to slap penalties on Vodafone by declaring it as an assessee in default even the case was being heard by the Supreme Court which immediately put a stay on further proceedings till it handed down its verdict.
The government had stunned investors around the world by trying to undermine that landmark court verdict by announcing in this year’s budget that it would amend the tax laws with a 60-year retrospective effect.
Investors were appalled by the blatant attempt by the Indian government to muzzle the court’s verdict and flex its muscles to force Vodafone India to cough up $ 2.2 billion in taxes — with the threat of snowballing penalties hanging in the air.
It was one of the reasons why foreign direct investment in the first four months of this financial plunged 40 per cent year on year to $ 2.55 billion from $ 4.22 billion in the April-July period a year ago.
The sharp slump in FDI had a sobering effect on the government after the change of guard in the finance ministry on July 31.
Prime Minister Manmohan Singh immediately appointed the Shome committee to re-examine the two biggest issues that had prompted investors to forsake India: the introduction of the dreaded general anti-avoidance rules (GAAR) and the retrospective tax amendment to punish Vodafone.
In its earlier report submitted on September 1, the Shome committee has already advised the government to defer the implementation of GAAR by three years till 2014. GAAR is a device to stop companies from creating elaborate corporate structures that have no economic rationale and are crafted with the sole intent of avoiding taxes.
But investors were eagerly waiting for the committee’s second report on retrospective amendments in tax laws in general – and the tax liability on an overseas deal involving an underlying asset in India, in particular.
The Shome committee said that if retrospective taxes have to be imposed, “the government should apply the provisions only on the taxpayer who earned capital gains.” This would imply that the government should go after Hutchison and not Vodafone.
The panel also said that a deal involving the transfer of shares between two non-resident entities with an underlying asset in India would become liable to tax here only if 50 per cent of the value of the total assets transferred were located in India.
The latest recommendation by the Shome committee is seen as a much-needed balm to soothe foreign investors who have sworn off India.
Last month, Vodafone Plc’s chief financial officer Andy Halford had told a wire agency in an interview in London that the company had begun consultations to decide whether to make a provision in its books to cover the legal risks arising from $2.2 billion tax bill in India. The company had said it would make that decision in November – the first time that it has spoken about setting aside money to pay the tax that it has always contested in courts.
The government has already shown signs that it is eager to resolve the Vodafone tax issue. "Once we take a view (on Shome Committee report), I see no reason why we should wait for the budget session. We should move whatever changes have to be brought about in Parliament as early as possible," finance minister P. Chidambaram had told reporters yesterday in Delhi.
Sources said the government would in all likelihood ask Vodafone to pay the basic tax without any penalties or interests. Officials said, “Ultimately, it will be a political decision.”
Revenue officials have been arguing that Vodafone should not be let off the hook as it could affect a number of other cases. These include the Idea Cellular – AT&T deal, SABMiller's buyout of a 100 per cent stake in Foster's India, and General Electric's sale of its majority stake in Genpact under a $500 million deal struck in 2005.