As the dust begins to settle on the decision of the Mumbai high court in the Vodafone case, the eyes of the global tax fraternity are now on the outcome of the petition which Vodafone is most likely to file in the Supreme Court.
The questions remaining unanswered by the high court would have several multinationals on tenterhooks, as the consequences, both for tax payers with similar transactions and perhaps for Indian M&A fortunes may be far reaching.
BackgroundVodafone International BV ('Vodafone'), a Dutch resident company, acquired interest of Hutchison Telecommunications International Ltd ('Hutch') (a company registered in the Cayman Islands) in CGP Investments (Holdings) Ltd ('CGP Investments') also registered in Cayman Islands. CGP investments, through a host of intermediate companies, held 67 percent equity interest in Hutchison Essar Limited ('HEL'), an Indian company.
Indian Revenue issued routine show cause notice to Vodafone arguing that it had failed to discharge withholding tax obligation with respect to tax on gains made by Hutch on sale of shares to Vodafone.
Vodafone filed a writ petition in the Mumbai high court challenging the notice.
Vodafone also argued that the retrospective amendment in Finance Bill 2008 was motivated to impose onerous withholding tax obligation; an afterthought intended to bring offshore transactions within the Indian tax net.
Court's decision
The court in no uncertain terms upheld the action of Revenue.
In arriving at the conclusion, the court felt that Indian Revenue had made a strong case to demonstrate that there was 'transfer of a capital asset in India' in the shape of business/controlling interest/ share in telecom licence.
It held that the authority to investigate into facts could not be negated by invoking the writ jurisdiction.
Typically, a writ jurisdiction right is resorted in situations where either fundamental rights are violated or any administrative action is exercised without jurisdiction.
The court has drawn adverse inference regarding Vodafone's action to withhold material facts and documentation, including the actual share sale agreement.
In summary, the court upheld Revenue's jurisdiction and felt that Vodafone's petition was premature, as it had not exhausted ordinary remedies under Indian tax laws.
Does the Vodafone decision spell doom
While Revenue may like to adopt a view that its right to tax such (offshore) transactions has been upheld, it is important to observe that the court has rendered its decision merely on maintainability of Vodafone's writ petition.
The inference drawn by the court that transfer of shares in an offshore holding company results in transfer of underlying business/ economic interest in downstream operating companies is debatable.
The findings of the court regarding location of 'capital asset in India' should not be viewed as conclusive. The taxability of such transactions will necessarily have to be decided by Revenue based on the facts of each case.
Revenue was focused on basics
An interesting aspect is that revenue did not raise questions regarding the sale transaction being an ingenious method to avoid tax.
Such an approach would have saddled revenue with a greater responsibility of demonstrating the true intent.
Instead, revenue chose to stick to basics and focus on the effect of the transaction; thereby driving the point that the intent was acquiring controlling interest in HEL.
Revenue relied on interpretation of deeming provisions under the domestic law to conclude that there was an extinguishment of right (as a result of sale).
Extinguishment of rights is viewed as transfer for the purpose of levying tax on capital gains. While this may be a deviation from the normal approach a taxman follows, it does not necessarily mean that the argument of tax avoidance will be shelved by revenue.
Similarly, Revenue did not focus upon other legal issues such as substance over form, piercing the corporate veil, retrospective amendment and constitutional validity thereof (Vodafone's arguments).
Substance test and international precedents
The substance over form has been a debatable issue in many jurisdictions.
In the case of Azadi Bachao Andolan, the Supreme Court while giving interpretation under the India -Mauritius treaty has effectively held that the 'form' of a transaction is to be given precedence over its 'substance', unless the transaction can be proven to be sham.
Take, for instance, Canada is very much a form over substance jurisdiction.
It is unusual for Canadian courts to apply judicial anti-avoidance doctrines to prevent abusive tax practice.
This is despite the fact that Canadian tax law has general anti-avoidance Rule or GAAR as it is commonly referred to.
Interestingly, Revenue authorities in other jurisdictions such as South Korea and the UK have been giving precedence to the substance of a transaction.
Korean Revenue authorities have imposed taxes and penalties on companies such as Lone Star and Westbrook on the ground that they invested in Korea through shell companies located in tax favourable jurisdictions.
However, it is noteworthy to observe that domestic tax laws of Korea (unlike in India's case) allow Revenue to 'pierce the veil'. In the UK, courts have been increasingly inclined to look into the substance of transactions.
Numerous high profile cases such as the Ramsay case, Furniss v Dawson and McGuickan case are examples of such approach.
The 160-page Vodafone judgment, dealing extensively with jurisprudence, is delightful reading for any student and tax law practitioner, not to forget the elated taxman.
The ruling is by no means likely to be the bedrock for judicial interpretation as the issues under debate can hardly be said to have been concluded.
It is anybody's guess whether the Supreme Court would go into the merits of the case or simply decline to interfere, as the fact-finding authorities have not gone into it.
Whereas, it is well within the domain of the Supreme Court to lay down the law in case of ambiguity; ordinarily, the benefit of doubt in ambiguous situation should go to the taxpayer.
Possibly, the court could be directed by the construction of the agreement should it decide to get into the facts of Vodafone's case.
Whilst Vodafone shall anxiously await the outcome, my plea to tax administrators in the interim is to exercise restrain from taking any administrative action.
This will otherwise spell greater uncertainty in our tax laws and create nervousness.
The global tax fraternity would be closely following the Vodafone development. I am reminded of two leading tax personalities from the UK and Germany on a Panel discussion last week commenting upon tax dispute resolution in India.
The UK expert maintained that though the UK Transfer Pricing regulations date back to 1915, they did not have as many cases going to trial as in the context of India.
The German expert maintained that reading Indian jurisprudence, the German judiciary could derive persuasive value from Indian court cases! Kudos to the Indian Judiciary and not to forget the creativity of Indian tax advisors.
Thankfully, only one skill is portable!
The author is a partner with BMR & Associates and views expressed are personal