Vodafone International Holding vs Union of India

The Supreme Court of India pronounced the landmark judgment in Vodafone International Holding (VIH) v. Union of India (UOI). The Bench consisting of Chief Justice S.H Kapadia, K. S. Radha krishnan and Swatanter Kumar quashed the order of High Court of demand of Rs 12000 crores as capital gain tax and absolved VIH from liability of payment of Rs 12000 crores as capital gain tax in the transaction dated 11.2.2007 between VIH and Hutchinson Telecommunication International Limited or HTIL (non-resident company for tax purposes).

The court held that in Indian revenue authorities do not have jurisdiction to impose tax on an offshore transaction between two non-residents companies where in controlling interest in a (Indian) resident company is acquired by the non-resident company in the transaction.

Facts leading to the Dispute

Vodafone International Holding (VIH) and Hutchison telecommunication international limited or HTIL are two non-resident companies. These companies entered into transaction by which HTIL transferred the share capital of its subsidiary company based in Cayman Island i.e. CGP international or CGP to VIH.

VIH or Vodafone by virtue of this transaction acquired a controlling interest of 67 percent in Hutch is on Essar Limited or HEL that was an Indian Joint venture company (between Hutchinson and Essar) because CGP was holding the above 67 percent interest prior to the above deal.

The Indian Revenue authorities issued a show cause notice to VIH as to why it should not be considered as “assesse in default” and thereby sought an explanation as to why the tax was not deducted on the sale consideration of this transaction.

The Indian revenue authorities thereby through this sought to tax capital gain arising from sale of share capital of CGP on the ground that CGP had underlying Indian Assets.

VIH filed a writ petition in the High Court challenging the jurisdiction of Indian revenue authorities. This writ petition was dismissed by the High Court and VIH appealed to the Supreme Court which sent the matter to Revenue authorities to decide whether the revenue had the jurisdiction over the matter. The revenue authorities decided that it had the jurisdiction over the matter and then matter went to High Court which was also decided in favour of Revenue and then finally Special Leave petition was filed in the Supreme Court.

Issue before the Supreme Court

The issue before the Apex court was whether the Indian revenue authorities had the jurisdiction to tax an offshore transaction of transfer of shares between two non-resident companies whereby the controlling interest of an Indian resident company is acquired by virtue of this transaction.

Arguments of Revenue

The revenue submitted that this entire transaction of sale of CGP by HTIL to VIH was in substance transfer of capital assets in India and thus attracted capital gain taxes transaction led to transferring of all direct/indirect rights in HEL to VIH and this entire sale of CGP was a tax avoidance scheme and the court must use a dissecting approach and look into the substance and not at “look at” form of transaction as a whole.

Observations made by the Supreme Court

1. Corporate structures
   • Multinational companies often establish corporate structures or affiliate subsidiaries or joint ventures for various business and commercial purposes and these are primarily aimed to yield better returns to the investors and help in progress of the company.
   • And therefore the burden is entirely upon the revenue to show that such incorporation, consolidation, restructuring has been affected for fraudulent purpose so as to defeat the law or evade the taxes.
   • Even Ministry of Corporate affairs recognize such structures that consist of Holding and subsidiary companies wherein Holding company may include enough voting stock in the subsidiary to control the management and also hinted that many transnational investments are made in tax neutral /investor friendly nations primarily so as to avoid double taxation or plan activities in manner to yield best returns to investors.
2. Overseas companies
   • Many overseas companies invest in countries like Mauritius, Cayman Island due to better opportunities of investment and these are undertaken for sound commercial and sound legitimate tax planning and not to conceal their income or assets from home country tax jurisdiction and India have recognised such structures.
   • These offshore transactions or these offshore financial centres do not necessarily lead to the conclusion that these are involved in tax evasion.
3. Holding and Subsidiary Companies
   • The companies act have recognized that subsidiary company is a separate legal entity and though holding company control the subsidiary companies and respective business of the company within a group but it is settled principle that business of subsidiary is separate from the Holding company.
   • The assets of subsidiary companies can be kept as collateral by the parent company but still these two are distinct entities and the holding company is not legally liable for the acts of subsidiaries except in few circumstances where the subsidiary company is a sham.
   • The Holding company and subsidiary companies may form pyramid of structures whereby the subsidiary company may hold controlling interest in other companies forming parent company.
4. Shares and controlling interest
   • The transfer of shares and shifting of controlling interest cannot be seen as two separate transactions of transfer of shares and transfer of controlling interest.
   • The controlling interest is not an identifiable or a distinct capital asset independent of holding of shares and is inherently a contractual right and not property right and cannot be considered as transfer of property and capital assets unless the Statue stipulates otherwise.
   • The acquisition of shares may carry acquisition of controlling interest which is purely commercial concept and tax is levied on transaction and not on its effect.
5. Corporate veil
   • The principle of lifting of corporate veil can also be applied in relationship of Holding and subsidiary company in spite of their separate legal personalities if facts reveal that dubious methods were adopted to evade tax.
   • The revenue authorities should look at transaction in a holistic manner and should not start with the question that the impugned transaction is tax deferment/saving device.
   • The revenue authorities may invoke the principle of piecing of the corporate veil only after it is able to establish on the facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidant.
6. Tax planning/ tax evasion/tax avoidance
   • It is cornerstone law that a tax payer is enabled to arrange his affairs so as to reduce the liability of tax and the fact that the motive for the transaction is to avoid tax does not invalidate it unless a particular enactment so provided.
   • It is essential that the transaction should have some economic or commercial substance in order to be effective.
   • The revenue cannot tax a subject without a statute to support and every tax payer is entitled to arrange his affairs so that his taxes shall be as low as possible and he is not bound to choose that pattern which will replenish the treasury.
   • All tax planning is not illegitimate and observed that the majority in McDowell case held that tax planning is legitimate provided it is within the framework of law and colourable devices cannot be part of tax planning.
7. Role of CGP
   • CGP was already part of HTIL corporate structure and sale of CGP share was a genuine business transaction and commercial decision taken interest of investors and corporate entity and not a dubious one.
8. The site of shares of CGP
   • Shares of CGP were registered in Cayman Island and law of Cayman also does not recognize multiplicity of registers and hence site of shares and transfer of shares is situated in Cayman and shall not shift to India.
9. Extinguishment of rights of HTIL in HEL
   • The transfer of CGP share automatically resulted in host of consequences that included transfer of controlling interest.
   • And controlling interest cannot be dissected from CGP share without legislative intervention.
   • Upon transfer of shares of the holding Company, the controlling interest may also pass on to the purchaser along with the shares and this Controlling interest might have percolated down the line to the operating companies but that controlling interest is still inherently remains contractual and not a property right unless otherwise is provided by the statue.
   • The acquisition of shares may carry the acquisition of controlling interest and this is purely a commercial concept and the tax can be levied only on the transaction and not on its effect and hence, consequently, on transfer of CGP share to Vodafone, Vodafone got control over eight Mauritian Company and this does not mean that the site of CGP share has shifted to India for the purpose of charging capital gains tax.
10. Section 9 of the income tax act
    • The tax is imposed on the basis of source and this source in relation to income is the place where the transaction of sale takes place and not where the item of value which was subject of the transaction is derived or acquired from.
    • HTIL and VIH are both offshore companies and the sale also took place outside India thereby source of income is outside India unless legislation ropes in this transaction.
    • The revenue statutes are to be reasonably construed and tax cannot be imposed without clear words indicating the intention to lay the burden.
    • The charging section is to be strictly construed and section 9 (1) (i) cannot be extended to cover indirect transfer of capital assets in India by interpretation.
    • A specific nexus is required to exist between the earning of the income and the territory that seeks to impose tax for the imposition of tax.
    • Section 9 has no inbuilt “look in” mechanism and “look through” principle shall not shift the site of assets. This can be done only by express provision in this regard.
    • The Legislature in case wanted to tax “income” which arises indirectly from the assets; the same must have been specifically provided so. The court cited the example of Section 64.
11. Section 195
    • The tax presence has to be viewed in context of the transaction in question and not with reference to unrelated matter.
    • The section 195 shall apply in case payments are made by resident to non-resident and not between two non-resident companies.
    • The legal nature of transaction is to be examined.
    • The present transaction was between two non-residents entities through a contract executed outside India where the consideration was also passed outside India and hence VIH is not legally obliged to respond to the notice under section 163 which relates to the treatment of purchaser as a representative assesses.

Decision of the Court

Sale of CGP share by HTIL to Vodafone or VIH does not amount to transfer of capital assets within the meaning of Section 2 (14) of the Income Tax Act and thereby all the rights and entitlements that flow from shareholder agreement etc. that form integral part of share of CGP do not attract capital gains tax.

The order of High Court of the demand of nearly Rs.12, 000 crores by way of capital gains tax would amount to imposing capital punishment for capital investment and it lacks authority of law and therefore is quashed.

Conclusion

The apex court pronounced a landmark judgment in Vodafone International Holding v. Union of India and cleared the uncertainty with respect to imposition of taxes. The apex court through this judgment recognized:

• The principles of tax planning.
• Business entities or individual may arrange the affairs of their business so as to reduce their tax liability in absence of any statutory stipulation prohibiting the same.
• The multinational companies often establish corporate structures and all these structures should be established for business and commercial purposes only.
• The corporate veil may be lifted in case facts and circumstances reveal that the transaction or corporate structure is sham and intended to evade taxes.
• The transactions should be looked holistic manner and not in a dissecting manner and the presence of corporate structures in tax neutral/investor friendly nations should not lead to the conclusion that these are meant to avoid taxes.

In the end, it can be said that this judgment has helped in removing uncertainties with respect to imposition of taxes and recognized the principle the if motive of the transaction is to avoid tax does not necessarily lead to assumption of evasion of taxes and  the supreme court has endorsed the view of legitimate tax planning.