Volume 1, Issue 7

13 December, 2008

Tax Alert
Tax Implications for Foreign Companies structuring business forays in India
The Vodafone Case Study

The Bombay High Court has dismissed the writ petition filed by Vodafone International Holdings BV, (Vodafone) against the alleged violation of withholding tax obligation in relation to purchase of the business operations in India. In nutshell, the tax department had issued a show cause notice to Vodafone for levy of approximately USD 2 billion by way of withholding tax from Vodafone in relation to purchase of shares of Cayman Island company. The tax department contended that, in effect, the purchase was of the business operations of the Indian company whose shares were ultimately held by the Cayman Island Company.

The facts are unique and unprecedented and the outcome may have a telling impact on some of the overseas mergers and acquisitions having similar set of facts.

Key Facts of the Case:

Vodafone, a mobile service provider had acquired 100% shares in CGP Investments, a company incorporated in the Cayman Islands for a consideration of about USD 11.2 billion from HTIL, another Cayman Islands company. CGP Investments held stake in a series of Mauritian and Indian Companies which cumulatively held about 67% stake in Vodafone Essar Limited (VEL). The tax department issued show cause notices to both Vodafone and VEL as to why they should not be held as “assesses in default”, the former on the ground of failure to withhold taxes at source and the latter as a “representative assessee”. Both VEL and Vodafone filed respective writ petitions before the Court challenging the validity of these Notices.

The structure and the flow of transfer are explained in the following chart:

Issues before the High Court

  1. The Show Cause Notice (SCN) issued by the tax department is without jurisdiction.
  2. In an offshore transaction involving two non‐residents, where the asset transferred is not situated in India and the payment is made outside India, the transaction is not chargeable to tax in India.

High Court Ruling

After considering the arguments of both the sides, the High Court held that the totality of the circumstances indicated that the tax authorities have made out a strong (prima facie) case that the transaction was one of transfer of a capital asset situated in India. It would be too simplistic to hold that, under the circumstances, Vodafone had merely acquired shares of an unknown Cayman Islands company. On the issues involved, the High Court observed as follows:

Writ petition against the SCN is not maintainable

  • The Indian tax law provides for a complete machinery to challenge an order of assessment, and subsequent appeal proceedings. Therefore, the remedy provided by the statute should be availed of and recourse should not be made to filing of a writ petition to the High Court.
  • Vodafone is fully safeguarded under the provisions of the Indian tax law to determine withholding taxes on its payments to nonresidents and the only thing required to be done is to file an application before the Indian tax authorities in this regard. Certain Supreme Court decisions were referred to including the case of Transmission Corporation (239 ITR 587).
  • Vodafone has not been able to demonstrate that the SCN was totally non‐est in the eyes of law for want of jurisdiction of the authority to even investigate into the facts.
  • The High Court therefore, concluded that as the issue was a mixed question of facts and law, it is for the Indian tax authorities to investigate the taxability of the issue based on material which Vodafone may present. Accordingly, the High Court held that the SCN cannot be termed erroneous on its face or not based on any material at all. Chargeability in India
  • The very purpose of entering into agreements between the two foreign companies is for one foreign company to acquire the controlling interest in an Indian company from another foreign company. This being the dominant purpose of the transaction, the transaction would certainly be subject to local laws of India, including the Income‐tax Act.
  • Vodafone has itself admitted that HTIL has transferred their 67 per cent interests in VEL qua their shareholders, qua the regulatory authorities in India (FIPB), qua the statutory authorities in USA and Hong Kong and it has also admitted acquiring 67 per cent held by HTIL in VEL. A different stand cannot be taken before the tax authorities in India.
  • Prima facie, through the acquisition of shares of CGP, Vodafone has acquired controlling interests in the Joint Venture Indian Company and other interests and intangible rights situated in India. The shares were prima facie merely a vehicle to acquire these assets.
  • The High Court followed the observations of the Supreme Court in the case of M/s Sri Tirumala Venkateswara Timber and bamboo Firm v Commercial Tax Officer (AIR 1965 SC 784), wherein it was held that where the question involved is as to the nature of the transaction depending on the construction of documents, the same is a mixed question of fact and law and it is for the fact finding authorities to go into the same, particularly when the law prescribes a particular procedure for ascertaining those facts and the same cannot be subject matter of a Writ Petition.

In addition to the above observations, the High Court has also commented about the non‐coperative attitude of Vodafone as under:

  • Vodafone was requested to produce certain documents for proper adjudication in the matter. One of the crucial documents required by the Tax department was the primary agreement entered upon between Vodafone and HTIL. The said agreement has not been produced by Vodafone either before the tax department or before the High Court. Inspite of repeated demands by the tax department, the same have not been produced and therefore it clearly amounts to withholding of the best evidence, even assuming that the onus of proof does not lie on Vodafone.
  • Vodafone has willfully failed to produce the primary / original agreement dated 11 February, 2007 and other documents entered into with HTIL. In the absence of all relevant agreements and documents, it is not possible to appreciate the true nature of the transaction. Further, in the absence of the said agreement and other relevant documents, constitutional validity of tax provisions cannot be gone into. The High Court therefore dismissed the Writ Petition with Costs awarded to the tax authorities.

Our Comments

While the High Court agreed with most contentions of the Revenue, it must be noted that it has not held that Vodafone is liable to pay tax or penalties under the Act in respect of the subject transaction. However, its observations could be a cause for concern from the point of view of cross‐border mergers and acquisitions that involve underlying Indian assets. Foreign investors therefore need to consider the tax implications while structuring business forays in India.

A development that would be worth tracking in the future is whether the tax authorities would use this judgment as a basis for dismantling holding company structures that are put through by non residents for investing into India which are covered by certain tax treaty benefits. However, based on international experience, any structure which is backed by 'substance' and confirms to the 'Limitations of Benefits' clauses (both implied and explicit) should pass through these tests.