Volume 4, Issue 9

8th August, 2011

Tax Alert
Vodafone Case: Supreme Court says can probe into any takeover deal

This tax alert summarizes the recent ruling pronounced by the Bombay High Court (‘HC’) in the case of Aditya Birla Nuvo Limited (‘ABNL’), Tata Industries Limited (‘TIL’), New Cingular Wireless Services Inc (‘NCWS’) and others1, where the HC has ruled on the tax implications arising from transfer of shares of an Indian company by a Mauritian company, where the latter is only a Permitted Transferee of its US parent.

Facts of the case:

  1. Idea Cellular Ltd (‘ICL’), an Indian company, was set up pursuant to a Joint Venture (‘JV’) agreement between AT&T Corporation, USA (‘AT&T USA’), and the Birla Group, represented by Grasim Industries Limited. Under the JV agreement, 51% of ICL’s shares were to be held by Birla Group and balance 49% were to be held by AT&T USA.
  2. The ICL shares could be held by the JV partners in their own name or through a ‘Permitted Transferee’. A ‘Permitted Transferee’ could be any company which is a 100% subsidiary of the JV partners. However, all rights in respect of shares of ICL would vest with the JV partner. Hence, the Permitted Transferee was merely a representative of the JV partner.
  3. In pursuance of the above JV agreement, 49% shares of ICL were allotted to AT&T Mauritius, a 100% subsidiary of AT&T USA, as a Permitted Transferee of AT&T USA.
  4. Subsequently, TIL was inducted as a JV partner as a result of merger of Tata Cellular with ICL. A shareholders’ agreement was entered into between the JV partners and TIL, being the fresh partner.
  5. Subsequently, AT&T Wireless Services Inc (shareholder of AT&T Mauritius) was acquired from AT&T USA by Cingular Wireless LLC and renamed as NCWS.
  6. At a subsequent date, NCWS received an offer from an independent party to acquire its shareholding in ICL. However, as required by the “first right to refusal” condition in the shareholders’ agreement, NCWS offered its shares in ICL to Birla Group and TIL. The total value of the shares was approximately US $ 300 million.
  7. Both TIL and Birla Group (through ABNL) accepted the offer.
  8. In order to purchase its share of 50% of ICL’s shares from NCWS, in August 2005, ABNL made an application for ‘Nil’ withholding certificate to the Indian Tax Authorities (‘ITA’) for making remittance to AT&T Mauritius towards shares of ICL. In the application, ABNL claimed applicability of India-Mauritius treaty provisions to AT&T Mauritius. Relying on the treaty provisions, a ‘Nil’ withholding certificate was issued by the ITA to ABNL pursuant to which ABNL made remittance of US $ 150 million to AT&T Mauritius (being the price for 50% of ICL’s shares held by the latter).
  9. TIL, on the other hand, instead of purchasing its share of 50% of AT&T Mauritius’ holding ICL (worth US $ 150 million), proceeded to purchase the shares of AT&T Mauritius itself from NCWS for US $ 150 million thereby making AT&T Mauritius a 100% subsidiary of TIL.
  1. In the background of the above facts, the ITA issued scrutiny assessment notices to ABNL and TIL as representative assessees of NCWS and separately on NCWS for determining amount of income chargeable to tax in India from the above mentioned transfers.
  2. Aggrieved by the notices, ABNL, TIL and NCWS filed writ petitions with the HC challenging the validity of initiation of assessment proceedings.
  3. The issues before the HC were as under:
    1. Whether the capital gains on sale of shares of ICL by AT&T Mauritius to ABNL was taxable in India?
    2. Whether proceedings for treating ABNL as an agent of AT&T Mauritius could be initiated even after ABNL obtained a ‘Nil’ withholding certificate from the ITA?
    3. Whether the initiation of proceedings for treating TIL, being acquirer of shares of AT&T Mauritius from NCWS, as an agent of NCWS was valid?
    4. Whether the assessment proceedings initiated against NCWS were valid?

Observations and Ruling of the Bombay High Court

I Capital Gains
  The shares in ICL were held in the name of AT&T Mauritius. However, AT&T Mauritius was not the beneficial owner of the shares on account of the following:
    i. Under the JV agreement, 49% of ICL shares were to be held by AT&T USA. However, AT&T USA could hold ICL shares through a Permitted Transferee. Hence, the shares were allotted to AT&T Mauritius merely as a Permitted Transferee.
    ii. The JV was entered into with a view to facilitate AT&T USA to carry on wireless telecommunication business in India.
    iii. Further, AT&T USA had a right to appoint four directors to the board of ICL and to designate one board member as a Principle Founding Member.
    iv. AT&T Mauritius was not a party to the JV agreement. Further, obligation to pay the amount under the JV agreement was with AT&T USA and not with AT&T Mauritius. AT&T Mauritius only discharged the liability of AT&T USA.
    v. Though the shares were allotted to AT&T Mauritius, all rights of voting, management, right to sell etc. were vested in AT&T USA under the JV agreement.
    vi. The agreement for sale of shares of ICL was executed both by AT&T Mauritius and NCWS (successor to AT&T USA).
    vii. On receipt of funds from sale of ICL shares, AT&T Mauritius remitted the funds of US $ 150 million immediately to NCWS by way of dividend and repayment of loan.
  Nothing was brought on record to show that AT&T Mauritius had entered into any transaction to subscribe to or purchase the shares of ICL in its own name. Hence, it could be concluded that the allotment of ICL shares did not confer any beneficial ownership to AT&T Mauritius. Accordingly, the beneficial ownership lay with AT&T USA, the parent of AT&T Mauritius.
  Having concluded that AT&T Mauritius was not the beneficial owner of shares of ICL, the provisions of the India-Mauritius tax treaty would not apply to this case, even though AT&T Mauritius was a tax resident of Mauritius.
  The Supreme Court in the ruling of Azadi Bachao Andolan, proceeded on different fact pattern, ie there was no dispute in that case that the beneficial owner of the shares were the Mauritian entities. The facts of the present case can be distinguished.
II Validity of proceedings for treating ABNL as an agent of AT&T Mauritius
  The shares in ICL were held in the name of AT&T Mauritius. However, AT&T Mauritius was not the beneficial owner of the shares on account of the following:
  ABNL at the time of applying for ‘Nil’ withholding tax, made a statement that shares of ICL were ‘purchased’ by AT&T Mauritius. However, the background of the JV agreement and the fact that shares of ICL were held by AT&T Mauritius as a ”Permitted Transferee” of AT&T USA were suppressed by ABNL. Accordingly, the ‘Nil’ withholding certificate issued to ABNL was on the basis of factually inaccurate information and documents furnished by ABNL. Consequently, refuge could not be taken on the basis of such a certificate obtained after suppressing true facts.
  Further, the liability of withholding tax is different from the liability of being treated as an agent of a non-resident. The ground that no tax was required to be withheld at the time of remitting income cannot bar the ITA from treating the payer of income as an agent of a non-resident.
  On discovering the true facts, the ITA could initiate proceeding for treating ABNL as an agent of AT&T Mauritius.
  However, given the facts of the case, the proceedings initiated on ABNL as an agent, were held to be barred by limitation of time.
III Purchase of shares of AT&T Mauritius by TIL
  Instead of exercising its right to buy 50% of ICL shares at a value of US $ 150 million, TIL purchased the shares of AT&T Mauritius from NCWS for the same price.
  Hence, the actual intention of TIL was to purchase shares of ICL and not of AT&T Mauritius.
  Consequently, proceedings for considering TIL as an agent of NCWS were valid.
IV Re-assessment proceedings against NCWS
  As per the “first right to refusal” condition in the agreement, NCWS offered to sell the shares to the JV partners. Although shares were actually transferred by AT&T Mauritius, shares could not be transferred without consent of NCWS to quit the JV.
  Hence, by virtue of this transfer, NCWS relinquished all rights conferred under the JV/ Shareholders agreements.
  The argument raised by the ITA as to the nature of consideration received by NCWS was of merit and hence the re-assessment proceedings were validly initiated.
  Since AT&T Mauritius was not the beneficial owner of the shares but was a Permitted Transferee under the JV agreement, the sale of shares of ICL by AT&T Mauritius was taxable in India and the capital gains therefrom arose in the hands of NCWS and not AT&T Mauritius.
  Since ABNL had suppressed facts while obtaining ‘Nil’ withholding certificate, the argument that the ITA cannot ignore the said certificate and consequently cannot take a
  different view about the taxability of the capital gains arising on sale of shares of ICL was not acceptable. Consequently, the ITA could initiate assessment proceedings by treating ABNL as an agent of AT&T Mauritius.
  Since the intention of TIL in purchasing shares of AT&T Mauritius was actually to purchase shares of ICL, the ITA could initiative assessment proceedings by treating TIL as an agent of NCWS.
  Since the ITA had made out a prima facie case for initiating reassessment proceedings against NCWS, the action of the ITA was upheld. The ITA has been directed to expedite the assessment proceedings and it would be open to both the ITA and NCWS to make their contentions and argue the matter on merits.

Our Comments

On the back of the favorable HC decision in the landmark Vodafone case which involves taxation of indirect transfer of Indian assets, the ITA are increasingly becoming aggressive in their pursuit of such indirect transfers by companies structuring investments in India through favorable tax jurisdictions like Mauritius. In fact, during the ongoing proceedings in case of Vodafone, the Supreme Court has hinted that it is open for the ITA to go behind a deal to ascertain whether it is a genuine and legal transaction or something else dressed up as a business deal.

In light of the above, the latest ruling of the Bombay High Court upholding validity of opening/re-opening of previous tax years may lead to similar notices being issued by the ITA to other companies investing in India through Special Purpose Vehicles located in favorable tax jurisdictions. Ultimately, the facts will decide the outcome of such cases. Therefore, the back-up documents supporting such transactions and structures should be carefully drafted.

1: [2011] 12 Taxmann.com 141 (Mum)