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Case Note
Vodafone International
Holdings BV (Vodafone NL)
A Critical Review of Pre- and Post-Ruling Impact
and Future Course of Action
G Mahadevan*
The Supreme Court of India has held' that the transfer of shares in an
offshore entity between two non-resident persons/entities cannot be taxed
in India where the plea put forward is that the underlying assets determining
the value of the shares were in India. The tax dispute on which the above
ruling was pronounced by the Supreme Court involved the transfer and
acquisition by Vodafone International Holdings BV (VIH) of the entire
share capital of CGP Investments (Holdings) Limited (CGP) in the Cayman
Islands, from Hutchison International Limited (HTIL) by virtue of which
CGP's shareholding in its Indian subsidiary HEL was also transferred.
The process of acquisition of equity interests in HEL by various potentially
interested parties began in 2006. Vodafone and HTIL announced that
the former acquired a controlling interest in HEL, via its subsidiary, after
Vodafone Group Plc agreed to acquire a 67 per cent interest in HEL through
a single share of CGP.
VIH and Vodafone had agreed to acquire the companies, which controlled
a 67 per cent interest in HEL. Vodafone applied to the Foreign Investment
Promotion Board (FIPB), seeking approval for the indirect acquisition of a
controlling interest of 51.96 per cent in HEL. FIPB approval was received by
Vodafone in May 2007. HEL was later renamed as Vodafone Essar Limited (VEL).

* Fox Mandal, Bangalore.

1 Vodafone InternationalHoldings BV (Vodafone NL) (SLP (c) No 26529 of 2010)

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Transaction and structure of the company

Hutchison Telecommunications Limited (HTL), a constituent of the Hong
Kong-based Hutch group, invested into the telecoms business in India in 1992
through ajoint venture arrangement (JVA) under the name of Hutchison Max
Telecom Limited (HMTL), later renamed Hutchison Essar Limited (HEL).
In 1998, HTL set up a company in the Cayman Islands called CGP as
an exempt company in which HTL was the sole shareholder, holding its
entire share capital. As part of its expansion programme, HTL had set up
its subsidiaries in the name of Hutchison Telecom International Limited
(HTIL) in Hong Kong, the Cayman Islands and the British Virgin Islands.
In September 2004, HTL's shareholding in CGP was transferred to
HTIBVI, an indirect subsidiary of HTIL. HTIBVI became the registered
shareholder of CGP.
In 2005, as part of a consolidation of HMTL, all operating companies
below HMTL came under the umbrella of one holding company, HMTL,
with the requisite statutory approvals. The ownership of HMTL was further
consolidated into the next level of companies, all based in Mauritius.
Through a process of consolidation, CGP acquired a controlling interest in
the Indian company, HTML, through the Mauritian companies.
In 2007, HTIL Hong Kong sold the entire shareholding held through its
subsidiary, HTIL (in the Cayman Islands), in CGP (in the Cayman Islands)
to VIH BV Netherlands for US$11.2 billion.
The transaction detailed above is set out in Figure 1. At the completion of
the transaction, the Indian entity was renamed Vodafone Essar Limited (VEL).

Transactions in India

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Issue
The basic issue raised by the Indian tax authorities in respect of the above
transaction was whether the gains made by HTIL on the sale of CGP's share
to VIH were capital gains, chargeable to tax under section 45 of the Indian
Income Tax Act, read with sections 9, 163 and 195 of the Income Tax Act.

Critical analysis of the tax proceedings and other issues

In August 2007, the Indian tax authorities issued a notice to VEL under
section 163 of the Income Tax Act to show cause as to why it should not be
treated as a representative assessee of Vodafone. In September of that year,
another show cause notice was issued to VEL for its failure to deduct taxes
at source while making payment to HTIL and therefore considered it to be
an assessee-in-default.
Both the notices were challenged by VEL filing a writ petition in the
Bombay High Court. Both VEL and Vodafone believed that since the
transaction of the sale of the shares in CGP was between two non-residents
and took place outside India, the income tax authority (ITA) in India lacked
jurisdiction to tax the gains and therefore there was no incidence of the
gains to tax in India.

In December 2008, the Bombay High Court dismissed the writ petition
filed by VEL as the inherent intention behind the transaction was to acquire
a controlling interest in HEL. The High Court also commented that all
the relevant facts and circumstances were not produced before it to make
further comments.
In January 2009, against the order of the Bombay High Court, Vodafone
filed a special leave petition (SLP) before the Supreme Court of India. The
Supreme Court directed the ITA to decide the issue of the jurisdiction of
the tax authorities on merit to proceed against Vodafone. The Supreme
Court further observed that if the order of the tax authorities was found to
be unjustly prejudicial to the interests of Vodafone, Vodafone could appeal
before the Bombay High Court directly.
Consequent to the Supreme Court directive to the ITA to decide the
jurisdictional issue, the ITA issued a show cause notice to Vodafone to treat
Vodafone as an assessee-in-default under sections 201 and 201 (A) of the
Income Tax Act. Vodafone responded in the same way. The ITA passed
the order confirming their jurisdiction to tax the transaction in the hands
of Vodafone. A show cause notice was issued under section 163(1) of the
Income Tax Act to Vodafone as to why it would not be treated as an agent
or representative assessee of HTIL.

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Against this, Vodafone filed a writ petition before the Bombay High Court
and the Court dismissed the writ petition, upheld the jurisdictional issue and
ruled in favour of the ITA. While delivering its ruling, the Court observed
as follows.

Bombay High Court order

The Bombay High Court in its order on the writ petition by Vodafone ruled
that the Indian ITA had jurisdiction under the Indian Income Tax Act to tax
the transaction that had taken place between Vodafone and HTIL.
The transactions between Vodafone and HTIL were not merely a transfer
of a single CGP share, but the 'controlling interest' in HEL in India, which
was an identifiable capital asset, independent of the CGP share. Further,
the Court observed that Vodafone obtained an indirect interest in HEL;
rights to use the Hutch brand in India; a non-compete agreement with the
Hutch brand in India that constituted a capital asset as per section 2(14) of
the Income Tax Act; and the price of US$11.02 billion, paid by Vodafone to
HTIL, factoring in part consideration of these diverse rights and entitlements
in relation to the transfer of one CGP share, and the transactional documents
for rights and entitlements consequential to the transfer of the CGP share.
The High Court went on to hold that section 9 of the Income Tax Act was
wide enough to cover the transaction. Where assets or sources of income were
situated in India, income accruing or arising directly or indirectly through or
from them is chargeable under section 9(1) (i) or 163 of the Income Tax Act.
Vodafone by virtue of its diverse agreements had a nexus with Indian
jurisdiction and hence the proceedings initiated under section 201 of the
Income Tax Act for failure to withhold tax by Vodafone could not be held to
lack jurisdiction. The Bombay High Court finally held that income gained
on the transfer of the CGP share was taxable in India.

Arguments before the Supreme Court

Against the Bombay High Court order, which decided the jurisdictional
issue in favour of the Income Tax Department (ITD), Vodafone filed an SLP
before the Supreme Court of India. The Supreme Court ordered Vodafone
to deposit INR 2,500 crores and the balance tax amount of INR 8,500 crores
by way of a bank guarantee. Vodafone complied with this directive and
proceeded on appeal before the Supreme Court of India.
The Supreme Court commenced its hearing on 19 September 2011. The
apex court heard rival submissions.

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Submissions of Vodafone
Vodafone contended that the corporate structure and restructuring designed
by it carried good commercial reasons and were not aimed at the evasion
of tax. Where regulatory provisions mandated investment into a corporate
structure, such structures could not be disregarded for tax purposes by lifting
the corporate veil, especially when there was no motive to evade tax. The
HTIL structure was not designed to evade tax and the transaction was not a
colourable device to achieve that purpose. The source of income used to lie
where the transaction was effected and not where the underlying asset for
considering valuation was situated or where the economic interest used to
lie (Seth PushalalMansinghkha (P) Ltd v CIT (1967) 66 ITR 159 (SC)).
Further, Vodafone contended that without any express legislation, offshore
income could not be taxed in India. The situs (of the shares) was determined
depending on the place where the assets (the shares) were situated. Just
because Vodafone acquired control of HEL by virtue of the transfer of the
CGP share did not mean that the transaction could be taxed on any arbitrary
basis or assumption.
Section 2(47) of the Income Tax Act, which provided for 'extinguishment',
was relevant only if there was a transfer of legal right and not a contractual
right. The Tax Residency Certificate (TRC) issued by the Mauritian
authorities had to be respected and in the absence of a limitation of benefits
clause, the benefit of the Indo-Mauritian treaty was available to third parties
who invested in India through the Mauritian route.
Section 195 of the Income Tax Act could not be enforced on a non-resident
person without a presence in India. The words 'Any Person' in section 195
should apply to taxpayers who have a presence in India. Section 195 did not
apply to offshore entities making offshore payments.
The findings of the ITD that the benefit of the telecom licence was
transferred to Vodafone were misconceived. Under the telecoms policy of
India, a telecoms licence can only be held by an Indian company and there
was no direct or indirect transfer of any licence to Vodafone.

Arguments of the ITD

The situs of CGP could only be in India as the entire business purpose of
holding that share was to assume control in Indian telecoms operations. The
controlling interest expressed by HTIL would amount to property rights and
hence would be taxable in India. Call and put options, though a contingent
right, were property rights capable of being transferred and not merely
contractual rights and hence were taxable.

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Referring to the share purchase agreement (SPA) between HTIL and

Vodafone, the transaction could be viewed as an extinguishment of HTIL's
property rights in India and the CGP share was merely a mode to transfer
capital assets in India.
It was pointed out that the charging section should be construed
purposively and that it contained a look-through provision. The definition
of transfer in section 9(1) (i) was an inclusive definition meant to explain
the scope of that section and not to limit it.
Judgment in the case of MCDowell has to be relied on, rather than that in
Azadi Bachao Andolan, which was incorrectly referred. The ITD could make
an enquiry into whether capital gains had been factually and legally assigned
to a Mauritian entity or to a third party and whether the Mauritian company
was a facade, for which a lifting of the veil would be a necessary procedure
to be resorted to.

Role of CGP in the transaction

The Supreme Court of India, after reviewing the two documents, namely a
KPMG report dated 18 October 2010 and an annual report from HTIL for
the year 2007, observed that the sole purpose of CGP was not only to hold
shares in subsidiary companies but also to enable a smooth transition of
business, which was the basis of SPA and it could not be said that CGP had
no business or commercial purpose. The Court further held that in a case
where a transaction involved the transfer of shares lock, stock and barrel,
such a transaction could not be broken up or split into separate individual
components, assets or rights.
Thus it was not open to the ITA to split the payment and consider a
part of such payments for each of the rights. The essential character of
the transaction as an alienation could not be altered by the form of the
consideration. The Supreme Court observed that one needed to 'look at'
the entire ownership structure set up by Hutchison as a single consolidated
bargain and interpret the transactional documents accordingly.

Supreme Court ruling

The Supreme Court of India, in a Bench comprising the Chief Justice of
India Mr Justice S H Kapadia, Justice Swatanter Kumar and Justice K S
Radhakrishnan, delivered the judgment in two parts to state that the ITD
lackedjurisdiction. It rejected the ITD's argument that CGP was 'fished out'
from the HTIL structure solely to evade tax, rejected the explanation given in
respect of an application made by VIH to the FIPB and the argument that the

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sale of the CGP share by HTIL to Vodafone would not amount to a transfer
of capital assets within the meaning of section 2(14) of the Income Tax Act.
An analysis of the judgment of the Supreme Court of India gives rise to
an understanding of the following important principles qua taxability.
The tax authorities as well as the courts had to 'look at' the legal nature
of the transaction as a whole instead of taking a 'look through'. The 'lookthrough' approach could be taken only in situations where the facts and
circumstances suggested that the transaction was a sham, was deceptive and
had been entered into for the purposes of tax evasion. Section 9 of the Income
Tax Act did not cover indirect transfers of capital assets or property situated
in India. No purposive interpretation could be rendered to a legal statute.
On the situs of the sale of shares, the Supreme Court held that the situs
of the shares would be where the company was incorporated and where its
shares could be transferred and was not determinable on the basis of the
location of the underlying assets.
On the basis of valuation, the Supreme Court was of the view that it could
not be the basis of taxation and the basis of taxation was only profits or
income or receipts. Valuation could be a science or law and would take into
consideration business realities, such as the business model, the duration of
the operations, concepts such as cash flow, discounting factors, assets and
liabilities, intangibles, etc.
Section 195 of the Income Tax Act was applicable only when the
transaction was liable to tax in India and if the transaction was not liable to
tax in India, section 195 of the Income Tax Act would have no applicability.
The Supreme Court held that a representative assessee was liable as such
only if all the conditions prescribed under section 161 of the Income Tax
Act were satisfied. The Court upheld the Westminster principle and made it
clear that form prevailed over substance in genuine transactions.
The Supreme Court observed that all tax planning could not be said to
be illegal, illegitimate and impermissible and every taxpayer was entitled to
arrange its affairs so that the taxes would be as low as possible and that the
taxpayer was not bound to choose the pattern that replenished the treasury.
The Court clarified that the holding company and subsidiaries were
separate legal entities and would have distinct relevance. The controlling
interest was not a separate capital asset and a controlling interest was an
incidence of ownership of shares in a company, something that flowed out
of the holding of the shares. A controlling interest was, therefore, not an
identifiable or distinct capital asset independent of the holding of the shares.
Thejudgment suggested that if the government proposed a 'limitation of
benefits' or 'look-through' provisions, it would be a policy matter that could
be introduced either under the extant law or the tax treaties.

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Post-ruling events
The government filed a review petition on 17 February 2012 and the
Bench decided on the review petition on 21 March 2012, again in favour
of Vodafone.
A Bench comprising Chief Justice S H Kapadia and Justices K S
Radhakrishnan and Swatanter Kumar observed: 'We have carefully gone
through the review petition filed by the Union of India on February 17, 2012.
We find no merit in the review petition. It is accordingly dismissed.'
The order on a review petition can be challenged by filing a curative
petition, which is heard by a larger Bench. Such a petition is filed only in
extraordinary circumstances.
In the meantime, on 16 March 2012, the Finance Minister in his Union
Budget for 2012-13 proposed certain clarificatory retrospective amendments
to restate the legislative intent in respect of the scope and applicability of
sections 9 and 195 of the Indian Income Tax Act and also to make other
amendments to clarify the law especially because a large number of such
capital gains had been taxed earlier and the assessees paid the tax on the
understanding that in a similar situation the law had the provision of taxing
the transaction. The Vodafone case judgment introduced a level of confusion
and uncertainly in tax matters.
Thus, there was a proposal to amend section 9(1)(i) of the Income Tax Act to
clarify that an asset or a capital asset, being any share or interest in a company
or entity registered or incorporated outside India, shall be deemed to be and shall
always be deemed to have been in India if the share or interest derives, directly or
indirectly, its value substantially from assets located in India. Section 195 of
the Income Tax Act has been amended to clarify that the obligation to comply
with the provisions of making a deduction applies and shall be deemed to have
always applied and extends and shall be deemed to have always extended to persons
resident or non-resident, whether or not the non-resident has a residence or
place of business connection in India, or any other presence in any manner
whatsoever in India. Similarly, section 2(47) of the Income Tax Act has been
amended to clarify that transfer includes the transfer of an asset directly or
indirectly, notwithstanding that such transfer of rights has been characterised
as being effected or dependent on or flowing from the transfer of a share or
shares of a company registered or incorporated outside India.

Effects of the amendments

The budgetary changes, which would have retrospective effect on the income
tax provisions with effect from 1 April 1962, would make serious inroads into

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the jurisprudential cannons of taxation including certainty and prospective

application and would also have the effect of eroding the credibility of the
Indian tax system.
Retrospective amendments are not uncommon in modern times but the
purpose of amendments of this magnitude, which would have the effect of
taxing a transaction to the tune of approximately Rs 20,000 crores including
the penalty amount, are open to question.
Economists and political analysts in India understood that these changes
might have an effect on the inflow of foreign capital into the country while
the government believed that these changes would not have any adverse
effect on the inflow of foreign capital but would strengthen the tax regime
and make tax system transparent and certain.
The Finance Minister in his post-budget speech on the retrospective
amendments made it clear that the amendments were not Vodafone specific.
He said:
'We are making three points quite clear - that India is a not a "no tax"
or "low tax" or even a "tax haven". India is a country where all taxpayers,
whether resident or non-resident, will be treated on a par. Secondly, India
is a country where tax laws are that if you pay tax in one country, you
need not pay tax in the other country of your business operation which
is covered by the DTAA. But it cannot be a case that you pay no tax at all.'
Explaining the circumstances under which the amendments had become
necessary, he said that some companies or entities would do their tax
planning in such a way that they didn't have to pay tax at all. Had the case
been that they had to pay tax in one country and pay tax in another country
as well, it would have been a case of double taxation and would have been
dealt with accordingly.

Constitutional validity
The tax system is likely to face many challenges once the demands have been
levied retrospectively by reopening the file. It is clear that Parliament has
absolute power to pass legislation in respect of retrospective amendments
but subject to questions of competence and judicially recognised limitations.
If a clarificatory explanation seeking to overcome previousjudicial decisions
was seen to be amounting to a 'new' levy - or was in substance a change in
law - the retrospective amendment would then be tested in the touchstone
of'judicial review (NationalAgriculturalCooperativeMarketingFederationofIndia
v UOI (2003) 5 SCC23 260 ITR 548).

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The Supreme Court of India could certainly determine whether a law was
constitutionally valid. Any law that could be declared as invalid or ultra vires
would come under the provisions of Article 265, that is, taxation without
the authority of law. The Supreme Court has the necessary power to call for
appropriate writs under Article 138/39 to examine such issues.

Direct Taxes Code Bill

The Direct Taxes Code 2010, which is set to replace the existing Income Tax
Act 1961, contains regulatory provisions on this subject.
Clause 5(4) (g) of the bill provides that income from the transfer, outside
India, of a share in a foreign company would be deemed to arise in India if
the fair market value (FMV) of assets of the Indian company owned by the
foreign company is at least 50 per cent of its total assets.
In an environment of moderate rates of tax, the bill provides that the correct
tax base be subject to tax in the face of aggressive tax planning and use of
opaque, low-tax jurisdictions for residence as well as for sourcing of capital.
The bill proposes to provide a general anti-avoidance rule (GAAR) to deal
with aggressive tax planning. Under the GAAR tax regime, an arrangement
whose main purpose or one of the main purposes is to obtain a tax benefit
and in which the transaction is carried out in a manner that is not normally
employed for bona fide purposes and similar other tests would be declared as
'impermissible avoidance agreements'. The assessing officer would determine
the consequences of such a positive declaration of arrangement as an
impermissible avoidance arrangement in his order, which would be appealable.

Arbitration
Vodafone recently served a notice of dispute against the Indian Government
initiating a dispute settlement process under the India-Netherlands Bilateral
Investment Treaty (BIT). The dispute arose from the retrospective tax
legislation proposed by the Indian Government, which, if enacted, would
have serious consequences for a wide range of Indian and international
businesses, as well as direct and negative consequences for Vodafone. The
basic issue was that the retrospective tax proposals amount to a denial of
justice and a breach of the Indian Government's obligations under the BIT
to accord fair and equitable treatment to investors.
Article 9 of the India-Netherlands BIT provides that by notifying the
host state of its 'intentions', the investor could trigger a dispute settlement
mechanism under the BIT. Once such a notice is served, the treaty provides for
a three-month period of negotiations for amicable settlement of the dispute.

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If negotiations fail to resolve the dispute within three months, conciliation

could be resorted to if both parties agree to it. Otherwise, or if the conciliation
proceedings are terminated at any stage, arbitration proceedings are initiated
under Article 9(3) of the BIT, being, in all likelihood, an UNCITRAL
arbitration before an ad hoc arbitral tribunal.
It is apparent that the main intention underlying this notice as per Article
9(1) is an intention to go for a negotiated amicable settlement.

Conclusion
The Supreme Court of India through its assertive order decided that India
did not have jurisdiction to tax the transactions discussed above, especially
where the transactions were between two non-resident persons on a transfer
of securities lying offshore on the plea that the underlying assets determining
the value of such securities were stationed in India. The Government of
India, on the other hand, was of the opinion that the income on these
transactions could not escape untaxed in any country. If, however, the
proposed clarificatory amendment was passed through an Act of Parliament,
the Government of India would have the power to tax the Vodafone deal and
all such other deals by opening the file with retrospective effect.
The author's firm did not think that this could be yet another demonstration
of a show of strength between the Indian judiciary and executive on the
legislative pitch. Nor did it believe there wouldn't be any scope for a
negotiated deal for a transaction of this type. What were the various options
for Vodafone? Once, at the instance of the Supreme Court, the ITA decided
to assume jurisdiction over the transaction and imposed tax and also claimed
tax deduction at source, Vodafone had two options. The softer option would
be to go for an appeal in the Income Tax Appellate Tribunal and against that
decision the company could have appealed to the High Court. The harder
option would be to suggest that there was a taxation with the sanction of any
law as required under constitutional mandate under Article 265 and the
company could then go to the High Court/Supreme Court on a writ petition
and consequently on an SLP. Vodafone took the harder route. It could have
first exhausted the domestic remedies, which it did not opt for.
Now, post-amendment, what are the various options for Vodafone?
Pursuing the same, harder path, Vodafone could test the constitutional virus
of the amendment by challenging the legal validity of the Act in another writ
for judicial review. It could then, at any stage of the writ petition argument,
exercise the option of arbitration in the judicial proceedings. But by not
doing so and opting to serve a notice pending the bill, did it now show its
interest in taking the easy route of amicable settlement?

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Some ITA officials, after dismissing the notice for being on presumptive
grounds, further added that Vodafone could approach the Income Tax
Appellate Tribunal, which might consider the tax amount to exempt the
amount of the interest and the penalty, which formed nearly two-thirds of
the total claim amount. Could we consider this to be a step forward from
both sides?
The author's firm always believed that there was another way of arriving
at a win-win situation from the initial stages. Did the hard line push the
Indian Government towards financial sector tax reform? For the past few
years, the government has been of the firm opinion that in the name of
hard tax planning, global concerns were using corporate restructuring as a
dominant method for tax evasion and misusing the Mauritius routes for the
purpose. The two governments also shared their mutual concerns regarding
such operations.
In this context, the softer line of negotiations would always bring a winwin situation for both sides with a better mutual understanding and an
appreciation of their relative positions.

Trench & AssociateS

2nd Floor, Union National Bank Bldg, Dubai, UAE

Legal Consultants

T: 04-3553146
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Dubai

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E: coordinator@trenchlaw.coi