vodafone – the facts and high court ruling

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VODAFONE – THE FACTS AND HIGH COURT RULING
Decision of the Bombay High Court (“HC”)
Vodafone
Netherlands
 Transaction had significant nexus with
India; hence withholding tax provisions
applicable
100%
CGP Investments Limited (“CGP”)
Direct and indirect
shareholding in HEL - 52%
Cayman Islands
12 intermediate holding companies
 Several other rights transferred besides the
CGP share - the consideration should be
allocated over such rights also
Direct and indirect shareholding of 52%
Mauritius / India
Other Indian
entities
 Essence of the transaction was a change in
the ‘controlling interest’ of HEL, which
constituted a source of income in India
India
+ Options over the indirect shareholding of
15% of Other Indian entities in HEL
= ‘Economic interest’ of 67 percent
(approx) in HEL transferred to Vodafone
Indirect shareholding in
HEL – 15%
Hutchison Essar Limited (“HEL”)
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All rights reserved | Preliminary & Tentative
Hutch
Telecommunication
International Ltd
(“HTIL”)
Share Purchase
Agreement (“SPA”)
for shares of CGP
VODAFONE – THE FACTS (CONT)
The consideration of USD 11.08 billion paid by Vodafone was for the following –

52 percent direct and indirect equity shareholding in HEL

Control premium

Use of rights of the Hutch brand in India

A non-compete agreement with the Hutch group

Value of non-voting, non-convertible preference shares

Value of loan obligations

Entitlements to further acquire 15 percent indirect interest in HEL
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Question before the Supreme Court of India (“SC”) – Whether capital gains arise from
the sale by a non-resident of the share capital of CGP, a foreign entity, which held
underlying Indian assets?
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Vodafone
Revenue
SC

In the absence of fraud, India to respect corporate identity and corporate veil
cannot be lifted (unless the law is specifically provides so)

Regulatory provisions mandate investment in telecom sector only through a
corporate structure; it could not be disregarded by lifting of corporate veil

Existing provisions to be construed ‘purposively’

The transaction was an artificial tax avoidance scheme

Separate legal existence – corporate structures ordinarily to be respected

Reasonable business purpose test - holding structures to be ignored, if indirect
transfer results from abuse of organization form / legal form

Concept of ‘participation in investment’ relevant, other considerations to be borne
in mind to determine abuse

The onus to identify and establish abuse lies on Revenue

International holding company structures set up for commercial reasons

Difference between having power and persuasive position on the subsidiary
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HOLDING STRUCTURES
Vodafone
Revenue

Language of section 9 does not create ‘look through’ provisions

Words ‘indirectly’ and ‘through’ appearing in section 9 do not make transaction
taxable, unless capital asset situated in India (in this case the Cayman Islands
Company’s share was situated outside India)

In a transaction between two foreign entities – source of income cannot be traced
back to India to establish nexus with India

Section 9 to be construed in a wide manner; intent of the transaction to be seen

Consideration paid for property rights in India which created a source of income
from India

Situs of CGP share can only be in India as the entire business purpose of holding
that share was to assume control in Indian telecom operations, the same was
managed through board of directors controlled by HTIL
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SCOPE OF SECTION 9 AND DETERMINATION OF
SITUS OF SHARES
SC

Section 9(1) a legal fiction, and cannot be expanded by giving purposive
interpretation

It does not envisage “look through” provisions

Scope of income arising from transfer of capital assets which is dependent on
three elements - transfer, existence of capital asset and situation of such asset in
India

The word “indirectly” used goes only with ‘income’; not “capital asset”

Specific provision in the Direct Taxes Code Bill, 2010 (“DTC”) deals with taxation
of indirect transfers

Source of income is where the transaction of sale takes place; and not where the
value lies

A share is situated where the company is registered and the register of members
is kept; and not where the ‘underlying assets’ are situated
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SCOPE OF SECTION 9 AND DETERMINATION OF
SITUS OF SHARES (CONT)

Hutch holding structure existed since 1994

Complex corporate structure evolved for good commercial reasons, recognized by
Indian tax and regulatory laws
Revenue

CGP share was interposed at the last minute to avoid tax in India
SC

Principle of internal correlation: Every multinational company reconfigures itself
into a corporate group by dividing itself into a number of subsidiaries which are
financially interlinked

Court(s) have evolved doctrines like piercing the corporate veil, substance over
form etc; however, genuine tax planning cannot be ruled against by the Court(s)

CGP was an investment vehicle; sale of shares of CGP was more efficient way of
ensuring a smooth transition of business. It cannot, therefore, be said that CGP
had no business or commercial purpose
Vodafone
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ROLE OF CGP IN THE TRANSACTION
CONTROLLING INTEREST AND OTHER RIGHTS
AND ENTITLEMENTS
Revenue
SC

No transfer of controlling interest independent from transfer of shares

Controlling interest cannot be taxed in the absence of express legislation

The entire purpose of transferring the CGP share was to transfer control in HEL

Controlling interest is a property right – the transfer of which is taxable in India

The Vodafone transaction held to be an ‘investment to participate’ instead of a tax
avoidance transaction; difference between power and persuasive position

Reason for execution of the SPA was to provide exit to Hutch

Controlling interest in the management of the company - not an identifiable or
distinct capital asset independent of the holding of shares

Tax is to be levied on the transaction ie share sale and not on its effect

Method or basis of valuation of shares cannot be a basis of taxation
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Vodafone
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CONTROLLING INTEREST AND OTHER RIGHTS
AND ENTITLEMENTS (CONT)

Bargain was for sale of CGP share and not an itemized sale transaction

Options entitling Vodafone to 15 percent indirect holding in HEL do not constitute
a property right or equity interest until exercised
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SC
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Vodafone
Revenue
SC

Indian Parliament has legislated on form; the Court(s) cannot get into the
substance of the transaction

Concept of substance over form has been rejected by SC in case of Azadi
Bachao Andolan (“ABA”)

Tax recognizes form and decoupling as a part of bonafide transnational
structuring

Real intention should be looked upon

Reliance to be placed on SC decision in the case of McDowell – ABA incorrectly
decided, should be reconsidered

There is no conflict between McDowell and ABA and the latter did not require any
reconsideration

Court(s) not compelled to look at a document or transaction in isolation and the
legal nature of the transaction should be discerned by looking at the entire
transaction as a whole and not by adopting a dissecting approach – the ‘look at’
approach – guidance taken from English cases
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AZADI BACHAO ANDOLAN REGARDING TAX
AVOIDANCE
VALIDITY OF MAURITIUS TAX RESIDENCY
CERTIFICATE
Vodafone

Reliance placed on ABA – Tax Residency Certificate (“TRC”) conclusive evidence
even for investors who invest through the Mauritius route
Revenue

Enquire to check whether capital gains beneficially and legally belong to a
Mauritian entity or to a third party ie whether the Mauritian company is a mere
façade
SC

Per Justice Radhakrishnan–
 However, Revenue not precluded from denying the treaty benefits, if
established that the Mauritius company had no commercial substance and had
been interposed solely with a view to avoid tax or for tax evasion
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 Valid TRC, in the absence of a Limitation Of Benefits (“LOB”) clause, conclusive
as regards the residence and beneficial interest / ownership
WITHHOLDING TAX
Vodafone
 Section 195, referring to withholding from payments to non-residents, cannot be
enforced on a non-resident not having any taxable presence in India
 The words ’any person’ in section 195 should be used sensibly, else the
enforcement of the provision would be impossible
 In the absence of income chargeable to tax, tax not required to be withheld
Revenue
 The term ‘person’ widely defined to include a foreign company
 Once the nexus is shown to exist, the provisions would operate
SC

Applicability of section 195 depends on the “tax presence” of the non-resident
payer in India - tax presence must be construed in the context of the transaction
under question

Per Justice Radhakrishnan – section 195 does not apply to non resident payors;
does not have extra territorial applicability
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 Section 195 applicable when the taxpayer has some of nexus with India,
irrespective of deductor being a non-resident
WITHHOLDING TAX (CONT)

Investment by a group company in an Indian company does not create a tax
presence of all companies of that group in India

In the absence of chargeability to tax, nothing could be recovered from the
deemed agent under domestic tax laws

Merely treatment as an agent, would not lead to an automatic liability to pay taxes
on behalf of the non-resident
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SC
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SC
observations

Tax avoidance is a problem faced by almost all countries following civil and
common law systems and all share the common broad aim to combat it

Vodafone case an eye-opener of what India lacks in regulatory laws and what
measures India has to take to meet the various unprecedented situations
without sacrificing national interest

The DTC envisages to create an economically efficient and effective direct tax
system by proposing a GAAR

Certainty is integral to rule of law - the basic foundation of any fiscal system

Tax policy certainty is crucial for taxpayers (including foreign investors) to make
rational economic choices in the most efficient manner
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NEED FOR LEGISLATION AND CERTAINTY
BMR ANALYSIS
Binding nature of the concurring but separate judgment of Justice Radhakrishnan
Substance vs form - will TRC remain a conclusive proof of residency?
Future for Mauritius investors
Applicability of withholding tax provisions in future M&A/Private Equity deals
Applicability of this ruling to other similar transactions
Relevant guidance by the SC on the need, scope and application of GAAR
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Provisions of the DTC relating to indirect transfers – a game changer?
What to expect in the Finance Bill, 2012?
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OTHER CONSIDERATIONS

(i) the concept of ‘participation in investment’

(ii) the duration of time during which the holding structure exists

(iii) the period of business operations in India

(iv) the generation of taxable revenues in India,

(v) the timing of the exit

(vi) the continuity of business on such exit
These considerations relate to an investment to participate in India which is conceptually different
from a pre-ordained transaction which is created for a tax avoidance purpose
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Considerations to be borne in mind to determine if there is an abuse –

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