In a recent judgment passed by Bombay High Court in Vodafone International Holdings v Union of India, writ petition no. 2550 of 2007, it was held that Vodafone was liable under section 9 of the Income Tax Act, 1961, to pay approximately US$2 billion in capital gains tax for its transaction with Hutch International, in which US$11.2 billion worth of shares was purchased from a Cayman Islands company in 2006.
Hutchison Essar (HEL), a cellular telecommunications company in India, was an Indian joint venture of the Hutchison group – a foreign enterprise – and an Indian company, Essar. Hutchison Telecommunications International (HTIL), a foreign Hutch group company, held a 67% interest in HEL. HTIL’s 67% holding included a 51.95% holding through another foreign company, CGP Investments (CGP), which was registered in the Cayman Islands. Vodafone, a Dutch company, entered into an agreement with HTIL to acquire its 67% controlling interest in HEL subject to the approval of Indian authorities.
The Foreign Investment Promotion Board (FIPB) approved the transaction on the condition that Vodafone would comply with Indian laws, including the Indian Income Tax Act (ITA). The Indian partner, Essar, agreed to the arrangement and as a result, a new joint venture – Vodafone Essar (VEL) came into existence, replacing HEL. Thus, through this arrangement Vodafone purchased 100% of the share capital in CGP from HTIL.
The income tax authorities believed the transaction would result in capital gains which were chargeable to tax in India, and therefore Vodafone was liable under section 195 of the ITA. The tax authorities issued a notice to Vodafone to show cause as to why it should not be treated as an assessee-in-default.
According to the income tax department, Vodafone should have deducted the tax, estimated at around US$2 billion, and paid the money to the income tax department when it acquired the shares of HTIL.
Vodafone opposed this claim by filing writ against the issuance of the notice and questioning jurisdiction of the income tax authorities. Vodafone claimed the transaction was the transfer of the share capital of a non-resident company and was not a transfer of capital assets situated in India. Vodafone maintained that the transaction was between two foreign companies on foreign soil and was therefore exempt from tax payments in India.
Vodafone further argued that the share capital in question belonged to CGP, the transfer of which would be undertaken from its registered office in the Cayman Islands. Vodafone stated that it was through the acquisition of the share capital of CGP that it had acquired control of CGP directly and VEL indirectly. Vodafone thus claimed that section 9 was not applicable in this case.
Bombay High Court stated that the transaction between the parties did not involve the shares of CGP, but rather the assets situated in India.
The court held that apart from the acquisition of a controlling interest, Vodafone had acquired other interests and intangibles rights. Vodafone, accordingly, became a successor in interest in the joint venture between HTIL and the Essar group and also became a co-licensee with the Essar group to operate mobile telecommunicatons in India. Thus, Vodafone acquired a beneficial interest in the licence granted by the Department of Telecommunications in India to VEL.
In addition, the court stated that the income earned by HTIL was liable for capital gains tax in India since it contributed to the sale of its business interests as a group to Vodafone.
Impact on foreign companies
The court’s decision in this case illustrates that the acquisition of shares in an offshore company where the underlying assets (and rights) are Indian, creates a connection for the transaction in India.
The ruling may have a bearing on similar offshore deals in which one or both of the companies concerned are not resident in India, a structure commonly used by foreign companies in the country. If the final verdict is against Vodafone, it will have a significant impact on similar transactions and global mergers and acquisitions indirectly involving an Indian company.
Foreign companies are now likely to verify their plans with the Authority for Advance Rulings (AAR) prior to finalizing a deal, in order to protect themselves from the exposure to tax liabilities arising from cross-border mergers and acquisitions. The AAR will decide if a transaction made by non-resident companies is taxable and how much they are expected to pay. Any rulings by the AAR are binding on both the company seeking approval and the income tax department.
Sumes Dewan is a partner and Shradha Puri is a senior associate at KR Chawla & Co Advocates & Legal Consultants. The firm is headquartered in New Delhi and has offices in Chennai and Bangalore as well as a representative office in Singapore.
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