Thursday, September 9, 2010

HC verdict may force Vodafone to pay $2.6bn tax

In a landmark verdict that could cost Vodafone International $2.6 billion (over Rs 12,000 crore) in tax and perhaps worry foreign investors, the Bombay high court on Wednesday dismissed a petition filed by the global telecom giant against the Indian income tax department's power to impose a capital gains tax on its $11 billion-plus acquisition in 2007 of a controlling 67% stake in Hutchison Essar Ltd (HEL).

The significance of the case lies in the fact that this is the first time an Indian court has ruled on whether Indian tax authorites have jurisdiction over a transaction between two overseas corporate entities concerning a business venture in India. The court held that that the deal should be subject to Indian capital gains tax because the operating assets of HEL were in India. It did not accept the argument that the transaction took place overseas between British-born Vodafone and the Hutchison group of Hong Kong-based multibillionaire Li Ka-shing, and hence was outside the purview of Indian tax laws. Vodafone, by buying out Hutchison's 67% share, gained control of HEL, which it has since renamed Vodafone Essar. The remaining 33% rest with the Ruias of Essar Group.

An HC bench of Justices D Y Chandrachud and J P Devadhar said that "the Indian tax authorities acted within their jurisdiction" when they initiated proceedings against Vodafone.

If the judgment stands, it'll represent an enormous windfall for the Indian exchequer -- Rs 12,000 crore is more than the Union government's power budget. It is expected to have ramifications for India's budget calculations, said economic analysts. All foreign direct investments coming into India must now factor in the fact that they will have to deduct and pay tax in India.

In a precedent-setting case -- one that has attracted the attention of transnational and Indian corporations alike -- tax authorities in Mumbai had asked Vodafone three years ago to show cause why it failed to deduct tax at source during its offshore 2007 deal. Vodafone had argued that it was under the belief that it was not liable to pay such tax.

The court observed that at the heart of the matter, the transfer of one share at $11.01 billion also involved the transfer of rights and entitlements of local Indian partners and hence the "transaction required complex contractual arrangement in India". This, the court ruled, was sufficient to establish a nexus with Indian tax jurisdiction.

The court did not stay its judgment on Wednesday. But while allowing the proceedings to now continue before the tax authorities, it said that a final decision cannot be taken for eight weeks. This will give Vodafone a window to appeal against the HC ruling; the company said it would appeal to the Supreme Court against the high court ruling.

The entire case of Vodafone, as argued by its counsel Harish Salve but not accepted by the court, was that the share of CGP Investments (Holdings) Ltd -- which was incorporated by Hutchison in the Cayman Islands, a tax haven in the Caribbeans -- was a capital asset situated outside India and that the transaction was hence outside the purview of Indian tax authorities.

The 200-page judgment penned by Justice Chandrachud dismissed the argument of Vodafone that it was "merely a sale of one share of a foreign company from one non-resident company to another". The court noted that through this transaction, Vodafone International acquired control over CGP and companies under its control, including ultimately Hutchison Essar Ltd.

The court pointed to the "complete fallacy" of the main argument of Vodafone that "rights and entitlements that flow out of the holding of a share cannot be dissected from ownership of the share". And thus accepted the Indian government's stand submitted by additional solicitor general Mohan Parasaran that the objective of acquiring one share was basically to aquire total control of the Indian telecom company. Significantly, the court held that "the rights and entitlements constitute in themselves capital mean property of any kind held by the assessee".

After referring to Indian and international taxation laws at length and also on the need for Indian courts to have a "conservative aproach" while interpreting fiscal laws and policies, the HC concluded, "The transaction in question had a significant nexus with India. The essence of the transaction was a change in the controlling interest of HEL which constituted a source of income in India... In these circumstances, the proceedings initiated by the income tax authorities in India cannot be held to lack jurisdicton."

The court said it was now up to the tax authorities to decide how to apportion the income that has accrued to Hutchison as a result of the "nexus within the Indian tax jurisdiction".