“Disinvestment will be decided by market conditions. So if market conditions are not normal, it is sensible for the government to hold back,” Planning Commission deputy chairman Montek Singh Ahluwalia said in an interview to a business news channel
New Delhi: Defending the government’s decision to hold back disinvestment due to bad stock market conditions, the Planning Commission today said the process of stake sale in state-owned companies could begin after the improvement in market situation, reports PTI.
“Disinvestment will be decided by market conditions. So if market conditions are not normal, it is sensible for the government to hold back,” Planning Commission deputy chairman Montek Singh Ahluwalia said in an interview to business news channel CNBC TV18.
He further said: “I don't think there is any change in the government’s plans that we can realise the value of these assets over time. If the government decides not to disinvest in the certain period because it feels the stock prices are unduly low, that's not only understandable but it is actually quite a sensible decision.”
The Department of Disinvestment (DoD) is running against time to meet its ambitious disinvestment target of Rs40,000 crore for the current fiscal. Till date it has been able to raise only Rs1,145 crore through disinvestment in PFC.
In order to fast track the disinvestment programme, the DoD had sought opinion of concerned ministries for buyback of shares and prepared a list of cash-rich PSUs in this regard.
Several ministries like oil, power, steel, coal and mines are believed to have opposed the proposal as it could impact the business expansion plans of the PSUs.
Market regulator Securities and Exchange Board of India (SEBI) has relaxed norms for buyback of shares and dilution of equity by companies.
The new norms would help the companies to complete the process of selling shares within days against the normal process which can take months, a move that will facilitate offloading of government shares in central PSUs.
Mr Ahluwalia said that timing of the disinvestment will be decided by market conditions.
“I think we will continue with the disinvestment and the timing of the disinvestment will be decided by market conditions. Which means that whenever we put a number in for disinvestment, it assumes normal market conditions,” he said.
He also brushed aside concerns about the impact of failure in disinvestment front and its impact on the government’s fiscal deficit target of 4.6% of gross domestic product (GDP) in 2011-12.
“If, for example, a certain amount of resources get shifted from one year to the next, I don’t think that the impact of that on the fiscal deficit should be a matter of great concern,” Mr Ahluwalia said.
He also said that in the next three months the government should focus on removing impediments to project implementation.
Partha Sarthi Das, director in the exploration division of the oil ministry, on 25th January wrote to RIL executive director PMS Prasad saying “as on date”, no dispute has arisen to warrant arbitration and the company should withdraw the notice invoking arbitration forthwith
New Delhi: The petroleum ministry has asked Reliance Industries (RIL) to immediately withdraw its arbitration notice against the proposed move to curtail cost-recovery at its KG-D6 gas fields, saying “as on date”, there was no cause for such action, reports PTI.
Partha Sarthi Das, director in the exploration division of the ministry, on 25th January wrote to RIL executive director PMS Prasad saying “as on date”, no dispute has arisen to warrant arbitration and the company should withdraw the notice invoking arbitration forthwith, ministry sources said.
RIL had on 24 November 2011, slapped the notice upon learning that the ministry was moving to restrict cost-recovery in the KG-D6 block after flagging gas production led to utilisation of less than half of the 80 million metric standard cubic metres per day (mmscmd) of infrastructure the company had built.
The ministry’s technical advisor, the Directorate General of Hydrocarbons (DGH), advised disallowing $1.235 billion of out of the $5.7 billion expenditure already made as RIL has drilled and completed only 18 wells as against agreed the 31 wells in the block, resulting in lower gas output.
Gas production averaged 48.13 mmscmd against the target of 53.40 mmscmd in 2010-11 and 38.61 mmscmd (up to 31 October 2011), compared to the target of 61.88 mmscmd, in 2011-12.
Production of 80 mmscmd was envisaged in 2012-13.
RIL says it has not drilled the committed wells as the reservoir has not behaved as previously predicted and output dipped due to a fall in pressure and water and sand ingress in wells.
Sources said before the ministry could write to RIL on restricting cost-recovery, the company slapped the arbitration notice.
The ministry had referred the arbitration notice to the law ministry, which was of the opinion that as on date, there was no cause of action for RIL to raise a dispute (as defined in Article 33 of the Production Sharing Contract) entitling the company to refer it for arbitration.
Also, RIL did not wait for the mandatory 90 days from the date on which the dispute arose, they said, adding that the three-month period expired on 15 December 2011, and not 15 November 2011, as ‘wrongfully’ mentioned in the arbitration notice.
RIL had appointed SP Bharucha, former chief justice of the Supreme Court, as its arbitrator and had asked the ministry to appoint its arbitrator within 30 days.
The ministry had days before the 23rd December deadline expiry sought a one month extension to respond to the notice and after receiving the law ministry’s opinion, has now written to the company saying its claims are based on surmises, conjecture and apprehensions, sources added.
It remains to be seen how RIL will respond to the ministry’s letter. Under the dispute resolution process set out in the PSC, the claimant (RIL) can ask the Chief Justice of India to appoint an arbitrator on behalf of the government.
The two arbitrators would then appoint a third neutral arbitrator.
Sources said RIL, as per the revised field development plan approved in 2006, was required to drill, connect and put on stream 22 wells by 1 April 2011, with an envisaged production rate of 61.88 mmscmd and 31 wells by 1 April 2012, at an envisaged production rate of 80 mmscmd.
However, till date, it has completed the drilling of only 18 wells and out of these 18 wells too, only 13 wells are presently in operation.
The ministry and the DGH feels RIL had ‘woefully’ fallen short of drilling the required number of wells and/or utilising the total number of wells already drilled has taken an irreparable toll on the projected production targets.
They feel that had RIL performed its obligations under the PSC and the approved field development plan, the production rate ought to have been touching 80 mmscmd at present, rather than showing a gradual trend to decline.
Further, RIL drilled two wells in 2010-11 and another two wells in 2011-13. However, these have not been connected to production facilities, thereby resulting in less output.
The company has indicated that these wells would be completed and connected to the production facilities by mid 2013-14, which the ministry saw as clear non-compliance with the approved field development plan.
The judgement has addressed the issues of certainty and stability in a fiscal system and has rightly identified the areas for improvement for the Indian legislature to boost the confidence of foreign investors. We would now have to wait and watch to find out how the revenue authorities react to this bitter defeat in such a high profile case
For the past few days most tax professionals in the country who practice in international taxation have had only one thing on their minds—the Supreme Court’s verdict in the famous Vodafone case. Financial newspapers, TV channels and various law and accounting firms in India and abroad have been talking about this decision and analyzing it at depth.
What is the big noise about? Why is it so important? How does it impact foreign direct investment (FDI) in India? What does this defeat mean for the Income Tax (I-T) department? This article seeks to answer some of these questions.
The basic issue that gave rise to this whole controversy is that a foreign company incorporated in Netherlands—Vodafone International Holdings BV (VIH) entered into a share purchase agreement with another foreign company incorporated in Cayman Islands—Hutchison Telecommunications International (HTIL) to buy one share of a third company incorporated in Cayman Islands—CGP Investments (Holdings) (CGP) for about $ 11 billion. CGP ultimately held shares in an Indian company called Vodafone Essar (VEL) which was an operating company engaged in the business of mobile telephony. The entire shareholding structure was highly complex and included about 30 companies spread across various jurisdictions.
It may be noted that there was no sale of shares of the Indian company. The Indian tax department however took a stand that in effect, what was really being sold were the underlying assets and business of the Indian company VEL and therefore, this gave rise to income that was taxable in India. Consequently, there were various repercussions on VIH and HTIL. This stand of the Indian tax department resulted in a huge demand on VIH on the ground that it had failed to deduct tax at source (known in popular Indian parlance as TDS) from the payment that it made to the seller company HTIL as required by section 195 of the Income Tax Act (ITA).
Thus this controversy had several angles to it and there were a large number of issues that the Bombay High Court and now the Supreme Court had to decide upon. The fundamental issues that were to be decided upon were:
a) Whether the sale of one share of the Cayman Islands-based company CGP was, in effect, sale of underlying assets and business interests in an Indian operating company VEL?
b) Does India have the jurisdiction to tax income/surplus arising from sale of assets not situated in India?
c) Can the provisions of Section 195 apply to a non-resident payer of income or do they apply only to resident payers?
d) Was the complex holding structure used by the Vodafone group merely a tool to avoid taxes in India?
e) Can the corporate veil be lifted to look through a particular transaction?
f) Is substance over form important in such cases or form over substance?
g) Would this be a case of tax avoidance through tax planning and therefore, it qualified to be struck down as illegal based on the Supreme Court’s famous decision in the case of McDowell (rendered sometime in 1985)?
In order to understand the controversy better, it would be important to understand some of the facts and some of the tax provisions closely.
Why did the I-T department claim that the transaction gave rise to income taxable in India?
The genesis of the stand lies in section 9(1)(i) of the ITA which states that “all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India or through the transfer of a capital asset situate in India” would be deemed to accrue or arise in India. And such income would be chargeable to tax in India.
The I-T department took a stand that the Cayman Islands-based company CGP (whose single share was being sold) was the ultimate holding company of VEL in India. The huge amount that was being paid ostensibly for that one single share was actually being paid for the value of the assets and business of VEL. Therefore, there was an indirect transfer of assets situated in India. Accordingly, as per the Indian tax authorities, this sale gave rise to income that could be said to have accrued or arisen in India and which was therefore chargeable to tax in India.
Here the main issue in dispute is whether section 9(1)(i) covered in its purview income accruing or arising indirectly in India or whether the term ‘indirectly’ was also qua the term “through the transfer of a capital asset situate in India”. The I-T department was of the view that because there was an indirect transfer of assets and business interests that were located in India, section 9(1)(i) applied to this transaction.
How come the purchase of the share was made liable for the tax?
Under the ITA, the onus of withholding TDS is on the payer. When it comes to payments to non-residents, there is a common section—Section 195 under which deduction has to be made. As per this section, whenever a payment is to be made to a non-resident and that payment gives rise to income chargeable to tax in India, the payer is required to deduct tax at source.
In this case, the I-T department took a stand that it was necessary for VIH to deduct tax at source under Section 195 (as the purchase of one share of CGP by VIH from HTIL gave rise to capital gains chargeable to tax in India) at the time of making payment to HTIL and because this was not done, the tax was required to be recovered from VIH.
Here, the main issue in dispute was whether Section 195 applied to payments by non-residents also or whether it applied only to payments by a resident.
Dividing line between tax evasion and tax avoidance
The I-T department was of the view that the complex shareholding structure put in place to ultimately hold the shares in the Indian company VEL was employed by a clever foreign corporate house with the primary objective of avoiding tax payment in India. It was the Income Tax department’s contention that the use of various tax havens/tax friendly jurisdictions (Mauritius, Cayman Islands, and Netherlands) was a part of a well thought out strategy to avoid paying tax in India.
Throughout the entire legal battle leading to the Supreme Court, there has been constant reference to three important decisions of the Supreme Court in the cases of:
It was the contention of the I-T department that in the case of McDowell, the Supreme Court had dealt with the issue of when could a case of tax avoidance be brought under the tax net. It was argued by the revenue department’s lawyers that the subsequent decision of the Supreme Court in the case of Azadi Bachao Andolan (ABA) needed to be overruled as it departed from the McDowell judgement. It was also stated that in the ABA case, the court did not take into consideration the observations of the Supreme Court in the case of Mathuram Agrawal.
Here, a brief reference to the case of ABA would be necessary. This was a rare case where the I-T department and the tax payer community were on the same side. They were both fighting a public interest litigation (PIL) which challenged the tax benefits being availed by Mauritius-based investors. In this case, the court ruled that the treaty was a valid document entered into by the Government of India and that if an investor had in its possession a Tax Residency Certificate duly issued by the Mauritian tax authorities, then the benefits of the treaty were available to the investor and the Indian tax authorities could not challenge the validity of the Mauritian tax residency of such an investor. It may be added that this case had put to rest a huge controversy that had arisen at that time about Mauritius-based entities and the tax exemption that they claimed in respect of capital gains earned from sale of shares of Indian companies. Ever since that decision was rendered, virtually, all Mauritian foreign institutional investors (FIIs) and investors were having a peaceful time with the Indian tax authorities and there have not been any major tax disputes since then on the issue of access to the tax treaty.
However, in the Vodafone case, the I-T department has tried to open the can of worms again and has tried to challenge the Supreme Court’s decision by referring to the other two decisions.
The main argument of the tax authorities before the Supreme Court in this case was that the maze of holding and subsidiary companies present only proved that the whole structure was put in place with an intention to avoid payment of tax in India. Consequently, based on the McDowell’s case, the same should be “looked through” instead of being merely “looked at”. If this was done, then it would be obvious that finally, what was being sold were the assets and business interest in VEL which was an Indian company. By “looking through” the structure, the tax department wanted the court to pierce the corporate veil and go deeper right up to the ultimate subsidiary company i.e. VEL.
Thus, there were a large number of very important issues before the Supreme Court. The stakes too were substantially high and this case had become the talk of the international community with most international tax conferences having speakers referring to it. For the I-T department, victory in this case would have boosted its sagging revenue collections and would have also given it the moral support and strength to pursue a whole host of other high-profile and high stakes M&A transactions and try to extract its pound of flesh from the big money that is being exchanged for taking over lucrative Indian business arms of multinational companies.
Supreme Court’s verdict
The Supreme Court bench which heard this case comprised of three judges—justice SH Kapadia the Chief Justice of India, justice KS Radhakrishnan and justice Swatanter Kumar. The hearing of the case lasted for several weeks and the judges took their own time to finally decide the case. On 20 January 2012, justice Kapadia read out the judgement that was finalized by him and justice Swatanter Kumar. In a surprising development, justice Radhakrishnan passed a separate order in which he finally concurred with the two-judge order.
In effect, the Supreme Court judges have held in favour of VIH and have ruled that the sale of one share of CGP by HTIL to VIH did not give rise to capital gains that was chargeable to tax in India and accordingly, VIH was not liable to deduct tax at source from the payment made by it to HTIL.
The gist of the Supreme Court’s orders on the important principles and issues raised in appeal is as under.
Azadi Bachao Andolan vs McDowell and McDowell vs Mathuram Agrawal
The Supreme Court has rightly interpreted and reconciled the decisions in the case of Azadi Bachao Andolan, McDowell and Mathuram Agrawal on the concept of tax avoidance/tax evasion.
The English courts in the case of Commissioner of Inland Revenue vs His Grace the Duke of Westminster and WT Ramsay vs Inland Revenue Commissioner have laid principles on the concept of tax avoidance / tax evasion. The Westminster principle states that “given that a document or transaction is genuine, the court cannot go behind it to some supposed underlying substance”. The said principle has been reiterated in subsequent English courts judgements as “the cardinal principle”.
11935 All E.R. 259
21981 1 All E.R. 865
In the case of Ramsay, the House of Lords had held that the transaction should be fiscally nullified if the same are entered through a colourable device. It was also held that the court has to look at a document or a transaction in the context to which it properly belongs. It is the task of the court to ascertain the legal nature of the transaction and while doing so it has to look at the entire transaction as a whole and not to adopt a dissecting approach.
Based on the above principles, the apex court in the case of McDowell, relying on the English case of Ramsay, held that where there are artificial and colourable devices adopted by the taxpayer to avoid tax then the same should be ignored and the corporate veil should be lifted.
Whereas the Supreme Court in the case of Azadi Bachao Andolan had held that legitimate tax planning is permissible and the same cannot be ignored merely because the taxpayer has so arranged its affairs to minimize its tax cost.
The Supreme Court has rightly reconciled both the apex court decisions and has held that where the taxpayer has done legitimate tax planning then it is unjust to hold the same to be illegitimate or illegal or impermissible merely because tax is minimized. Further, it has been held that where the taxpayer has arranged its affairs through the use of colourable device or by resorting to dubious methods and subterfuges to minimize tax then the revenue authorities have every right to lift the corporate veil.
Applicability of Section 9(1)(i)—Does it includes indirect transfer of capital assets /property situated in India?
On the issue of applying section 9(1)(i) of the ITA, the revenue authorities contended that under section 9(1)(i) they can “look through” the transfer of shares of a foreign company holding shares in an Indian company and treat the transfer of shares of the foreign company as equivalent to the transfer of shares of the Indian company on the premise that section 9(1)(i) covers direct and indirect transfers of capital assets.
The Supreme Court has analyzed the said section 9(1)(i) and has held that charge on capital gains arises on transfer of a capital asset situate in India. The said sub-clause consists of three elements, namely, transfer, existence of a capital asset and situation of capital asset in India. All three elements must exist together for an income to accrue or arise in India.
The court has given a categorical finding that section 9(1)(i) of the ITA does not cover indirect transfers and that the words “directly or indirectly” used in section 163 read with section 9(1)(i) go with the income and not with the transfer of a capital asset. Further, the legislation has not used the words indirect transfer in section 9(1)(i) and therefore, adopting the ‘look through’ principle would amount to legislation by the courts.
Interestingly, the court has gone on to state that the legislature in its wisdom has proposed to cover indirect transfer of capital asset under the proposed Direct Tax Code. This proposal indicates that indirect transfers are not covered by the existing section 9(1)(i) of the ITA.
3Section 163 of the ITA deals with persons treated as agents of non-resident in India.
The Supreme Court has given a food for thought to the Indian legislature to provide “look through” provisions either in the statute or in the treaty to cover such situations. According to the court, applying the “look through” provisions is a matter of policy and the same should be expressly provided and cannot be read into the provision on the basis of purpose construction.
Recognition of Holding Structure
The Supreme Court has aptly recognized the holding company structure which has been accepted not only internationally but also under the Indian Companies Act as well as the ITA. The approach of both the corporate and tax laws, particularly in the matter of corporate taxation, generally is founded on the separate entity principle i.e. to treat a company as a separate person for tax purposes. Further, under the tax treaty, a subsidiary and its parent are also totally separate and distinct tax payers.
The apex court has accepted the need for corporate structures which are created for genuine business purpose at the time when investment is being made or further investments are being made or when a group is undergoing overall or financial restructuring or when operations such as consolidation are being carried out to clean defused or over-diversified interests. Sound commercial reasons like hedging business risk, hedging political risk, mobility of investment, ability to raise loans from diverse investment often underlie creation of such structures.
The court has further stated that in transnational investments, the use of a tax neutral and investor friendly countries to establish SPV is motivated by the need to create a tax efficient structure to eliminate double taxation wherever possible and also plan their activities attracting no or lesser tax so as to give maximum benefit to the investors and that it is a common practice in international law, which is the basis of international taxation, for foreign investors to invest in Indian companies through an interposed foreign holding or operating company such as Cayman Islands or Mauritius based company for both tax and business purposes. In doing so, foreign investors are able to avoid the lengthy approval and registration processes required for a direct transfer (i.e. without a foreign holding or operating company) of an equity interest in a foreign invested Indian company.
The Supreme Court had applied the “look at” concept enunciated in Ramsay in which it was held that the revenue authorities or the court must look at a document or a transaction in the context to which it properly belongs to. It is the task of the revenue department/court to ascertain the legal nature of the transaction and while doing so it has to look at the entire transaction as a whole and not to adopt a dissecting approach. The Revenue cannot start with a question as to whether the impugned transaction is a tax deferment /saving device but that it should apply the “look at” test to ascertain its true legal nature.
Applying the above test, the Supreme Court is of the view that every strategic foreign direct investment coming to India, as an investment destination, should be seen in a holistic manner. While doing so, the revenue department/courts should keep in mind the following factors:
The onus is on the revenue department to identify the scheme and its dominant purpose to prove that the impugned transaction is undertaken as a colourable or artificial device to avoid tax.
Taxability of the transaction in India
Based on the above facts, the court finally held that the transaction of sale of one share of CGP by HTIL to VIL was not subject to tax in India by the Indian tax authorities.
Application of section 195 to a non-resident payer
The Supreme Court has held that Section 195 applies to a resident payer in respect of payments made to a non-resident and that it cannot be applied to a non-resident payer. Accordingly, the court has held that VIH cannot be held liable for deduction of tax at source from payment made to HTIL. Also, in any case, since the court held that the transaction did not give rise to any income accruing or arising in India, the question of applying section 195 to such a transaction did not arise.
The Supreme Court has laid down some far reaching principles relating to international taxation. An important point that the court appears to have highlighted to the Government of India is to bring about a semblance of certainty in tax laws. This decision of the Supreme Court should be read and appreciated in the context of the recent aggression that the I-T department has displayed while completing assessments of various tax payers. Whether it is a multinational as is the case in the Vodafone situation or whether it is a local company or an individual, the common thread that runs across most completed assessments is of aggression and belligerence. It would not be an exaggeration to state that most assessments completed in the country result in disallowances and additions to the income returned by the tax payer. This, in turn, has the effect of large demands being raised against the tax payers—of tax, interest and penalty. The Vodafone case is symptomatic of this aggression. It is only in recent times that our I-T department has got ambitions of taxing extra-terrestrial transactions. This would rarely have happened 10 years back. But today, it’s a different story. Those tax payers who take their tax returns lightly and pay scant attention to what is stated in the cumbersome tax return forms that the government has prescribed are only putting their peace of mind in jeopardy. Today, the Income Tax Act is relatively a simple Act and there is hardly any scope for ingenious tax planning. In this scenario, if a tax payer attempts to cut corners or to put in place complex structures to avoid taxes, he would only be inviting a long drawn litigation. Only the brave-hearts and the ones with deep pockets can afford to litigate in our country.
In conclusion, it can be definitely said that this is one of the landmark and exceptional judgements passed by the Indian judiciary and for the time being, seems to have salvaged the faith of foreign investors in the Indian judicial system. The judgement has addressed the issues of certainty and stability in a fiscal system and has rightly identified the areas for improvement for the Indian legislature to boost the confidence of foreign investors. We would now have to wait and watch to find out how the revenue authorities react to this bitter defeat in such a high profile case. It may not be out of place to mention here that history is replete with examples of retrospective amendments carried out in the law with a view to nullify the judgements passed by the courts. It would be a matter of great shame for the country if, in this case too, the finance ministry gets tempted to strike down a sensible and reasoned order by amending the law retrospectively.
(The author is a partner of Sudit K Parekh & Co)