Mumbai: The Bombay High Court today dismissed Vodafone International's petition challenging an Income Tax (I-T) department order that demanded Rs12,000 crore in liabilities arising out of the company's $11 billion takeover of Hutchison Telecom, reports PTI.

A division bench held that the I-T department had the jurisdiction to tax the transaction.

It, however, gave liberty to Vodafone to argue before the tax department that no penalty should be imposed as they genuinely believed they had no liability to deduct tax at source.

The department held Vodafone liable for not deducting tax at source from payment made to Hutchison and claimed around Rs12,000 crore in tax and penalty in the 2007 deal.

"The transaction has sufficient nexus with India and the I-T has the jurisdiction to levy tax on the transaction," Justice Dhananjay Chandrachud and Justice J P Deodhar noted while delivering the verdict.

The court refused to stay its order to enable the petitioners file an appeal and allowed the proceedings to continue before the tax department. The judges, however, said that the department would not give its order until eight weeks.

Justice Chandrachud pronounced the operative part of the verdict in the Bombay High Court while Justice Deodhar, currently on an assignment at Nagpur bench, was at the other end of the video conference link.

The question before the high court was whether Income Tax (I-T) department can ask a foreign company to pay tax in India if it takes over another foreign entity that owns an Indian subsidiary, and particularly so, if the deal is made outside India?

The judgement is considered in legal circles as a setback to the companies who are looking forward to takeover deals involving Indian companies.

While the I-T contended that the transaction was liable for tax payment in India, Vodafone International Holdings contended that both the seller and buyer were foreign companies and that the deal was made outside India.

Vodafone submitted that in the past, similar transactions have not been held eligible to taxation in India and that the Indian revenue authority has been stating through the media that the transaction in issue is a "test case".

The I-T affidavit said that Hutchison Telecommunications International Ltd (HTIL), through its investments in India, had made substantial gains which were chargeable to tax under the provisions of the Income Tax Act 1961.

HTIL held 66.98% direct and indirect interest in Vodafone Essar Ltd (previously known as Hutchison Essar Ltd), which had telecom licenses to operate across India under the brand name Vodafone (formerly Hutch).

The I-T department said it was correct in holding that Vodafone was an assessee in default as it had failed to deduct tax at source from over $11.2 billion payment made to HTIL on 8 May, 2007.

The revenue department had sent an advisory through a letter dated 23 March, 2007, communicating to Hutchison Essar Ltd and through them to Vodafone International that the transaction was liable to tax in India, N K Govila, assistant director of Income Tax contended in an affidavit.

Vodafone, challenging the I-T letter, contended in its petition that there has been no transfer of any capital asset located in India since the share capital acquired by it was of a foreign company registered in Cayman Islands (i.e. HTIL).

Moreover, it said, the transaction was negotiated and completed outside India.

Vodafone argued that the jurisdiction of the Income Tax department was not extra-territorial and as such cannot be extended to encompass foreign entities transacting in assets outside India.