Vodafone tax case: Implications of the SC judgment on pending cases
Fereshte Sethna 31 January 2012

The Vodafone tax case was conceded as a ‘test’ case, but diverse issues raised by the I-T department, who seek to render exigible to tax similar cross-border transactions, remain to be adjudicated on a case-by-case basis, including ‘treaty shopping’, which did not arise in the Vodafone case

The Supreme Court verdict in the Vodafone tax case has far-reaching ramifications on diverse cross-border transactions sought to be brought within the tax dragnet, including Sanofi Aventis-Shanta Biotech, Sabmiller-Fosters, Idea Cellular-AT&T, whose challenges to demands by the Indian revenue department are pending before courts of law in India. The verdict of  20 January 2012 marks a closure to the tax demand of Rs11,218 crore in the form of withholding taxes and interest, plus Rs7,900 crore (towards penalties) from Vodafone following the international cross-border transaction by which it acquired the Indian telecommunication interests of Hutchison for $11.076 billion.

The Supreme Court, in its resounding validation of the settled legal principle that tax planning per se is neither illegal nor impermissible and rejected the stand of the Income Tax (I-T) department that the overseas transaction relating to the acquisition by a Netherlands-based subsidiary of Vodafone of share capital of an upstream company that was incorporated by Hutchison in the Cayman Islands and ensconced within the corporate structure evolved in the course of effectuating telecommunications investments into India from 1992 onwards, was sham, fictitious and a means to evade tax exigible in India upon such transfer, entailing concomitant withholding tax obligations qua Vodafone in relation to capital gains in the hands of Hutchison, since downstream companies held underlying assets situated in India, founded inter alia on a purposive interpretation of certain provisions of the Indian Income-tax Act, 1961.

As the final appellate court in the land, the Supreme Court has, through the majority judgment delivered by the Chief Justice SH Kapadia and Justice Swatanter Kumar, on the basis of Article 141of the Constitution of India which stipulates that “the law declared by the Supreme Court shall be binding on all courts within the territory of India” andon the enshrined doctrine of stare decisis, constitutes mandatory precedent, evolved key principles relevant to international tax jurisprudence, with courts of concurrent jurisdiction and/or inferior courts being thus bound.

The ratio decidendi or legal principles evolved and established in the Vodafone case, and thus capable of reliance advantageously by entities that have, in cross-border transactions, similarly acquired stakes in companies situated overseas with downstream assets in India, and faced with a tax demand on similar premise to that applied by I-T department to Vodafone, subject to individual fact matrices permitting them to fall squarely within its purview, broadly include:

I.    In an offshore transfer of shares between two non-residents, no liability to capital gains tax arises in India, and correspondingly no obligation to deduct tax at source can arise in India;
II.    Transfer of a capital asset situated in India does not occur indirectly in consequence of a transfer of capital asset overseas, so as to render income derived overseas to become taxable in India;
III.    ‘Look at’ is the test vis-à-vis cross border transactions, rather than ‘look through’: ‘single consolidated bargain’, rather than resort to dissecting and challenges to commercial substance, particularly in circumstances where regulatory permissions have been secured from statutory authorities in India as a prelude to or in the course of infusing strategic foreign direct investment to participate in India;
IV.    Surrounding circumstances of a transaction are key to evaluating whether it is a colorable device for distribution of earnings, profits and gains, and are thus liable to be viewed holistically;
V.    An investment vehicle, which in addition to holding shares in a subsidiary company(ies), performs the function of facilitating smooth transition of business,  does not per se lack business or commercial purpose;
VI.    The mere exercise by a parent company of shareholder influence over its subsidiaries will not render subsidiaries as deemed resident of the State in which the parent company is incorporated and/or has its seat of business;
VII.    ‘Controlling interest’ is an incident of ownership of shares in an entity, but not a distinct capital asset, capable of segregation from shares held;  
VIII.    ‘Situs’ of shares is located where the company is incorporated and its shares can be transferred, where its register of members is maintained, thus shareholding in companies incorporated outside India shall constitute property located outside India;
IX.    Burden is on the tax department to establish tax avoidance, and ‘dominant purpose’ to be viewed in the context that foreign investments are oft routed through holding company structures, relating to which the duration for which it is in place, business operations have been conducted in India with corresponding revenue generation in India, as also the timing of an exit by an investor and continuity of such business, to be key in discerning whether it isa fictitious or sham scheme preordained with the purpose of tax evasion;
X.    A non-resident, unless the place of accrual of income is within India, is not liable to be subjected to tax in India;
XI.    Basis of taxation is profits or income or receipt, but not valuation of an enterprise;
XII.    Absent transfer of a capital asset in India, an overseas buyer of shares cannot be held as “representative assessee” of an overseas seller;
XIII.    A ‘look through’ in a statute or treaty has to be expressly stipulated and cannot be read in through resort to rules of purposive interpretation.

While the I-T department’s endeavors to re-visit the settled legal position in relation to the sacrosanct status accorded to Tax Residency Certificates pertaining to Mauritian entities through which foreign direct investment is legitimately routed into India (in the 2003 Azadi Bachao Andolan case), were squarely rejected in the Vodafone tax case, ‘round-tripping’ has been specifically carved out of the ambit of ‘foreign direct investment’.

The Vodafone tax case was conceded as a ‘test’ case, but diverse issues raised by the I-T department, who seek to render exigible to tax similar cross-border transactions, remain to be adjudicated on a case-by-case basis, including ‘treaty shopping’, which did not arise in the Vodafone case, but is due for adjudication by Supreme Court, in the AT&T case, shortly.

(The author is a partner of DMD-Attorneys at Law)

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