The purchase of shares of a foreign company by one non-resident from another non-resident attracts Indian tax if the object was to acquire the Indian assets held by the foreign company
A Cayman Island company called CGP Investments held 52% of the share capital of Hutchison Essar Ltd, an Indian company engaged in the mobile telecom business in India. The shares of CGP Investments were in turn held by another Cayman Island company called Hutchison Telecommunications. The assessee, a Dutch company, acquired from the second Cayman Islands company, the shares in CGP Investments for a total consideration of US $ 11.08 billion. The AO issued a show-cause notice u/s 201 in which he took the view that as the ultimate asset acquired by the assessee were shares in an Indian company, the assessee ought to have deducted tax at source u/s 195 while making payment to the vendor. This notice was challenged by a Writ Petition but was dismissed by the Bombay High Court. In appeal, the Supreme Court remanded the matter to the AO to first pass a preliminary order of jurisdiction which the AO did. This order was challenged by the assessee by a Writ Petition on the ground that as one non-resident had acquired shares of a foreign company from another non-resident, s. 195 had no application. HELD dismissing the Petition:
(i) An assessee is entitled to arrange his affairs so as to avoid tax and the department is not entitled to disregard it on the ground of motive. However, a “sham” or “colourable” transaction can be disregarded by the AO. Azadi Bachao Andolan 263 ITR 706 (SC) & Wallfort followed;
(ii) A share, being a capital asset, comprises of an indivisible set of rights, not capable of being separately transferred at law. A controlling interest does not constitute a distinct capital asset because it is an incident of the ownership of shares and flows out of the holding of shares. Also, the business of a company is not the business of its shareholders and the assets of a company are not the assets of its shareholders;
(iii) The State has jurisdiction to tax non-residents if there is a nexus connecting the non-resident and the State. The nexus arises where the source of income originates in the jurisdiction. The source of income is determined in accordance with source rules. U/s 5 & 9, the nexus for charging a non-resident is provided by the receipt or accrual of income in India. If the income can be taxed in more than one jurisdiction, it has to be apportioned;
(iv) U/s 9(1)(i), income arising from the transfer of a capital asset situated in India is chargeable to tax. The situs of the capital asset is the crucial jurisdictional condition that must be fulfilled in order to attract chargeability to tax of income arising from the transfer of a capital asset;
(v) Article 13 of the OECD Model Convention illustrates how a value driven deeming nexus may be created by legislation and how one can look behind corporate structures if the ownership of shares represents an interest of a certain value in real estate situated within the taxing jurisdiction;
(vi) S. 195 creates an obligation to deduct tax where the sum payable to a non-resident is (even partly) chargeable to tax. If the sum payable is not assessable in India, there is no question of TDS being deducted by an assessee. The argument that as the payer is a non-resident, it was not obliged to deduct tax is not acceptable because there is sufficient territorial connection or nexus between the payer and India. The fact that enforcement of the obligation may be difficult as the payer is a non-resident does not mean that obligation is not applicable;
(vii) On facts, the argument that the transaction involved merely a sale of a share of a foreign company by one non-resident to another is not acceptable. It would be simplistic to assume that the entire transaction between the non-residents was fulfilled merely upon the transfer of a single share of the Cayman Islands company. The commercial and business understanding between the parties postulated that what was being transferred from one non-resident to the other was the controlling interest in Hutchison Essar, an Indian company. The object and intent of the parties was to achieve the transfer of control over the Indian company and the transfer of the solitary share of the Cayman Islands company was put into place as a mode of effectuating the goal;
(vii) Even the price of US $ 11.01 Billion paid by the assessee factored in diverse rights and entitlements that were being transferred to the assessee. Many of these entitlements were not relatable to the transfer of the CGP share. The transactional documents were not merely incidental or consequential to the transfer of the CGP share, but recognized independently the rights and entitlements of the vendor in relation to the Indian business which were being transferred to the assessee;
(viii) As the consideration was paid for acquisition of a panoply of entitlements including a control premium, use and rights to the Hutch brand in India, non-compete agreement with the Hutch group etc, it will have to be apportioned by the AO to determine which portion has a nexus within the Indian taxing jurisdiction and which lies outside;
(ix) Accordingly, as the transaction between the assessee and Hutchison Telecommunications had sufficient nexus with Indian fiscal jurisdiction, the AO did have jurisdiction to initiate proceedings against the assessee for failure to deduct tax at source.
Note1: The judgement was pronounced today via video-conferencing with Justice Chandrachud sitting in Mumbai and Justice Devadhar sitting in Nagpur. This is the first tax judgement delivered this way
Note2: Clause 5(4)(g) of the Direct Taxes Code Bill 2010 provides that income from transfer outside India of a share in a foreign company shall be deemed to arise in India unless if the FMV of assets in India owned by the foreign company is less that 50% of its total assets.
Legal reactions
DSK Legal partner Balbir Singh said that the decision opened a Pandora's box, "as tax authorities will find a reason and basis to open the already closed transactions".
"So long as this high court ruling remains," added Economic Laws Practice (ELP) partner Pranay Bhatia, "the tax dept may certainly say, I do have a legal basis to examine withholding tax liability of every offshore transaction which results in a change of ownership."
Singh said: "The Vodafone judgment will have far reaching impact as it would certainly influence the way transactions are structured in terms of instruments and jurisdiction."
Lawyers would have to "go back to the drawing board" to come up with new and valid tax efficient structures, agreed ALMT Legal partner Hitesh Jain, who had previously also advised Vodafone on the case.
Bhatia commented that structures such as the one in the Vodafone Hutch acquisition were used in “some” cases but were not unique. "This decision is backed on a very specific factual matrix. Every case may not be pari passu to the Vodafone and Hutch transaction because here there is a controlling stake involved, a third telecoms regulator and in every case that may not be the situation."
"There are a number of factors which could make a case go one way or another but this Vodafone case is an important one but can not be a decider whether everything going forward will be looked at like that," he said.
Singh said the consequences of the case could negatively affect foreign investment. "It will impact the cost of acquisition and doing business in India. By charging tax on offshore transactions, tax authorities may garner more tax but will lose on larger FDI in India."
"The most critical part of this judgment is confirming liability to withhold tax by an offshore company while making payment to the seller in another offshore jurisdiction and treating the underlying entity as an 'assessee in default'," noted Singh.
The reasoning
"The transaction was of a composite nature and created reciprocal rights and obligations which included but were not limited to the transfer of the CGP share," explained ELP in its analysis of the decision:
Link to Download the full 196 page judgment :
https://docs.google.com/fileview?id=0B-0hzoMM8_XZN2JmNjY3N2QtNDk1Mi00ZjQ1LTgxMDgtMjA4YWM3ZjIxNzY0&hl=en
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