I-T dept raises 11,000cr tax demand on Vodafone

23-Oct-2010

TOUGH CALL: CASE TO SET PRECEDENT FOR M&As
Supreme Court to take final call on dispute; ruling to influence pricing & structure of all future cross-border deals

THE battle between tax authorities and telecom major Vodafone is nearing its climax. The income tax (I-T)department on Friday raised a demand of over 11,000 crore on Vodafone International Holdings BV, on account of its $11-billion deal to acquire Indian telecom firm Hutchison Essar in 2007.

Vodafone has 30 days to comply with the demand. Whether Vodafone will have to eventually cough up the tax will be decided by the Supreme Court after it resumes hearing on the case on October 25. The final outcome of the tax dispute will influence the pricing and structure of all future cross-border M&;A deals.

Strongly disagreeing with the tax calculation, Vodafone said, “In this ‘test case’, the tax authority is attempting to interpret Indian law as it has never been interpreted for the past 50 years, and this interpretation also goes against internationally recognised tax norms.”

“Vodafone,” said a company release, “continues to believe that it is not liable for any tax on this transaction involving the transfer of a company outside of India.”

The I-T demand follows the apex court’s direction last month to quantify the tax demand on Vodafone. The Supreme Court gave its order while hearing Vodafone’s appeal against the Bombay High Court ruling that upheld the I-T department’s position that it has jurisdiction to tax the cross-border acquisition.

“We are waiting to see whether the Supreme Court will acknowledge the substance of the transaction or the law binding to these transactions,” said Vispi T Patel of chartered accountancy firm Vispi T Patel & Associates.

The tax department claims it has the jurisdiction on the M&A deal because the company and the business that was sold was based in India, even though the transaction happened offshore between two nonresidents. The high court had turned down Vodafone’s argument that no tax was payable locally as the transaction had no “territorial nexus” with India.

The tax demand was made on Vodafone, the buyer, instead of Hong Kong-based Hutchison International that sold the shares of Hutch Essar to Vodafone. ‘Vodafone informed in advance’

ACCORDING to the income-tax department, since Vodafone did not deduct tax while making payment to Hutchison, the liability to pay the tax falls on Vodafone. The I-T department also claimed that Vodafone was informed in advance about the tax liability arising in India on account of its acquisition of Hutch Essar, even while the government was processing its foreign investment application.

Consequently, the I-T department issued the order treating Vodafone as an assessee in default. A press release issued by the department on Friday said, "The income-tax department today issued an order raising a tax demand of 11,217.95 crore on Vodafone International BV, treating it as an assessee in default under Section 201 (I) of the Income-Tax Act, 1961, for failure to deduct tax as required under Section 195 of the Act before making a payment of $11,076 million to Hutchison Telecommunications International."

"This is a very good order passed by the income-tax department. All aspects of the transaction were taken into consideration before making the order," said Girish Dave, counsel for the income-tax department.

But Vodafone feels since it was the acquirer, it has made no gain on the transaction. The company also believes the tax calculation does not follow the conclusions of the recent Bombay High Court judgement. "Vodafone will continue to take whatever actions are necessary to defend itself in this matter," said the company.

Vodafone moves court against I-T Dept treating it as Hutchison's agent

New Delhi, Oct 15

Vodafone International BV on Friday filed a writ petition in the Bombay High Court to defend itself against a different course of action now taken by the Income-Tax (I-T) Department in the landmark Vodafone tax case.

The I-T Department recently sent a notice that sought to treat Vodafone International (purchaser) as a “representative assessee” (agent) of Hutchison Whampoa (seller) and therefore bring to tax assessment the entire income (gains/profit) in the $11-billion Vodafone-Hutch deal of 2007.

The implication of this move is that Vodafone may now be faced with a much higher tax bill from Indian tax authorities than earlier envisaged for its alleged failure to deduct tax at source. The I-T Department was hitherto looking to demand Rs 12,000 crore-plus from Vodafone towards tax and interest relating to the withholding tax obligations on the deal.

Vodafone International has, however, in the writ petition filed today contested the Tax Department's latest step to treat it as an agent of the seller, stating that such an action was misguided and premature when the key issue of jurisdiction was currently under appeal before the Supreme Court.

The main issue on jurisdiction was whether the Indian tax authorities could tax the transfer of a foreign company's shares between two non-residents if some of the underlying assets were located in India.

Meanwhile, the Income-Tax Department sees merit in adopting a new course of action of seeking to treat Vodafone International as a representative assessee.

“The earlier action was for failure to conform to TDS obligations. That is different as it related to deductor's liability. We are now further proceeding to do income assessment of the deal and treating Vodafone as a representative assessee of the seller for this purpose,” official sources said.

The Bombay High Court is slated to hear the matter on the writ petition on October 27. The Supreme Court hearing on the jurisdiction matter is scheduled for October 25. The four-week period given by the Supreme Court to the Tax Department to determine and quantify the tax liability of Vodafone ends on October 23.

Meanwhile, Vodafone said on Friday that the Indian tax office's actions are “an unusual development, not least because they ignore the imminent hearing of the Supreme Court on the jurisdiction issue”.

Vodafone continues to believe that it has no tax liability whatsoever on this transaction and we look forward to this matter being thoroughly reviewed by The Supreme Court, a Vodafone Group Plc spokesperson said.

Source Link : http://www.thehindubusinessline.com/2010/10/16/stories/2010101651310300.htm

Vodafone International Holdings B.V. vs. UOI (Bombay High Court)

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

Vodafone ruling a game changer for share transfers to foreign companies

NEW DELHI: Tax treatment of overseas M&A deals involving Indian assets may have changed forever with the Bombay High Court ruling in the Vodafone tax issue.

The court on Wednesday accepted Indian tax authorities’ jurisdiction over the $11 billion acquisition of mobile phone operator Huchison Essar by Vodafone, making it difficult to conduct transfer of big assets held in a holding company structure through sale of shares.

Armed with the ruling, the income tax department plans to revisit other such transactions. “This is a test case, we will look at similar cases,” said Sudhir Chandra, acting chairman of the central board of direct taxes (CBDT).

There were already some cases under investigation, he said. The court order may have a bearing on deals such as SABMiller-Foster and Sanofi Aventis-Shanta Biotech transactions.

“The high court has accepted the contention that transfer of shares of the Cayman Company was only a mechanical step for the eventual transfer of various commercial rights of the telecom business situated in India,” says Sudhir Kapadia, tax markets leader at consultancy firm Ernst & Young.

Vodafone argues that it need not pay tax as the transaction was done between two offshore entities. Vodafone International Holdings BV, a Netherlands entity, had acquired 100% shares in CGP (Holdings) Ltd, a Cayman Islands company from Hutchison Telecommunications International Ltd for $11.2 billion.

Information available with the income tax authorities, however, show that only one $1 share was transferred by the Cayman islands-based entity, although the total consideration was much higher.

The income tax department issued a show cause notice to Vodafone to explain why tax was not withheld on payments made to HTIL in relation to the above transaction.

The court, while accepting that shares of a foreign company are located outside India, observed that the transfer of the attendant commercial rights would attract tax in India.

In other words, the court seems to be suggesting a bifurcation of the total consideration into two parts. First part attributable to the shareholding per se, which would include all the relevant shareholder rights and controlling interest, and the second part represented by various commercial interests such as telecom licences and brands situated in India.

“The High Court has mentioned about the proportionality theory. But, the issue of proportionality is tricky one and it is difficult to resolve. I guess it would have to be settled in a mutually acceptable manner,” said Mukesh Butani, partner, BMR Legal.

Tax authorities can also issue a show-cause notice to Vodafone, even as the matter looks all set to go to the Supreme Court, said another tax department official. The tax notice, he said, would be issued after the expiry of the eight-week period stipulated by the High Court.

Several countries have in their legislation something known as “look-through” provisions by which a tax is imposed on gains arising from transfer of shares outside the country if it results in the passing of control over a company, which holds specified assets or property in the country. Indian tax laws, however, do not have such provisions.

The Direct Taxes Code Bill, 2010, introduced in Parliament recently, proposes to tax transfers outside India of shares in a foreign company, in proportion to the fair market value of assets located in India. This rule will apply if the fair market value of assets in India exceeds 50% of the value of all assets owned by the foreign company.

Source : http://economictimes.indiatimes.com/Telecom//articleshow/6527486.cms