Is it the end of the tale? Decoding Vodafone vs. Union of India
The unanimous decision that came on 25th September from the Permanent Court of Arbitration at The Hague (Netherlands) ruled that India’s retrospective demand of 22,100 crore as tax on Capital Gains from Vodafone since the year 2007 is “in breach of the guarantee of fair & Equitable treatment” of investors.
No case in the corporate history has evoked as much interest as the Vodafone tax case. For the first time in the history of India, the tax authorities of India went after a fat-pursed multinational. India’s response to tribunal’s award is something what everyone is looking forward too. Accepting the defeat and moving on may appear to be the viable move for the government but this may fuel opposition’s affirmation of NDA being “Suit Boot Ki Sarkar” that may turn out to be perilous in the election season. On the other hand, challenging tribunal’s award and taking proceedings further may send adverse message to foreign investors. Strong states grow stronger by putting limits on their own power; weak states become weaker by descending into arbitrariness. Now, India has to choose which it wants to be.
Understanding the case-
Hutchison Telecommunications International Ltd (HTIL) Hong Kong owned CGP Investments Holding Ltd. of Cayman Islands. CGP Investments further held 52% shares in Hutchison Essar (an Indian telecom joint venture of Hutch & Essar Group) through its SPVs (Special Purpose Vehicles are separate entities formed for undertaking some investments and isolate financial risks involved in them).
Vodafone Group of United Kingdom, through its subsidiary- Vodafone International Holdings, Netherlands in 2007 agreed with HTIL Hongkong & acquired its subsidiary CGP Investments Holdings of Cayman Islands. The transaction went smooth as both Netherlands & Cayman Islands were tax heavens. Cayman Islands never levied capital gains or income tax.
The problem however started when The Income-tax Department of India issued a show cause notice to Vodafone that why it should not be treated as an assessee in default for its failure in deducting TDS (Tax Deducted at Source) on its payment to HTIL for acquisition of CGP Holdings since Hutchison Essar (held by CGP Holdings) was based in India and that too was indirectly acquired by Vodafone. For reference, under TDS law, it is the duty of the payer (Vodafone) to deduct Tax that accrues and arise on the payee’s capital gain, (Hutchison Essar) even before making payment to the payee & depositing the same with the tax authorities.
Vodafone in 2010 challenged the show cause notice at Bombay High Court on the grounds that Indian Tax Authority had no territorial jurisdiction to tax that transaction. The Court however dismissed the writ and held that “the very purpose of entering into agreements between the two foreigners is to acquire controlling interest which one foreign company held in the Indian company by other foreign company. The Indian law does not permit the use of any “colorable” device by any taxpayer for perpetuating tax evasion in India.”
The court also held that it was a case of tax evasion & not tax avoidance.
Vodafone subsequently challenged High Court’s judgement in the Supreme Court. In 2012 Supreme Court overruled High Court’s judgement in the favor of Vodafone Group.
The Hon'ble Court observed that the transaction was between two non-resident entities through a contract that was executed outside India. Consideration for the same was also passed outside India. Therefore, the transaction has no nexus with the underlying assets in India. In order to establish a nexus, the ‘legal nature’ of the transaction has to be examined and not the indirect transfer of rights and entitlements in India.
In other words, the main contention of the Supreme Court was that the Income Tax Act, as it stood then, did not have the provisions to charge capital gains tax on the transactions that do not directly involve sale/purchase of assets in India. Even though the transaction indirectly led to transfer of controlling rights of Hutchison Essar which was an Indian company, the ‘legal nature’ of the transaction still suggested that it was a deal conducted between two foreigners that affected transfer of ownership of a non-Indian entity i.e. CGP Investments Holdings. So Indian tax authorities had no territorial interest over that transaction.
In the absence of an enabling provision, the question of taxation did not arise in India. Therefore, the provisions of section 195 relating to deduction of tax at source will not apply.
In the same year, an amendment was brought by the center under the Finance Act that granted power to the IT department to tax such transactions of sale of shares or units by making them deemed to accrue or arise in India, if they somehow relate to underlying assets in India even if the transaction took place outside India.
The new law stated that the transfer of shares or interest of an entity outside India, which draws its value substantially from assets located in India, “shall always be deemed to have been situated in India”.
This amendment was enforced retrospectively therefore circumventing the Honorable Supreme Court’s Ruling in the Vodafone case.
The move that overturned the decision of the apex court of the country, faced a lot of criticism followed by a bad international investor sentiment. Since then, it has become infamous as the ‘Retrospective Taxation Case’. The then Finance Minister- Late Dr. Pranab Mukharjee stated in an interview- ‘it was not the first time when any law has been enforced retrospectively. It has been the law of the land’.
However due to high international criticism, India tried to settle the matter amicably with Vodafone but was unable to do so.
The Group then invoked Clause 9 of the Bilateral Investment Treaty (BIT- an agreement between countries to protect the private investors in one another nations) signed between India & Netherlands back in 1995. The old treaty formulated with the objective of promotion of private investments either way explicitly exempted such investments from taxation.
The Permanent Court of Arbitration at Hague (Netherlands) ruled India’s retrospective demand as a violation of the treaty and has also asked India not to pursue the tax demand any more against Vodafone Group and to reimburse a sum of 4.3 million pounds (approx. 41 crore INR) towards costs and charges.
According to a press release, the Finance Ministry is studying all aspects of the awards and is in consultation with legal counsels for future course of action.
If the 1995 treaty between India & Netherlands imply no further course of action and complete helplessness in matters like this, then other old treaties like this too needs to be reconsidered and appropriate majors needs to be taken to ensure that such a situation never happens again. After all due to a deficiency in the law, someone has managed to escape from paying tax that would have been payable under Indian law if the same transaction had happened between two Indian parties. This seems more of a PREFERENTIAL treatment being given to a foreign investor rather than being a breach of fair and equitable treatment. The government of India has been constantly reviewing such policies and have terminated BITs with 58 countries including 22 European Union countries in 2017. BIT between India & Netherlands terminated from December 2016. Such actions however send mixed messages at the time when government is making efforts to attract investments with its ‘Make in India’ campaign.
By Vibhu Agarwal