Sep 08 2010 , New Delhi/ Mumbai
In a judgement that may have far-reaching consequences for several existing and proposed foreign investment projects in the country, the Bombay High Court dealt a Rs 12,000 crore tax blow to Vodafone International on Wednesday.
The court dismissed the company’s petition challenging the showcause notice issued by the income-tax department with regard to capital gains from the 2007 acquisition of Hutch-Essar.
A senior income-tax official with direct knowledge of the case told Financial Chronicle: “The income-tax department will raise a tax demand of Rs 12,297 crore on Vodafone as its liability for tax deduction at source (TDS) on capital gains it made in the $20 billion deal to acquire Hutch-Essar.”
The high court ruled that controlling assets in the country could be treated as capital assets for a tax trigger.
The tax liability will have a significant bearing on the company’s balance sheet for its Indian operations, Vodafone Essar, given that its 2009-10 revenue stood at about Rs 24,000 crore. The company said the tax burden, all inclusive, last financial year stood at Rs 6,500 crore. Vodafone though remains confident that there is no tax to pay on the transaction.
Charting out the future course of action, the income-tax official said, “The department will carefully go through the 195-page order of the high court to determine if it can now raise the statutory tax demand on Vodafone, though the company can still approach the Supreme Court against the high court order.”
The official further said, “The Rs 12,297 crore assessment as tax dues is unlikely to undergo any major change. It has been assessed on the basis of capital gains accrued in the $20 billion valuation of the Vodafone deal after deducting the investments Hutch and others had made over a period of time.”
The department in May this year sent a “simple letter”, not a statutory demand notice, to Vodafone, assessing the company’s tax liability in the deal at Rs 12,297 crore. In the letter, the department offered the company the opportunity to be heard on the tax assessment, but the company did not take it, choosing instead to challenge the “letter” in the Bombay High Court.
In response to the petition by Vodafone, the high court judges, DY Chandrachud and JP Devadhar, said there was no merit in the petition as Vodafone, “by the diverse agreements that it entered into, has a nexus with Indian jurisdiction. In these circumstances, the proceedings, which have been initiated by the income-tax authorities cannot be held to lack jurisdiction.”
The order said the “essence of the transaction was a change in the controlling interest in HEL which constituted a source of income in India. The transaction between the parties covered within its sweep, diverse rights and entitlements.”
The court said the petitioner is “open to agitate before the tax authority.” It added that in an earlier case of Eli Lilly, the apex court had held that “the liability to the levy of penalty can be fastened only on the person who does not have good and sufficient reason for not deducting the tax,” the burden being on the person to prove the existence of good and sufficient reasons.
The tax authorities have been directed by the court not to raise any final order for a period of eight weeks, which will provide Vodafone time to review the judgement in detail and consider its next steps.
The Vodafone group in a statement said “its contention that the transfer of shareholding of the Cayman islands-based CGP (Investment) Holdings was a valid transaction (that is not a sham structure) and, therefore, not liable to be taxed in India, has been upheld in the judgement.”
“However, the judgement holds that certain other contractual rights with the Indian parties were also a part of the transaction and this has ‘nexus’ with India. The judgement indicates this gives jurisdiction to the tax office to levy a tax on that part of the transaction. Vodafone is seeking legal advice to challenge this part of the judgement,” the statement said.
Desmond Webb, Vodafone group tax executive, told reporters in Mumbai that “we will be evaluating this long and detailed order with our advisers and we continue to believe strongly that this transaction is not taxable in India and will continue to defend our position.”
The company had argued that there was no tax liability on the transaction as Indian tax officials had no jurisdiction over a transaction between two non-residents and that took place on foreign soil.
The court decision, as well as the results of the subsequent appeal, could have far-reaching implications on how foreign companies view investing in India.
The cellular operator industry body, Cellular Operator Association of India (COAI), said the court decision was disappointing and that it would send a negative signal to foreign investors.
Rajan Mathews, director-general of COAI, said, “The court ruling is disappointing. Without getting into merits or demerits of the case, it does not really send a positive vibe on the FDI investment climate in India. A few questions would be posed on the efficacy of the investment in the country.”
However, SC Khanna, secretary-general, Association of Unified Telecom Service Providers of India (AUSPI), said, “This is purely a company issue. We do not wish to comment as an industry body.” Asked if the association would try and assist the company or allow it to fend for itself, he said, “We do not have anything to say on this.”
The tax liability issue comes into sharper focus though with the advent of the direct taxes code. The income-tax official FC spoke to explained that the code, proposed to come into effect from April 1, 2012, amplified the existing provisions of the Income-Tax Act with regard to TDS on capital gains in cases of mergers and acquisitions involving foreign companies.
“The code makes it clear and does not leave anything to doubt. Otherwise the provisions have existed under Section 9 of the Act of 1961 and even of the 1922 Act,” the official stated.
Tax experts held a view that the high court order may significantly impact the flow of FDI into the country. “Any transaction between two non-resident parties taking place outside India may attract tax here, if the transaction relates to assets in the country. This may impact FDI into the country,” said Ravishankar Raghavan, principal of the tax group at Majmudar & Company.
The legal community felt there was a strong case for Vodafone to knock on the doors of the Supreme Court. Manoj Kumar, managing partner, Hammurabi & Solomon, said, “The Supreme Court window is there. But in a globalised world transfer of ownership at the top in a foreign country cannot be taxed by every country in which such a company has business. If this is to be adopted by every country where Vodafone is providing services, the consequences are unimaginable.”
Noted corporate lawyer Lalit Khanna said, “The Supreme Court window is always available. The issue of capital gains tax being levied on the buyer does not arise in the normal course. It might only be provided for in a situation where a buyer and seller include the transfer of the tax liability from the seller to the buyer. This does not seem to be the situation here or at least this is not in public domain.”
While it appears certain that Vodafone will go to the Supreme Court, it is to be seen whether the apex court will just admit Vodafone’s petition or also stay the high court order till it hears the case. If it just admits the case and does not give a stay on the order, then Vodafone will have to deposit the entire money with the income-tax department and then fight the case in the Supreme Court.
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