India - Vodafone ruling

Paris, 23 janvier 2012 - Visualiser l'eAlerte

La Cour Suprême en Inde vient de rendre son jugement dans la décision très attendue relative à l'affaire Vodafone et dont les enjeux sont très significatifs. La Cour décide en faveur de Vodafone International BV que la cession indirecte des titres de la société indienne n'est pas taxable en Inde.

The Supreme Court of India (SC) has rendered its judgement in the much awaited verdict in the US$ 2 billion Vodafone tax case [S.L.P. (C) No. 26529 of 2010]. In one of the most high profile cross border matters involving taxability of a transaction between two non-resident companies (having no presence in India), in relation to transfer of shares of an overseas company, and after a period of four years involving two rounds of litigation at the High Court, and after hearing the matter over a period of two months, the SC has given a landmark decision in favour of Vodafone International BV (VIH) to hold that the transaction is not taxable in India.

The case involved the transfer of entire share capital of a Cayman Islands company, which held a Mauritius company and this in turn held a maze of Mauritian companies. These second-tier Mauritius companies held majority shareholding in Vodafone Essar Ltd., the Indian operating-cum-holding company. After hearing the arguments of both the parties, the SC adjudicated the matter in favor of VIH on the following key points :

• The Indian Tax Authority (ITA) does not have any territorial jurisdiction to tax such an overseas transaction.
• The SC rejected the ITA’s argument that under section 9(1)(i) of the Income-tax Act, 1961 (the Act), the ITA can ‘look through’ the transfer of shares of a foreign company holding shares in an Indian company and treat the transfer of shares of the foreign company as equivalent to the transfer of shares of the Indian company. Thus, the SC held that section 9(1)(i) of the Act envisages only ‘direct’ transfer of capital assets situated in India.
• The SC reversed the decision of the High Court which held that there was transfer of ‘other rights and entitlements’ which in themselves constituted capital assets.
• The SC held that the case concerns ‘a share sale’ and not an ‘assets sale’. A controlling interest is an incident of ownership of share in a company and is not a distinct capital asset independent of the shares held. Thus, it was not open to the ITA to split the payment and consider a part of such payment for other rights and entitlements.
• On the issue of whether the present case deserves lifting of the corporate veil and whether the true nature and character of the transaction is required to be ascertained from the covenants of the contract and from surrounding circumstances, the SC observed that in the application of a judicial anti-avoidance rule, the ITA may invoke the ‘substance over form’ principle or ‘piercing the corporate veil’ test only after it is able to establish on the basis of the facts and circumstances surrounding the transaction that the impugned transaction is a sham or is tax avoidant. Every strategic investment should be seen in a holistic manner keeping in mind factors like i) concept of participation in investment; ii) the duration of time for which the holding structure exist; iii) period of business operation in India, etc. However, in the present case, Hutchison was not a fly-by-night operator since the holding structure is a bona fide, structured foreign direct investment (FDI) investment into India and thus cannot be treated as a sham transaction or a pre-ordained transaction. The SC reinforced the principles laid down by it in the case of Azadi Bachao Andolan [2003] 263 ITR 706 (SC) by observing that genuine and strategic tax planning cannot be ruled out.
• The SC observed that since VIH did not have any tax presence in India vis-à-vis the overseas transaction, this does not bring VIH under the jurisdiction of the Indian tax authorities. Further, since the revenue failed to establish any connection with section 9(1)(i) of the Act, the withholding tax provisions under section 195 of the Act would not apply to VIH.
• The SC further held that since there was no transfer of a capital asset situated in India, the provisions of section 163(1)(c) of the Act were also not attracted.
• On the controversy surrounding the India-Mauritius Double Taxation Avoidance Agreement (tax treaty), the SC held that in light of i) the fact that the treaty does not have limitation of benefit (LOB) clause, ii) presence of Circular No. 789 issued by the Central Board of Direct Taxes, and iii) existence of the tax residency certificate issued by Mauritian authorities, the ITA cannot at the time of sale, deny treaty benefits on the reasoning that the FDI was only ‘routed’ through a Mauritius company.  The SC also observed, however that, it would not preclude the ITA from denying the tax treaty benefits, if it is established, on facts, that the Mauritius company has been interposed as the owner of the shares in India, at the time of disposal of the shares to a third party, solely with a view to avoid tax without any commercial substance. (observations of Justice K. S. Radhakrishnan).
• The SC has directed the ITA to refund the INR 25 billion to VIH with interest @ 4% per annum within a period of two months from the date of the order. Also, the SC has directed to return the bank guarantee within four weeks that was earlier issued by VIH.

Net net, the SC held that the transaction is not liable to tax in India under the provisions of Income tax law and VIH was not required to withhold tax thus settling a prolonged litigation.

The Vodafone controversy had created a lot of uncertainty for multinationals having similar structures and/or which had entered into or were proposing to enter into similar transactions, and thus, this should provide the much needed respite to these litigants.

However, any conclusions in this regard in each individual case can only be reached based on the fine print analysis of the judgment. Further, the Direct Taxes Code Bill (DTC) contains a proposal to tax similar transactions; hence this ruling may have limited relevance post implementation of the present form of the DTC.

Having said the above, the SC judgment does send positive signals to the global investing community that India is indeed a top destination for investment and provides the much needed certainty around deals/M&A activity in the otherwise lackluster market.

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