LAW OF TAXATION

DR. RAM MANOHAR LOHIYA NATIONAL LAW

UNIVERSITY
2018-19

LAW OF TAXATION
FAIR DRAFT

On

“Impact of the Vodafone Case on Income Tax Authorities”

SUMBITTED TO SUBMITTED BY

Mr. BHANU PRATAP SINGH VIPIN KUMAR VERMA

Asst. Professor (Law) ENROLL. NO. – 150101163

RMLNLU SECTION – B

Impact of the Vodafone Case on Income Tax Authorities

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ACKOWLEDGEMENT

I owe a great many thanks to a great many people who helped and supported me during the
writing of this research project. I wish to express my deep appreciation to my teacher MR.
BHANU PRATAP SINGH, for his guidance and persistent help without which completing this
research would not be possible. He continuously and convincingly conveyed his knowledge on
the subject and the right spirit and excitement for teaching. He has taken pain to go through the
project and make necessary correction as and when needed.

I would also thank my Institution and my faculty members without whom this project would
have been a distant reality.

I also extend my heartfelt thanks to my family, seniors and friends for their continuous support
and advice helping me to complete my project.

- VIPIN KUMAR VERMA

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INTRODUCTION

The Supreme Court judgment in the Vodafone case argues that the 'corporate veil' cannot be
pierced as long as there was no intention to avoid taxes. This matter concerns a tax dispute
involving the Vodafone Group with the Indian Tax Authorities, in relation to the acquisition
by Vodafone International Holdings BV (VIH), a company resident for tax purposes in the
Netherlands, of the entire share capital of CGP Investments (Holdings) Ltd. (CGP), a company
resident for tax purposes in the Cayman Islands (CI)] vide transaction dated 11.02.2007, whose
stated aim, according to the Revenue, was "acquisition of 67% controlling interest in HEL",
being a company resident for tax purposes in India which is disputed by the Appellant saying
that VIH agreed to acquire companies which in turn controlled a 67% interest, but not controlling
interest, in Hutchison Essar Limited ("HEL" for short). According to the Appellant, CGP held
indirectly through other company’s 52% shareholding interest in HEL as well as Options to
acquire a further 15% shareholding interest in HEL, subject to relaxation of FDI Norms. In short,
the Revenue seeks to tax the capital gains arising from the sale of the share capital of CGP on the
basis that CGP, whilst not a tax resident in India, holds the underlying Indian assets.

CITATION & BENCH

(2012) 6 SCC 613

Full Bench: CJI J. S.H.Kapadia; J. K.S.Radhakrishnan, and J. Swatanter Kumar.

FACTS

Vodafone International Holdings BV, Netherlands (“VIH“) entered into a Share Purchase
Agreement (“SPA”) with Hutchison Telecommunications International Limited, Cayman Islands
(“HTIL”), for purchasing equity share holding of its subsidiaries i.e. CGP Investment (Holdings)
Ltd., Cayman Islands (“CGP”). CGP in turn, directly and indirectly, owned approximately 52%
share capital of an Indian Company named as Hutchison Essar Limited (“HEL"). The acquisition
resulted in VIH acquiring control over CGP and its subsidiaries, including HEL. The Revenue
Authorities held that the gains were taxable in India as there was transfer of controlling stake /

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business situated in India and accordingly alleged failure on part of VIH to withhold tax on gains
arising to HTIL on the transfer of shares of CGP.

CONTENTIONS

 Use of look at and look through principles.

It was contended that HTIL has, under the SPA, directly extinguished its property rights in HEL
and its subsidiaries. It was submitted that the word "through" in Section 9 of the IT Act inter
alias means "in consequence of". It was, therefore, argued that if transfer of a capital asset situate
in India happens "in consequence of" something which has taken place overseas (including
transfer of a capital asset), then all income derived even indirectly from such transfer, even
though abroad, becomes taxable in India. That, even if control over HEL were to get transferred
in consequence of transfer of the CGP Share outside India, it would yet be covered by Section 9.
Thus, the Revenue could look through the transfer of the shares of the holding company and treat
it as the transfer of shares of subsidiary company.

 Controlling interest of VIH in HEL

It was contended that if we look with the commercial point of the transaction that has taken
place, it evidences that a transfer of HTIL’s property rights by their extinguishment, i.e, HTIL
had extinguished its right to control and management (the property rights) over HEL and thus,
consequently, there was a transfer of capital asset situated in India.

 Why CGP was used to make the said investment?

It was contended that since CGP was a tax-free entity (i.e. to avoid taxes) and thereby avoid
capital gain tax, the said entity was entered into the agreement on a later stage. Thus, HTIL
devised an artificial scheme to avoid taxes by selling CGP shares, where in fact, what HTIL was
intending to sell were its property rights in the said CGP. According to the Revenue, under the
Companies Law of Cayman Islands, an exempted company was not entitled to conduct business
in the Cayman Islands. CGP was an ‘exempted company’. Since CGP was a mere holding
company and since it could not conduct business in Cayman Islands, the sites of the CGP share
existed where the “underlying assets are situated”, that is to say, India. That, since CGP as an

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exempted company conducts no business either in the Cayman Islands or elsewhere and since its
sole purpose is to hold shares in a subsidiary company situated outside the Cayman Islands, the
sites of the CGP share, in the present case, existed “where the underlying assets stood situated”
(India).

 Scope of Section 9, Income Tax Act, 1961.

It was contended that the expression “transfer” in Section 2(47) read with Section 9 has to be
understood as an inclusive definition comprising of both direct and indirect transfers so as to
expand the scope of Section 9 of the Act. It was also submitted that the object of Section 9 would
be defeated if one gives undue weightage to the term “situated in India”, which is intended to tax
a non-resident who has a source in India. Further, the effect of SPA is not only to effect the
transfer of a solitary share, but transfer of rights and entitlements which falls within the
expression capital asset defined in Section 2(14) meaning property of any kind held by the
Assessee. Further, it was stated that the word ‘property’ is also an expression of widest
amplitude and would include anything capable of being raised including beneficial interest.
Further, it was also pointed out that the SPA extinguishes all the rights of HTIL in HEL and such
extinguishment would fall under Section 2(47) of the Income Tax Act and hence, a capital asset.
If a holding company incorporated offshore through a maze of subsidiaries, which are investment
companies incorporated in various jurisdictions indirectly contacts a company in India and seeks
to divest its interest, by the sale of shares or stocks, which are held by one of its upstream
subsidiaries located in a foreign country to another foreign company and the foreign company
step into the shoes of the holding company, then Section 9 would get attracted. Thus, it would be
a case of indirect transfer and a case of income accruing indirectly in India and consequent to the
sale of a share outside India, there would be a transfer or divestment or extinguishment of
holding company's rights and interests, resulting in transfer of capital asset in India.
On contrary, the Petitioner, submitted that Section 9(1)(i) of the Income Tax Act deals with
taxation on income and that there was a distinction between a legal right and a contractual right.
Referring to the definition of "transfer" in Section 2 (47) of the Income Tax Act which provides
for extinguishment, it was submitted, that the same is attracted for transfer of a legal right.
Moreover, the court cannot by a process of interpretation or construction extend the meaning of
that section to cover indirect transfers of capital assets/properties situated in India.

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 Interpretation of Section 163 of Income Tax Act, 1961

It was contended that VIH can be considered as a representative assessee. If this section is read
with Section 160(1)(i) and Section 161(1) of the act, then it shows that certain persons can be
treated as representatives on behalf of non-resident under Section 9(1). This also includes an
agent under Section 163. Thus, VIH fulfils the requirements of Section 163 and can hence be
taxed.

 Interpretation of Section 195 of Income Tax Act, 1961

It was contended that Section 195 makes it necessary on payer to deduct tax at source from
payments made to non-residents which are chargeable to tax and which have an element of
income embedded with them. Thus, HTIL must have complied with the said provision while
selling CGP to VIH.

JUDGEMENT

 Controlling interest of VIH in HEL

The case went up to the Supreme Court and the first line of reasoning was that the transaction
between Vodafone and Hutch was a share transfer (sale) rather than a transfer of capital assets
and that the ownership of the capital assets remained vested in the Indian company. The
judgment took recourse to the legal distinction between a company and its shareholders and thus
the judgment does not make a distinction between shareholding that constituted a controlling
interest and that which was a pure financial investment. Consequently it becomes completely
immaterial in this specific case that the share(s) actually transferred were not of the company
located in India but of offshore companies that ultimately controlled the shares that constituted
the controlling interest in the Indian company. Even if the shares were of a company located in
India, in the court's view it would not have constituted a transfer of capital assets. Once it is
accepted that the shareholders of a company have a legal identity distinct from the company, no
matter what the proportion of shares they hold, it follows that the two companies would have
distinct identities even if one held a controlling share in the other. The Supreme Court judgment
makes it a point to emphasise that even a subsidiary has an identity that is distinct from its parent
holding company. In none of the authorities have the assets of the subsidiary been held to be

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those of the parent unless it is acting as an agent. Thus, even though a subsidiary may normally
comply with the request of a parent company it is not just a puppet of the parent company. The
difference is between having power or having a persuasive position. The Honourable CJI has
held that control and management is a facet of the holding of shares and applying the principles
governing shares and the rights of the shareholders to the facts of this case held that this case
concerns a straightforward share sale.

 Use of look at and look through principles.

The second aspect of the Supreme Court judgment is that it argues for a ‘look at’ test in which
tax authorities consider the entire Hutchison structure as it existed, holistically, at its face value,
and not adopt a ‘dissecting approach’. In other words, authorities should not ask whether the
transaction is a tax avoidance method, but apply the ‘look at’ test to ascertain its legal nature.
The Supreme Court was not in favour of the High Court's ‘look through’ test because, it claimed,
this was inconsistent with the need for certainty and consistency of tax policies that are crucial
for taxpayers’ confidence (especially foreign investors). The judgment argues that such a going
behind the corporate veil or looking through would be legitimate only in cases where it can be
established that there is a deliberate intention of evading taxes. In the Supreme Court's view no
such inference can be made in this case if the steps that led to the creation of the complex
holding structure of Vodafone and the eventual Vodafone-Hutch transaction were seen in the
proper context. According to the court the structuring of the transfer of control from Hutch to
Vodafone was not done with the specific intention of avoiding taxes. Hence the corporate veil
need not be pierced and the fact that there was a transfer of control from Hutch to Vodafone must
be ignored. And thus the tax authorities should concern themselves only with the corporate
structure or form of a merger deal, and not the substance of what assets are changing hands.

An additional implication of the judgment is that as long as it can be established that a

mechanism was not originally created with the intention of avoiding taxes, it does not matter if it
eventually led to such a consequence. The court has directed that when assessing whether an
entity is evading the tax law, the authorities have to examine whether the means of evasion
(which here is the creation of CGP, Hutchison's Cayman Islands unit) was originally intended for
this purpose. Since Hutchison made its investments and engaged in activities in India (in

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collaboration with Essar) for several years before the deal and during that period CGP existed,
the latter is not to be seen as primarily created to avoid capital gains.

Section 9 has no ‘look through provision’ and such a provision cannot be brought through
construction or interpretation of a word ‘through’ in Section 9. In any view, ‘look through
provision’ will not shift the sites of an asset from one country to another.

 Scope of Section 9, Income Tax Act, 1961.

The meaning of the expressions "either directly or indirectly", "transfer", "capital asset" and
"situated in India" are of prime importance so as to get a proper insight on the scope and ambit of
Section 9(1)(i) of the Income Tax Act. Section 9(1)(i) covers only income arising or accruing
directly or indirectly or through the transfer of a capital asset situated in India.
Section 9(1)(i) cannot by a process of "interpretation" or "construction" be extended to cover
"indirect transfers" of capital assets/property situated in India.

The words "directly or indirectly" occurring in Section 9, therefore, relate to the relationship and
connection between a non-resident Assessee and the income and these words cannot and do not
govern the relationship between the transaction that gave rise to income and the territory that
seeks to tax the income. In other words, when an Assessee is sought to be taxed in relation to an
income, it must be on the basis that it arises to that Assessee directly or it may arise to the
Assessee indirectly. In other words, for imposing tax, it must be shown that there is specific
nexus between earning of the income and the territory which seeks to lay tax on that income.

 Interpretation of Section 163 of Income Tax Act, 1961

Merely because a person is an agent or is to be treated as an agent, would not lead to an

automatic conclusion that he becomes liable to pay taxes on behalf of the non-resident. It would
only mean that he is to be treated as a "representative Assessee". Section 161 of the Act makes a
"representative Assessee" liable only "as regards the income in respect of which he is a
representative Assessee" (See: Section 161). Section 161 of the Act makes a representative
Assessee liable only if the eventualities stipulated in Section 161 are satisfied. This is the scope
of Sections 9(1)(i), 160(1), 161(1) read with Sections 163(1)(a) to (d).

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In the present case, the Department has invoked Section 163(1)(c). Both Sections 163(1)(c) and
Section 9(1)(i) state that income should be deemed to accrue or arise in India. Both these
Sections have to be read together.

 Interpretation of Section 195 of Income Tax Act, 1961

Section 195, would apply only if payments made from a resident to another non-resident and not
between two nonresidents situated outside India. In the present case, the transaction was between
two non-resident entities through a contract executed outside India. Consideration was also
passed outside India. The present case concerns the transaction of "outright sale" between two
non-residents of a capital asset (share) outside India. Further, the said transaction was entered
into on principal to principal basis. Therefore, no liability to deduct tax at source arose.

EFFECT OF THE JUDGEMENT ON INCOME TAX

AUTHORITIES

 Why 'look at' and not 'look through'?

The first interesting issue that arises is why authorities should look at and not look through the
transactions, especially if what is being examined are complex transactions of mammoth
corporations like Vodafone? After all, even simple cases of wrongdoing may not be caught out
without looking at the substance of the act beyond the mere form of what is being claimed by the
parties.

 Why Cayman Islands?

The second interesting aspect is that the court chooses to ignore the fact that the merger deal was
structured through a corporate vehicle stationed in the tax haven of Cayman Islands. In the
Supreme Court's view, since Hutch-Essar existed for several years before the 2007 deal and was
an active corporate and taxpaying subject, the deal was perfectly legal and it cannot be said that
the Cayman Islands were brought into the loop with the express purpose of tax avoidance. But
the point is that what else could be the possible purpose of bringing Cayman Islands and vehicle
stationed there into the deal if not tax avoidance? It is hard to imagine any other strategic
advantage that Cayman Islands can bring in for a corporation like Vodafone.

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 Compartmentalisation of the corporate form

Perhaps the most interesting and the least commented aspect of the Supreme Court judgment is
that which takes us to the very heart of the contemporary debate regarding the nature of gigantic
corporations like Vodafone. The judgment has upheld the principle of maintaining a clear-cut
separation between companies and between companies and their shareholders. But the point is
that if the holding companies, the subsidiaries and their respective shareholders are all different
entities then how do we make sense of the complex and mammoth corporate structures like
Vodafone that influence the lives of such large numbers of people and control enormous natural
and public resources like spectrum globally?

CRITICAL ANALYSIS IN THE LIGHT OF DIRECT TAX CODE

This case is a classic example of application of various rules of interpretation applied in the case
of a taxing statute. Various tools of interpretation are applied by the court to reach to the said
conclusion and support the said decision with a solid reasoning. The court expressly mentioned
that since, we are dealing with a taxing statute and the Revenue has to bring home all its
contentions within the four corners of taxing statute and not on assumptions and presumptions.
The court also considered the parallel developments proposed in the existing laws to determine
the true nature of the transaction. The DTC Bill, 2010 proposes taxation of offshore share
transactions. This proposal indicates in a way that indirect transfers are not covered by the
existing Section 9(1)(i) of the Act. In fact, the DTC Bill, 2009 expressly stated that income
accruing even from indirect transfer of a capital asset situate in India would be deemed to accrue
in India. These proposals, therefore, show that in the existing Section 9(1)(i) the word indirect
cannot be read on the basis of purposive construction. The question of providing "look through"
in the statute or in the treaty is a matter of policy. It is to be expressly provided for in the statute
or in the treaty. Similarly, limitation of benefits has to be expressly provided for in the treaty.
Such clauses cannot be read into the Section by interpretation. Also, Para 82 talks about burden
of proof on Revenue to identify the scheme and dominant purpose, i.e, to identify as to what was
the task and for what reasons it was undertaken.

The court has also discussed as to what the general principles are and how such general
principles can or cannot be applied in the cases related with taxing statutes. The general principle

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that ‘controlling interest which a shareholder acquires is an incident of the holding of shares and
has no separate or identifiable existence distinct from the shareholding’ should be applicable in a
situation where controlling interest is acquired as an incidence of acquisition of a particular
number of shares. However, it should be evaluated in further detail if the above general principle
will hold good in a situation where transaction between the parties is explicitly for acquisition of
controlling interest in a subsidiary company and the same is given effect to by transferring shares
of an overseas parent company (as is the situation in the present case). In our humble view, such
evaluation doesn’t seem to have been done in the judgment.

The court further discussed as to what way a statute imposing liability on the affected persons
should be construed while a question of interpretation comes into play. The proper course in
construing revenue Acts is to give a fair and reasonable construction to their language without
leaning to one side or the other but keeping in mind that no tax can be imposed without words
and that equitable construction of the words is not permissible.

Further, the court took into consideration all possible aspects through which the Revenue had
tried to bring VIH in the purview of Income tax Act, 1961 and reasoned such decision. It also
used comparative analysis for deriving the judgment. On a comparison of Section 64 and
Section 9(1)(i) what is discernible is that the Legislature has not chosen to extend
Section 9(1)(i) to "indirect transfers". Wherever "indirect transfers" are intended to be covered,
the Legislature has expressly provided so. The words "either directly or indirectly", textually or
contextually, cannot be construed to govern the words that follow, but must govern the words
that precede them, namely the words "all income accruing or arising".

A literal construction of the words "any person responsible for paying" as including non-
residents would lead to absurd consequences. A reading of Sections
191A, 194B, 194C, 194D, 194E, 194I, 194J read with Sections115BBA, 194I, 194J would show
that the intention of the Parliament was first to apply Section 195 only to the residents who have
a tax presence in India. It is all the more so, since the person responsible has to comply with
various statutory requirements such as compliance of Sections 200(3), 203 and 203A.

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BIBLIOGRAPHY

Primary Sources:

 Nikhil Mehta (June 2010), Growing Capital Pains in Indian Taxation and other Fiscal
Ailments for Foreign Investors
 India Tax Potent on Global M & A – The Vodafone Case Update, (December 2008),
Accretive Business Consulting Private Limited
 Haripriya Padmanabhan, Levy on Capital Gains Tax on Extraterritorial Transaction, The
Practical Lawyer, Eastern Book Company.
 Direct Tax Code

Secondary Sources:

 <http://taxmannindia.blogspot.in/>, Last accessed 27th October 2014.

 <scconline.co.in>
 <http://taxguru.in/income-tax/vodafone-issues-notice-indian-government-violation-
investment-protection-treaty.html>, Last accessed 27th October 2014.
 <http://www.business-standard.com/article/companies/vodafone-wins-2-bn-tax-case-in-
supreme-court-112012000125_1.html>, Last accessed 27th October 2014.
 <http://taxguru.in/income-tax/india-tax-hell.html>, Last accessed 27th October 2014.

Impact of the Vodafone Case on Income Tax Authorities