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Important Ruling on Taxation of Offshore Transfer of Shares

Vodafone's controversy with the Indian Revenue is well known.

To recap, the Indian Revenue had sought to tax the gains derived from an offshore Hutch entity on the sale of shares of a Cayman company that was indirectly holding a substantial stake in an Indian telecom operating business. Vodafone, from whom tax was being demanded on account of default in withholding Indian taxes on the payment made to Hutch, succeeded before the Indian Supreme Court, but the Indian Parliament amended the law retrospectively seeking to make such a demand on Vodafone legitimate.

There were several other transactions which were similar in nature to the Vodafone deal, and which were pending at different stages in the administrative or judicial process. One such transaction was the purchase by Sanofi Pasteur Holding SA, France ("Sanofi") of an indirect stake in an Indian entity, Shanta Biotechnics Ltd ("SBL"), through the acquisition of shares in another French holding company named ShanH SAS ("Shan").

This matter had travelled from an adverse ruling by the Authority for Advance Rulings ("AAR") to the Andhra Pradesh High Court ("HC"). The decision of the HC, in favor of Sanofi, was rendered recently. Taxand India discusses the matter and how this could affect similar cases moving forward.

Ruling in favour of Sanofi, the HC has made some significant observations which could benefit similar matters. Upholding the validity of operating companies that are being held through intermediate investment entities, the court observed that a distinction needs to be drawn between structures created solely for tax avoidance, and those evidencing investment decisions. Relying on the observations of the Supreme Court in the Vodafone matter, the HC held that once the existence of factors indicating an investment decision and not tax avoidance is established, questions relating to de facto control over the operating entity and practical rights, need not be enquired into. It was observed that controlling rights could not be separated from the shareholding itself and, in any case, the cost for such controlling rights in the Indian company being unascertainable, the computation machinery would fail rendering the transaction beyond taxation.

Based on the facts provided, the Court held that there was nothing to indicate that Shan was not the legal and beneficial owner of the shares, and that it held shares of SBL on behalf of the sellers. The corporate existence of Shan could not, therefore, be looked through.

It was held that the retrospective amendment to the domestic tax laws, extending the meaning of "transfer" to include indirect transfers, cannot be read into the India - France Tax Treaty, which clearly gave taxing rights only to France in such a situation. Further, legitimate tax planning by way of treaty shopping needs to be distinguished from artificial and dubious devices, and the provisions of the treaty being more beneficial to the taxpayer, will apply. The Court also observed that because French taxes are higher on such gains, the transaction could not be said to have been abusive.

Since the transaction could not be brought to tax in India, the Court held that there was no obligation on Sanofi to withhold taxes on the consideration paid to the sellers.

It is important to note that in India, the parliament is competent to enact retroactively (if it has powers to legislate on the matter), except where retroactive operation is considered to be arbitrary. If the retrospective amendment is considered arbitrary by the courts, they may rule that the provision should be considered as prospective in operation only. The HC in Sanofi's case did not go into the validity of the retrospective amendment, but merely said that the amendment cannot be considered for the purposes of treaty interpretation.

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Taxand's Take

Although the ruling is based on the specific provisions of the India-France Tax Treaty, several of the observations made in relation to the use of holding companies for investment purposes will help MNCs investing in India. This will help not only in the context of offshore transfers, but also for investments made in India from Mauritius and other similar jurisdictions.

This decision reaffirms the principles articulated in the case of Vodafone around the legitimacy of corporate holding company structures. The HC has upheld the proposition that an amendment in the domestic law does not influence the outcome of a tax treaty. This principle is valuable in dealing with similar recent retrospective amendments, in relation to software and bandwidth payments wherein reliance is placed on the tax treaties to determine the appropriate jurisdiction and characterisation.

The decision has not dealt with the constitutional validity of the retrospective amendments, however, and an appeal to the SC by the Revenue against this order is likely.

Taxand's Take Author