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Vodafone Ruling on Principles of Taxation of Cross-Border Acquisitions

7 Dec 2010

The Bombay High Court ("HC") has delivered a landmark judgment in the case of Vodafone International Holdings B V on the tax implications related to cross border acquisitions. Vodafone case ruling was a much awaited one as it was a high voltage dispute involving an unprecedented tax position taken by the Revenue and equally unprecedented quantum of tax demand of more than US $2 billion. Taxand India examines the details of this important ruling and subsequent impacts.

Vodafone International Holdings BV ("Vodafone"), a Dutch subsidiary of the British telecom giant acquired, in May 2007, a 67 percent stake in CGP Investments Ltd., a Cayman Islands company, which held the India telecom assets of Hong Kong's Hutchison Telecommunications International Ltd ("HTIL"). The 'Billion dollar' question was when Vodafone acquired the stakes in CGP which held the India telecom assets of HTIL, whether it resulted in a transfer of a 'capital asset' in India, which was chargeable to tax in India.

The Revenue held that the transfer must be taxed in India as the transaction did not represent mere transfer of shares but a transfer of composite rights of HTIL in the Indian business. The subject matter of the transaction was only to transfer the interest in the Indian company and the acquisition of one CGP share was only a means to achieve that object. Further HTIL had to adopt several steps to consummate the transaction of transferring all its rights in Hutchison Essar Ltd ("HEL"), the Indian operating (telecom) company, which included assignment of loans, facilitating framework agreements, transferring management rights in HEL, transferring the Hutch brand, transferring the Oracle license etc. All these were independent of the transfer of CGP share. The consideration paid was for composite rights and not for a mere transfer of CGP share. The Revenue also observed that several valuable rights which were property rights and capital assets stood relinquished in favour of Vodafone, by reason of the agreements, which formed part of the composite transaction and not merely by the simple transfer of one CGP share. Hence the Revenue held Vodafone as 'assessee-in-default' for not withholding tax on the payment made for the share acquisition.

Contentions of Vodafone
The transfer of the shares of CGP which was a capital asset situated outside India could not result in any income chargeable to tax in India. A share in a company represents a bundle of rights and its transfer results in a transfer of all the underlying rights. However, what was transferred was only a share and not the individual rights.

When there is no look-through provisions under the Income Tax Act, 1961 ("the Act"), such a provision cannot be read into the statute and the corporate veil cannot be lifted unless a tax fraud is perpetrated. The Supreme Court ("SC") in the case of Azadi Bachao Andolan (2003) 263 ITR 706 has held that there was no tax consequence in India when the shares of one of the intermediate holding company in Mauritius were transferred. Similarly, there should not be a tax consequence, even when an upstream holding company transfers its shares.

Where an asset situated outside India is transferred, the location of such an asset does not notionally shift to India because the agreement pursuant to which it is transferred has also led to certain related agreements, which have nexus with India. Where a controlling interest in shares is transferred, it is customary to incorporate transitory arrangements without specific consideration. The value of the transfer of the enterprise is captured in the sale proceeds of the shares and the gains made by the seller should relate to where the property is situated. Independent values are not assigned to these arrangements.

HC ruling
The HC held that the series of transactions in question has a 'significant nexus' with India. Since the essence of it was change in controlling interest in HEL, it constituted a source of income in India. The fact that Vodafone has a nexus with Indian jurisdiction can be substantiated by diverse agreements that it entered into with HTIL. In these circumstances, the HC concluded that the proceedings which have been initiated by the Indian Revenue authorities cannot be held to be lacking jurisdiction.

It held that the price paid by Vodafone factored in, as part of the consideration, diverse rights and entitlements being transferred as part of the composite transaction. Many of these entitlements were not relatable to the transfer of the CGP share. The transactional documents were not incidental or consequential to the transfer of the CGP share, but recognised independently the rights and entitlements of HTIL in relation to the Indian business transfer to Vodafone.

The transaction between Vodafone and HTIL was a composite transaction which covered a complex web of structures and arrangements, not referable only to the transfer of one share of an upstream overseas company. The transfer of one share alone would not have been sufficient to consummate the transaction. It held that intrinsic to the transaction were transfer of other rights and entitlements. Such rights and entitlements constitute 'capital assets' as per the provisions of the Act.

The apportionment of consideration paid by Vodafone for a bundle of entitlements stated above lies within the jurisdiction of the Indian Revenue. The Indian Revenue Authorities sought to apportion income resulting to HTIL between what has accrued or arisen or what is deemed to have accrue or arise as a result of a nexus with India and that which lies outside.

Further developments
Subsequent to the HC ruling, the Revenue has raised a tax demand of Rs. 112,180 million on Vodafone for failure to withhold taxes. Meanwhile, the appeal filed by Vodafone before the Supreme Court is likely to be heard in November 2010.

Taxand's Take

This is a landmark ruling which throws light on principles of taxation of cross-border transfers. The HC's observation on the 'principle of proportionality' that a portion of the income would be chargeable to tax is a significant one. The Court has also observed that the other rights and entitlements, passed on as a part of the deal are separate assets and can be regarded as 'capital assets', within the meaning of the Act. These observations seem to indicate that transactions involving a simpler transfer of shares of a company outside India, which has companies in its fold in India, would not be chargeable to tax in India. However, if certain other rights and entitlements in India are transferred along with the transfer of shares, there would be an incidence of tax in India.

In that case, the consideration should be determined on the basis of apportionment of the consideration. The HC has not commented on the basis of such apportionment and has left it to the Revenue authorities. The principle of proportionality could come under challenge before the SC on the basis that there is no legal mechanism for applying such principle.

This decision could certainly embolden the Revenue authorities to investigate offshore transactions, which have a connection with India or cases where limited interest exists in India and the demand raised by the Revenue authorities is a clear indication of things to come.

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