Wednesday, 17 August 2011

The Vodafone Controversy

The hottest issue of the tax world right now is the Vodafone case. There has already been enough discussion on the structure of the deal so I won't go into the details. Vodafone (Netherlands) paid 11 billion dollars to Hutch (Hong Kong), for purchasing Hutch’s wholly-owned subsidiary in Cayman Islands (HCI). HCI owned a company in Mauritius which directly and indirectly (through various companies) held a controlling stake of 67% in Hutchison Essar Ltd, India (HEL). By purchasing HCI, Vodafone acquired a controlling stake in HEL.

The Department cried foul and sought to tax Vodafone on the deal, conducted and concluded outside India. The Department’s claim rested on the fact that the underlying purpose of the transfer of HCI was to acquire Indian operations of HEL and therefore, such transfer had a sufficient nexus with India to attract tax. And we’re not talking peanuts here; the tax liability is 2 billion dollars.

The Bombay HC ruled against Vodafone and the case is currently in the Supreme Court. There has been enough debate on the applicability of section 9(1), whether there is ‘transfer’ of a ‘capital asset’ ‘situated in India.’ While it is true that Vodafone’s intention was to acquire Indian operations, the ultimate question that arises is, whether the IT Department can tax an ‘indirect’ transfer of a capital asset situated in India, effected through intermediary companies.

My take is, no they cannot do that until the DTC is introduced or the present Section 9 is amended. Section 9 of the IT Act says that income accruing or arising, directly or indirectly, through the transfer of a capital asset in India is liable to tax in the hands of the non-resident. It is section 5 of the DTC, however that lays down that such ‘transfer’ can be ‘direct or indirect.’ The DTC is not an amendment to the current Income Tax Act, but is a whole new legislation, which will repeal and replace the Act. In my view, bringing indirect transfers into the ambit of taxation is possible only after DTC comes into effect or after Section 9 is amended to that effect.

Moreover, other countries like China, Australia and Peru have specifically enacted provisions making indirect transfers taxable. Can India tax such transfers without a specific provision in place? Not unless there is clear tax evasion, in the garb of a colourable device (lawyers simply love to use this phrase). In my opinion, Vodafone has not evaded tax, it has merely structured an indirect transfer as a part of some creative tax planning, which is legal. In the glaring absence of a specific provision, it will be unfair to tax Vodafone.

The outcome of the case is keenly awaited by foreign investors and MNCs who are waiting for settlement of the issue before structuring any deals involving Indian assets/operations.

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