Sunday, 22 January 2012

Vodafone is out of coverage area. Literally.

"FDI flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. ... Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner." - CJI Kapadia

"We will continue to grow our Indian business - including making significant investments in rural areas and in 3G network coverage - for the benefit of Indian consumers" - Vittorio Colao, Vodafone CEO

"The damage to the economy of our country and the welfare of our people, arising from the maddening instability of our laws, is truly incalculable." - Nani Palkhivala

Vodafone International Holdings vs. UOI. Awaited with bated breath and received with jubilation. Undoubtedly a landmark judgment, not only because of the high stakes (a $ 2bn tax liability) and the legal intricacies involved, but because it welcomes foreign investment into India. (LOL, this brings to mind a statement made by Anna Hazare not so long ago - "FDI in retail will enslave India." Tell that to the Supreme Court, Mr. Hazare). How I dearly wish Palkhivala were alive today.

The moment it became clear that Vodafone (based in Netherlands) has no liability to pay any capital gains tax on the purchase of a Cayman Island company (CGP Investments Ltd), sold to it by Hutch (HTIL, based in Hong Kong), I simply sat there, grinning from ear to ear like a Zoozoo. I have all along been thoroughly opposed to the tax liability imposed on Vodafone. I always thought that in the glaring absence of a specific provision, it will be unfair to tax Vodafone on an 'indirect' transfer of assets situated in India. And I am happy that the Supreme Court too thought so.

Few of the key legal conclusions laid down by the SC are:

1. Section 9, taxing non-residents on income deemed to accrue or arise on transfer of capital assets situated in India, does NOT cover indirect transfers and is not a 'look-through' provision. A legal fiction, a deeming provision, has to be literally interpreted. It is only a capital asset 'situated in India' whose transfer will attract capital gains, and not transfer of an foreign company who happens to own this asset. If the Government wants to tax indirect transfers, a separate enactment will be required (which the DTC happens to incorporate).

2. Section 195 (TDS) is applicable only to payments made by an Indian resident to a non-resident. Justice Radhakrishnan in his judgment, made this expressly clear. "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 Sections 115BBA, 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. ... The expression 'any person', in our view, looking at the context in which Section 195 has been placed, would mean any person who is a resident in India." Hence, Vodafone was not obliged to deduct any tax while making payments to Hutch. (The original tax liability is on Hutch, being the seller)

3. Azadi Bachao Andolan and McDowell are not in conflict with each other and Ramsay does not override Westminster. Upholding the correctness of the decision given in Azadi, SC held that "it cannot be said that all tax planning is illegal/illegitimate/impermissible." SC finally put to rest the debate, whether Azadi had correctly interpreted McDowell. McDowell, while relying on Ramsay, had laid down that colourable devices cannot be a part of tax planning and it is wrong to encourage the belief that it is honourable to avoid payment of tax by resorting to dubious methods. The key word is 'dubious.' Unless the transaction is clearly a case of tax 'evasion,' its structure cannot be disregarded and as laid down in Westminster, "given that a document or transaction is genuine, the court cannot go behind it to some supposed underlying substance."

An important thing to be noted here is that the Supreme Court accepted the genuineness of the purchase of CGP Investments Ltd (Cayman Island), because purchasing this company enabled Vodafone to derive certain additional advantages that it would not have derived had it purchased Array Holdings (Mauritius), rejecting the Department's contention that the Mauritius route was not open to it. The additional advantage was obtaining (indirectly) call option rights held by 3GSPL in the companies that held a 15% stake in HEL, which was beneficially owned by HTIL. Had Vodafone opted for the Mauritius route, it would not have obtained these rights. Hence, the taxpayer should be able to SHOW why he opted for a particular transaction structure. If the ONLY purpose is avoiding tax, the transaction will not be bondafide. There has to be a commercial reason behind its structure, other than  saving tax. This will prove to be a major factual difference, while applying the principles of this judgment to other cases.

Lastly, why do I care so much about this judgment, people have asked. I care because it not only carries academic interest but because I am now a taxpayer myself. If I can save tax, I will. Through this judgment, the Supreme Court has reaffirmed that there is indeed a difference between tax avoidance and tax evasion and that the former is legitimate. If I can legally opt to pay lesser tax, then I will choose that option. Especially when I see how the Government chooses to spend the money *I* earn. I work hard to earn it and if I give some part of it to the Government, I don't want to see it wasted on salaries paid to MPs who merely rant, rave and tear papers in the Parliament, taking inordinate amounts of time to actually come to a conclusion about anything. You want my money, you give me good governance.

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