One of the most important cases for time is of the Telecom major Vodafone wherein it won a long pending case against the Indian government in an international court and the amount crossed over Rs.22,000 crore in a retrospective tax dispute.
Background and Facts of the Case
The companies involved in this dispute are:
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HTIL
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Hutchison Telecommunications International Ltd (Hong Kong) which was the seller and earner of Capital Gain.
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VIH
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Vodafone International Holdings BV (Netherlands) which was the purchaser of shares of CGP.
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CGP
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CGP Investments (Holdings) Ltd. (Cayman Islands Mauritius) which is the company whose shares had been transferred.
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HEL
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Hutchison Essar Ltd. (India). The above transfer of CGP shares led to an indirect transfer of HEL to VIH.
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HEL was an Indian Company wherein CGP (Mauritius) held 67% of the shares and Essar holding held the remaining 33 % shares in total. CGP was a 100% subsidiary of HTIL (Hong Kong) and subsequently a Share Purchase Agreement (SPA) was entered into between the non-resident Companies of VIH and HTIL on 11.2.2007, wherein HTIL agreed to procure the sale of these CGP shares. However, the problem arose when the question of whether the transfer of shares between two foreign companies which in turn resulted in the extinguishment of controlling interests within the Indian Company held by a foreign company to another foreign company, amounted to the transfer of capital assets in India and as thereby chargeable to tax in India.
The Supreme Court in its verdict analyzed section 9(1)(i) and held that it comprised of mainly three elements i.e. the transfer of the capital asset, the existence of the capital asset and the situation of capital asset in India which must co-exist for any income to accrue within the country. Thus, the court held that section 9(1)(i) of the ITA did not cover any of the indirect transfers and that Section 195, cannot be applied to a non-resident payer and hence, VIH cannot be held liable for any deduction of tax at source from the payments made to HTIL. Further, because of the non-existence of any viable income, there is no question of TDS being applicable. The court thus ruled in favour of VIH and held that the offshore transaction was a participated investment and not a sham or tax avoidant.
However, the government had to amend its law retrospectively in order to enable it to tax any gain on transfer of shares in a non-Indian company which derived substantial value from underlying Indian assets. Thus, the liability was put back on VIH.
The International Arbitration Tribunal, in its judgment over the issue stated that the Company was served in 2016, with a demand notice of Rs. 22,100 crore which included the interest. The Tribunal at The Hague convention ruled that India’s imposition of a tax liability over Vodafone, as well as the interest and penalties, were in a breach of an investment treaty agreement between India and the Netherlands. Furthermore, it held that the government had to cease all its dues from Vodafone and must bear partial legal costs borne by VIH as well.
This case has now served as a reminder for all big conglomerates to keep in mind the tax implications and responsibilities prior to any international agreement.
Guidelines for Foreign Investor based on above Case"
1. Invest through the country having the Income Tax Treaty with India: The above case only goes to show that it is investments only through companies located within the jurisdiction which the treaty covers that are considered under the law. Despite the Indian-Mauritius tax treaty being the most preferred one till date, there are still several other nations such as Singapore, Cyprus and The Netherlands and many more which also provide various protections in tax treaties particularly when there is a necessary need to exit from such an investment. Thus, in the Vodafone case it is evident that Hong Kong (which is the residence of the seller in the Vodafone case) does not exactly have a favourable tax treaty with India and hence, the direct protection of the treaty could not be invoked.
2. Have a substance in Foreign Jurisdiction: The next aspect to remain vigilant about is, that whenever there is the need to structure investments through any international treaty jurisdiction, it is imperative that the product or the substance is created within the jurisdictions itself. This is because the substance bolsters the applicability of the protection provided within these treaties and thus the Courts shall treat the treaty as inapplicable wherever they believe that there is no substance to the company relying on any of the treaty benefits. Therefore the shell holding companies are the most vulnerable to being disregarded by authorities and the effective management and control of the investments has to be vested within the treaty jurisdiction of the holding company so as to be recognizable by tax authorities.
3. Proper Legal Documentation between the Parties: It goes without saying, that all the legal documentation and information which is to be disseminated to the public relating to the transaction be carefully constructed by the parties so that the rights and obligations only come to vest in the treaty jurisdiction entity. In this case, the routing of payments through the Mauritius holding company and thereby having the Mauritius holding company become the holder of the record of the shares in the joint venture agreement proved to be insufficient, for example, in the Cingular Wireless matter and related matters the High Court directed at the fact that the Mauritius holding company was not a party to the original joint venture agreement and thus all obligations and liabilities within the agreement were ultimately of the parent company. This also directed at all the shareholders’ agreement amongst the founders of the joint venture to support their findings that the Mauritius holding company was only a conduit with no substance. It is further important that all the paper trails of these transactions be carefully established so as to comply with the law better. It would be worth mentioning that in both the Vodafone and the Aditya Birla case, the High Court commented extensively over the public disclosures made by Vodafone and Cingular Wireless in their filings with the U.S. Securities and Exchange Commission in order to characterize the transactions. It becomes imperative to make sure that these documents are carefully drafted so as to not find any legal ramifications of not following the guidelines.
4. Advance Ruling from the Income Tax Department: Keeping in mind the timings, all interested parties should always approach the tax authorities for an advance ruling for any applicability of tax in India to the transaction. This process could last from a few weeks to several months depending upon the case and may even provide the parties the ability to adjust the economics of the deal between them prior to closing, and the set up pre-closing mechanisms to handle the issue post-closing (for instance, through escrow and indemnification arrangements if the findings of the Indian tax authorities are contested). It is also important to note, that in the Vodafone case, the High Court noted the availability of these procedures and remarked that the parties chose not to use those procedures, making it very important to always keep in mind the procedural requirements under all tax laws in India.
5. Indemnification from the Seller: It is important that every buyer seek indemnification with respect to any taxes applicable to the transaction from the sellers. This indemnification must be supported through escrow whenever possible under the terms of the agreement. Under Indian law it is the buyer’s obligation to withhold and remit the tax to the Indian authorities and thus this indemnification would need to cover all the penalties and fines which may be imposed over the buyer as a result of the failure to withhold.
6. Segregation of the Assets: It is also important to note that the investors must necessarily segregate all of the assets and rights from every other aspect of the transaction in transactions in which multiple assets and rights are involved from different nations. This would limit all the tax liabilities for all those assets and rights which have a true India nexus. This is true in transactions within which the value of the Indian-related assets being transferred is only a small portion of the total value of all assets being transferred in totality.
7. Nexus within Laws: The above case is basically providing us with a better interpretation regarding the concept of nexus within our courts. In most such international cases, the High Court has disregarded the parties’ argument that the transactions were offshore transactions and thus pierced through the corporate veil to find nexus with our laws wherein indirect ownership of assets was concerned. This has wider implications as Adidas AG realised recently, that it was assessed tax over the insurance payments it had received under a global insurance policy with respect to the damages which were sustained at its facilities in India owned by its Indian subsidiary. Thus the tax authorities took the position that even though the premiums on the policy had been paid by the parent company, the payments received from the insurer must be allocated to the Indian subsidiary since the damage occurred in India itself.
8. Impact of Withholding Tax: It is necessary that all the buyers be ready to withhold and negotiate the economics of the transaction with the sellers whenever it seems that the treaty protection is not going to be available. This must also comprise of the tax planning with the sellers for determining how the impact of withholding could possibly be mitigated through the use of foreign tax credits.
9. Clear Understanding of the Agreement: It is very important to always go through and understand every agreement especially when such an agreement provides for payments to be subject to applicable withholding taxes since this is a very important aspect to consider in itself. It is important to note in every transaction that the buyer and the seller completely understand the scope of the withholding prior to entering into the agreement.
10. Stay Updated: One of the most important lessons to be learnt in this case is to always be aware with the updated laws since there are always newer ad better amendments coming forth all the time for the ease of doing business.
Conclusion
The ruling of Vodafone International Holdings BV (the ‘Vodafone’ or ‘Claimant’) vs The Republic of India (the ‘Respondent’ or ‘India’) dated on 25th September 2020 by International Arbitral Tribunal increases the confidence of foreign company planning to make an Investment in India. However, it is advisable to consider the above-mentioned points before making the investment to mitigate the risk of income tax and safeguard from unnecessary liabilities.
