PURISTS were horrified when the tax Department started proceedings against Vodafone for its alleged failure to deduct tax at source from its transactions with Hutchison Group of Hong Kong. How can Indian Revenue authorities ask a non-resident to deduct tax at source in respect of its transactions with another non-resident asked the angry commentators. The dispute which has now dragged on for over three years and engaged the attention of scholars and commentators is far from over. Vodafone lost its battle in the first round right up to the Supreme Court. In the second round also, it has lost in the Bombay High Court. The much awaited verdict of the High Court is out and it seems that the tax department had succeeded in ferreting out certain inconvenient facts which are tumbling out of the closet and the hullabaloo created in respect of this case might not have been entirely justified. The Bombay High Court has held that the tax department indeed had jurisdiction to commence proceedings against Vodafone for not deducting tax at source as required by the Indian laws. It left the issue of the determination of the exact liability to be decided by the assessing Officer (A.O) at the time of the assessment. The High Court had granted time to Vodafone to appeal to the Supreme Court and had asked the tax department not to pass any order regarding the liability of the telecom giant. Within a week, Vodafone filed an appeal and requested a stay of the Bombay High Court Judgement. Today, a bench of the Supreme Court comprising the Chief Justice of India heard Vodafone’s plea but refused to stay the High Court’s order. It has in fact, directed the TDS officer to determine the liability of Vodafone within 4 weeks. If it is still unsatisfied, Vodafone has been given the liberty of approaching the Supreme Court thereafter. The next date has been fixed on the 25th October, 2010.  

Obviously, Vodafone will not be satisfied with the order of the TDS officer and it will still take some more time for the final word on the issue to be authoritatively pronounced by the Supreme Court. By the Indian standard, that will be quite a fast-track resolution. In the meantime, the decision of the Bombay High Court will hold since no  stay has been granted and similar structures adopted by other non-residents may be under increased attack. But whatever may be the final outcome of the case and it is an important case, there are two things, which are certain. The lawyers and advisors of Vodafone are laughing all the way to their Banks. Secondly, ferreting out information by the tax authorities of a developing country from multinationals is quite a task and as this case indicates, is almost impossible without the intervention of the Courts.

The latest Bombay High Court judgement in this case runs into 198 pages. The complex web of holdings and cross-holdings created involving jurisdictions such as Cayman Islands and that all time favourite of anyone who has anything to do with India – Mauritius, was so convoluted and opaque that in an unusual departure from the rather austere tone of Indian Courts, the Bombay High Court has appended a chart in a heroic attempt to explain the transactions.

Before delving into the facts of the case and the judgement of the Court on the issues involved, it is interesting to understand a few aspects of Indian law relating to withholding of taxes. In respect of any payment to a non-resident by any person, tax has to be deducted at source. Of course, the sum involved must be chargeable to tax in India.  Who decides about the chargeability? Some recent court cases lay down the proposition that the judgement in this regard is to be exercised by the taxpayer himself. Of course, the taxpayer will run the risk of penalty and interest if such decision turns out to be wrong and against the law. In case of any doubt about the chargeability, the taxpayer can approach the tax department for determining the appropriate portion that will have to be deducted. The law says that in case, there is a liability to deduct  but the taxpayer defaults in his duties, the person liable for such deduction is held to be an ‘assessee in default’ and the money can be recovered from him even though the income does not belong to him. This, in short, is the mandate of section 201 of the Income Tax Act.

It is with this backdrop that we can now examine the background facts of the case. It was sometime in 2007, that the then Director General of Income Tax who was part of a delegation to Mauritius to reexamine the current treaty with Mauritius to assess the revenue loss that the treaty is causing to India that the case of Vodafone’s proposed acquisition of Hutch Essar hit the headlines. There was speculation about the use of Mauritius based companies to overcome the taxability of capital gains arising out of the huge 10 billion dollar acquisition. The tax Department, after initial examination of the issues, came to a tentative conclusion that since the controlling interests in an Indian company with licensing rights over 23 telecom circles in India was the subject matter of the proposed transfer, there was a prima-facie liability of tax deduction at source on the part of the payer. Accordingly, the Department first sought information from the Indian Joint Venture Company, Hutch Essar, about the proposed deal. In a rather unusual move, it was also put on notice that there might be tax implications and that the parties should deduct appropriate tax at source before the transaction was consummated. It was also pointed out that in case of doubt, application could be made to the Assessing Officer in terms of sections 195(2), 195(3) or 197 of the IT Act. The Indian company gave some information but as far as the deal was concerned, stated that it was not privy to the transaction but that the information had been passed on to the two parties involved. Therefore, both Vodafone and Hutch were fully aware that the Indian revenue was of the prima-facie opinion that tax should be deducted at source. It was possible in such circumstances for the parties involved to approach the Revenue for clarification on the issue. However, the parties chose to ignore the advice, based obviously on the advice of eminent consultants both Indian and foreign.

But, we have gone ahead. Let’s begin at the beginning. To understand the issues involved, it will be necessary to briefly take note of the regulatory environment in the telecom sector in India. In the year 1992, as a result of the New Economic Policy the Indian telecom market also opened up. Foreign investment was allowed through the Joint Venture route. Bids were invited for providing cellular services. It was at this time that Hutchison Whampoa of Hong Kong (HTIL) teamed up with Max India of Analjit Singh to form a JV – Hutchison Max Telecom Pvt Limited (HMTL) and made an unsuccessful bid for metro cellular licences. There was controversy about the bidding process and the matter went to the Court.  Hutchison Max joined as an intervener along with two other losing bidders against the issue of eight franchises for the operation of cellular services. In terms of Delhi High Court’s verdict, the Department of Telecom (DoT) modified the list of selected franchisees after reevaluation of bids and the HMTL was selected as one of the two franchisees for the Mumbai Circle, the most lucrative circle in the country. In the meantime the New Telecom Policy was announced in 1994, and DOT finally awarded the mobile telephone licence to Hutchison Max Telecom in October 1994. The other operator for Mumbai was BPL Mobile Communications Ltd. The operators in Delhi was Bharti Cellular Ltd and Sterling Cellular Ltd; in Chennai, these were RPG Cellcom Ltd and Skycell Communications Pvt Ltd and in Kolkata, Modi Telestra Pvt Ltd and Usha Martin Telecom Ltd. There were other operators in other category A, B  and C areas and the HMTL had separate licences to operate paging services in Bangalore, Hyderabad, Ahmedabad, Pune, Vadodara, Ludhiana and Chandigarh.

Cellular services in India were growing and many Indian promoters started to cash out of their ventures. Thus, in 1998, Max India, which had 51% stake in the JV, sold its 41% stake in HMTL to Telecom Investments India Private Limited, itself a 51:49 JV between Kotak Mahindra Group and Hutchison Telecon Hong Kong. In 1999, a new telecom policy was unveiled and there was liberalisation regarding the number of circles one could operate in besides change in the revenue sharing model. In December, 1999, Hutchison Telecommunications International Limited (HTIL) acquired 49% equity shares in Sterling Cellular Limited in India from Swisscom, an Essar group company; the remaining 51% being held by Essar Teleholdings limited. Hutch thus gained foothold in Delhi. In August 2000, HTIL acquired 49% equity shares in Usha Telekom Ltd, which was providing cellular services in Kolkata under the brand name Command. Kotak Group acquired the balance. In September 2000, Hutchison Telecommunications Limited acquired a 14.7% shareholding in Fascel Ltd, which was the number one cellular operator in Gujarat. In  2001 Hutchison won cellular licenses in  Chennai, Andhra Pradesh and Karnataka. In 2003, Essar Teleholdings sold its operations in Rajasthan, Uttar Pradesh (East) and Haryana to Hutchison Essar. Hutchison also bought from Escotel  licence to provide cellular services in Punjab.

By 2004, Hutch had presence almost throughout India. It sought and received clearance from FIPB to consolidate its shareholdings. In February 2005, it made a disclosure to the Hong Kong Stock Exchange about its India telecom rejig whereby Hutchison Max Telecom Limited (HMTL) acquired shares of Hutchison Essar Telecom Ltd, Hutchison Telecom East limited, Hutchison Essar South Limited etc in return for shares of HMTL. Subsequently, HMTL was renamed as Hutchison Essar.(HEL). In the mean time, there was another significant change in the telecom policy. In 2005, the FDI cap in the telecom sector was increased from 49% to 78%.  In December, 2005, Max sold its remaining 10% stake to Hutch Essar.

The structure of Hutch’s interest in India before and after the consolidation as given by Hutchison to the Hong Kong Stock exchange was as per the chart given below:

In January 2006, HTIL announced that Hutchison Essar Limited its joint venture in India with Essar Teleholdings Limited has completed the acquisition of BPL Mobile Cellular Limited. With this Hutchison Essar now operated in 16 circles including all metro and A circles.

In a March 2006 Press release, Hutch announced that Max Chairman Analjit Singh re-entered Hutchison Essar by acquiring the Kotak Group’s indirect stake in Hutchison Essar. At the same time, it is announced that Mr Asim Ghosh, Managing Director of Hutchison Essar, has been offered and has accepted an opportunity to become an indirect shareholder through an investment in one of the JV Companies. In June 2006, HTIL entered into agreements for the acquisition of a further 5.11% stake in Hutchison Essar from affiliates of the Hinduja Group. In October 2006, HTIL announced that Hutch Essar had acquired Essar Spacetel Limited from the Essar Group.

At this time, Hutch Essar(HEL) had a pan India presence in tune with the famous ad designed for Hutch by Oglivy and Mather of “Wherever you go, our network follows”.

On 22nd December, 2006 in a press release HTIL stated that it had been approached by potentially interested parties regarding a possible sale of its interests in HEL. On the same day Vodafone made a non-binding offer to acquire 66.9848% of HTIL’s shareholding in HEL for $16.5 billion. On 25th December, 2006 Essar group matched Vodafone’s offer claiming a right of first refusal. Offer was also made by Hinduja Group. Finally, on 20th February, 2007, Vodafone applied to the Foreign Investment Promotion Board (FIPB) for approval of its acquisition through a Cayman Island Company and at the same time an offer was made to Essar to purchase its interest in HEL. On 6th March, 2007, Essar Teleholdings lodged its objection with the FIPB against the acquisition by Vodafone on ground of Vodafone’s link with the Bharti Airtel. On 14th March, 2007 however, Essar withdrew its objection and on 15th March, 2007 there was a settlement agreement between HTIL and Essar in terms of which HTIL agreed to pay $415 million to Essar in return for it acceptance of the deal with Vodafone. On 15th March, 2007, there was a term sheet agreement between Vodafone and Essar Group to regulate their relationship. On the same day, Income Tax Department issued an advisory notice to HEL conveying obligations of Vodafone towards withholding tax.

These are the facts leading up to the first brush of Vodafone and Hutch with the tax authorities in India. In the second installment, we will examine what transpired between now and the final payment made by Vodafone and its skirmishes with the tax authorities in India leading up to the final denouement.