UGLAND House, 301 South Church Street, George Town, Grand Cayman, Cayman Islands is a famous address. It is famous with the all those who need the smokescreen of companies floated in this sun kissed island of about 52,000 people with the reputation of fiercely protecting the privacy of the clients and keeping the same away from the prying eyes, particularly of the taxman. Ugland House is a five-storey building and its sole occupant is an international law firm who provide ‘registered office' service to its clients. According to a report submitted to the US Senate, as of 2008, there were 18,857 registered entities in this house. As it turns out, our story also leads us to the very same Ugland House where, a company by the name of CGP Investment (Holdings) Ltd (CGPC) came to be promoted by one Nicola Melia on 12th January 1998 with just one share and a share capital of US$1.On the same day, the Company was acquired by Hutchison Telecommunications Limited, Hong Kong. This $1 company registered as an exempt company under the laws of Cayman Islands with a single share holder came to play an apparently important role in the Vodafone saga that we are in the process of narrating.

At the outset, it needs to be clarified that although we call it the Vodafone saga, it is not really Vodafone whose tax affairs we are discussing. It is in fact, the tax liability of the Hutchison Group that one should really talk about, for, Vodafone, as we have discussed in the earlier episode was only responsible for withholding liability in respect of Hutch's income. It is, of course, a different matter that Vodafone chose to ignore the taxman's warning and got embroiled in the process.

Hutchison Telecom, having established itself in the cellular business in India, went public in the year 2004 when it got itself registered, where else- in Cayman Islands and listed in Hong Kong and New York stock exchanges. At this time of the global offering, Hutchison Telecom International Limited (HTIL) was, through its Mauritius Holding Companies, holding interest in six Indian telecom companies, Hutchison Max Telecom Private Ltd., Hutchison Telecom East Ltd, Aircel Digilink India Ltd., Hutchison Essar Telecom Ltd., Hutchison Essar South Ltd  and Fascel Ltd., who, in turn had telecom licenses in various telecom circles of India. Although, its direct shareholdings in such downstream companies were kept at 49% to nominally comply with the FDI cap in the telecom sector in India, the prospectus for the ‘global offering' mentioned that notwithstanding the fact that the Group did not own a majority of the voting equity interests in the Hutch India mobile telecommunications operator companies, their results were consolidated as subsidiaries into the combined financial statements included in the prospectus, in terms of the Hong Kong GAAP. It was mentioned: “We take the majority of the economic risks and are entitled to the majority of the rewards from these subsidiaries” and that “our direct and indirect economic shareholdings result in our group holding, in some cases, more than 50% of the economic interest in the Indian operations”. Much of some such information that the Indian tax department could gather was thanks to the disclosures made by the company itself with the SEC because of the strict disclosure requirements. It is interesting to note that HTIL has now been privatized with the parent company Hutchison Whampoa buying back the shares and the company getting delisted from both Hong Kong and NY stock exchanges in May and June 2010 respectively.

Be that as it may, let us now try to follow the rest of the story. In mergers and acquisitions, the buyer or the seller or both get a due diligence done to ensure that valuation is proper and the price to be paid represents what was actually agreed between the parties. In this case, Vodafone had appointed Ernst and Young LLP, U.K to do the due diligence and E&Y apparently reported that CGP Investments (Holdings), Cayman Islands was not originally in the target group but was included at the instance of the seller and that very little information was available of the company or its Mauritius based subsidiaries and that there might be tax exposure as the residential status of these companies was not clear. It suggested that a warranty may be sought to protect against the consequences of any of the Companies being resident in a jurisdiction other than Mauritius and Cayman Islands. As for valuation, the entire value that was ascribed to HTIL's stake in CGP was computed on the basis of the enterprise value of the Indian operating companies.

In respect of its proposed acquisition of the direct and indirect interest of 52% of HTIL in HEL, Vodafone also applied to the FIPB under press note1 since it had a JV interest in Bharti also. As disclosed to the FIPB, the transaction was to be effected by VIH BV, Netherlands acquiring the entire share capital of CGP Investment (Holdings) Ltd, Cayman Islands, which through its 10 subsidiaries in Mauritius, owned 42.34% of the issued share capital of Hutchison Essar Limited (HEL) and had indirect interest in 9.62% of the same. Vodafone argued that since the transaction involved transfer of shares of an overseas company from one non-resident to another, the transaction only needed to be noted by the FIPB. On being quizzed about the difference between its declaration before the SEC that it was acquiring 67% of the interest in HEL and the declaration before the FIPB that the same was at 52%, Vodafone clarified that this was due to US GAPP where indirect subsidiaries were also to be consolidated; that HEL's existing partners Mr Asim Ghosh and Analjit Singh and IDFC between them held 15% interest which they had agreed to retain and which VIH BV had an option to buy. Asked to explain as to how then the consideration could remain the same if only 52% was being acquired and not 67%, Vodafone conceded that the payment of $11.01 billion was to be for the acquisition of entitlements including a control premium, use and right to use the Hutch brand, the value of non-voting non-convertible preference shares, a non-compete agreement with the Hutch group, various loan obligations and the entitlement to acquire the further 15% indirect interest in HEL. When asked for a break up of the different components of the interests and their valuation, Vodafone submitted that it had not individually placed a price on the components but its approach was to look at the package of the assets, liabilities and other intangible factors.

Even though a share purchase agreement (SPA) was signed between Hutch and Vodafone in Febreuary, 2007, it was only on the 4th May 2007, that HTI (BV) delivered the now famous one share of CGPL to their lawyer in Cayman Islands with strict instruction for the transferring agent not to release the document till instructions were received, presumably pending the final approval of the FIPB. On 7 th May, 2007, FIPB finally gave its approval to the deal subject to compliance with and observance of all the applicable laws and regulations in India and on 8th May, a new set of directors were appointed for all the companies concerned and Vodafone paid US $ 10,854,229,860 to Hutchison Telecommunications (Cayman) without meeting its withholding tax liability under the Indian Income tax Act. No application was filed with the tax authorities.

Subsequent to these developments, a number of agreements or arrangements were entered into for the smooth succession of Vodafone in place of Hutch in the entity which now will be called   Vodafone-Essar Limited. (VEL)  Of these, of particular interest will be the Framework Agreements with Mr. Asim Ghosh, ex Managing Director of Hutch in India and Mr. Analjit Singh, the original promoter of Hutchison Max. The sum and substance of the arrangement was that Mr. Ghosh and Mr. Singh owned certain Indian companies which, in turn owned certain other Indian companies and these companies subscribed to the shares of another Indian company, TII which, together with its wholly owned subsidiaries, had 19.54% interest in HEL. The acquisition of the shares in TII Ltd was facilitated by HTIL which provided credit support. In exchange, Hutch entered into option agreements in terms of which HTIL had the option of buying their interests at a predetermined price much below the market price. The rights under these option agreements also stood transferred in favour of Vodafone and Vodafone, in its turn, entered into similar option agreements. Interestingly, Vodafone also entered into a consultancy agreement with a party for payment of US $ 1, 30 00,000 [Rs 60 crores approximately] in consideration for “advice on (i) appropriate understanding within the Indian Government of Vodafone's future role within India and (ii) tactical and strategic advice in relation to the acquisition by Vodafone Group of controlling interest in HEL and related regulatory approvals.”

While the take over process was going on, the tax department was keeping a watch. On 15 th March, 2007, the Directorate of International Taxation, Mumbai issued a notice to HEL seeking information regarding the sale of the stake of Hutchison Group to Vodafone Group Plc including information in relation to the shareholders Agreements and details of the transaction for the acquisition of the share capital of CGP. In reply, On 22 March 2007, HEL furnished information relating to HEL. As regards the transaction, HEL stated that it was not in a position to provide any responses, since it was neither a party to the transaction nor would there be any transfer of shares of HEL. However, considering the various announcements and filings of both Vodafone and Hutch and the clarifications given to the FIPB to the effect that 67% of the controlling interests of Hutchison in HEL was being transferred and being acquired by Vodafone and considering further the fact that all the valuations were of the Indian operating companies holding telecom licenses in India, the tax department was of the prima-facie opinion that the transaction gave rise to taxable income in India. On 23rd March 2007, the IT department again wrote to HEL stating that the transaction could be taxable in India and HEL was specifically requested to impress upon HTIL/Hutchison Telecom group to discharge the tax liability on the gains, before they cease operations in India. Additionally, the attention of HEL was also drawn to Sections 195 and 197 of the Act implying that either HTIL or Vodafone could approach the Department for determination of the appropriate amount of tax to be deducted at source. On 5 April 2007, HEL clarified that it had no tax liabilities arising out of the transaction and the transaction being between two non-residents; it had no locus- standii in the matter. It transpired that HEL had indeed informed both HTIL and Vodafone about the tax issue. Thereafter, On 6 August 2007, the IT Department issued a show cause notice to VEL under Section 163 of the Income Tax Act, to explain why it should not be treated as a representative assessee of Vodafone. The answer came swiftly in the form of a writ filed before the Bombay High Court.

On 19 th September, 2007, when it was clear that the transfer process was over and the change in management has also taken place without a penny coming to its coffers, the tax department issued a notice direct to Vodafone asking it to show cause as to why it should not be treated as an assessee in default for not deducting tax at source and asking it to produce certain documents, most important of which was the share purchase agreement dated 21.2. 2007. Vodafone responded by filing a writ before the Bombay High Court.

By order dated 3 rd December, 2008, a division Bench of the Bombay High Court held that the transaction was more than transfer of one share of a Cayman Island shell Company and agreed with the tax Department that it involved a sale of the controlling interest by Hutch of its Indian operations and that the share transfer might just be a mode of transferring such interest. It dismissed the writ. While doing so, the High Court also pointed out that the recipient of the sale consideration was not the Cayman Islands based Company, CGP Investment (Holding) Ltd but Hong Kong based HTIL who even distributed a special dividend out of the same. The Court also pointed out that Vodafone had admitted that HTIL had transferred 67% interest in HEL qua the statutory authorities in USA and Hong Kong and the FIPB and hence a different stand could not be taken before the tax authorities in India. The High Court also adversely commented on the willful failure of Vodafone to procure the share purchase agreement dated 11 th February 2007 and other prior and subsequent documents.

Vodafone filed a special leave petition before the Supreme Court and at the time of hearing, their counsel stated that despite the fact that the agreements were not produced before the High Court or the Supreme Court, the same was served on the Additional Solicitor General. Thereupon, the Supreme Court by its order dated 23rd January, 2009, disposed off the appeal with a direction to the Tax Department to first determine the jurisdictional issue based on the interpretation of the agreement.

Thereafter proceedings commenced again before the tax authorities. There were voluminous submissions including opinion of international experts - Guglielmo Maisto of Italy, Lawrence Mark Magid of Australia, John Ulmer of Canada, Hal Hicks of USA, Bruno Gouthier of France, Dr Thomas Rodder and Prof Dr Andreas of Germany, Stephen Edge and Dr Philip Baker of the UK. Of course, the experts gave their opinion on the question posed and the facts presented. The tax Department, however, passed a final order reportedly running into 761 pages refuting all the submissions of Vodafone and holding it to be an assessee in default and reportedly asking it to pay taxes and interests to the tune of 2 billion dollars.

As expected, Vodafone filed another writ in Bombay HC. The hearing went on for 7 ½ days with Mr Harish Salve appearing for Vodafone arguing for 5 days. The High Court, as we have seen in the earlier episode, passed a 198 page order holding that the tax department had, in the facts of the case, correctly assumed jurisdiction u/s 201. As for the amount to be taxed in India, the Court held that the matter should be decided by the A.O in the assessment proceedings. It also held that Vodafone would be at liberty to plead before the tax authorities that penalty may not be levied on it. It must be noted that the Department had attacked the transaction from a number of angles, including the theory of piercing corporate veil, substance over form, the theory of transfer of controlling interest. None of the above arguments found favour with the High Court. In fact, the Court held that the form of the transaction can not be ignored, that rights and liabilities appurtenant to a share may vary widely within the law, but they cannot exist independently of the inherent attributes with which a share has been created and that control and management is but one facet of the holding of shares. However, the Court ultimately held in favour of the Department on the ground that what was transferred in this case was certainly not one share of CGP holdings but a complete gamut of right and loans.

The High Court held: “Besides procuring the sale of one share belonging to CGP, HTIL had necessarily to adopt several steps to consummate the transaction of transferring all its rights in HEL in India. These steps included (i) Procuring assignment of loans; (ii) Facilitating framework agreements; (iii) Transferring management rights in HEL; (iv) Transferring the Hutch Brand; and (v) Transferring Oracle Licence etc. All these were independent of the transfer of the CGP share. The consideration paid by the Petitioner to HTIL was for a package of composite rights and not for a mere transfer of a CGP share.” And further: “The diverse clauses of the SPA are indicative of the fact that parties were conscious of the composite nature of the transaction and created reciprocal rights and obligations that included, but were not confined to the transfer of the CGP share. The commercial understanding of the parties was that the transaction related to the transfer of a controlling interest in HEL from HTIL to VIH BV. The transfer of control was not relatable merely to the transfer of the CGP share. Inextricably woven with the transfer of control were other rights and entitlements which HTIL and/or its subsidiaries had assumed in pursuance of contractual arrangements with its Indian partners and the benefit of which would now stand transferred to VIH BV. By and as a result of the SPA, HTIL was relinquishing its interest in the telecommunications business in India and VIH BV was acquiring the interest which was held earlier by HTIL.”

Before this judgement of the High Court, most of the commentators had criticized the action of the tax Department and even the first judgement of the Bombay High Court dismissing the writ petition on the assumption that the transaction involved was a mere transfer of one share of a Cayman Island Company which gave Vodafone the rights over the entire 67% of VEL. It transpires that that the transaction was infinitely more complex. Hutch had a joint venture with Essar to run telecom business in India. Hutch went out and Vodafone came in with the same right as Hutch. In fact, Vodafone simply stepped into the shoes of Hutch. For that, other shares, rights and interests that Hutch had assiduously built up in India, needed to be transferred.

As expected, Vodafone again filed an S.L.P before the Supreme Court and requested for a stay of the High Court's order. The SC refused this and has asked the Department to quantify the demand within three weeks, and the hearing will now take place on the 25th of October.

Even before the issue could be settled, reports suggest that the lawyers of Vodafone have informed that Vodafone has filed another writ petition against the tax department. It seems that along with its order u/s 201, the tax department had also sent a notice u/s 163 of the IT Act to Vodafone B.V asking it to show cause why it should not be treated as an agent of the seller, the Hutch group. One has to appreciate the fact that tax can be recovered from a non-resident without presence in India only through the expedience of withholding tax or by treating the payer as an agent of the non-resident. Section 163 of the IT Act gives the tax department the power to treat even one non-resident as agent of another non-resident when the non-resident acquires a capital asset in India from the other non-resident. It may be recalled that the Department had initially issued show cause notice to VEL, the Indian JV to show cause as to why it should not be treated as agent of Hutch in India. Although a writ was filed even at that time, nothing further was heard on that front. However, at the time of passing of the 201 order in May, 2010, after studying the matter in detail, it seems the Department wanted to hold Vodafone, the payer itself as agent of Hutch, the payee. Now, after more than 4 months, on the 15 th of October, Vodafone has filed another writ before the Bombay High Court challenging the action of the Department. Vodafone's special counsel is reported to have said that while the core question of jurisdiction is being considered by the Supreme Court, the department has resorted to this different approach to recover the tax from Vodafone in relation to the same demand and hence the writ was filed which will come up for pre-admission hearing on the 29 th October. Section 161(2) of the IT Act does say that when a person is assessable in a representative capacity, he shall not in respect of that income be assessed under any other provision of the Act. It stands to reason that once a person has been assessed as an agent of the non-resident, he may not again be asked to deduct tax at source on the same income but does it work the other way around? Whatever may be the outcome of the writ; this matter is also likely to travel to the Supreme Court. Obviously, the Vodafone saga will continue to enthrall us for some more time to come.

Also see - Vodafone Saga - The Story of Project Comet - Part I