THE Standing Committee report on the DTC Bill is out. The Budget is coming. It is time for us then to wrap up the discussion on the Vodafone case although there are many issues yet to be covered.

The action of the Revenue in the Vodafone case has been criticized mainly on the ground that the Revenue has tried to tax capital gains arising out of the transfer of share of a foreign company and thereby bringing in the concept of extraterritoriality, which is an anathema to many. The facts are, however, not that simple. The Supreme Court in its judgement also seems to fall into the same trap. The Hon’ble Chief Justice writing the judgement for the Court mentions at the very beginning that “this matter concerns a tax dispute involving the Vodafone Group that the Indian Tax Authorities, in relation to the acquisition by Vodafone International Holdings B.V., a company resident for the tax purposes in the Netherlands, of the entire share capital of CGP Investment (Holdings) Ltd. ….. and further he mentions ….. “In short, the Revenue seeks to tax the capital gains arising from the sale of the share capital of CGP on the basis that CGP, whilst not a tax resident in India, holds the underlying Indian assets.”

As the discussions in the subsequent paras will reveal, there is a very basic and fundamental flaw in this statement. The Court, it seems, starts with the conclusion that it was a case of transfer of share of a foreign company by one foreign company to another foreign company and thereafter argues as to why the capital gains arising from such a transaction could not be charged to tax in India even if the underlying assets in the transaction were shares of Indian companies operating telecom licences in India. The court then goes on to a long spiel about tax evasion, tax planning, lifting of corporate veil, whether one has to look at or look through while interpreting section 9 etc., which were all incidental arguments. But, I do not find anywhere in the Court’s judgement a categorical finding about the real subject matter of the transaction. Consequently, the entire superstructure of arguments built on this flawed foundation, in turn, becomes flawed.

For the record, the Tax Department has nowhere stated that it was interested in taxing the transfer of underlying assets, which arose from the transfer of the shares of CGP. The Department’s primary case was that there was a transfer of 67% of the interests in an Indian company by Hutch and since such interests represented capital assets which undisputedly were situated in India, the capital gains arising therefrom were taxable in India under section 9 of the Income-tax Act which lays down that income from direct or indirect transfer of a capital asset in India is deemed to arise in India. The other related issues were Vodafone’s liability to deduct tax at source from the payments made by it to Hutch as also its liability to be treated as an agent of the non-resident. But these are subsidiary issues, dependent on the answer to the primary question as to what in the facts and in the circumstances of the case was the real subject matter of the transaction. It may also be mentioned that the countries involved in the transaction being Cayman Islands and Hong Kong, no tax treaty could come into play and there was no question of determining whether India had the taxing right under any treaty even if under the domestic law, the transaction could be taxed in India

It is also important to remember that the issue before the Supreme Court was the order passed by the Revenue u/s 201, Vodafone having lost in its procedural challenge right up to the Supreme Court. In this order which runs into more than 700 pages, the Department’s argument all along has been that there was a transfer of interests in an Indian company; that this was borne out from a reading of the Sale Purchase Agreement that Vodafone entered into with Hutch; that if the said SPA, which was a document of more than 300 pages was properly examined and understood in the proper context, there would not be an iota of doubt that the subject matter of the transaction between the Hutch group and the Vodafone group was the acquisition of the Indian assets. It may be mentioned that the Sale Purchase Agreement itself was not produced before the Tax Authorities in the first instance and it was only after the intervention of the Supreme Court that the same was ultimately produced. (For a backgrounder see Vodafone Saga Part II: What happens When Venus takes over Moon). The issue therefore ultimately boils down to the proper interpretation of this document. Unfortunately, the Supreme Court has not gone into it and its reference to the SPA is only superficial.

This voluminous document mentions the Cayman Island Co. in just one place in clause 2 and in all other places the reference is to the Indian company or the telecom business in India. The fact that the subject matter of the transaction was transfer of shares of Indian company is further corroborated by the Hutch offer document, which nowhere mentions the transfer of CGP shares. It always mentions 67% of shares of the Indian company. Similarly, the acceptance by Vodafone again nowhere mentions that the subject matter of the transaction was the shares of the Cayman Island Co. It is elementary that before an agreement fructifies, there is an offer and there is an acceptance. There was an offer by Hutch. It does not refer to transfer of CGP share. There was an acceptance by Vodafone. It does not refer to the CGP share. In fact, as was pointed out by the Ernst and Young due diligence report, CGP was inserted as an afterthought and at the instance of Hutch.

The order u/s 201 raised a number of questions, which required answers to arrive at the real nature of the transaction between Hutch and Vodafone. Some of these were as follows:

• If in actual fact the transaction related only to the sale and purchase of one share of US$1 of CGPC, what was the need to stipulate in Clause 1.18 of the SPA that in the case of a claim, the value of the claim will be translated into US$ at the RBI Reference Rate?

• The Agreement was conditional upon the consent of the FIPB to be obtained by the purchaser. If the subject matter was only the sale and purchase of one share of CGPC, a Cayman Islands based company, what was the need for any approval from the FIPB and why was it stipulated that in case the FIPB approval was not received, the agreement would fall through?

• If it was not the case of a transfer of 67% interests in HEL, the Indian company, what was the necessity for Hutch to intimate its joint venture partner Essar about the signing of the Agreement between HTIL and Vodafone?

• Para 7 of the schedule 4 to the Agreement concerning compliance with laws and regulations clearly spelt out that each of the group companies should be in compliance with the laws of India with regard to foreign ownership restrictions and FDI rules as also other applicable laws and regulations. Why was this condition necessary if it the subject matter of the transaction was not the transfer of 67% interest of Hutch in HEL but was of transfer of one share of CGP?

• Clause 9.5 of the SPA stipulates that for any breach of the Agreement the basis for ascertaining the damages would be whether HTIL has fulfilled its obligations not only to procure delivery of, but to deliver 67% of the share capital of HEL to Vodafone and in case of breach, HTIL will be deemed to have transferred 67% of the issued share capital of HEL to the purchaser i.e. Vodafone. If the essence of the SPA was the transfer of one share of CGP, in case of any breach, should it not have been enjoined that the share of CGP should be delivered to Vodafone?

There are a number of case laws including from the Supreme Court of India that lay down the proposition that in assessing the true nature and character of a transaction, the label, which the parties may ascribe to the transaction, is not determinative of its character. The nature of the transaction has to be ascertained from the covenants of the contract and from the surrounding circumstances. As pointed out by the Bombay High Court, in interpreting contracts, there is a trend towards an objective theory of contract, which gives effect to the reasonable expectations of honest people. It is by applying these principles that the Bombay High Court had held that from the perspective of Income Tax Law what is relevant is the place from which or the source from which the profits or gains have generated or have accrued or arisen to the seller. In the present case, it is undeniable that the income accrued and arose as a consequence of the divestment of HTIL’s interest in India. If there was no divestment or relinquishment of its interest in India, there was no occasion for the income to arise. Thus, the real taxable event was the divestment of HTIL’s interests, which in itself had various facets or components that included a transfer of interests in different group entities.

The discussion above will indicate that on a proper appreciation of the surrounding circumstances and the sale purchase agreement entered into by the parties themselves, it was the telecommunications business operations of the Hutchison group in India along with all accompanying assets, rights, and interests, which was the subject matter of the transaction between HTIL and Vodafone and that all these assets, rights, interests were situate in India, for effecting the aforesaid transfer of Indian assets. The judgement of the Bombay High Court clearly indicates that the entire interests of Hutch in India could not be transferred through the sale of one CGP share. Even for the sake of argument, if it is assumed that it could do so, Hutch could transfer its controlling stake in the Indian Company HEL directly to Vodafone resulting in the transfer of shares of HEL to Vodafone, which would have definitely given rise to capital gains in India. Hutch could also possibly pass over the control of its Indian assets through transfer of shares of the Mauritius intermediaries, which held the shares of the Indian companies, or the CGP share could be transferred. In all such scenarios, the subject matter of the transaction is Hutch’s interests in the telecom business in India, which it had built up in course of the years. The mode of transfer in each case would only be different and logic demands that such difference in the mode of transfer should not affect the subject matter of the transfer.

These then were the real issues in this case. The Revenue in its order u/s 201 very clearly mentioned that the basic question that needed to be addressed was as to what in effect was the subject matter of the transaction between Vodafone and HTIL and that the answer to this core question was at the very root of determining the taxability or otherwise of the transaction in India. The Bombay High Court having found in favour of the Revenue on this factual aspect, one would have expected the Supreme Court to at least point out what was wrong in the said finding. Instead, we find the Supreme Court start its judgement by assuming that what was transferred was the share of CGP outside India. Once that assumption is made, the rest of the decision follows and the Revenue is justified in feeling aggrieved that its case has been dismissed without going into the roots of the issue.

(Three-part Series Concluded)

Also See:

Vodafone Judgement: Invest in India and get Full Azadi from capital gains tax

Vodafone Part II - Pay No Taxes - Treaty-shop, Invest & Go!