There are many legal experts in the area of international taxation who, while trying to ingratiate themselves with their foreign principals, don’t even bat an eyelid before badmouthing the Indian tax administration at the slightest pretext. There is in fact a competition to outdo each other in their vituperative outpourings with the sole aim to attract the client - the more vicious one is, the better it is.

The Vodafone judgement has again brought to the fore such competitive tongue-lashing. One of the comments that I find absolutely stupefying is the summary by Catheleen Phillips, Editor of Tax Notes International, a very respectable tax magazine - ‘the experts’ expert’. In the context of the Vodafone judgement, referring to an analysis by Indian experts, she says: "There has been a fog of corruption hanging over India’s governments and courts. The Supreme Court’s ruling could be a sign that judges are less susceptible to accepting bribes from the country’s top officials." Now, this is an allegation that I have never heard before. Why should ‘top officials’ try to bribe the judges and that too for trying to uphold the revenue’s point of view? One can understand the top officials trying to extract a favour from Vodafone but trying to bribe judges to get a judgement against Vodafone? Beats me!

In the last article on Vodafone, we saw how the Supreme Court while discussing tax evasion and tax planning chose to ignore a larger Bench decision in the McDowell case. In the present article, we analyse the views of the Supreme Court in relation to the use of conduit companies, tax havens, treaty shopping and try to compare the same with views of the courts of some other countries. We find that despite the worldwide outcry against the deleterious effect of tax havens on the Revenue, our Supreme Court continues to believe that it is perfectly honourable to do business with these jurisdictions. It is also important to mention that India has apparently taken the lead in the fight against tax havens as evidenced by the Seoul declaration of the G-20 and which the Finance Ministry never fails to highlight.

In this context, let us examine the following observation of the Supreme Court main judgement:

"… It is a common practice in international law, which is the basis of international taxation, for foreigners to invest in Indian companies through an interposed foreign holding or operating company, such as Cayman Islands or Mauritius based company for both tax and business purposes. In doing so, foreign investors are able to avoid the lengthy approval and registration processes required for a direct transfer (i.e., without a foreign holding or operating company) of an equity interest in a foreign invested Indian company…." (Emphasis supplied)

This is an astonishing statement coming out of our Supreme Court. Instead of coming down hard on the practice of foreign companies using conduit companies in tax havens for investing in India to get around not only laws relating to investment in India but also taking tax treaty benefits, the Supreme Court encourages the same! And what is the reasoning of the Court? Supposedly, it is a common practice. Well, if it is a common practice for multinationals to evade taxes in India, should the same be encouraged? And, the following statement that the foreign companies are able to avoid lengthy approval and registration processes. Where from does our Supreme Court get this idea? It is much too naïf to think that the investments through Cayman Island/Mauritius are made to avoid lengthy processes? The Hon’ble court goes on to find both tax and business purpose in such investments without examining the glaring facts surrounding such investments where it is always hard to find any business purpose.

In the Azadi case, the Supreme Court has given sanction to the practice of treaty shopping in the name of foreign investment. Whenever this cozy scheme of things has been challenged, the tax planners and accountants and the spin-doctors of the Mauritius Government invariably insist that it is because of the Mauritius treaty that India has received so much of foreign investment and that it will be undesirable to upset the apple cart. The logical corollary of such an argument is that no foreign investment will come to India if treaty shopping is not allowed. Apart from the moral and other legal aspects, the effect of allowing treaty shopping through Mauritius is that capital gains escape tax in India (and Mauritius does not tax the same). But, why this fixation of channeling investments through Mauritius and, of late, through Singapore and UAE? Why should the government give such non-transparent tax breaks only to foreign investors? And this is not done after any debate or discussion in Parliament or elsewhere. One must remember that the domestic investors are the ones supporting the Governments’ programmes by paying their due taxes. If the government cannot ignore foreign investors, can it do without the domestic investors? Then why not give equal treatment to all? Why not make capital gains completely tax-free for all investors from all jurisdictions? There will then be a flood of investments, domestic and foreign. The answer probably is that allowing tax break through Mauritius route facilitates laundering of their black money by the rich, powerful and the connected and showing the same as precious foreign investment.

It must also be remembered that despite protestations to the contrary from the Mauritius government, shell companies can be formed in Mauritius in two days with a minimum capital of $1 and a two local directors (source Outlook India). Moreover GBC-1 companies are formed by foreigners in Mauritius and are specifically targeted to do business outside Mauritius. These so-called Mauritius companies are not allowed to do any business in Mauritius. It is most unfortunate that the Supreme Court did not use the opportunity to go into the details of such schemes.

In the context of examining the SPA, the Supreme Court also mentions (in Para 75): "Exit is an important right of an investor in a strategic investment." Although it is not specifically stated, it seems that the Court is advocating the legitimacy of the SPA by devising an exit without payment of tax. While there cannot be any question about the fact that the exit option should be available to an investor, how does it ipso facto follow that the exit must be without any payment of taxes? Again, what is the rationale of allowing a tax-free exit only for foreign investors as compared to the domestic investors?

We have seen earlier that while legitimizing aggressive tax planning, the Supreme Court has quoted extensively from many British tax cases to point out that the Westminster doctrine is not dead; that taxpayers are free to organize their affairs in a way so as to minimize the tax liability. While doing so, there was an attempt to demonstrate that the Ramsay doctrine, which represented the opposite end of the spectrum and was frequently applied by the Inland Revenue, was also dead; that British courts now have gone to the other end of the pendulum. In particular, justice Radhakrishnan, refers to the judgement in the case of Barclays Mercantile Business Finance Ltd v. Mawson (BMBF) and the following quote from a subsequent article by Lord Hoffman in ‘Tax Avoidance’: " the primacy of the construction of the particular taxing provisions and the illegitimacy of the rules of general application has been reaffirmed by the recent decision of the House in "BMBF". Indeed, it may be said that this case has killed off Ramsay doctrine as a special theory of revenue law and subsumed it within the general theory of the interpretation of statutes."

It is surprising however to note that when so much is being discussed about the British jurisprudence on tax evasion and tax planning, one of the latest on the subject by the UK Supreme Court in the case of Tower MCashback has not been discussed by the judges. (It seems that the Revenue had mentioned this case though.)

In MCashback, the UK Supreme Court considered both BMBF as also the earlier Ensign Tankers case. The case involved a tax planning scheme where under wealthy sportspersons, rock stars would have been able to save taxes through claim of first year allowance on software on four times their investments made. The case went in favour of the taxpayer till the stage of court of appeals. The appeals court judge had, inter-alia, held as follows: "In the absence if a finding of sham the only conclusion open to him (the tax inspector) was that the whole of the consideration for the software… was expenditure incurred on the provision of plant within the meaning of section 11 of CAA 2001."

In this connection the Supreme Court of UK held that though it is not enough for the HMRC in attacking a scheme of this sort, simply to point to money going round in a circle, however, it is also not the law that unless one finds the transaction to be a sham, the only possible conclusion was that the whole of the SLA was expenditure incurred on the provision of software. It was held that in the context of a complex pre-ordained transaction, the Court’s task is to test the facts, realistically viewed, against the statutory test, purposively construed. (See official summary of the case)

While writing his judgment in favour of Revenue, Lord Walker concludes as follows (Para 80):

"If a majority of the Court agrees with my conclusion, it is to be expected that commentators will complain that this Court has abandoned the clarity of BMBF and returned to the uncertainty of Ensign. I would disagree ... Any uncertainty that there may be will arise from the unremitting ingenuity of tax consultants and investment bankers determined to test the limits of capital allowances legislation." (Emphasis supplied)

The view taken by the Supreme Court in relation to tax evasion and tax planning is thus not in sync with the thinking on the subject elsewhere. The Supreme Court refuses to give purposive construction to the law on the ground that the scope of a deeming fiction cannot be enlarged. It also refuses to view the transaction realistically and commercially. In fact, the stand taken by the Supreme Court seems to be a departure from the current thinking on the subject.
The Vodafone case was not a case involving any treaty. Nevertheless, the Court got drawn in the process and made certain unnecessary observations, which seem to reiterate the Azadi view that treaty shopping is inevitable for India for the sake of foreign investment.

This attitude of our Supreme Court is again in marked contrast with the view taken on the subject by Courts in other countries. In particular, we may make reference to the observation of the Supreme Court of Canada in the Crown Forest case. In this case, the assessee Crown Forest rented barges from Norsk, a company that was incorporated in the Bahamas but whose office and place of business was in the USA where it was considered as a foreign corporation whose income from barge rentals was exempt under Internal Revenue Code. The assessee applied for reduced withholding rate in respect of the rentals under the Canada-USA treaty. The Court negatived the claim and in relation to treaty shopping, Justice Iacobucci held as follows:

"The goal of a Convention is not to permit companies incorporated in a third party country (the Bahamas) to benefit from a reduced tax liability on source income merely by virtue of dealing with a Canadian company through an office situated in the United States…. There is no reason to assume that, in the context of this case, Canada entered into a treaty with the United States with a view to ceding its taxing authority to a jurisdiction that is a stranger to the Conventions, namely the Bahamas….

It seems to me that both Norsk and the respondents are seeking to minimize their tax liability by picking and choosing the international tax regimes most immediately beneficial to them. Although there is nothing improper with such behaviour, I certainly believe that it is not to be encouraged or promoted by judicial interpretation of existing agreements…."

The Court held that if the taxpayer’s interpretation was accepted, a foreign corporation whose place of management was in the USA would be a resident of the USA for purposes of the convention notwithstanding that such a corporation might not have any effectively connected income to the USA and hence no US tax liability at all. The judge observed: "I find this possibility to be highly undesirable. " Treaty shopping" might be encouraged in which enterprises could route their income through particular states in order to avail themselves benefits that were designed to be given to residents of the contracting states. This result would be patently contrary to the basis on which Canada ceded its jurisdiction to tax as the source country, namely that the U.S as the resident country would tax the income."

The Honourable Supreme Court’s observations in the Vodafone case are thus not in line with the current thinking on the subject relating to tax planning, tax evasion and treaty shopping.

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

(To be concluded)