The landmark judgement was made by the Supreme Court of India in Vodafone International Holding (VIH) v. Union of India (UOI). In the transaction dated 11.2.2007 between VIH and Hutchinson Telecommunication International Limited or HTIL, the Bench consisting of Chief Justice S.H Kapadia, K. S. Radha krishnan and Swatanter Kumar quashed the order of the High Court of claim for Rs 12000 crores as capital gain tax and exempted VIH from responsibility for payment of Rs 12000 crores as capital gain tax(non-resident company for tax purposes).

The court held that the Indian revenue authorities do not have authority to tax an offshore transaction between two non-resident companies where the non-resident company is purchased in the transaction in order to control the interest in the (Indian) resident company.

After the proposals made by Prof. Kaldor to levy tax on benefits arising from any transfer or selling of the specified non-stock resource, i.e. non-inventory properties, the introduction of CGT in India goes back to 1956. As it stands today, CGT is collected on the transfer of any Capital Asset (other than held as stock-in-exchange / trade) due to steady growth, which is done with the appropriate mechanism referred to in Sections 45-55A of the IT Act. Section 2 (14) of the Act on Income Tax, characterizes the expression "Capital Assets".

It is defined as combining any kind of property, regardless of whether set, streaming, dynamic, steady, substantive or immaterial, and whether used with his company's final target and calling. Rejections under Section 2 (14) of the IT Act are likewise calculated. Capital gains are usually assessable in the year in which the transfer of capital assets has taken place. The word 'transfer' is specified by section 2 (47) of the Income Tax Act.

Sale, relinquishment, swap, or any compulsory acquisition of the asset or extinction of any rights in that asset is included in the word 'transfer' in relation to Capital Asset. The capital assets are split into two groups with the overall aim of computing income tax:

• Long Term Capital Assets
• Short Term Capital Assets

It is important that the procedure for measuring taxable income and the speed of assessments for all forms of capital gains are diverse. Momentary or Short Term Capital Assets refers to any asset owned by an assesse for a period not exceeding three years, quickly preceding its transfer date. Then again, Long Term Capital Assets applies to any asset owned by an assesse for more than three years, quickly prior to its transition date.

However, the above rule of three years has certain extraordinary circumstances wherein such period is taken as years i.e. 12 months are as follows:

• Securities like debentures, etc. which on a recognized stock exchange is listed
• Equity or preference shares which may be quoted or unquoted of a company
• Units of a Mutual funds, etc.
   

Case Of Vodafone: The Realistic Review
In February 2007, the Dutch group Vodafone International Holding (VIH) purchased 100 % of the shares in CGP Investments (Holding) Ltd (CGP), a Cayman Islands group, from Hutchison Telecommunications International Limited for USD 11.1 billion. 67% of Hutchison Essar Limited (hereinafter HEL), an Indian Company, was governed by CGP through various transitional organisations / authoritative courses of action. The acquisition resulted in Vodafone acquiring control over CGP and its subsidiaries downstream, including eventually Hutchison Essar Limited. HEL was a joint effort between the gathering at Hutchison and the gathering at Essar. As of November 1994, it had obtained telecom licences to provide cell contact in different circles in India.

In September 2007, Vodafone Company received a show-cause notice from the Indian Tax Department to explain why tax was not withheld on payments made to HTIL in connexion with the transaction in question above. The tax department argued that the aforementioned transaction involving the sale of CGP shares had an effect on the aberrant or indirect sale of India-based properties. Among other items, Vodafone filed a petition with the Bombay High Court questioning the jurisdiction of the tax authorities in this matter, where the Court held that the Indian income tax authorities had jurisdiction over this matter. In the Supreme Court of India, the order was then appealed.

In 2009, the Court ordered the tax authorities to decide initially, by appeal in the present case, on the jurisdictional question presented before the court. The tax authorities announced in May 2010 that they were entitled to continue proceedings against Vodafone on account of their alleged failure to withhold tax on instalments made under Section 201 of the Income Tax Act. This order was challenged in the Bombay High Court by Vodafone.

Vodafone 's appeal against the order was dismissed by the Bombay High Court. In compliance with Article 136 of the Indian Constitution, Vodafone then filed a Special Leave Petition (SLP) against the High Court's decision before the Supreme Court. The SLP was approved and admitted in November 2010, and Vodafone was also ordered by the Supreme Court to deposit a total of INR 25000 million within three weeks and to provide a bank guarantee of INR 85000 million within two months from the date of the order.

Should the indirect transfer of India - based capital assets be subject to taxation?
With regard to Section 9, which states that income is considered to accrue or arise in India if it accrues to or arises from a transfer of capital assets in India or to a non-resident, the Court observed that there is an omission under Section 9(1)(i) of the word 'indirect transfer.'

If the word 'indirect' used is read with the phrase' Capital asset located in India 'on the off chance, then it would be made worthless. And there is no 'look through' clause in Section 9(1)(i) and can therefore not be expanded to include indirect transfers of capital assets located in India. Therefore, the transfer of shares to CGP did not result in the transfer of capital assets located in India and was not subject to taxation.

Transfer of HTIL’s property rights by extinguishment through SPA?
The tax authorities claimed that HTIL's control and management rights over HEL constituted property rights which had been extinguished under the Selling and Purchase of Shares and Loans Agreement (SPA) signed on 15 October 2007. This led to the transfer of the taxable capital assets in question. The Supreme Court ruled that due to the transfer of the Capital Asset and due to the separate SPA clauses, the rights were extinguished.

In addition, the Supreme Court held that the primary justification for CGP was not merely to own stakes of subsidiary businesses, but also to allow a smooth transition in business to take place. It could not be said in this way that CGP had no market or corporate content. The tax authorities claimed, as the case may be, that the transfer of the CGP share was not in itself sufficient to fulfil the intent of the transfer between HTIL and Vodafone Company and that the essence of the transfer was not sufficient to fulfil the transfer of other rights and privileges. It was additionally arguedthat such rights and privileges established Capital Assets and gains from such transfer are liable to taxation.

The Court observed that if a non-resident renders an indirect transition by mistreatment of the corporate structure or legal form and without a fair and valid commercial purpose, resulting in tax shirking or tax withholding evasion, the tax authorities may, at that point, deny the type of plan or operation reproved through the use of holding companies and may re-describe the type of plan or operation reproved through the use of holding companies.

Interpretation of Section 5 and 195 of IT Act?
The income obtained worldwide (counting any income that is real or perceived to be accrued / arise / received) of a person living in India is included within the definition of total income under Section 5(1) of the IT Act. Under section 5(2) of the IT Act, compensation that is assessable or taxable for a non-resident is compensation that accrues or exists or is deemed to have incurred or occurred or earned or is deemed to have earned in India.

Vodafone argued and urged the Court to follow an understanding of Section 195 in compliance with the existing principles of law enforcement and authoritative intent, as it agreed that Section 195 was not applicable to seaward persons making payments / payments from seaward or offshore.

The Court henceforth held that chargeability and enforceability are unique and distinct legal terms and provided certain guidelines by which Section 195 is to be viewed, such as the two conditions suggested by that section, first, there must be a reimbursement / payment made to a non-resident, and such payment must be an aggregate chargeable under the Act, the duty to deduct charge arises.

Information which led to the dispute:
The two non-resident firms are Vodafone International Holding (VIH) and Hutchison Telecommunication International Limited, or HTIL. These companies entered into a deal whereby HTIL exchanged the share capital of its Cayman Island-based subsidiary business, i.e. CGP International or VIH CGP.

As a result of this acquisition, VIH or Vodafone gained a 67 percent controlling interest in Hutch on Essar Limited or HEL, which was an Indian joint venture firm (between Hutchinson and Essar), whereas CGP owned the above 67 percent interest prior to the above contract.

A show cause notice was given by the Indian Revenue Authorities to VIH as to why it should not be treated as 'assesse in default' and requested a clarification as to why the tax was not deducted from the sales consideration of this purchase.

Via this, the Indian revenue authorities tried to tax capital gains resulting from purchases of CGP's share capital on the basis that CGP had Indian assets underlying it.

In the High Court, VIH lodged a written petition seeking the authority of the Indian revenue authorities. The High Court denied this written petition and VIH appealed to the Supreme Court, which referred the case to the Revenue Authority to determine if the revenue had jurisdiction over the matter. The tax authority agreed that they had control over the issue and so the matter went to the High Court, which also agreed in favour of taxation and then finally Special Leave petition was filed in the Supreme Court.

Issue before the Supreme Court
The issue before the Apex court was whether the Indian Revenue Authority had power to tax a sale of shares between two non-resident companies on an offshore transaction whereby the controlling interest of a resident Indian corporation is purchased on the basis of that transaction.

Arguments of Revenue Claims
The revenue argued that the entire trade of HTIL's selling of CGP to VIH was in the substance transfer of capital assets in India and therefore triggered capital gain taxes, which culminated in the transfer of all direct/indirect rights in HEL to VIH, and that the entire selling of CGP was a tax evasion scheme, and the court would use a dissecting approach to investigate the material and not 'look at' it.

Observations made by the Supreme Court
Corporate structures
Multinational corporations also set up corporate structures or associate branches or joint ventures for separate market and financial reasons, mainly aimed at supplying customers with greater returns and allowing the organisation to develop.

Therefore, the responsibility is solely on the revenue to prove that all merger, consolidation and redistribution have been compromised for dishonest reasons in order to defeat the legislation or evade taxation.

Even the Ministry of Corporate Affairs acknowledges certain frameworks consisting of holding companies and subsidiaries under which the holding company can have ample voting stock in the subsidiary to control the management and also suggested that many transnational investments are made mainly in tax-neutral / investor-friendly countries in order to prevent double taxation or plan operations in order to achieve the best returns to investors.

Overseas companies
Due to better investment opportunities, many overseas businesses invest in countries such as Mauritius, Cayman Island, and these are carried out for sound business and sound legal tax planning and not to hide their revenue or properties from the tax jurisdiction of the home country, and such mechanisms have been accepted by India.

Such offshore investments or such offshore financial hubs do not inherently lead to the presumption that tax avoidance requires them.

Holding and Subsidiary Companies
The corporate act agreed that the subsidiary corporation is a different legal body and while the holding company manages the subsidiary companies and the company's respective sector within a community, the idea that the subsidiary sector is different from the holding company is resolved.

The properties of the subsidiaries will be held by the parent corporation as collateral, but these two are both independent companies and the holding firm is not legitimately responsible for the actions of the subsidiaries. except in few circumstances where the subsidiary company is a sham.

The holding company and the subsidiary companies may form a pyramid of arrangements in which the subsidiary company may retain majority interests in other parent companies.

Shares and controlling interest
The sale of shares and the sale of controlling interest can not be deemed to be two distinct activities including the purchase of shares and the transfer of controlling interest.

Unless otherwise specified in the Statute, the controlling interest is not an identifiable or separate capital asset independent of the ownership of shares and is inherently a statutory right and not a right to property which can not be considered as a transfer of property which capital assets.

The purchase of securities may be subject to the transfer of controlling interest, which is a strictly economic term and which is imposed on sales and not on their results.

Corporate Veil
Despite their distinct legal identities, the concept of raising the corporate veil can also be applicable in the relationship between the holding firm and the subsidiary corporation where evidence show that questionable tax avoidance practises have been implemented.

The revenue authorities should look at the transaction in a holistic way and should not proceed with the issue that tax deferment / saving equipment is the disputed transaction.

The revenue authorities may invoke the concept of the dissolution of the corporate veil only after they have been able to determine, on the basis of the facts and circumstances concerning the transaction, that the transaction at issue is a scam or tax evasion.

Tax planning/ tax evasion/tax avoidance
It is universal rule that a tax payer is entitled to coordinate his affairs in order to mitigate the tax burden and the fact that the purpose for the operation is to prevent tax does not invalidate it unless a clear enactment is so given.

It is important that, in order to be successful, the transaction should have some economic or commercial content.

Without a law to help, the income will not tax a subject and any tax payer is entitled to plan his affairs so that his taxes are as low as possible and he is not obligated to select the method that will replenish the treasury.

All tax planning is not illegal and it was acknowledged that, in the case of McDowell, the majority ruled that tax planning is valid given it is within the legal context and that colourful instruments should not be part of tax planning.

Role of CGP
Controlled Goods Program Registration was still part of HTIL's organisational structure, and the selling of CGP 's shares was a genuine economic operation and a strategic judgement that was not questionable and in the interest of customers and corporate bodies.

The site of shares of CGP
CGP shares have been registered on Cayman Island and Cayman Law therefore does not accept the multiplicity of registers and, thus, the location of the shares and the movement of shares is located in Cayman and shall not be transferred to India.

Extinguishment of rights of HTIL in HEL
The sale of CGP shares has immediately resulted in a number of ramifications, including the sale of control interest.

And without legislative action, controlling interest can not be dissected from the CGP share.

The controlling interest may also be passed on to the shareholder along with the shares upon the sale of the shares of the holding firm, and this controlling interest may have percolated down the road to the operating firms, but the controlling interest remains essentially contractual and not a property right until the statue guarantees otherwise.

The purchase of shares which entail the purchase of controlling interest and this is strictly a financial term and the tax can only be imposed on the sale and not on its impact and, subsequently, Vodafone has gained possession of eight Mauritian companies on the conversion of CGP shares to Vodafone and this does not mean that the site of CGP shares has shifted to India for the purposes of charging the shares.

Section 9 of the income tax act
The tax is levied on the basis of the source and this source is the location where the selling process takes place in regard to sales and not where the item of product that was the focus of the process is derived or purchased from.

HTIL and VIH are both overseas companies and the sale also takes place outside India, so the source of revenue is outside India unless this trade is protected by legislation.

The income laws have to be fairly construed and tax should not be collected withoutclear words indicating the intention to lay the burden.

The provision on charging shall be narrowly construed and Provision 9(1)(i) must not be expanded to include, by interpretation, the indirect movement of capital assets to India.

There must be a clear relation between the earnings of income and the territory which seeks to impose tax for taxation.

Section 9 does not have an inbuilt "check in" function and the concept of "check around" shall not move asset locations. Only by explicit clause in this respect may this be achieved.

The Legislature in case wanted to tax “income” which arises indirectly from the assets; the same must have been specifically provided so. The court cited the example of Section 64.

Section 195
The tax involvement must be regarded in the sense of the activity at issue and not in regard to an external matter.

In the event of transfers made by residents to non-resident firms and not by two non-resident companies, section 195 applies.

It is important to analyse the legal existence of transactions.

The present transaction was carried out between two non-resident persons in a contract conducted outside India where the consideration was also rendered outside India and VIH is therefore not legally obligated to respond to the notice referred to in section 163 relating to the purchaser's care as a representative measure.

Decision of the Court
The selling of HTIL's CGP shares to Vodafone or VIH does not lead to the transfer of capital assets under the scope of Section 2(14) of the Income Tax Act and therefore does not attract capital gains tax on all rights and entitlements resulting from the shareholder agreement, etc., which form an integral part of CGP 's shares.

The order of High Court of the demand of nearly Rs.12, 000 crores by way of capital gains tax would amount to imposing capital punishment for capital investment and it lacks authority of law and therefore is quashed.

Conclusion
In Vodafone International Holding v. Union of India, the supreme court released a landmark judgement and explained the ambiguity with regard to the imposition of taxes. Through this judgement, the apex court recognized:

The tax planning rules.
In the absence of any legislative stipulation prohibiting the same, business entities or individuals may arrange the affairs of their business to decrease their tax liability.

Corporate structures are mostly established by international corporations and all of these structures should be established for corporate and economic purposes only.

In cases where evidence and circumstances indicate that the transaction or corporate structure is sham and designed to evade taxes, the corporate veil can be lifted.

Transactions should be viewed holistically and not dissentingly, and the existence of corporate structures in tax-neutral / investor-friendly countries should not contribute to the inference that taxes are supposed to be avoided.

Finally, it can be said that this judgment helped to remove complexities with regard to the imposition of taxes and agreed that the concept that the object of the transaction is to escape tax does not necessarily lead to the hypothesis of tax evasion and the Supreme Court embraced the view of legitimate tax planning.

Written By: Saif Ali Ansari - Galgotias University, Greater Noida
E-mail: [email protected]