In this blogpost, Mohammed Azharuddin, legal counsel at Borderless Access Panels Pvt. Ltd and a student of Diploma in Entrepreneurship Administration and Business Laws by NUJS, writes about, the case study of how did vodafone avoid capital gains tax through clever structuring. 

In order to recognize the concept highlighted in this topic, one must first understand as to what exactly constitutes “capital gains tax” and how it is levied under the Indian legal and taxation parlance. Capital Gains Tax as defined by the Income Tax Act, 1961 constitutes “Any profits or gains arising from the transfer of a capital asset” hence any income derived from a capital asset which can be either moveable or immovable is liable to be taxed as per Indian Tax laws.

Bearing relevance to this topic is whether if the shares of a company also fall under the ambit of Capital Gains Tax, the IT Act in this regard specifies that there are mainly two types of Capital Gains Tax.

The first would be Short-term capital gains tax, which is applicable if a person or an entity which owns shares of a company for a period of less than 12 months before selling them and the second would be long term capital gains which is applicable if the shares of a company are owned for more than 12 months before selling the shares.

This information would help us in assessing and analysing the case of Vodafone’s Capital Gains Tax.

Brief Facts

Parties Involved

• Vodafone International Holdings BV (VIH)
• CGP Investments (Holdings) Ltd
• Hutchison Telecommunications International Ltd (HTIL)
• Hutchison Essar Limited (HEL)

Overview of the Transaction

Vodafone International Holdings BV, which forms a part of the Vodafone Group, incorporated in Netherlands intended to buy the entire share capital of CGP investments Holdings Ltd, which in turn had its base in the Cayman Islands. Now, Hutchinson Telecommunications International Ltd being a Hong Kong-based entity was the owner of CGP Investments Holdings Ltd and controlled its affairs. CGP Holding Ltd through various contractual agreements happened to own 67% in its Indian subsidiary namely Hutchinson Essar, which was a joint venture between Hutch and Essar.

After the completion of the instant transaction, Vodafone attracted a Capital Gains Tax of nearly INR 12,000 Crore in a deal which was worth over $11 billion (INR55,000 Crore).

• Note: Since Hutch was the seller and the Indian tax convention mandates that the buyer shall pay the capital gains tax to the authorities on behalf of the seller hence, Vodafone was expected to pay the tax and not hutch.

Legalities of the Transaction

Since the concept of Capital Gains Tax has already been explained earlier, it becomes pertinent to note that Vodafone structured the entire deal in such a manner that it gave room for Vodafone to avoid payment of Capital gains taxes to the Income Tax Authorities. The acquisition being a billion dollar transaction was based on such a model that it refrained from showcasing any record of it having taken place in the Indian soil. Tax haven’s such as the Caymen islands were chosen to structure the deal so that the capital gains tax could be avoided in the Indian Territory.  Vodafone’s main stand against the contention of the Income Tax authorities of “Vodafone being liable to pay the taxes since the intention of Vodafone was to purchase the 67% shareholding under Hutchinson Essar, which was a company based out of India and also that the gains were liable to be taxed since as the transfer of controlling stake had taken place in India” was that neither Vodafone nor Hutch was liable to pay the taxes as the entire transaction was carried out outside Indian Jurisdiction hence making the deal a jurisdictional issue rather than a transactional issue.

Some of the main viewpoints noticed and conveyed by the Bombay High Court in its verdict after Vodafone filed a writ petition challenging the jurisdiction of IT Authorities are as follows:

• Since the matter concerned itself with jurisdictional and territorial issues, sec 9 (1) of the IT Act 1961 was widely interpreted to mean that the fundamental assets and business of Hutchinson Essar is in India and the Capital Gains from the transfer should be subjected to Capital gain tax in India.
• The crux of the entire transaction was to have a controlling interest in Hutch Essar India, and the structuring of the share purchase agreement between the parties was the evidence of this fact.
• The Hon’ble High Court of Bombay further noticed that “The commercial and business understanding between the parties postulated that what was being transferred from Hutchinson Telecommunications International Limited to Vodafone International Limited was the controlling interest in Hutchinson Essar Limited. Hutchinson Essar Limited was at all times intended to be the target company and a transfer of the controlling interest in Hutchinson Essar Limited was the purpose which was achieved by the ”

The Bombay High Court in its verdict upheld the matter in favour of the Income Tax Authorities. The issue was later brought up before the Hon’ble Supreme Court by way of Vodafone International Limited filing a petition before the apex court.

The Hon’ble Supreme Court in its verdict overturned the Judgement passed by the Bombay High Court and made the following observations.

• In its broad interpretation of section 9 of the IT Act 1961, the Supreme Court held that the presence of three elements is required to conclude that Income is deemed to accrue in India which are i) “Transfer”; ii) the existence of capital; iii) location of such assets in India.

The Supreme Court held that in the instant scenario neither the capital asset exists in India, not the capital asset is situated in India.

• It was also observed that the transaction was held between two entities belonging to the foreign jurisdiction on a principle to principle basis and the same is outside the territorial tax jurisdiction of India.

• The Apex court opined that “look at” approach needs to be adopted rather than a “look through” approach. Further held that the word underlying asset ‟ is not covered anywhere in section 9 of Act.

Conclusion

Based on the careful study of the entire transaction and as per the findings of Supreme Court, it can be concluded that:

• Contrary to the popular belief that Vodafone was expected to pay the Capital Gains tax, the Supreme Court highlighted the legalities for the IT Authorities to have enabled to collect the taxes.

• As per the existing state of affairs the apex court has held that section 9 of the IT Act can be invoked only when a capital asset is located in India.

• Vodafone through its careful structuring pattern could avoid payment of taxes worth INR 11,000 Crore.

• The court also held that any transactions should not be arranged in such a manner which would entail any entity to avoid the payment of taxes.