Bombay Chartered Accountants society

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1 Bombay Chartered Accountants society Implications of Vodafone Judgement and Way Forward Pinakin Desai

2 Fact Pattern Listed in Hong Kong & New York HTIL (Cayman Islands) Vodafone plc UK HTI (BVI) Holdings Ltd. Vodafone NL Netherlands CGP (Cayman) Transfer of CGP share to Vodafone NL Array (Mau Co) Investee JV Mauritius 15% options (unencashed) 3GSPL (India) Mau Cos / Ind Co WOS / JV 42% 10% VEL India 2 15 February 2012

3 Fact pattern 1992: Hong Kong based Hutchison Group (Hutch) acquires interest in Indian mobile telecommunication business through a JV company 1998: Incorporation of CGP Investments [CGP] in Cayman Islands : Consolidation of Indian telecom business under HEL HTIL (Cayman Islands), listed on HK & NY stock exchanges ultimate holding company Announcement by HTIL regarding possible sale of equity interest Vodafone bids for acquiring the telecom business Negotiations between HTIL and Vodafone Announcements / filings reiterating acquisition of equity stake FIPB consents to the Vodafone Hutch deal 3 15 February 2012

4 Fact pattern HTIL an active negotiating party to the agreement Vodafone enters into an arrangement for purchase > 50% controlling stake in VEL Warranties provided by HTIL Transfer of CGP shares by BVI shareholder Upward flow of sale proceeds 4 15 February 2012

5 Key issues In the facts of the case, would capital gain accruing to NR seller from transfer of shares of CGP to NR purchaser in a transaction completed outside India be chargeable to tax in India u/s. 9(1)(i) of the Act or otherwise? Is the purchaser of share of CGP liable to withhold tax? 5 15 February 2012

6 Various facets of SC judgement

7 Section 9(1)(i) covers direct transfer S. 9(1)(i) is a fictional provision capturing income accruing directly or indirectly Through or from any business connection in India; Through or from any property in India Through or from any asset or source of income in India; Through the transfer of a capital asset in India. Requires strict construction, cannot expand scope on doctrine of purposive construction Section merely covers a direct transfer of asset situated in India Subject matter of transfer is a capital asset outside India Cannot extend to indirect transfer disregarding look at approach 7 15 February 2012

8 Court favours Look at approach Interpret s. 9(1)(i) adopting Look at approach Nature and character of transaction to be determined by looking at legal form and not effects or incidents Look through permits chargeability having regard to consequential commercial effects or the substance Tax is payable on transaction and not on effects Source of income not based on moving theory of nexus Look-through mechanism cannot shift situs of an asset to India Expression through would not dispense look at approach 8 15 February 2012

9 Court favours Look at approach Look through permitted in case of fraud, devices, sham transactions Onus of proof is on revenue Question of having look through provision in the statute is a matter of policy Express legislation provision required Cannot read the same into statute by purposive interpretation Absence of taxability at the time of exit would not make the entire share sale a sham or a tax avoidant transaction 9 15 February 2012

10 Court discards dissection theory Subject matter of transfer was transfer of CGP share for a slump value / package deal Subject matter of transfer was participative investment represented by CGP share with associated arrangements Transaction not structured as a sale of shares + CI + Rights / entitlements Rights and entitlements which HC regarded as assets located in India Direct and indirect interest of 52% equity shares of VEL Indirect interest of 15% in VEL through call options held by Indian partners Right to do business through telecom license Non compete in India ; Acquisition of right to use Hutch brand Management rights over VEL under SHA No split of consideration envisaged or even provided to FIPB Certain extinguishments were because of sale of shares February 2012

11 Recognition of consequential effects CGP share carried congeries of rights Shares and various rights attached therewith flow together and cannot be dissected Controlling interest a commercial concept Controlling interest in step down subsidiaries Indirect equity stake Indirect control over GSPL (which held options to 15% interest) Right to appoint directors; right to manage downstream subsidiaries Protective rights under SHA / under AOA; including ROFR, TAR, options, etc. Non compete Agreement as an adjunct of share transfer February 2012

12 Tainted by tax avoidance? SC in McDowell (154 ITR 148), 5 member bench Tax planning is legitimate if within the framework of law, Colorable devices cannot be part of tax planning (4 member decision) Principle in Duke of Westminster (taxpayer can arrange his affairs so as to reduce tax liability) is dead, principle in Ramsay (tax avoidance schemes to be ignored) is the right approach (fifth member Justice Chinnappa Reddy) SC in Mathuram (8 SCC 667), 5 member bench Taxpayer is not to be taxed by inference or analogy, but only by the plain words of a statute applicable to the facts and circumstances of each case SC in Azadi Bachao (263 ITR 706) An act which is otherwise valid in law cannot be treated as non est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interests February 2012

13 Tainted by tax avoidance? Tax Authority: Decision in Azadi Bachao (263 ITR 706) on tax avoidance needs a re-look Divergent view taken from its earlier 5-member judge decision in McDowell Vodafone relied on Azadi Bachao and argued Every attempt at tax planning is not illegitimate Acts otherwise valid in law not non-est merely based on underlying motive Principle laid down in Duke of Westminster [1935 All ER 259] continues to remain in force Tax evasion is different from tax avoidance Taxpayer has a legal right to attract the least amount of tax Tax avoidance within the four corners of law permissible February 2012

14 No conflict between McDowell and ABA Interpretation of the SC ruling in McDowell Majority ruling accepted tax planning to be legitimate if within the framework of law Colorable devices not a part of tax planning Separate ruling by the fifth judge dealt with Tax evasion through colorable devices by resorting to dubious methods and subterfuges Nowhere mentioned in the ruling that tax planning is illegitimate/impermissible Fifth judge himself agreed with the majority ruling No conflict between McDowell and Azadi Bachao No consideration by a larger bench is required McDowell and ABA are reconcilable McDowell principle as relevant to interposed intermediate steps February 2012

15 Judge made anti-avoidance Rule SC not concerned with statutory GAAR Not averse to tax planning, tax saving motive, or treaty shopping However, no acceptance of : colourable devices, pre-ordained schemes tax frauds, dubious methods Onus on revenue to establish trigger Threshold of impermissibility prone to subjectivity Considerations different for statutory GAAR or LOB February 2012

16 Right to Exit MNC has right to exit participative investment Exit coupled with continuity : A sign of strategic investment Transition is a very wide concept Usual to deal with contingencies from date of SPA to completion Holding on to standstill position creates no fresh right Certain arrangements integral to exercise of exit right Transit use of brand No compete Call / put options Settlement of possible disputes Framework agreements Assignment of loans Warranties by parent February 2012

17 Parent subsidiary and corporate veil Each company a separate entity A shareholder does not own assets of company No conflict with commercial concept of equity interest or stake WOS is no exception Parent, subsidiaries work as a group A parent may exercise parental influence; may provide guidance A subsidiary may consider requests of the parent A parent may propose exit option for subsidiary Lifting corporate veil an exception Onus on tax authority Beware : Role as a puppet; executive directors subordinated Abuse of corporate form merely for fiscal nullity Equity transfer to re-characterize as per economic substance February 2012

18 Bonafide Hutchison Structure Not uncommon for corporates to have operating or holding compaines Several commercial reasons may contribute to the structure Emergence of structure on incorporation, acquisition, re-organisation 6 factor test to holistically judge strategic investment for commercial purpose (Para 68, Para 73) Investment to participate Duration of time during which the holding structure existed The period of business operations in India Generation of taxable revenue in India during the period of business operations The event of exit The continuity of business on such exit, etc. Short lived guest appearance for tax avoidance disapproved as abuse 6 factor bench mark; an overall impression test!! February 2012

19 Bonafide Hutchison Structure If bonafide structure, factors not so relevant: Third country participation Entire funds received from a foreign parent Controlled/managed by a foreign parent No assets in SPV other than investment / in Indian Co. Dominant role of parent in deciding time and price of disinvestment Sale proceeds transferred as special dividend / loan repayment Real/beneficial owner was the foreign parent!! February 2012

20 Rationale for exit at CGP level CGP was a part of bonafide structure of Hutchison Commercial rationale for exit at CGP layer Exit at CGP layer had ease of transfer, Facilitated transfer of GSPL with attached rights; Avoided multiple transfers, etc. Need for justifying exit at a given layer? February 2012

21 Contractual right SHA is a contract between shareholders for internal management A shareholder has a right to enter into SHA AOA is a public document Right to vote in a particular manner is recognition of right to vote Contractual right is not a property Extinguishment would not ignite capital gains chapter! In any case, no movement of any such right No compete covenants February 2012

22 India-Mauritius DTAA Absent LOB, treaty unlikely to be disregarded owing to third country participation Tax efficiency motive is in realm of permissible tax planning in absence of LOB Even for DTAA, a subsidiary and parent are separate taxpayers Prime controversy is invocation of anti avoidance principles (majority) DTAA may not be respected, if fraud, round tripping or impermissible abuse TRC not sacrosanct in case of colourable device February 2012

23 Section : 195 / Section 163 No tax withholding obligation, since income not chargeable to tax. Extra territorial operation valid if there is tax presence What constitutes tax presence? Would parameters differ for income recipient v/s. tax deductor? Tax presence not to be viewed qua unrelated transaction In context, S. 195 can apply only to a resident payer. (Justice RK) Tax presence of NR immaterial!! February 2012

24 Key take aways Sets a binding precedent for taxpayer/ tax authority while dealing with other similar transactions Indirect transfer of underlying Indian assets not taxable in India either under judicial illegitimate tax avoidance principle or under source rule Reiterates judicial position on tax avoidance Legitimate tax planning within framework of law permissible; but tax authority can disregard colourable devices/ sham transactions Reinforces the view on Mauritius tax treaty Circular 789/ TRC cannot be disregarded in the absence of LOB provisions; sham/colorable device an exception February 2012

25 Key take aways Acknowledges the use of holding companies/ offshore financial centers in corporate structures May provide greater certainty to taxpayers on M&A transactions/ use of Mauritius tax treaty Recognizes the importance of stability and certainty in fiscal/ tax policy from a taxpayer/ foreign investor perspective Advice to modify Government Policies February 2012

26 Way ahead Acceptance of decision Retrospective amendment? For a deductor!! Clarificatory amendment!! Review petition? Enquiry/ investigation into facts Negotiating LOB in DTAA Toning down CBDT Circular following Justice Radhakrishnan Enactment of anti avoidance provisions February 2012

27 Vodafone and GAAR SC concerned with judicial anti avoidance principles GAAR a legislative mandate GAAR raises a presumption against the taxpayer Shift of onus to taxpayer February 2012

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