Mumbai High Court Remands Vodafone's writ petition

The following is a reproduction of Tax flash edition of Grant Thorton on the Vodafone case

Mumbai High Court Remands Vodafone's writ petition 

The Mumbai High Court Judgment in the Hutch-Vodafone case would most probably turn out to be the most talked about ruling in the history of Indian tax legislation both in terms of the magnitude of the amount involved and the recent thinking of the Indian revenue authorities. The judgment is a remand as the High Court concluded that Vodafone had not exhausted all alternate remedies by stating that there is "prima facie" a tax but also reiterates that Vodafone has not shared any of the critical agreements and since the High Court is required to pronounce more on matters of law than facts – it needs to be remanded back and granted Vodafone an eight week window to file an appeal with the Supreme Court. 

  

Background 

Hutchison Telecommunications International (Cayman) Holdings Ltd (HTIL), a Cayman Islands-based subsidiary of the Hutchison Group (Hutch) held shares in CGP Investments [Holdings] Limited (CGP), another Cayman Islands-based company. Hutch directly and indirectly owned 67% controlling interest in an Indian entity, Hutch Essar Limited (HEL) through CGP. 

  

Vodafone International Holdings BV (Vodafone), a Netherlands-based Company entered into an agreement with HTIL to acquire CGP from HTIL for USD 11.1 billion in February 2007. Vodafone also applied to the Foreign Investment Promotion Board (FIPB) to seek its approval for acquisition of stock in HEL, which was granted subject to condition that applicable Indian laws, including tax law, would be complied with. Pursuant to the agreement, payments were made by Vodafone to HTIL for acquisition of CGP. With regard to the said transaction, the Indian tax authorities issued a show cause notice to Vodafone asking as to why it should not be treated as an "assessee in default" under Section 201 of the Income-tax Act, 1961 (the Act) for not withholding taxes on its payments to Hutch. Vodafone filed a writ petition challenging the validity of the notice before the Bombay HC. 

  

Vodafone's contention 

Vodafone sought to challenge the show cause notice on the following grounds –   

• The Act provided for circumstances where a person could be deemed to be an assessee in default in the event there was failure to deduct tax out of dividend paid under Section 194[1] of the Act or where a person had deducted tax at source and had failed to deposit the same under section 200 of the Act. In the present case, none of these two provisions were applicable. While the writ petition was pending, the Finance Act 2008 was retrospectively amended to add an explanation to Section 191 and substituted the existing Section 201(1) of the Act. The effect of the 2008 amendment provides that a person failing to deduct tax under Section 195 is liable to be treated as an assessee in default and also liable to penalty. The said amendments were therefore arbitrary, unreasonable and violative of Article 14 of the Constitution.

• Even if the amendments were upheld, provisions of Section 191[2] and 201 had to be harmoniously construed which meant that where a person fails to deduct tax at source under Section 195, he is liable for penalty but is not liable for the tax, which continues to be the primary liability of the assessee i.e. the payee (HTIL in this case).

• Section 195 has no extra territorial operation and the expression 'person' occurring in Section 195 must be read to mean a person, resident or non-resident, having a presence in India. As Vodafone was a non-resident, it had no obligation under Section 195 of the Act to withhold any tax on payments made by it. It was further contended that if Section 195 were to apply to non-residents having no presence in India, it would amount to treating unequals equally by imposing upon them the same compliance obligation as a person resident / having a presence in India. Hence, the same would violate Article 14 of the Constitution of India.

• The amount paid by Vodafone to Hutch is not chargeable under the provisions of the Act, hence there is no liability to deduct income-tax at source. The scope of total income as contemplated by Section 5(2) of the Act does not include capital gains arising out of the transfer of assets situated outside India. Such gains also cannot fall under Section 9 of the Act as income deemed to accrue and arise in India. 

Indian tax authorities' contention 

In reply to Vodafone's contentions above, the Indian tax authorities sought to impress their stand on the following lines - 

 

• The transaction is prima facie chargeable to tax in India. Income on capital gains of HTIL is deemed to have accrued or arisen in India as the asset sought to be transferred were not shares simplicitor but the business / economic interest in India. The authorities relied upon various statements made in public by the officials of Hutch and Vodafone, which indicated that the economic interest in business and assets in India were sought to be transferred. The transaction resulted in the substitution of Vodafone as the Joint Venture partner in HEL in India. The transfer of controlling interest of a company or a group of companies with the attendant management rights constituted an asset in India.
  

• In accordance with the American principle of "effects doctrine", the jurisdiction of the Indian tax authorities in relation to a transaction would have to be viewed with respect to where the effect of the transaction is felt. In the present case, the transaction has the effect on a property in India and involved controlling interest in an Indian company.
  

• The writ petition is not maintainable at the stage of show cause notice and is premature. No adverse order has been passed against Vodafone and only a show cause notice has been issued. All contentions are yet to be examined by the tax authorities. The fixing of liability is a question of facts and law and the tax authorities were yet to arrive at their findings on the facts of the matter.
  

• Vodafone had an equally efficacious alternative remedy in as much as any order passed by the assessing officer would be appealable and hence the extra ordinary remedy by way of a writ petition was not maintainable.

• Remedy of writ under Article 226 of the Constitution was discretionary and Vodafone did not deserve that discretion because it had failed to produce primary and original agreement dated February 11, 2007 and certain other prior and subsequent agreements.
  

The true nature of the transaction and the controversies involved could not be appreciated without the aid of the primary transaction documents. The matter involved complex questions, arising out of disputed facts that still remain undisclosed. 

  

Observations of the High Court while dismissing the Writ 

The High Court did not render any definitive conclusion on the chargeability to tax in India. However, it upheld the issuance of show cause notice and dismissed Vodafone's writ petition based on the following observations: 

Validity of the notice and jurisdiction of RevenueThe High Court held that since Vodafone had approached the FIPB before effecting the transfer of shares of CGP, it was within the jurisdiction of the Revenue to proceed against Vodafone and therefore,the notice served was valid. Further, Vodafone was not able to demonstrate that the show cause notice was totally non-est in the eyes of law for absolute want of jurisdiction of the authority to even investigate into the facts. As the issue was a question of facts and law, the Indian tax authorities had the responsibility to investigate the taxability of the issue. Hence, the show cause notice cannot be termed erroneous on its face or not based on any material. Further, the authority to investigate into facts can not be negated by invoking writ jurisdiction of the Courts.

Transfer of Capital Asset in IndiaPrima facie , the transaction amounted to an indirect transfer of controlling interest in HEL, an Indian company, and hence an indirect transfer of capital asset situated in India.  The agreement entered into by Vodafone in February 2007 resulted in the acquisition of the controlling interest in the Indian company and a nexus was clearly established in India, as was evident from the chronology of events relating to the acquisition and the media releases issued while concluding the transaction.

Principle of "Effects Doctrine"Due to the nexus between India and Vodafone, the "Effects Doctrine" as understood in the US can be applied, which upholds that "any state may impose liabilities, even upon persons not within its allegiance, for conduct outside its borders that has consequences within its borders which the state represents." Indian Supreme Court has also upheld this principle in the past.

Details WithheldSince the agreement between Vodafone and HTIL was not furnished, Vodafone had withheld material information and consequently an adverse inference would have to be drawn. In the absence of the aforementioned agreement and other relevant documents, it was not possible to examine the constitutional validity of the Indian tax law as the nature of the agreement was unascertainable.

Alternative remedies not exploredVodafone could have safeguarded its interest by obtaining appropriate nil / low withholding certificate from the Indian tax authorities; an option which it chose not to exercise. The writ petition to impugn the show cause notice was not maintainable when an alternative statutory remedy was available to Vodafone. 

 

Our comments 

While the High Court agreed with most contentions of the Revenue, it must be noted that it has not held that Vodafone is liable to pay tax or penalties under the Act in respect of the subject transaction. However, its observations could be a cause for concern from the point of view of cross-border mergers and acquisitions that involve underlying Indian assets.  Foreign investors therefore need to consider the tax implications while structuring business forays in India. 

  

The High Court has not made any observation that the structure was primarily put in place for avoiding tax.  In light of this, there may be a view that in the absence of a need to lift the corporate veil, it should not have disregarded CGP's status as a separate legal entity different from HEL. 

  

Though Vodafone challenged the constitutional validity of retrospective amendments to Section 191 and 201 of the Act, the High Court has chosen not to intervene on this matter. Similarly, applicability of withholding tax provisions to non-residents having no presence in India is a debatable issue and also appears not to have been dealt with in the judgment. It seems that the High Court focused more on the question of maintainability of the writ against the show cause notice issued by the Indian tax authorities. 

  

A development that would be worth tracking in the future is whether the tax authorities would use this judgment as a basis for dismantling holding company structures that are put through by non-residents for investing into India which are covered by certain tax treaty benefits. However, based on international experience, any structure which is backed by 'substance' and confirms to the 'Limitations of Benefits' clauses (both implied and explicit) should pass through these tests..

[1] This Section provides for tax deduction at source on dividends, not applicable in the present case.

[2] This Section provides that in the case of income in respect of which the Act does not provide for tax deduction at source and in the case where income-tax has not been deducted in accordance with the provisions of the Act, income-tax shall be payable by the assessee directly.

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