Vodafone wins $2 bn tax case in Supreme Court

The Supreme Court today ruled in favour of Vodafone in the $2 billion tax case saying capital gains tax is not applicable to the telecom major. The apex court also said the Rs 2, 500 crore which Vodafone has already paid should be returned to Vodafone with interest.

(Watch special analysis by Arijit Barman, corporate affairs editor)

The decision, experts said, will be a big boost for cross-border mergers and acquisitions here. The Income tax department’s contention, if upheld, would have rendered standard transaction structures too risky forcing foreign companies to weigh potentially new litigation and insurance costs.

Nearly five years after the Indian taxman issued the first notice to Vodafone international on September 2007 for failure to withhold tax on payments made to Hutchison Telecom, Chief Justice of India SH Kapadia and Justice KS Radhakrishnan pronounced their judgement.

(Click here to read the detailed Supreme Court order)

Vodafone had argued India doesn't have jurisdiction to tax the Hutchison deal because it was structured as a transaction between two overseas entities. The tax department had said it has authority because the underlying asset was Indian.

The verdict would also impact several other companies, including AT&T of the US and Britain's SABMiller PLC, are fighting similar tax claims and Indian authorities have been handing out tax notices to other companies, deal lawyers say.

In the Vodafone case, the transaction was between Vodafone and Hong Kong-based Hutchison, which sold its shares in the Indian company through a holding company based in an offshore destination. The I-T department has been of the view that it was immaterial whether the transaction took place outside India. (Click here for case timeline)

According to the I-T department, what counts for the purpose of taxation was whether capital gains were generated in India. Therefore, tax has to be paid in India if the overseas sale of shares had resulted in a change of ownership of the Indian company, it has argued.

The Bombay high court had earlier said tax authorities could unbundle different rights conferred through shareholding to tax aspects relevant to India. According to lawyers, this judgement would be difficult to implement as unbundling the value of a company’s assets arising from ownership of shares is bound to be messy.

In May 2007, Vodafone bought Hutchison Telecommunications International Ltd’s 66.98% stake in Indian telecom company Hutch Essar Ltd for $11.2 billion (around Rs.52,300 crore). Hutchison controlled its Indian telecom subsidiary through a Cayman Island company called CGP. CGP’s shares were sold to Vodafone, which consequently became majority owner of the Indian telecom firm.

Tax consultants and lawyers were not sure how tax authorities can unbundle the value of assets of a company arising from shareholding.

The issues that were argued before the SC include the transfer of shares resulting in transfer of underlying assets, the extra-territorial applicability of section 195, income chargeable to tax under section 9, but the crux of the argument was whether the transaction was designed to avoid tax.

The verdict would have implications for cross border M&A activity and similar pending cases before various courts.

Madhu S, Project Associate with ADR Centre, Centre for Policy Research has said the Vodafone tax case threw an interesting question on the taxability of a non resident company acquiring shares of a resident company through an indirect route. This is a landmark case, as it is for the first time that the tax departments had sought to tax a company through a mechanism of tracing the source of acquisition.

The judgment will have direct impact on transactions of major acquisitions like SABMiller-Foster and Sanofi Aventis-Shanta Biotech. Similar transactions that existed earlier are Sesa Goa, AT&T and General Electric. British firm Cairn Energy has already agreed to pay tax in India as well as the UK on selling its stake in Cairn India to Vedanta Resources from $6.65 billion to $8.48 billion. Depending upon the size of the stake sale, the tax liability could range between $868 million and $1.1 billion. The judgment would definitely throw a cautious note to major investors and M&As in India; however, it does not have that great an impact to curtail the investment flow to an emerging destination like India.