Several reports have been published in the press regarding the dismissal of Vodafone International Holdings BV’S (VIH) Writ Petition by the Bombay High Court. In the wake of these reports, many acquaintances and friends have accosted me to find out what exactly was decided by the High Court. I was, therefore, sufficiently intrigued to obtain a copy of the decision and to study in order to satisfactorily answer the queries addressed to me.
The limited issue for determination before the High Court was the jurisdiction of Revenue to issue notice to VIH, a Dutch company, u/s 201(1) and 201(1A) of the Income Tax Act 1961 (Act). However, this necessary involved issues of law and the facts of the case. The High Court reiterated certain basic legal principles as follows:
(a) Tax planning is legitimate provided it is within the framework of law and no colourable device is resorted to with the object of avoiding payment of tax by resorting to dubious methods.
(b) The legal effect of a transaction cannot be displaced by probing into the substance of the transaction. The High Court, therefore, held that it will decide the issue before them in the light of the relevant documents.
(c ) A shareholder’s right can be exercised only by the registered shareholder and no claim can be made by a person whose name is not in the Register of Members against the company.
(d) Ownership of shares may result in the assumption of an interest which has the character of controlling interest in the management of a company, however, a controlling interest does not for the purposes of the Act constitute a distinct capital asset. A controlling interest is something which flows out of the holding of shares as a consequence and is not an identifiable or distinct capital asset independent from the shares themselves.
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(e) Since a company has a juristic personality that is distinct from its shareholders, the purchase of all the shares of a company would not have the effect of the acquisition of the undertaking of the company itself.
Analysis of facts and documents (i) The High Court reviewed various documents including the Sale and Purchase Agreement (SPA) between Hutchison Telecommunications International Limited (HTIL), a Cayman Islands company listed in Hong Kong, and VIH, a Term Sheet Agreement dated July 5, 2003, certain Framework Agreements and a Brand Licence Agreement.
Under the SPA HTIL sold its 100 per cent equity stake in CGP Investments (Holdings) Ltd (CGP), another Cayman Islands company, and certain loans. The High Court analysed how HTIL and VIH construed the transaction. The fillings made by HTIL to comply with the applicable stock exchange listing rules stated that the transaction represented a discontinuation of its operations in India upon which it has generated a gain of approximately US $ 9,610 million. The equity value of CGP was derived from the enterprise value of Hutchison Essar Limited (HEL, the Indian telecoms company which was an indirect subsidiary of HTIL) on the basis that HTIL had an economic interest of 66.9848 per cent in HEL.
(ii) The Term Sheet Agreement was in the nature of a shareholders agreement and was an agreement to enter into a full shareholders agreement which would cover al the usual terms found in such agreements. The term Sheet was between a Hutchison Telecoms Group Company (Different from HTIL which was not incorporated until later), Essar Teleholdings Limited and as an Indian company. The parties agreed that certain cellular operations would be consolidated into one Indian holding company and that the full shareholders agreement would related to the India holding company. No consideration was paid by any party for agreeing to enter into the Term sheet. The Term Sheet dealt with matters such as approval of major contracts, appointment of certain senior management positions and changes to the share capital. The Term Sheet also contained an obligation that in the event the Hutchison Telecoms company found a buyer for its interests, it would ensure that the buyer makes an offer to buy the interest held by Essar on similar terms. Incidentally, the rights under the Term Sheet arose as a natural consequence of the parties’ respective shareholdings.
(iii) There were three Framework Agreements (also known as Option Agreements) in existence prior to the date of the signing of the SPA which were an substantially the same terms. The counterparty to all three Framework Agreements was 3 Global Services Private Limited (3GSPL), an indirect wholly owned subsidiary of CGP.
In consideration of 3GSPL agreeing to procure credit support to in order to enable the other parties to acquire interests in certain holdings companies which held equity interests in HEL, the other parties granted options to 3GSPL to acquire at market value their respective companies which held interests in these holding companies. The exercise of these options was subject to regulatory (if any) and legal compliance.
(iv) The Brand Licence Agreement contained a transitional arrangement, for a limited duration, under which a non-transferable royalty free right was given to VIH as licensee to use the trademarks and other intellectual property rights authorised by the licensor.
(v) The transaction was approved by the FIPB which was required under Press Note 1 (2005 series) in view of the fact that VIH held a 5.61 per cent stake in Bharti Airtel which was a competitor in the same sector.
Taking into consideration the correspondence VIH had with FIPB and the analysis of the facts, the High Court held that the price paid by VIH to HTIL factored in, as part of the consideration, diverse rights and entitlements that were being transferred to VIH. Many of these rights were not relatable to the transfer of the equity interests in CGP.
The High Court observed “The facts clearly establish that it would be simplistic to assume that the entire transaction between HTIL and VIH BV was fulfiled merely upon the transfer of a single share of CGP in the Cayman Islands. The commercial and business understanding between the parties postulated that what was being transferred from HTIL to VIH BV was the controlling interest in HEL”. It, therefore, held “the transfer of the CGP share was not adequate in itself to achieve the object of consummating the transaction between HTIL and VIH BV. Intrinsic to the transaction was a transfer of other rights and entitlements. These rights and entitlements constitute in themselves capital assets within the meaning of Section 2(14) which expression is defined to mean properly of any kind held by an assessee”. The High Court therefore, came to the conclusion that part of the consideration paid by VIH to HTIL was in respect of these rights and entitlements. However, crucially the High Court did not identify the location of these assets in terms of whether they were situated in India or whether they gave rise to income that had a nexus in India. All the High Court did was to say that the overall transaction had “a sufficient nexus with Indian fiscal jurisdiction” or a “significant nexus with India”.
The High Court, therefore, held that the Revenue had the jurisdiction to initiate proceedings under section 201(1) & 201 (1A) of the Act and that the Assessing Officer would be required to “apportion the income which has resulted to HTIL between that which has accrued or arisen…. as a result of a nexus within the Indian taxing jurisdiction and that which lies outside”.
It is, therefore, clear that as per the decision of High Court, the Revenue is required to:
(i) Determine the capital assets involved in the SPA which have a nexus in India.
(ii) Apportion the consideration in respect of such assets; and
(iii) Determine the amount of Capital Gains arising to HTIL from the transfer to such assets in terms of Section 45 to 48 of the Act.
These are all complex issues which are bound to generate a lot of litigation. Therefore, in my opinion, the eventual resolution of the issue determined by the High Court is a long way off until the matter is finally decided by the Supreme Court. In the event that it is concluded that there were no capital assets situated in India that were transferred, it is obvious that no tax will be payable on the transaction.
(The author is a former Chairman, CBDT)