Early last week, the Mumbai revenue department issued show cause notices to Vodafone, proposing to tax offshore transaction, as a result of which Vodafone acquired a controlling interest in GSM licences from Hutch.
This battle seems to be entering a climax, given developments in the past 18 months since the deal. Essentially, the dispute surrounds Indian tax administration’s claim to levy tax on controlling interest acquired by Vodafone (from Hutch) via a complex chain of offshore companies. Vodafone and Hutch claim that India does not have a right to tax such offshore sale transactions, given the interpretation of law on ‘transfer of assets’ located in India.
On the other hand, the tax administration continues to hold that such ‘indirect transfer of assets’ would be liable to tax in India, based on strict source based interpretation. As a matter of fact, several offshore transactions, including international takeovers and mergers have come under the tax administration’s scanner and multiple investigations are under way.
Recapping SC verdict
The last we heard on Vodafone was when, early this year, the Supreme court while declining to intervene in the matter, directed that Vodafone submit the relevant documentation to the revenue authorities such that a point of view can be formulated if indeed (the revenue) has the jurisdiction on such a deal. Remember, Vodafone besides challenging the withholding tax obligation, also challenged the jurisdiction (of revenue) to issue notices and seek information on the grounds that it is extra territorial.
Other grounds of challenge included constitutional validity of a retrospective amendment in 2008 budget to treat Vodafone as an “assessee in default” with respect to withholding tax obligation. The retrospective amendment, as most believe, was ostensibly intended to fasten withholding tax liability on Vodafone (as acquirer of interest in underlying Indian assets), should the tax administration fail in recovering tax from Hutch (alleged beneficiary of capital gains). To that, the courts declined to give its judement and felt that the most important aspect was ‘jurisdiction’ and not taxability or withholding obligation.
Whereas Vodafone seems to have rightly interpreted the apex court’s order that the revenue has merely assumed rights to determine the question of jurisdiction, the tax administration viewed it as a right to raise the tax demand, besides establishing jurisdiction. The fact that the revenue has issued a show cause suggests to me that the spirit of apex court’s decision is being adhered to.
Options before Vodafone
Though the contents of show cause notice are not public, in an unprecedented move, the revenue department issued a press release informing about the developments in the Vodafone case and in no uncertain terms, made its intent known to the world at large. The said release also mentions that Vodafone is being allowed time until November 16, to respond to the show cause.
It seems that the show cause notice runs into several hundred pages in addition to equal pages devoted to annexures. It will be interesting to observe how and when Vodafone responds to the show cause notice. If I paint a scenario, firstly, I feel the 16 day time period to respond is inadequate and I won’t be surprised if a suitable extension is sought. Secondly, what if Vodafone considers challenging the show cause? Plain reading of the Supreme court order suggests that Vodafone can challenge the jurisdiction (now that it has established it) and the jurisdictional High Court (Mumbai) shall have to admit the plea. It will not surprise me if Vodafone seeks a stay of proceedings until the high court gives its verdict on jurisdiction.
What would be the revenue department’s approach?
By thoroughly investigating the case and assembly of detailed facts (pursuant to supreme court’s order), the revenue seems to be bracing up for a long battle. The length of its show cause notice suggests a level of preparedness and spells out its intent loud and clear. The first step would be to establish jurisdiction and thereafter, raise the tax demand.
It is also clear that the revenue by not raising the issue on the taxability of income (in the hands of Hutch) shall successfully circumvent the dispute resolution panel (DRP) procedure, as mandated in the 2009 budget. The panel process suggests that all demands on foreign companies be subject to an approval by the panel, comprising of a collegium of 3 commissioners. Interestingly, the DRP provisions do not apply where a demand is being raised by invoking withholding tax provisions. Had the revenue pursued its case against Hutch, it would have been obligatory to follow the DRP process and thereafter, an appeal would lie with the tax tribunal.
International Developments
The international tax fraternity is anxiously observing the developments on Vodafone case as they continue to believe that India can exercise its fiscal jurisdiction to businesses that have a personal link or to income or assets which have a real or proprietary link to India. Further, taxation of capital gains has been intensively dealt with in model tax conventions, providing that the state of residence of a tax payer shall have primary jurisdiction to tax gains, subject to certain exceptions. However, despite established precedents, tax administrations in select jurisdictions are questioning international reorganisations.
Recently, Chinese tax authorities have asserted to impose tax on transfers by non-residents of equity interest that would otherwise appear not to be taxable in China. To me, these cases seem to have a treaty abuse undertone and do not in any way establish that China intends to tax all such transactions. Similarly, Brazil has been expanding its application of ‘substance over form’ doctrine in its tax law. Nevertheless, there are no reported instances of taxability of offshore transactions. Russian law allows tax authorities to disregard entities or recharacterise transactions, where there is ‘unjustified tax benefit’.
These provisions seem similar to proposals mooted in the direct tax code by way of general anti-avoidance rules. If the DTC provisions have to be viewed in its context, should India be imposing tax on such offshore sale transactions is a question in minds of the international tax fraternity? Though, the proposals under direct tax code clearly suggest that India would prospectively exercise its jurisdiction on such transfers (either by expansion of direct and indirect transfer of capital assets located in India or by invoking GAAR), it still doesn’t answer the question for past transactions under question.
Vodafone has become a case study in its own right, and it is anticipated that the case study be taken to a logical close. The question is how and when?
(The author is a Partner with BMR Advisors and views are entirely personal)
