Taxes and borders

The unprecedented case relating to the income-tax department’s demand for Rs 11,000 crore in the form of capital gains tax from Vodafone International, which was rejected by a three-judge bench of the Supreme Court led by the Chief Justice of India, S.H. Kapadia, has become extremely murky and convoluted with an advocate petitioning for a reconsideration of the judgment on the ground that the Chief Justice should not have heard the case since his son is working for a consulting firm that had advised Vodafone on its tax dispute with the I-T authorities.

The Union government has called for a review of the January 20 judgment; it has listed 121 objections and described it as “erroneous” and “contradictory”. The tax authorities have stated in a 101-page review petition that they were surprised by the judgment which described the offshore transaction relating to Vodafone as a “structured foreign direct investment” pointing out that not a single rupee entered India.
What is cyrstal clear is that the Supreme Court’s decision on the Vodafone tax case is not merely highly contentious. If indeed the judgment is upheld by a larger review bench of the apex court, such a development would have far-reaching negative implications for future revenue collections by the I-T department. Most importantly, if the Supreme Court judgment is not reversed, it would aid and abet clever tax lawyers and accountants (and their friends among corporate captains, politicians and bureaucrats) who have, over the years, successfully obliterated the distinction between tax planning, tax avoidance and tax evasion — mostly through tax havens, notably Mauritius, as far as India is concerned.
The Vodafone case is significant for more than one reason and it is, therefore, important to demystify it. Not only is the tax demand the biggest of its kind, the legal dispute relates to the largest-ever merger and acquisitions deal that has taken place in the Indian telecommunications industry, a deal involving more than $11 billion or around Rs 50,000 crore at prevailing exchange rates.
On February 11, 2007, Vodafone International Holdings BV, a company registered in the Netherlands, announced that it had agreed to acquire a controlling interest in Hutchison Essar Limited — an Indian telecom operator — by acquiring a company that controls 67 per cent of Hutchison Essar from another company registered in the tax haven of Cayman Islands, namely, Hutchison Telecommunications International Limited, part of a Hong Kong-based group.
In August and September 2007, the assistant-director of I-T (international taxation), Mumbai, N.K. Govila, issued two showcause notices — the first to Vodafone Essar, the new name for Hutchison Essar, and the second to Vodafone International, under specific sections of the Income Tax Act, 1961, claiming that the gains made by Vodafone International from the deal are taxable in this country. Vodafone International argued that the Indian government does not have the jurisdiction to levy tax on an overseas transaction.
The deal, while rather complicated — there is a family tree of firms involved in the transactions that have been displayed in the Supreme Court judgment — essentially relates to a change in ownership and control of an overseas firm leading to a change in the ownership and control over its assets in India. After the showcause notices were issued by the I-T authorities, both Vodafone International and Vodafone Essar moved the Bombay high court. On December 3, 2008, a bench of the court, comprising Justices F.I. Rebello and J.P. Devadhar, upheld the position of the tax department. During the hearings, the additional solicitor-general of India, Mohan Parasaran, remarked that this was a “test case”.
Vodafone International then moved the Supreme Court which, on January 23, 2009, ruled that the I-T department should first decide on the issue of jurisdiction based on an examination of facts provided by Vodafone International and facts obtained independently. Almost three years later, the three-judge Supreme Court bench headed by Justice Kapadia dismissed the arguments of the I-T department that all income received or deemed to have been received by a non-resident company includes income arising directly or indirectly through or from any business connection, property, assets or sources of income or from the transfer of a capital asset situated in India and that the department’s claim that all income payable to a non-resident arising from sources in India should be subject to tax in India.
Vodafone International’s claims that the I-T department has no jurisdiction over it since it is a non-resident company and has no obligation to withhold tax for a transaction that took place with another non-resident company with respect to the transfer of shares in yet another non-resident company, which were supported by the three-judge bench of the Supreme Court, are now going to be reviewed.
On the fate of the government’s review petition hangs the future of a number of major deals involving major multinational corporations and Indian business houses, including companies or groups such as SabMiller (in breweries), Sanofi-Avenits (pharmaceuticals), Kraft (foods), Vedanta (oil), Genpact (outsourcing) and Tata Industries-Grasim-AT&T (telecom).
Muddying the picture is the petition by advocate M.L. Sharma who has claimed that the Chief Justice should not have heard the case because of an alleged conflict of interest since his son, Hoshnar Kapadia, is employed by Ernst & Young (E&Y), a firm which advised Vodafone on its tax dispute. On Justice Kapadia’s behalf, his principal private secretary H.K. Juneja has pointed out that Hoshnar was not part of E&Y’s tax department, that he joined the firm after the February 2007 deal and that it was E&Y (UK) that advised Vodafone, not E&Y (India).
Senior advocate Harish Salve, who argued the case for Vodafone in the Supreme Court, has added that Hoshnar was working for E&Y’s competitor, KPMG, when the deal was struck and that the report by E&Y (UK) was used by the I-T department as evidence against Vodafone.
Advocate Prashant Bhushan has argued in a recent newspaper article that the Supreme Court’s January 20 judgment goes against the tenor of an earlier 1985 judgment by a five-judge bench of the apex court in the McDowell case wherein, inter alia, it was stated: “No one can now get away with a tax avoidance project with the mere statement that there is nothing illegal about it.” He contends that the Vodafone judgment, if not reversed, could lead to foreign companies not paying any capital gains tax in India thereby causing huge losses to the exchequer.
The last is yet to be heard on this controversial case.

The writer is an educator and commentator