What will India's Vodafone judgment mean for other investors?

06 February 2012

It was one of the most eagerly awaited judgments in recent times. On January 20, the Indian Supreme Court held that UK based telecom service provider Vodafone was not liable to pay tax on a deal involving the 2007 takeover of the Indian telecom assets of Hong Kong-based Hutchison.

The issue can be summarised as follows: The US$11 billion paid for a 67% stake in Hutchison Essar (the Indian company) was a transaction between two foreign entities. But the underlying assets were almost entirely in India. The Indian tax authorities claimed that the deal should thus attract capital gains tax in India. Vodafone was issued with a demand for tax because the Indian Tax department deemed it should have withheld the tax amount before paying Hutchison.

Vodafone appealed the decision and the Supreme Court found that the transaction was not a sham or an attempt at tax avoidance. “We hold that the offshore transaction herein is a bona fide FDI (foreign direct investment) into India which fell outside India’s territorial tax jurisdiction,” said the court. “Hence [it is] not taxable.” The Bombay High Court had earlier ruled in favour of the tax authorities.

The Supreme Court in giving its judgement has crystallised the following principles:
• Respect for the legal form of the transaction
• Respect for the corporate veil unless there is a sham (i.e. has no business principle or lacked continuity)
• Tax efficient holding company structures created to minimise taxes and avoid the incidence of double taxation should satisfy the “business purpose” test
• Mauritius route upheld (Azadi Bachao Andolan judgement remains)

Commenting on the judgement, Neel Sahai, Director, Minerva Trust & Corporate services said “The verdict will bring certainty in the minds of global investors regarding Indian tax consequences in case of the sale of their investments. It is generally believed that this decision will go a long way in giving foreign investors faith in India. It also provides certainty to the issue of taxation of similar transactions. Many investors have been concerned about the uncertainty that surrounded the Indian Tax laws since the original decision. This decision will, hopefully, provide some much needed certainty to investors”.
 

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