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Foreign buyers beware

The Vodafone decision, as expected, was appealed to the SC where the Attorney General reportedly wanted Vodafone to deposit 50 per cent of the tax demand of Rs 12,000 crore.

Arvind P. Datar        Print Edition: October 31, 2010

The Vodafone decision, as expected, was appealed to the Supreme Court where the Attorney General reportedly wanted Vodafone to deposit 50 per cent of the tax demand of Rs 12,000 crore. For the time being, the Supreme Court had asked the apportionment to be done by the Income Tax Department before the question of stay could be decided. The case may be taken up for an early hearing in view of the enormous tax liability and the far-reaching consequences that the Bombay High Court decision may have for other acquisitions of business interests in India.

The recent decision of the Bombay High Court was the second round of litigation. The basic issue concerned the purchase of one share in a Cayman Islands company which, through more than 20 offshore companies, held indirect interest to the extent of more than 50 per cent in Hutchison Essar Ltd. (HEL). This overseas purchase of one share by a Vodafone company from a Hutch company resulted in Vodafone stepping into the shoes of Hutch in HEL. The name of the Indian joint venture company was then changed to Vodafone Essar Ltd. In the past, the Income Tax Department had never questioned such transfer of shares even where the consequence was the transfer of business interests in India.

 EXISTING LAW

 COURT'S VIEW

  •  "Controlling interest" cannot be transferred separately
  • Transfer of even 100% shares does not amount to transfer of the assets of the undertaking
  • A composite contract or an indivisible contract cannot be divided into its component parts
  • Transfer of shares by one non-resident to another non-resident will not be treated as a transfer of assets or transfer of an undertaking in India
  • Controlling interest has been transferred and should be reckoned for taxation
  • Transfer of 67% shares in Hutchison Essar Ltd. has resulted in transfer of assets
  • The principle of apportionment can be used to determine the assets that have been transferred in India
  • Entitlements that flow out of holding of share can be dissected from the ownership of a share: the transfer of one share was not enough to consummate the transaction
Transfer of shares of an overseas company by one non-resident to another interest never resulted in any taxable income (or capital gains) in India. What perhaps attracted the attention of the Department was the sheer size of the transaction and it alleged that Vodafone should have deducted tax at source on the $11 billion paid to Hutch because the gains made by Hutch were chargeable to income tax in India. The stand of Vodafone was that it had only purchased the shares from Hutch and the consideration was paid abroad. As no assets were transferred in India and no income accrued or arose to Hutch in India, there was no liability.

Vodafone cited several decisions in its favour that had clearly held that even if all the shares of a company are purchased, it would not amount to acquiring assets of the undertaking. Shareholders are not the owners of a company's assets and even the purchase of a 100 per cent shareholding would not make the buyer of shares the "owner" of the company's assets.

Interestingly, under Section 29(1)(b) of the old Foreign Exchange Regulation Act, 1973, a non-resident could not acquire any part of an undertaking in India without the prior permission of the Reserve Bank of India. About 40 per cent of the shares of Shaw Wallace were held by four companies in the United Kingdom.

These shares were acquired by a Hong Kong company owned by the late Manu Chhabria and the agreement itself stated that the purchase of these shares would result in indirect control of 40 per cent of the share capital of Shaw Wallace in India. The Enforcement Directorate argued that the purchase of these shares resulted in acquisition or control of Shaw Wallace without the permission of the Reserve Bank of India. But the plea that such purchase of shares, in effect, amounted to acquiring the assets was rejected.

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