The much awaited hearing in the Vodafone matter started on August 3, 2011 before the Supreme Court (“SC”). The Proceedings for first four days are as under:
Day 1 : August 3, 2011 : Vodafone SC hearing begins, judges ponder over situs vs control
On the first day of hearing in the SC over taxability of the landmark $11bn Vodafone- Hutch deal, Vodafone counsel Harish Salve argued that the complex structuring was not designed to avoid tax and the transaction was in no way a colourable device. But the day also witnessed some tough questions from Chief Justice SH Kapadia, especially on Azaadi Bachao Andolan and its application. Former Solicitor General and Vodafone counsel Salve argued aggressively that though in ‘commercial parlance’ the transaction was for sale of an Indian telecom business, it was actually a foreign company (Vodafone ) buying shares of a foreign company ( CGP ) from another foreign company ( Hutchison ). But when Salve submitted that India does not have ‘ look through provisions ‘ and also cited Azaadi Bachao Andolan on the issue of tax planning vs tax evasion, Chief Justice Kapadia asked Salve – ” Can’t IT Department make any enquiry once Tax Residency Certificate is there? ” To which Salve surprisingly replied that if a Mauritian company remits the income or money back to some other company then Mauritian company would not be considered the ‘real owner of income.’ CJ Kapadia’s first question when Salve opened proceedings at 11.45am was whether Hutchison had invested in India via a tax haven. Salve, replying in the negative, told the Court that Cayman Island was a OECD compliant jurisdiction. Salve stressed on the point that a ‘share’ is situated where the registered office of company is situated and since in this case the target company shares were situated in Cayman Island, the same could not be brought to tax in India. When the Court asked Salve as to what was the ‘ form ‘ of the transaction and why couldn’t the tax department look into the substance, Salve retorted that ” Absent fraud, transfer of control of downstream companies is not a basis for asserting tax jurisdiction.”The word ‘ controlling interest ‘ too generated a lot of interest among the 3 judge bench, with Chief Justice Kapadia observing that ” The maximum doubt is over the word ‘control’. Even a huge loan to a company may indicate substantial interest… ” Salve spent better part of the day explaining the complicated, multi layered structure through which Hutchison had invested in India and how the same was in place right from the beginning. He listed out all important dates from the early 1990s when the company was first formed. At one point CJ Kapadia interrupted Salve and said point blank.. ” Why are you taking us through all these dates? The question before us is quite straight forward. “
The Court also observed that when someone is buying shares of a foreign company, one looks at the business the company owns. Salve however pointed out that even then the situs of transaction doesn’t change. Salve kept harping on the point that such structures were quite common in global trade and when Indian groups like Tatas acquire overseas companies, they too use such structures. He argued that in the age of evolving financial markets, such structures were inevitable. Chief Justice Kapadia concurred with Salve and observed that a sale and lease back transaction could not be called bogus just because there is tax saving. The Court finally framed the question to be decided in this case as ” Should we go by situs or can tax department tax it because control of Indian business has been transferred. ? “
Day 2 : August 4, 2011 : Sec 9 (1)(i) interpretation dominates Day 2 of Vodafone proceedings
Starting his arguments on the heart of the matter, Vodafone counsel Harish Salve told the Supreme Court today that the ‘Source’ of Income is where the transaction is and not where one’s business is. Salve put forward Vodafone’s basic proposition that the words ‘ Deemed to accrue or arise ‘ appearing in Sec 9 exhaust the universe of what can be taxed in India. He argued forcefully that Sec 9 (1)(i) allows taxation of income deemed to accrue or arise in India through the transfer of a capital asset ‘situated in India’. Salve stated that it was abundantly clear from the provision that the capital asset ought to be ‘situated in India’. He stressed that there was considerable body of jurisprudence on the rule of ‘situs’. Salve placed heavy reliance on SC rulings in Chunnilal B Mehta (1938) 6 ITR 521 (PC) and Seth Pushalal Mansinghka (P.) Ltd (1967) 66 ITR 159 (SC)to drive home the point that the source of income lies where the transaction is effected and not where the economic interest lies.
He stated that in the Hutch- Vodafone deal the IT Department was proceeding on a ‘ moving theory of nexus ‘ on the basis that the economic interest and underlying assets were in India. Salve gave the example of telecom company Bharti Airtel to say that just because 70% of Bharti’s income came from India and 30% from Africa, tax could not be divided in that proportion. However Salve seemed to suggest that had Essar bought Hutchison’s stake instead of Vodafone, the source of income could then have been an open question but in the instant case, both Vodafone and Hutchison were ‘non resident’ companies and since the deal involved the sale of shares of a Cayman Island company, the source of income could not be traced back to India. The judges posed a lot of queries on interpretation of Sec 9 and the reasons behind its introduction.
Chief Justice Kapadia questioned Salve on ‘ Substance vs Form ‘ and as to why the Assessing Officer cannot go behind the form of the transaction. Salve replied that as long as the transaction is bonafide and not a colourable device, it must be taxed only in ‘form’. On the Court’s question as to why only Vodafone case had been picked up and not any other companies before it, Salve stated that it was due to the high value of transaction. Chief
Justice Kapadia also asked as to why Vodafone had not approached the Authority for Advance Ruling, to which Salve submitted that all legal opinions were in Vodafone’s favour. For the second successive day, the judges asked Salve to clarify on the term ‘ control ‘ and ‘ controlling interest’. Chief Justice Kapadia at one point observed that ” When shares are acquired, you are acquiring a business..you are also acquiring cash flows and receivables of the business. Should we go only by ‘situs’ of shares ? “. Salve quickly responded that in the absence of specific legislation, such transactions could not be taxed and that the word ‘Controlling Interest ‘ is an amorphous term with different connotations for different legislations.
Link to BMR Publication on Day 1 and 2 Proceedings : BMR Tax EdgeDay 3 : August 9, 2011 : Can’t disrespect ‘form’ unless Azadi Bachao revisited, Vodafone to SC
Day 3 of the proceedings at the SC witnessed more of the same, with Vodafone counsel Harish Salve relentlessly harping on the ‘situs’ of the Cayman Island share. But the Court, led by Chief Justice posed some searching questions, answers to which may decide the fate of this case. Day 3 of the proceedings at the SC witnessed more of the same, with Vodafone counsel Harish Salve relentlessly harping on the ‘situs’ of the Cayman Island share. But the Court, led by Chief Justice posed some searching questions, answers to which may decide the fate of this case.
The proceedings started with the Court asking Salve to explain as to how the multi-billion dollar ‘Enterprise Value’ of Hutchison Essar had been calculated. Salve stated that it had been calculated on the basis of underlying assets of Hutchison in India. To a question by the Chief Justice on whether this value was a ‘legal’ or ‘economic’ reality, Salve submitted that ” How a share is valued is irrelevant for determining the situs and therefore the location of the gains on its transfer. “
Salve went into the history of 1922 Income Tax Act, specifically the amendments to Sec 42 of the said Act, which corresponds closely to Sec 9 of current Income Tax Act, 1961. Salve contended that both the 1922 as well as 1961 Act seek to tax ‘ transfer of capital asset situated in India’. Therefore, sans express legislation, an offshore share transfer between Vodafone and Hutch cannot be taxed, argued Salve. He referred to court decisions in Assam Consolidated Tea Estates 167 ITR and National & Grindlays Bank Ltd 72 ITR 121 to buttress his point. Chief Justice Kapadia however observed that ” …All these Acts and Sections are fine but we want to know statistics of last 10 years… ” The Chief Justice further pointed out that most MNCs are routing investments through tax havens and asked Salve to show some foreign court judgements in such cases. Chief Justice Kapadia also referred to the concept of ‘ booking of profit ‘, to which Salve said that he would submit a note on the same.
Salve emphasised that ” Our law has remained standstill in respect of such Structures..” He gave the example of GDR and how it had been excluded from the ambit of ‘transfer’ by Sec 47(viia) though the value of GDR is derived from the Indian company. But the Court pointed out that the GDRs would have been taxable but for the exclusion. The highlight of the day however was when Salve argued forcefully that the letter of law should be strictly construed and that the capital asset ( in this case Cayman Island company shares ) here was situated outside India, thereby falling outside the ambit of Sec 9(1)(i).
Chief Justice Kapadia shot back asking ” Should we go only by textual interpretation? How did the theory of real income then come about? “
Salve referred to judgement in Anglo India Jute Mills 129 ITR 352 to drive home the point that the capital asset ought to be situated in India. Salve crystallised the point further by stating that ” The consideration paid by petitioner ( Vodafone ) and received by HTIL is capital in nature. It can only be taxed u/s 45 read with Sec 9(1)(i), namely the transfer of capital asset situated in India. “
Chief Justice Kapadia referred to recent amendments to Sec 9 and observed that ” We find that there is a shift from situs to nexus..” But Salve persisted with his argument that tax could only be imposed on situs, not nexus. The day ended with another discussion on the classic, age old debate of ‘substance vs form’. Chief Justice Kapadia questioned Salve as to why wouldn’t the substance theory apply, to which Salve replied ” If Parliament has legislated on form, courts can’t get into substance. ” Salve also relied on SC ruling in Azadi Bachao, saying that unless the court revisited the ratio laid down therein, form ought to be respected.
The court asked Salve to show similar foreign cases where entire control had changed hands through sale of an instrument. Salve admitted that were hardly any such precedents available but referred to an Australian case – Commissioner of Federal Taxes vs Lamesa. He also cited opinions of tax consultants of Australia and Italy, who opined that such a transaction would not have attracted tax in their jurisdictions.
Link to BMR Publication on Day 3 Proceedings: BMR Tax EdgeDay 4 : August 10, 2011 : Substance vs Corporate Structurin​g argued on Day 4 of Vodafone proceeding
Day 4 of proceedings in SC started off on a dramatic note with Chief Justice Kapadia asking pointed questions on tax havens, OFCs, Azadi Bachao, de coupling and substance theory. The Chief Justice asked Vodafone counsel Harish Salve as to the difference between tax havens and off- shore financial centres (‘OFC’). Justice Kapadia observed that the substance of transaction is not taking place in the tax havens. Salve tried to explain the difference between tax havens and OFCs as that between opacity and transparency. He reiterated that Cayman Island falls in the OFC category and is not a tax haven.
Justice Kapadia then raised some pointed questions on applicability of SC ratio in Azadi Bachao (263 ITR 706) to ‘conduit’ companies. He observed that “There is a debate going on whether Azadi Bachao applies to only genuine investments or even to conduit companies”. Salve submitted that if the Mauritius Company receives income on behalf of someone, then the veil could possibly be lifted. But Justice Kapadia persisted, saying “Whether you use the word tax havens or OFCs, it is concerned with jurisdiction. Suppose a jurisdiction is artificially created and ‘decouples’ legal and real taxation then wouldn’t substance theory apply?” Salve replied in the negative, saying “Absence fraud, we (India) respect corporate identity”. He argued that ‘decoupling’ is recognised and permissible for tax purposes. Salve gave the example of Tata Motors and stated that the company could not be taxed in India on the profits of Jaguar and Land Rover which are based in UK and whose plants are owned by non Indian companies. But Justice Kapadia again raised the substance over form theory and asked as to why the IT Department could not examine a transaction and conclude that it was just a de coupling vis a vis location. Salve argued that it would mean applying the ‘Ramsay’ principle (historic UK case in which substance was affirmed). Salve then made his main proposition for the day as ” De coupling is a part of bonafide transnational structuring. Unless your law prohibits it or the tax department is authorised to disregard the form, then any tax levied would have to conform to such structure”. The Chief Justice quipped… ” Bonafide means? Again we are in circles”.
Salve tried to shore up Vodafone’s case by stating that if India’s legal structure and FEMA notification recognised Overseas Corporate Bodies (OCB), then Foreign Direct Investment (FDI) coming in via these OCBs could not be held as a ‘device.’ He summed up his arguments on substance theory by submitting that “Structuring based on corporate identity is recognised by Indian law and unless the tests of lifting corporate veil are satisfied, tax has to be levied on the basis of corporate structuring”. Justice Kapadia finally observed that “We are thinking from point of view of FDI, not FII… Investor needs certainty in law”.
Salve then continued from where he had left off yesterday, citing legal opinions from different countries as to how the Vodafone-Hutch transaction would have been dealt with under their respective tax laws. But Justice Kapadia quickly remarked that he had come across certain international opinions which may go against Vodafone. Salve quoted extensively from Australian court’s decision in Lamesa to buttress his point that an indirect transfer could not be taxed unless there was a specific provision in the legislation; something which Australia inserted in their tax laws post Lamesa verdict. Salve cited favourable legal opinions from Canada and US and stated that the Indian tax department had not been able to show any legal opinion or legal material to show that situs of foreign company’s share is deemed to be in India.
From: TaxSutra and BMR
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