1.1 With the liberalisation and the history of strong economic growth in the last few years and with the prospects of reasonably sound economic growth, India has become one of the major attractive destinations for Foreign Direct Investment (FDI) for carrying on business by Multinational Companies (MNC). 1.2 Large amount of FDI has flown to India through Mauritius for various commercial purposes including the tax advantage under Double Taxation Avoidance Agreement entered into by India with Mauritius (Mauritius Tax Treaty).
1.2.1 Under the Mauritius Tax Treaty, one major advantage is with regard to non-taxability of capital gain arising on alienation of shares of the Indian companies. Under the Mauritius Tax Treaty, the right to tax such a gain is only with Mauritius (with some exception with which we are not concerned in this writeup) and as such, the same cannot be taxed in India. For this purpose, Mauritian Company is required to establish that it is tax resident of Mauritius and which can generally be established by producing Tax Residency Certificate (TRC) issued by the Tax Department of Mauritius. Such TRC issued by the Mauritius tax officer is generally regarded as sufficient evidence for that purpose by virtue of the CBDT Circular No. 789, dated 13-4-2000. This legal position is also confirmed by the judgment of the Apex Court in Azadi Bachao Andolan (263 ITR 507). There is a historical background to this position, with which also we are not concerned in this write-up.
1.3 For the purpose of withholding tax from the taxable income received by a Non-Resident (NR), section 195(1) of the Income-tax Act, 1961 (the Act) provides that any person responsible for paying (Payer) to NR (Payee) any sum chargeable under the Act is liable to deduct tax (TDS) as provided therein. There are some exceptions to this, with which we are not concerned in this write-up. Effectively, under these provisions, the Payer is liable to deduct tax at source (TAS) in such cases and pay the amount so deducted to the Government. Procedural provisions are also made for compliance of these provisions and consequences are also provided for default in compliance of these provisions, with which also we are, effectively, not concerned in this write-up.
1.4 Multinational Groups (MNG) generally operate through various companies in different jurisdictions where such operating companies are directly or indirectly controlled through downstream subsidiaries set up by the main holding company of the MNG. Such holding and subsidiary structures are common in commercial world for various business needs. One of the objectives of putting-up overseas holding and downstream subsidiary structure for FDI is also to provide for easy exit at a later stage when it is decided to withdraw from a business carried on in India through Special Purpose Vehicle (SPV) created in India. At the time of exit, in such cases, generally shares of overseas company are transferred to the buyer who, in the process, acquires control and management of Indian SPV. Such overseas transaction, many times, takes place between two NR entities.
1.5 In case of a transaction of the nature referred to in 1.4 above, of late, the Revenue Department has taken a stand that on account of transfer of shares of such overseas holding company, there is indirect transfer of underlying assets of the Indian company as the control and management of the Indian company gets indirectly transferred in such cases. Therefore, the capital gain arising in such offshore transaction between two NRs is liable to tax in India by virtue of provisions of section 9(1)(i) which, inter alia, provides that all income accruing or arising, whether directly or indirectly through the transfer of capital asset situate in India shall be deemed to accrue or arise in India. According to the Revenue, indirect transfer of capital asset situated in India is covered within the scope of this provision.
1.5.1 In view of the above stand of the Revenue, further stand is taken by the Revenue that the Payer NR entity is also required to deduct TAS u/s.195(1) while making payment to the transferor of the share, which is also another NR entity. If such obligation of TDS is not discharged, then the Payer is regarded as ‘assessee in default’ u/s.201 and he would be liable to pay the amount of such tax with interest and will also be subject to other consequences such as penalty, etc. The Payer could also be considered as representative assessee of the Payee u/s.163.
1.6 The issues referred to in paras 1.5 and 1.5.1 are under debate currently in many cases and different views were being taken. The issue became more vital in view of the judgment of the Bombay High Court in the case of Vodafone International Holdings B. V. (VIH) reported in 329 ITR Page 126.
1.6.1 Recently, the issues referred to in para 1.6 above, came up for consideration before the Apex Court in the case of VIH and this hotly debated issue got finally decided. Relevant principles of law have been decided/re-iterated in this case and therefore, the judgment becomes more relevant.
1.7 Now, since the Revenue has filed a review petition before the Apex Court for recalling the judgment in Vodafone‘s case, it would also be useful to consider the judgment of the High Court in little greater detail. Various contentions were raised by both the parties before the High Court, as well as Supreme Court. Both the judgments are very long. For the sake of brevity and space constraints, only some of the main contentions are referred to in this write-up. For the same reasons, even the facts of the case are very broadly given in brief. For the sake of convenience, the percentages of shareholding referred to herein at different places are rounded off.
Vodafone International Holdings B.V. v. UOI — 329 ITR 126 (Bom.)
Facts in brief
2.1 In 1992, Hutchison group of Hong Kong (HK) acquired interest in Mobile Telecommunication Industry in India, through a joint venture Company in India (JV Co.), Hutchison Makes Telecom Ltd., [subsequently renamed Hutchison Essar Ltd. (HEL)] through its overseas group of companies. In 1998, CGP Investment Holdings Ltd., (CGP) was incorporated in Cayman Islands (CI) of which the sole shareholder was Hutchison Telecommunication Ltd., HK (HTL). The CGP had set up two Wholly-Owned Subsidiaries (WOS) in Mauritius viz. Array Holdings Ltd. (Array) and Hutchison Telecommunication Services India Holdings Ltd., (HTI-MS).
Array, through its various downstream subsidiaries in Mauritius held 42% shareholdings interest in HEL. Further, 10% shareholding interest in HEL was held by CGP through certain overseas JV companies. HTL-MS had set up WOS in India, namely, 3 Global Services Pvt. Ltd. (3GSPL). The shareholding of HTL in CGP got transferred to another group com-pany [HTI (BVI Holding Ltd.) HTIHL (BVI)], a company incorporated in British Virgin Island (BVI). The HTIHL (BVI) was indirectly WOS of Hutchi-son Telecommunication International Ltd. (HTIL), a company incorporated in CI. HTIL was listed on stock exchange of New York and Hong Kong. As part of group restructuring and consolidation, the structure was further evolved with certain arrangements/ agreements and finally in 2006, the Hutchison group held 52% shareholding in HEL through structural arrangement of holding and subsidiary companies and it had also options to acquire through 3GSPL, a further 15% shareholding interest in HEL from certain Indian companies, subject to relaxation of FDI norms as the Essar group, JV partner, was already hold-ing 22% shareholding through Mauritius companies. Effectively, CGP through its downstream overseas subsidiaries held 42.43% (42%) interest in HEL and it had indirect interest of 9.62% (10%) in the equity of HEL through its pro rata shareholding (indirect) in some Indian companies which had direct/indirect equity interest in HEL. These Indian companies [viz., Telecom Investment India Pvt. Ltd. (TII) and Omega Telecom Holding P. Ltd. (Omega)] belong to (with majority shareholding) its Indian Partners (viz. Mr. Asim Ghosh, Mr. & Mrs. Analgit Singh and IDFC). The structure created was very complex and various commercial arrangements were made between group companies and others for that purpose. The detailed chart of the structure is appearing in the judgment of the High Court at pages 134/135.
2.2 Vodafone International Holdings B. V., Netherlands (VIH) is a company controlled by Vodafone group, UK (Vodafone) . The said VIH acquired the entire shareholding of CGP from HTIHL (BVI) vide transaction dated 11 -2-2007, as a result of which the Vodafone group indirectly acquired the interest of Hutchison group in HEL which that group held through structural arrangement of holding and subsidiary companies (referred to in para 2.1) either through Mauritius-based companies having Tax Residency Certificates (TRCs), or through other entities in which the interest of Hutchison group was held by Mauritius companies. On these facts, the Revenue took a stand that it was a case of acquisition of 67% controlling interest in HEL by VIH from HTIL and since HEL is a company resident in India, such controlling interest is an asset situated in India. Therefore, the capital gain arising from this transaction is taxable in India on the basis that though CGP is not a tax resident in India, it indirectly also holds underlying Indian assets of HEL. The transaction results into indirect transfer of capital assets situated in India. As such, VIH was also under obligation to deduct TAS u/s. 195 from the payment made for acquiring 67% interest of Hutchison group. This was disputed by VIH saying that it agreed to acquire share of CGP and as a consequence, it has direct/indirect control of 52% shareholding of HEL with call options to further acquire 15% shareholding.
2.3 Prior to the above arrangement of transfer of direct and indirect interest of Hutchison group to Vodafone group, certain events took place such as: in December 2006, HTIL had issued a statement stating that is has been approached by various potential-interested parties regarding possible sale of its equity interest in HEL; in December 2006, Vodafone group had made non-binding offer to HTIL for its direct and indirect shareholding in HEL; in February 2007, the offer was revised with binding offer on behalf of VIH for ‘HTIL’s shareholdings in HEL together with inter-related company loans; in February 2007, Bharti Infotel Pvt. Ltd. had also given a letter stating it has no objection to the proposed transaction (as Vodafone had some shareholding in the said company). Ultimately, final binding offer was made by Vodafone group on February 10, 2007 of US $ 11.076 billion.
2.3.1 On 11th February, 2007, Share Purchase Agreement (SPA) was entered into with HTIL [and not with HIHL (BVI) which was holding share of CGP] under which HTIL agreed to procure and transfer to VIH the entire issued share capital of CGP by HTIHL (BVI), free from all encumbrances together with all rights attaching or accruing, and together with as-signment of its loan interests. This was followed by announcement of Vodafone group on February 12, 2007 stating that it had agreed to acquire a controlling interest in HEL via its subsidiary VIH. On February 28, 2007 Vodafone group, on behalf of VIH, addressed a letter to Essar group for purchase of Essar’s entire shareholding in HEL under ‘Tag along rights’ of Essar group under its joint venture with Hutchison group in HEL and so on.
2.3.2 On 28th February, 2007, VIH filed an application with the Foreign Investment Promotion Board (FIPB) of the Union Ministry of Finance in which, effectively, it was requested to take note and grant approval under Press Note 1 to the indirect acquisition of 51.96% stake in HEL through an overseas acquisition of the entire shareholding of CGP from HTIHL (BVI). HTIL in its filing before US SEC had, inter alia, stated that a combined holding of the HTIL group was 61.88%, which is sought to be transferred. Therefore, on a query being raised by FIPB in regard to the difference in percentage of shareholding mentioned in the application and in the filing with US SEC, it was clarified that the variation is because of the difference in the US GAAP and Indian GAAP declarations that the com-bined holding for US GAAP purpose was 61.88% and for the Indian GAAP purpose it is 51.96% and the Indian GAAP number reflects accurately a true equity ownership and control position. Based on this clarification, FIPB granted a requisite approval. On 15th March, 2007, a settlement was also arrived at between HTIL and set of companies belonging to the Essar group on certain payments on the basis of which the Essar group indicated its support to the proposed transaction between Hutchison group and Vodafone group. For the purposes of running the business of JV with Essar Group, a term sheet agreement between VIH and Essar Group of companies was entered into for regulating various affairs of the HEL and the relationship of shareholders of the HEL. In this term sheet, it was, inter alia, stated that VIH had agreed to acquire the entire indirect shareholding of HTIL in HEL, including all rights, contractual or otherwise, to acquire directly or indirectly shares in HEL owned by others, which shares shall, for the purposes of the term sheet, be considered to be part of holding acquired by VIH.
2.3.3 In respect of the above transac-tion, a show- cause notice u/s.163 of the Income-tax Act, 1961 (the Act) was issued by the Revenue to HEL in August 2007 asking it to explain why it should not be treated as a representative assessee of VIH. A notice was issued u/s.201(1) and 201(1A) of the Act to VIH in September 2007 asking it to show cause as to why it should not be treated as an ‘assessee in default’ for failure to withhold tax. This action of the Revenue was challenged by VIH before the Bombay High Court in a writ petition in which the jurisdiction of the Revenue over the petitioner for issuing such a notice was challenged. The petition was dismissed by the Bombay High Court (311 ITR 46) declining to exercise its jurisdiction under Article 226 in a challenge to the show-cause notice. Against this, a Special Leave Petition (SLP) was filed by the petitioner before the Supreme Court which was also dismissed with a direction to Revenue to determine the jurisdictional challenge raised by the petitioner and the right of the petitioner to challenge the decision of the Revenue (if, determined against the petitioner) on this issue was reserved keeping all the questions of law open (179 Taxman 129).
2.3.4 Subsequent to the above events, another show-cause notice u/s.201 was issued by the Revenue in October 2009 on the basis of which, after considering the assessee’s reply, the order was passed u/s.201 upholding jurisdiction of the Revenue on 31st May, 2010. On the same date, a show-cause notice was also issued u/s.163 to VIH as to why it should not be treated as an agent/representative assessee of HTIL. These were challenged by the assessee before the Bombay High Court by a writ petition.
Basic contentions from both the sides
2.4 Before the High Court, on behalf of the petitioner, it was pointed out that the CGP through its downstream subsidiaries, directly or indirectly controlled equity interest in HEL. The transfer of share of CGP has resulted in the petitioner acquiring control over the CGP and its downstream subsidiaries including ultimately HEL and its downstream operating companies. On the passing of downstream companies, commercial arrangements common to such transaction were put in place. The transaction represents a transfer of a capital asset (i.e., share of CGP) situated outside India and hence, any gain arising on such transfer is not taxable in India. Accordingly, there was no obligation on the part of the petitioner to deduct tax u/s.195. It was also pointed out that if the shares held by the Mauritian companies were sold in India, the capital gain, if any arising on such transaction would not be taxable in India in view of the Mauritius Tax Treaty. Section 195 is inapplicable to foreign entity which has no presence in India, not even a branch office, as such entity cannot be subjected to obligation to deduct tax in respect of offshore transaction. It is the recipient who is the potential assessee as he has received the sum chargeable, if any. This by itself, does not create nexus with the Payer who has neither taxable income nor any presence in India. In support of this stand, various submissions were made.
2.5 On behalf of the Revenue, primarily it was pointed out that SPA and other documents establish that the subject-matter of the transaction between HTIL and VIH was a transfer of 67% interest (direct as well as indirect) in HEL. The CGP share is only one of the means to achieve this object. The transaction constitutes a transfer of composite rights of HTIL in HEL as result of the divestment of HTIL’s rights which paved way for VIH to step in the shoes of HTIL. The transaction in question has a sufficient territorial nexus to India and is chargeable to tax under the Act. This is evident from various arrangements made to give an effect to the understanding between the parties including the fact that SPA was entered in to with HTIL and not HTIHL (BVI). The consideration paid was a package for composite rights and not for a mere transfer of a CGP share. It was also pointed out that there is a distinction between proceedings for deduction of tax and regular assessment proceedings. The jurisdiction issue should be legitimately confined to obligation of VIH u/s.195 to withhold tax. Nonetheless, the Revenue made various submissions before the Court with regard to chargeability to tax arising out of the transaction.
2.5.1 The view of the Revenue that the real nature of transaction is with regard to transfer of 67% interest of HTIL in HEL to VIH and not only transfer of one CGP share was based on the premise that on interpretation of SPA and other agreements/documents, it is clear that the form of the transaction is reflected therein. Several valuable rights which are property rights and capital assets of HTIL stand relinquished in favour of VIH under these agreements. These rights are property and constitute capital assets which are situated in India. But for these agreements, the HTIL would not have been able to effectively transfer to VIH, its controlling inter-est in JV Co., HEL, to the extent of 67%. The HTIL’s interest in HEL arose by way of indirect equity shareholding upon agreements; finance agreements, shareholdings agreements, call options agreements, etc. aggregate of which confers a controlling interest of 67% in HEL. All these varied interests did not emerge only from one share of CGP and could not have been conveyed by the transfer of only one equity share of CGP. The parties themselves have treated the transaction as acquisition of one share of CGP, as well as other assets in the form of various rights, and entitlements, which are situated in India.
Settled principles acknowledged
2.6 For the purpose of considering the submissions made by both the parties and the principles on which they have relied, the Court referred to various judicial precedents and the principles emerging therefrom and acknowledged various settled principles in that regard such as: in interpretation of fiscal legislation, the Court is guided by the language and the words used; a legal relationship which arises out of the business transaction cannot be ignored in search of substance over form or in pursuit of the underlying economic interest; the tax planning is legitimate so long as the assessee does not resort to colourable device or a sham transaction with a view to evade taxes; incorporated corporation has a distinct juristic personality and its business is not the business of its shareholders; during the subsistence of corporation, its shareholders have no interest in its assets; a share represents an interest of a shareholder which is made up of various rights; shares, and rights which emanate from them, flow together and cannot be dissected; a controlling interest is an incident of the ownership of the shares in a company and the same is not an identifiable or distinct capital asset independent of the holding of shares; control and management is one facet of the holding of shares; the jurisdiction of a State to tax NRs is based on the existence of nexus connecting the person sought to be taxed with the State which seeks to tax; in certain instances, a need for apportioning income arises where the source rule applies and the income can be taxed in more than one jurisdiction, etc.
2.6.1 Evaluating the contentions of the petitioner with regard to obligation to withhold tax, the Court dealt with the provisions of section 195(1) as well as the relevant precedents and then, the Court formulated the principles governing the interpretation of section 195 which, inter alia, include the position that the Parliament has not restricted the obligations to deduct TAS on a resident and the Court will not imply a restriction not imposed by the legislation.
Analyses of facts and tax implications
2.7 The Court, then, proceeded to analyse the fact of the case on hand to determine the issues raised on the basis of settled principles referred to hereinbefore. For this purpose, the Court noted that essentially the case of VIH is that the transaction was only in respect of the purchase of one share of CGP and that being a capital asset situated outside India, no taxable income arises in India. On the other hand, the case of the Revenue is that the subject-matter of the transaction on a true construction of SPA and other transaction documents is a composite transaction involving transfer of various rights in HEL by HTIL to VIH, which resulted into deemed accrual of Income for HTIL from a source of income in India or through transfer of capital assets situated in India.
2.7.1 To decide the issue, the Court first considered as to how both the parties have construed the transaction. The Court noted that it is revealed from both the interim and final reports of HTIL that the transaction represented discontinuation of its operations in India upon which, it had generated a profit of HK $ 70,502 million. From the proceeds of the transaction, the HTIL also declared special dividend to its shareholders. Accordingly, from HTIL’s perspective, it had carried on in India Mobile Telecommunications Operations, which were to be discontinued as a result of the transaction.
On the other hand, VIH also perceived the transaction as acquisition of 67% interest in Indian JV Co., for an agreed consideration. This is evident from various announcements made by VIH, as well as the arrangements entered into between the parties. The equity value of HTIHL (BVI)’s 100% stake in CGP was computed on the basis of the enterprise value of HEL at US $ 18,250 million and by computing 67% of equity value on that basis. The entire value that was ascribed to its stake in CGP was computed only on the basis of enterprise value of HEL.
The Court then noted that it is in the above background, various documents should be considered and analysed and the effect thereof should be determined.
2.7.2 After considering various clauses of the SPA and the relationship of shareholders of the Company, the Court observed as under (Page 207):
“The diverse clauses of the SPA are indicative of the fact that parties were conscious of the composite nature of the transaction and created reciprocal rights and obligations that included, but were not confined to the transfer of the CGP share. The commercial understating of the parties was that the transaction related to the transfer of a controlling interest in HEL from HTIL to VIH BV. The transfer of control was not relatable merely to the transfer of the CGP share.
Inextricably woven with the transfer of control were other rights and entitlements which HTIL and/or its subsidiaries had assumed in pursuance of contractual arrangements with its Indian partners and the benefit of which would now stand transferred to VIH BV. By and as a result of the SPA, HTIL was relinquishing its interest in the telecommunications business in India and VIH BV was acquiring the interest which was held earlier by HTIL.”
2.7.3 The Court also further noted various other agreements/arrangements made between the parties such as: the term sheet agreement with Essar group to regulate the affairs of HEL and relationship of the shareholders of both the groups, put option agreement with Essar group of companies, a tax deed of covenant for indemnifying various companies in respect of taxation and transfer pricing liabilities, the brand licence agreement, the loan assignment agreements, the arrangement with the existing Indian partners of HTIL (viz. Asim Ghosh, Analjeet Singh and IDFC), etc.
2.7.4 The Court then observed that the facts which have been disclosed before the Court support the contention of the Revenue that the transaction between HTIL and VIH took into consideration various rights, interests and entitlements which, inter alia, include: direct and indirect interest of 52% equity shares of HEL; indirect interest of 15% in HEL through call options held by Indian partners of Hutchison group; right to carry on business through telecom license in India; non-compete in India; management rights of HEL under SPAs; right to use Hutchison brand for a specified period, etc. (the complete details of rights, etc. are appearing on pages 211/212 of the judgment).
2.7.5 The Court then also referred to the FIPB process in the transaction, wherein various queries were raised and clarifications were given by VIH. Referring to one of the clarifications of VIH dated 19th March, 2007, the Court noted that VIH had stated that it had agreed to acquire from HTIL for US $ 11.08 billion interest in HEL, which included 52% equity shareholding (direct/indirect). This price included a control premium, use and rights to use the Hutch brand in India, a non-compete agreement, loan obligations and entitlement to acquire further 15% indirect interest in HEL, subject to the FDI rules, etc. These elements together equated to about 67% of the equity capital.
2.7.6 The above facts clearly establish that it will be simplistic to assume that the entire transaction between HTIL and VIH was only related to transfer of one share of CGP. The commercial and business understanding between the parties postulated what was being transferred was controlling interest in HEL from HTIL to VIH. In its due diligence report, Earnst & Young have also stated that the target structure now also includes CGP which was originally not within the target group. The due diligence report emphasises that the object and intent of the parties was to achieve the transfer of control over HEL and transfer of solitary share of CGP was put in place at the behest of HTIL, subsequently as a mode of effectuating the goal.
2.7.7 The Court further observed that the true nature of the transaction as it emerges from the transactional documents is that the transfer of solitary share of CGP reflected only a part of the arrangement put into place by the parties in achieving to object of transferring control of HEL to VIH. T h e Court, then, held as under (pages 213/214):
“The price paid by VIH BV to HTIL of US $ 11.01 billion factored in, as part of the consideration, diverse rights and entitlements that were being transferred to VIH BV. Many of these entitlements were not relatable to the transfer of the CGP share. Indeed, if the transfer of the solitary share of CGP could have effectuated the purpose it was not necessary for the parties to enter into a complex structure of business documentation. The transactional documents are not merely incidental or consequential to the transfer of the CGP share, but recognised independently the rights and entitlements of HTIL in relation to the Indian business which were being transferred to VIH BV.”
2.7.8 According to the Court, intrinsic to the transaction was a transfer of other rights and entitlements. These rights and entitlements constitute in themselves capital assets within the meaning of section 2(14) of the Act.
2.7.9 After concluding that the transaction should be dissected in to various rights and entitlements for which the consideration is paid, the Court, dealing with the issue of apportionment of consideration to such rights and entitlements to determine the taxability thereof, further held as under (page 215):
“The manner in which the consideration should be apportioned is not something which can be determined at this stage. Apportionment lies within the jurisdiction of the Assessing Officer during the course of the assessment proceedings. Undoubtedly, it would be for the Assessing Officer to apportion the income which has resulted to HTIL between that which has accrued or arisen or what is deemed to have accrued or arisen as a result of a nexus within the Indian taxing jurisdiction and that which lies outside. Such an enquiry would lie outside the realm of the present proceedings ……..”
2.8 The Court then considered the issue with regard to jurisdiction of the Revenue to initiate pro-ceedings u/s.195 in the case of VIH. In this context, after referring to the provisions of section 195(1) and the relevant judicial precedents, the Court concluded as under (page 221):
“Chargeability and enforceability are distinct legal conceptions. A mere difficulty in compliance or in enforcement is not a ground to avoid observance. In the present case, the transaction in question has significant nexus with India. The essence of the transaction was a change in the controlling interest in HEL which constituted a source of income in India. The transaction between the parties covered within its sweep, diverse rights and entitlements. The petitioner by the diverse agreements that it entered into has nexus with India jurisdiction. In these circumstances, the proceedings which have been initiated by the income-tax authorities cannot be held to lack jurisdiction.”
2.8.1 The Court finally stated that the issue of juris-diction has been correctly decided by the Revenue for the reasons already noted above and the VIH was under an obligation to deduct TAS while making payment to HTIL.
2.8.2 This judgment of the High Court is now reversed by the Apex Court (of course, subject to outcome of the review petition filed by the Revenue) which we will consider in the next part of this write-up.
(To be continued)
