Revenue Dept, courts asked to take holistic view

The Supreme Court judgment on the Vodafone tax issue has repeatedly said that Revenue Department and courts should “look at” the entire transaction as a whole and not adopt a dissecting approach.

“The Revenue cannot start with the question as to whether the impugned transaction is a tax deferment/saving device but should apply the “look at” test to ascertain its true legal nature,” said the judgment.

It was Revenue's view that the Cayman Islands company bought by Vodafone to get control of Hutchison Essar in India was a shell company and merely a tax-avoiding device.

The Court said that the onus will be on the Revenue to identify the scheme and its dominant purpose. “The corporate business purpose of a transaction is evidence of the fact that the impugned transaction is not undertaken as a colourable or artificial device,” said the judgment.

Every single foreign direct investment coming into India, as an investment destination should be seen in a holistic manner, said the Court. Revenue and courts should keep in mind factors such as the concept of participation in investment, the duration of time during which the holding structure exists, the period of business operations in India, the generation of taxable revenues in India, the timing of the exit and continuity of business on such exit.

It was a share sale and not an asset sale, held the Court. Hutchison Telecom International sold shares of Cayman Islands-based CGP Investment Holdings Ltd (which owned majority stake in Hutchison Essar in India through several Mauritius-based holding companies) to the Vodafone group.

Elaborating, the Court said, the transaction has to be looked at as one Single Consolidated Bargain which took place between two foreign companies outside India for which a lump sum was paid. As a general rule, said the Court, in a case where a transaction involves transfer of shares lock, stock and barrel, it cannot be broken up into separate individual components, assets or rights such as the right to vote, right to participate in company meetings, control premium, brand licence and so on.

The Court held that the Offshore Transaction is a bonafide structured foreign direct investment.

DTC CITED

The Court even cited the fact that the Direct Taxes Code Bill proposes taxation of offshore share transactions, even from indirect transfer of a capital asset situated in India. This proposal indicates in a way that indirect transfers are not covered by the existing Section 9 (1) of the Income-Tax Act, said the Court. Therefore the Vodafone-Hutchison deal is not taxable in India. It was the Court's view that there is no present provision in Indian laws to tax such transactions.

NO extinguishment of rights by HTIL

The Court said that under the HTIL structure, as it existed in 1994, it occupied only a persuasive position/influence over the down stream companies in the manner of voting nomination of directors and management right. It said that the minority investors had participative and protective rights which flowed from the CGP share; and also that the entire investment was sold to Vodafone through the investment vehicle (CGP). Consequently there was no extinguishment of rights as alleged by the Revenue, said the Court.

The HTIL structure, the call options, rights of shareholders and controlling interest….all support the fact that the sole purpose of CGP was not only to hold shares but also to enable a smooth transition of business, said the Court. Therefore it cannot be said that CGP had no business or commercial purpose as alleged by Revenue which contended that CGP was interposed later in the structure. The effective shareholding of Vodafone (and of HTIL) in Hutchison Essar in India was only 51.96 per cent. The rest of the 15 per cent holding is by other entities. It was for this reason and because of the sectoral cap that FIPB gave approval for transfer of 51.96 per cent stake in HEL to Vodafone, cited the Court.

This shows that the purpose of the share purchase agreement between Vodafone and HTIL was to continue the practice concerning nomination of directors on the HEL Board which in law is different from right or power to control and manage, and to keep the business going after acquisition, said the Court.

Under Company Law, management control vests in the board of directors and not in the shareholders, said the Court. As to why Vodafone paid Hutchison a value equivalent to 67 per cent stake in HEL, the Court said valuation cannot be the basis of taxation. It is profit or income that is.

The difference of 51.96 per cent and 67 per cent was on account of the differences in computation under Indian and US GAAP, said the Court.

On Section 195 under which Vodafone was charged in the first place, and which gave rise to the entire dispute, the Court said that there is no liability for capital gains tax when shares of an offshore company are transferred from one non-resident to another. Therefore there is no question of TAS.

Supreme Court on holding-subsidiary company structure

“The entire Hutchison structure is typical of the reconfiguration of business when it gets big enough. A typical large business corporations consists of subsidiary corporates. If large firms are not divided into subsidiaries, creditors would have to monitor the enterprise in its entirety.

“The creation of subsidiaries may also be a part of genuine strategic tax planning and the role of subsidiaries builds efficiency in a holding structure.

The Hutchison structure demonstrates the concept of de facto control which conveys a state of being in control without any legal right to such state.

“Accordingly as a group holding company, Hutchison International Holding Co (HIHC) had no legal right to direct its downstream companies in the matter of voting, nomination of directors and management rights. It exercises only a persuasive influence/position over a downstream company which cannot be construed as a right in the legal sense.”