Vodafone’s fresh notice to the Centre seeking international arbitration over a ₹20,000-crore tax demand relating to its acquisition of Hutchison Essar’s telecom business in India speaks very poorly of the latter’s ability to resolve commercial disputes through conciliation. The dispute itself was avoidable in the first place. True, the $11.1 billion dollar Vodafone-Hutchison deal in 2007 did result in transfer of real assets in India. The capital gains from this, in normal circumstances, would have been taxed. But in this case, the buyer (Vodafone), the seller (Hutchison), and the company being bought were all incorporated overseas. What took place, then, was an offshore transaction involving only shares, even though the underlying assets were located in India. Given that the Income Tax (IT) Act at that point only covered direct transfer of capital assets within India, Vodafone was under no obligation to deduct tax at source on the amount it paid to Hutchison. And that’s what the Supreme Court rightly ruled in January 2012.
The unfortunate part is what followed. The 2012-13 Union Budget amended the IT Act to allow tax to be levied retrospectively on any deal whose value derived, directly or indirectly, from assets in India. Despite the then Finance Minister Pranab Mukherjee’s claim that this was a generic proposal, it seemed directed at Vodafone; also, it raised genuine concerns about the predictability and stability of tax laws in India. Thankfully, the negative perception that the retrospective tax changes created among foreign investors forced the Centre to offer a non-binding conciliation to Vodafone, which had already threatened to launch arbitration proceedings under the India-Netherlands Bilateral Investment Treaty. The fact that Vodafone has served fresh notice now only shows that the talks have made no headway; the Centre is even considering withdrawing its conciliation offer. In short, we are back to 2012 and the IT Department set to raise afresh its tax demand — around ₹20,000 crore, inclusive of interest and penalty — on Vodafone.
The Centre needs to carefully weigh the consequences of not arriving at a negotiated settlement. It can claim that the retrospective tax amendments applied to all case of indirect capital transfers and were not aimed specifically at Vodafone. It can also point to Vodafone’s interest in expanding operations in India, by citing its investment of $3.2 billion for acquiring spectrum in recent auctions. But this ignores the fact that the Vodafone tax row marred India’s image as an investment destination in 2012, more than any other issue. It took lot of hard work, including sending clear signals to investors of the Centre’s keenness to resolve disputes and push ahead with reforms, to reverse some of that perception. That hard work should not go in vain.