On January 20, 2012, the Supreme Court delivered the long awaited verdict in the Vodafone appeal, to hold that the consideration of an offshore sale of shares cannot be taxed on the value of the underlying asset, regardless of its worth, actual or otherwise. The exchequer is unhappy over the loss of revenue to the extent of $2.5 billion, not to speak of more that was expected to be generated by pursuing this approach, had the Supreme Court upheld Bombay Court’s ruling.
Intensive debates have arisen on whether offshore transfer of shares should be subjected to valuation, on whether the underlying asset value concept is legally tenable, whether policy decisions on FDI are effectively frittering away the nations’ wealth – much of which is jingoistic and in disregard of the established law on the subject. But on balance there is relief that the rule of law has prevailed.
A study of the 100-odd pages of the two separate judgements is a must read for lawyers and all others connected with international tax. As a case study, it would have been exciting from a jurisprudential perspective, if the Supreme Court had upheld the impugned judgment to agree that Section-9 of the Income Tax Act could extend beyond a capital asset located in India, and could be invoked to include the underlying asset, or “the fruits investment” as per the High Court’s description of the CGPI share. One wonders how the Supreme Court would have justified the Revenue’s action and what would have been the reasoning as Section-5 of the Act read with 9(1) does not capture the transaction.
The backdrop to this particular appeal arises from the Supreme Court’s rejection of Vodafone’s initial appeal from Bombay High Court, directing the Revenue to decide on its jurisdiction, which resulted in Vodafone being treated as an “assessee in default”. The Supreme Court provided the Revenue every opportunity to justify its stand – critics are of the opinion that the Revenue was given too long a rope – raising flags about India’s reputation as a democratic business destination.
At the outset, the Chief Justice’s judgement (judgement) makes it clear that the Court is concerned with the sale of shares without any situs in India and, not with sale of assets underlying or otherwise. In such cases the Revenue has to ascertain the legal nature of the transaction by looking at it in its entirety (‘look at test’) and not adopt a piecemeal or dissection approach. It was not open to the Revenue to impute direct or indirect transfer of ownership or funds of investment of a capital asset being the Indian business. The Court has held such interpretation would render the purposive content of Sections 9(1) nugatory.
The High Court while observing vacillations in the Revenue’s approach had applied the “nature and character test” to arrive at a conclusion that the share transfer included transfer of rights and entitlements which constituted capital assets within the meaning of section 2(14) of the Act.
The Supreme Court has viewed the transaction applying the ‘look at test’ adopting a realistic perspective – that of a share sale as opposed to an asset sale, relying on the basic example of differing tax consequences in a slump sale in the latter form. It also examined the structure of the predecessor entity, and whether the sale was specifically intended for tax avoidance or for an investment to participate in an existing operational structure. The Court held that Hutchison had been a structure in long term existence generating revenue which satisfied the participatory test and delving further on control issues were not warranted.
The judgement squarely upholds the law laid down in the Azadi Bachao Andolan case, and the Indo-Mauritius tax treaty, rejecting the Revenue’s contention that this should apply only to investments originating in Mauritius.
The judgement further goes on to consider the aspects of control of a parent company over a subsidiary. Undoubtedly, a parent has to have control over a subsidiary. A subsidiary under any law has to meet a test of control through shareholding or board position, and therefore be subjected to certain practices and mandates of the parent. The Court in considering the scope of control has examined the nexus of companies in different jurisdictions to express its reservations in impediments a foreign parent located in a different jurisdiction encounter in relation to a subsidiary incorporated and operating overseas, whose functions, powers and compliances are governed by the local jurisdiction’s law, thereby ruling out an any overarching intervention of the overseas parent. The judgement recognises the abuses by corporate governors for unlawful gains, and that possibilities of misuse cannot be ignored, which is why applications of the look at principle and of lifting the corporate veil are available, but neither could be established in the case in hand.
Kumkum Sen is a partner at Bharucha & Partners, Delhi office and can be reached at firstname.lastname@example.org