A three-judge bench of the Supreme Court ruled on Friday on what has been one of the most watched and fiercely fought tax disputes in recent memory. It ended in victory for the giant mobile phone provider Vodafone, which the Court judged would not have to pay Rs11,000 crore in tax following its 2007 purchase of a 67 per cent stake in Hutchison Essar from the Hong Kong-based Hutchison Whampoa. This reversed the ruling of the Bombay High Court, which held in 2010 that tax was payable on the deal. The income-tax department will now have to return the funds the company paid over following that judgment — Rs 2,500 crore, along with interest charges of 4 per cent per annum. The numbers involved certainly catch and hold the attention. That an Indian court has ruled so strongly in favour of a UK-based company in a tax dispute with such great sums at stake should be taken as a reminder of India’s institutional strength, and might well help revive interest in Indian investments among the owners of capital abroad. Yet the substance of the case is of considerable importance, too.
The dispute arose after the purchase of the India-based collaboration between Hutchison Whampoa and Essar by the Dutch subsidiary of the United Kingdom’s Vodafone plc. The purchase was not carried out in a straightforward manner; through a complex network, Hutchison Essar was controlled by a holding company based in the Cayman Islands called CGP, owned by Hutchison Whampoa. It was in this offshore company that Vodafone’s subsidiary bought an interest, thereby acquiring the assets and network of Hutchison Essar. The income-tax department argued that Vodafone was defaulting on tax, by not withholding capital gains tax it insisted was due on the payment Vodafone made to Hutchison Whampoa. Vodafone argued that since it did not pay directly for an asset located in India, but for a controlling interest in a Cayman Islands-based holding company, it was not liable for tax. The question boiled down to this: was Vodafone’s action, under current law, tax evasion? Or was it tax avoidance? In other words, did Vodafone act to not pay tax that it already owed? Or did it structure its behaviour so as to avoid the creation of a tax liability in the first place? Going beyond these questions, the Supreme Court ruled that the government could not seek capital gains tax from the deal because it took place overseas between two foreign companies.
The government needs now to look forward, not back. That a deal of this Byzantine complexity over an Indian company can be carried out with no tax due means that the relevant aspects of the tax code are ripe for overhaul. Clearly, they should have been updated long since; most other economies work hard at amending their tax codes regularly, in order to plug obvious loopholes and reduce the offshoring of tax liabilities. Naturally, any action should have prospective, not retrospective impact. The government has made a good start by reportedly choosing not to appeal the Supreme Court’s ruling. It must now work on closing the loopholes this judgment has identified.