The Supreme Court’s ruling asserting the non-taxability of an acquisition by Vodafone, and the reaction of Indian revenue authorities in introducing an amendment to the Income-Tax Act in the 2012 Finance Bill enabling retrospective taxation, have brought up a string of questions on the interpretation and subsequent treatment for tax purposes of businesses. The particular context has been with respect to businesses operating in one country while dealing amongst themselves in another. Analysing this from a taxation point of view is challenging, especially when the minister of state for finance has asserted that the revenue implication of the amendment could be Rs 35,000 to 40,000 crore.
The amendment’s overall economic impact is also a matter to be reckoned with. For instance, another minister of state for finance is reported to have indicated that foreign investors make their decisions taking into account all relevant factors, and that the investments are admitted into the country within the framework of the applicable laws and regulations formulated to promote the country’s interest. The question remains if this was meant as an ex-post statement; if so, it would imply that a business would have to anticipate all relevant changes that might come in the life-cycle of the proposed business venture. That is not possible. If, therefore, it is to be taken as an ex-ante statement, then one would have to ask how such investors will react when the relevant factors and prevailing framework of applicable laws on the basis of which investment decisions were made are suddenly changed in an unanticipated way — that is, without consultation with stakeholders.
Indian law limits foreign investment in telecom infrastructure to 74 per cent of total capital. Diagram 1 shows, to this author’s understanding, how the business was organised prior to the acquisition while Diagram 2 shows the post-acquisition situation.
The issues to address are: first, though the economic activity took place in India, the transaction that enabled the changing of hands took place outside India; second, given the manner in which the transaction took place, and however dexterously we interpret it or which side we take, there is a general question of international tax minimisation if not avoidance, so that the expectation of making globally operating multinational companies (MNCs) pay their fair tax share continues to jar and frustrate; third, that Hutchison was the seller and Vodafone the buyer but, apparently since Hutchison was out of the picture, the revenue authorities pursued the buyer regarding the tax payments while, conceptually, it should be the seller who should pay the tax; and fourth, the interpretation of the gains as income or capital gains determines taxability — since, if it is income, India can tax it but, if it is capital gains, the foreign government does so as per tax treaty (which does not matter in the Caymans or Mauritius).
First, referring to Diagrams 1 and 2, all transactions took place above the India dividing line. Indeed, entities in Hong Kong, Netherlands, Cayman Islands and Mauritius, not just India, were involved, revealing the well-known prevalence of mind-boggling global corporate structures. Yet, Hutchison Essar, the entity under consideration, continues to operate and generate income and profits in India before and after its acquisition by Vodafone. Second, given the prominence of tax havens Mauritius and Caymans, and adherents of international tax competition in short headline tax rates Hong Kong and Netherlands, it does not take much intelligence to realise the overwhelming role of tax avoidance in the transaction.
Now come the difficult parts. Third, given that it was Hutchison the seller that must have made income or capital gains from the transaction, does not the onus lie on Hutchison to pay whatever tax they owed to the revenue authorities? What prompted the latter to go after the buyer and could this be justified? Reversing the onus of tax payment is called withholding tax or reverse charge in common taxation parlance. Take an example from the VAT or GST. If a construction industry contractor subcontracts out to small operators, then the former is asked to collect VAT from the latter before making payments to them. Then he has to pass the collection to the revenue authorities. Thus it works well typically when a large entity (on one side) and many small entities (on the opposite side) are transacting together. For the authorities to operate this principle between two large operating entities as a withholding tax is unusual and, in any event, the tax withholding provision (Section 195) does not apply extra-territorially.
Fourth, the question to examine is whether what technically took place was a transfer of shares of a non-resident entirely outside India, or a transfer of a capital asset situated in India. The mere transfer of shares abroad can be restricted from being interpreted as buying interest in the property in India. If so, it is not a transfer of a capital asset and, in turn, would not give rise to income chargeable to tax in India. I have used mere in italics since in reality it is of course not a small transaction. But small or large, unfortunately, it does not legally make it a transfer of a capital asset, and remains a transfer of shares. The revenue authorities, however, chose to interpret the proceeds as income rather than as capital gains from a sale of shares. While they won in the Mumbai High Court, resulting in Vodafone facing a tax bill of $2 billion, the Supreme Court subsequently reversed the judgment of the High Court.
In my next column, I will deconstruct this to arrive at some conclusions!
The writer is Director and Chief Executive of Icrier, New Delhi. These views are his own.