Tax planning in the context of verdict

Tax planning has once again come to the fore as a subject of discussion after the Vodafone judgement. In the case of Vodafone International Holdings BV versus Union of India, the Supreme Court gave a judgment on 20th January, 2012, in which in para 67 it has been said that “ whether a transaction is used principally as a colourable device for the distribution of earnings, profits and gains, is determined by a review of all the facts and circumstances surrounding the transaction... It is in the above cases that the principle of lifting the corporate veil or the doctrine of substance over form or the concept of beneficial ownership or the concept of alter ego arises”. Applying this test the Supreme Court concluded that “the Offshore Transaction herein is a bonafide structured FDI investment into India which fell outside India’s territorial tax jurisdiction and hence not taxable.”

Revenue highlighted in this case that Vodafone has done indirectly what could not be done directly. The contention of Revenue was that the transfer of shares of CGP (CGP Investment Holdings Ltd, which is incorporated in Cayman Islands) outside India resulted into indirect transfer of shares of Indian Company and therefore the transfer is liable to tax in India. Cayman Islands is one of the famous tax havens and ranks high above the similar tax havens. The Supreme Court, however, held that we have to look at the transaction as a whole and take into consideration various factors such as the duration of time during which the holding structure existed, the period of business operations in India, the generation of taxable revenue in India, the continuity of business, etc. Considering all these factors, the Supreme Court held that the transaction was genuine and not sham.

Regarding legal avoidance of tax, Justice Krishna Iyer made a very important observation in the case of CIT vs Arabinda Reddy – 1979(4)SCC721, when he said the following: “The Court is not the mint of virtue and one day in our welfare state geared to social justice, this clever concept of 'avoidance' against 'evasion' may have to be exposed. Enough unto this day is the evil thereof.”

This Vodafone judgement has discussed two previous judgements namely McDowell vs. Commercial Tax Officer – AIR1986SC649 and the UOI vs Azadi Bachao Andolan -(2000)263ITR706. McDowell judgement was relied upon by Revenue in the present Vodafone case. Revenue argued this judgement goes against the judgement in the case of Azadi Bachao Andolan. The later judgement was given in the context of Indo Mauritius Double Taxation Avoidance Convention, 1983, which observed that the McDowell case does not apply to this case. While Revenue wanted a review of this observation made in the case of Azadi Bachao Andolan, the Supreme Court observed that they are not contradictory because McDowell case is applicable in the case of tax avoidance whereas the other case is relating to treaty shopping. I respectfully agree with this observation of the Supreme Court. The principle adopted for interpretation of statute is not the same as the principle enunciated for interpretation of treaty.

Treaty is also a political document and not just legal. Therefore, the enunciation in the judgement of Azadi Bachao Andolan is not against the principle enunciated in McDowell case. There is no contradiction.

The conclusion is that the Vodafone judgement is the latest in the series of several judgements given by the Supreme Court earlier.

The substance of all these judgement is that tax planning can be done provided it is permitted within the law and the activity to avoid the tax is not just a sham (a colourable device) but a genuine transaction. Interpretation to be given by a judge should not be to encourage evasion but it can allow avoidance within the law. It has to be judged on the basis of facts in each case.

Tax planning is a feature of direct tax and not indirect tax. In the case of indirect tax the taxable event is act of manufacture, act of import and act of providing service which are quantifiable. There is, therefore, only tax evasion and not tax avoidance in indirect tax.

E-mail: smukher2000@yahoo.com