Vodafone case outcome may affect global M&As

A leading law firm has said the outcome of the Vodafone versus the income tax department litigation, final arguments for which have begun at the Bombay High Court, could have a telling impact on global mergers and acquisitions indirectly involving an Indian subsidiary.

The litigation began after the Income Tax department raised a tax demand of $2 billion on Vodafone for failing to deduct tax while paying $11.1 billion for a controlling stake in Hutchison-Essar (now called Vodafone-Essar) from Hong Kong's Hutchison Whampoa.

In a recent report, law firm Nishith Desai Associates has said it is closely following the proceedings in the Court after it received numerous queries on the case.

Reporting the June 26 proceedings in the Court, the report said the crux of the submissions by Vodafone's counsel was that the expression "person" cannot be interpreted to include a person having no presence in India.

Iqbal M Chagla, counsel for Vodafone International Holdings BV, said a plain reading of the expression in Section 195 of the Income Tax Act, 1961 would imply that even a foreign company without any presence in India would be liable to deduct tax at source.

However, Chagla submitted that the Court must "read down" the expression and interpret "person" to mean only persons, resident or non-resident, having a presence in India, the report adds.

Chagla's submissions before the division bench consisting of Justice S Radhakrishnan and Justice AV Nirgude, essentially dealt with the scope of the expression "person" as used in Section 195. Under this Section, any person making a payment to a non-resident would be liable to deduct tax at source.

The Income Tax department's contention is that Vodafone, a Dutch company, was liable to deduct tax at source while making payment to a Cayman Islands company for the acquisition of another Cayman Islands company, that indirectly owned shares in Hutchison-Essar.

Vodafone's submission's view on "person" says that only a person who has a factual or taxable presence in India can be made liable to deduct tax in India.

It adds that the Indian Parliament being a sovereign and plenary parliament, and in light of Article 245 of the Constitution of India, has the authority to pass laws with extra-territorial operation. However, these must be explicit in their extra-territorial ambit. These may, however, not always be enforceable, the report added.

Vodafone has also claimed that the definition of "person" must be interpreted in the context of what was intended by the legislature in light of the language used in Section 2 of the Income Tax Act. It has also said that the workability test was laid down by the House of Lords in Clark vs Oceanic Contractors, which has been upheld by various Indian judicial precedents, and should be followed and the interpretation accorded to a provision should be enforceable.

A broader interpretation to the expression "person", would render the provision unenforceable. In addition, the rule of "reading down" must be applied to the expression "person" so as to make it compatible with the workability test, the report adds.

In the subsequent hearings, the Vodafone counsel was to give a detailed submission on the constitutional validity of the retrospective amendment to Section 201 of the Income Tax Act. He will also put forth arguments on the issue of chargeability of capital gains tax.