The story of Vodafone's case in Supreme Court is not an old story. In the Vodafone's case, Vodafone, Netherlands, entered into an agreement with a Hong Kong company to acquire shares of a Cayman Island company which in turn held controlling interest in Hutchison Essar (Hutch), an Indian company. The effect of this transaction was that the controlling interest of Hutch was effectively transferred to Vodafone.
The Income-tax Department took a view that Vodafone was liable to withhold taxes on payments made to the Netherlands company since the transaction resulted in transfer of controlling interest of the Indian company. However, on appeal by Vodafone to Supreme Court, it was held by the court vide its order dated January 20, 2012, that the transaction is not liable to tax in India as no direct transfer of the shares of Indian company has been made. Section 9 does not cover indirect transfer of capital asset in India and Section 195 relating to withholding taxes would apply only for payments made from a resident to a non-resident.
The Government of India, instead of accepting the Supreme Court verdict, made retrospective amendments in the income-tax act to nullify the effect of Vodafone's case. The Act was amended to provide that:
- Section 9 includes indirect transfers.
- Section 2(14), "property" includes any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.
- Section 2(47), "transfer" includes transfer of controlling interest of an Indian company by way of transfer of shares of foreign company.
- "Situs of shares" of a company incorporated outside India shall be deemed to be in India if the share derives, directly or indirectly, its value substantially from the assets located in India.
The net effect of the aforesaid amendments was that the decision of the Supreme Court in Vodafone's case is no longer a good law. Now, any transaction entered into outside India between two foreign residents shall also be subject to the provisions of the Indian Income Tax Act if the said transaction has any bearing on any asset situated in India. The action of the Legislature to amend law retrospectively had a direct negative impact on the foreign investment in India.
The confidence of foreign investors in the indian judicial system was shaken. This was, however, quickly realised by the Government of India and, therefore, the government decided to settle Vodafone's matter amicably.
However, it may be emphasised that the impact of the amendments that the transaction between two non-residents would be taxed in India is not universally applicable. Reference in this regard may be made to the decision of the Andhra Pradesh in the case of Sanofi Pasteur Holding SA, 354 ITR 316. The facts are: There is a company in India which is being held by a company incorporated in France, SH. The said French company was ultimately held by other French companies. The ultimate French holding company entered into agreement with another French company, Sanofi, to buy the shares of SH. Applying the amended provisions of the Act, the Income Tax Department took the view that the transaction between the two French companies liable to tax in India. However, the AP High Court has observed that the amendments made in the I-T Act do not override the tax treaties India has with other countries.
It was further observed: "A strained construction which subverts the policy underlying India entering into a double taxation avoidance treaty with another State, by enabling dual taxation through artificial interpretation of treaty provisions, either by the tax administrator or by the judicial branch at the invitation of the Revenue of one of the Contracting States to a treaty would transgress the inherent and vital constitutional scheme, of separation of powers." It was held by the Court that provisions of Article 14 (relating to taxability of capital gains) of the Indo-France tax treaty does not provide for dual taxation.
Under Article 14(5), where shares of a company which is a resident of France are transferred, representing a participation of more than 10 per cent in such entity, the resultant capital gain is taxable only in France.
The fact that the value of the shares alienated comprises underlying assets located in other contracting state is irrelevant in the context of Article 14(5). The amended definition of "transfer" as per the Income Tax Act cannot be used for interpreting Article 14. It was further held by the court that there is no transfer of the right, title and interest in or transfer of Indian company shares.
The transaction could not be taxed in India on the basis that there was a deemed alienation of Indian company shares.The good faith interpretation does not permit incorporation of a see-through or look-through provisions in tax treaty provisions, to cover indirect or incidental transfer of rights in or control over assets of Indian company.
Thus, it is clear from the above decision that the amendments made in the Act do not override the provisions contained in the tax treaty and, therefore, even after the amendments, the transaction which is governed by the tax treaty may not be liable to tax in India.
The article has been co-authored by Alok Gupta e-mail: firstname.lastname@example.org