In the case of Vodafone International Holdings B.V (‘Assessee’), the Bombay High Court (‘High Court’) has held that the Indian tax authorities have jurisdiction to issue a show cause notice to claim withholding tax since the transfer of rights and entitlements in itself constitutes a capital asset under the Income-tax Act, 1961 and has sufficient nexus with the Indian fiscal jurisdiction. The ruling of the High Court has been discussed below:
The decision is bound to have a wide reaching impact on cross border M&A transactions involving Indian businesses for various reasons. The High Court while interpreting the matter has laid down the following theories / principles:
• Transfer of interest in a business would in itself constitute a capital asset that may be subjected to tax
• Section 9 of the Income-tax Act, 1961 (‘Act’)is wide enough to cover within its ambit such
transfer of interest; and
• Tax Deduction at Source (‘TDS’) is merely based on provisional assessment and as long
as nexus with Indian fiscal jurisdiction is established the requirement of deducting TDS would arise.
However, some of the important aspects of the matter that have not been dealt with by the High Court in the instant scenario are:
• Tax treatment of similar transactions entered by a tax resident of a country with whom India has a tax treaty;
• Appropriation of the portion of income to be charged to tax; and
• Penalty, if any, to be imposed on account of non-deduction of TDS.
The High Court has made certain observations on the contractual arrangement between the parties and deduced that:
• The transaction was of a composite nature and created reciprocal rights and obligations which included but were not limited to the transfer of the CGP share
• Payments were made to Hutchison Telecommunication International Ltd., Cayman Islands (‘HTIL’) for various entitlements like
o Control premium;
o Hutch brand in India;
o Non-compete agreement;
o Value towards non-voting and non-convertible preference shares;
o Loan obligations; and
o Entitlement to acquire additional shares.
• There was a clear intent to give up controlling interest in the business
The High Court has laid great emphasis on the intention of the parties to transfer the controlling interest in the business. It observed that transfer of a single share was not the intent of the parties but it was to change the controlling interest in the business.
While refuting the theory that the transaction was merely a transfer of a single share, it was observed that the rights and entitlements flowing out of holding a share cannot be dissected from the ownership of the share.
The High Court was of the view that transfer of rights and entitlements is intrinsic to this transaction and that these rights in themselves constitute a capital asset. The nexus of capital asset with India was critical in determining the taxability of the transaction. The High Court also observed that Section 9 of the Act is wide enough to cover within its ambit the scope of the instant transaction. It was observed that once territorial jurisdiction has been established, the TDS provisions of the Act are of wide purport to subject cases of indirect foreign income of a person.
The High Court observed that TDS is merely a tentative deduction of income subject to regular assessment and there is no detriment in deducting / paying it at this stage and concluding the assessment in due course of time.
It is interesting to note that the High Court in this decision has formulated the theory of ‘transfer of interest’ in the business. This aspect has been extensively considered now and is bound to provide the tax authorities with additional room to tax similar cross border M&A transactions.
It is important to highlight that while the High Court has made certain landmark observations, there are certain key aspects of the transaction that have remain un-addressed. Most importantly, the High Court while noting an extremely important submission of the Assessee regarding the non-taxability of the transaction [should the shares have been transferred by a Mauritian company on account of the Double Taxation Avoidance Agreement (‘DTAA’) between the countries] did not make any observation on such submission. This leaves scope for debate in cases of identical transactions where the transfer of shares is undertaken by the tax resident of the country with which India has a tax treaty.
The High Court also did not get into the debate of Appropriation of income that would be chargeable to tax and left the quantification to the tax officer. Finally, while adjudicating on the penalty aspect in case of non-deduction of TDS, the High Court has again not made any specific observations and has left the Assessee with the option of pleading ‘reasonable cause and genuine belief’ regarding non-taxability of this transaction before the tax officers.
A larger legal proposition that emerges from the decision is the element of revenue loss. While the court has held that TDS is a tentative deduction of income and not final assessment and directed payment / deduction an aspect that has to be borne in mind by any assessee is the cash flow aspect to the transaction. Refunds, especially tax refunds, in India are few and far in between and the pace at which tax assessments and litigations are concluded is far from satisfactory.
While the matter would be appealed to the Supreme Court, it would be interesting to note that this decision of the High Court has drawn reference to several landmark Supreme Court and other decisions. How the Supreme Court would deal with the propositions outlined in this decision is something to look forward to - especially from the perspective of a foreign investor.
(Pranay Bhatia is a Partner with Economic Laws Practise, Mumbai.)