Lifting The Corporate Veil To Test Tax Avoidance — Possible?

26 April, 2011

The Indian M&A market has been marching ahead witnessing an increasing trend in the number of deals with many more in the pipeline and to come. While this action is happening in the market, the Indian tax authorities are also keeping themselves busy by having a close watch on the deals specially the big ticket ones. This approach of the tax department and the consequent uncertainty of taxation continue to worry deal makers.

It was an unwritten rule that the Indian tax law regards form over substance. However, this does not seem to be completely correct. In a recent ruling, the Karnataka High Court has indicated that tax authorities can lift the corporate veil to ascertain the substance of a transaction in case there is any potential tax avoidance.

Case In Point

Richter Holdings Limited a Cypriot company and West Globe Limited a Mauritian company purchased all shares of Finsider International Company Limited (FICL),  a UK company from Early Guard Limited (EGL), another UK company. FICL held 51% shares of Sesa Goa Limited, an Indian Company.

The allegation of the Indian tax department was that this transaction would trigger withholding tax obligation on the ground that the transfer of shares constituted transfer of capital asset. On the other hand, RHL argued that the transfer of shares did not amount to acquisition of immovable property or controlling the management of Indian company and it was only an incident to owning the shares of a company which flows out of the holding of shares. The Karnataka High Court held that since the agreement produced in the Court did not throw any significant light on the transaction, the tax authorities should do a further fact finding exercise, for which the corporate veil can also be lifted.

While the Vodafone case (which is on similar lines) is still pending to be decided, the remark of the Karnataka High Court to permit the tax authorities to lift the corporate veil can be devastating.

Implications

The current income tax law does not have explicit provisions for “looking through” the transactions. However, the proposed Direct Taxes Code has General Anti Avoidance Rules (GAAR) provisions embedded in it which does provide a similar power to the tax authorities.

While one grapples with the uncertainties around tax issues which also keep increasing as the deals in the market, investors are eagerly waiting for judicial interpretation so as to put to rest some of the burning ones. In the meanwhile, they continue to revisit, discuss and strengthen protection under alternate insulation mechanisms like escrow account, insurance policy, etc. for concluding transactions.

(Anil Talreja , Tax Partner and Urmi Rambhia, Deputy Manager are from Deloitte Haskins & Sells. Views expressed are personal.)

 


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2 Comments
Abhijit Talukdar . 5 years ago

Meanwhile the verdict on the Vodafone-Hutch-Essar transaction is also pending. I guess that verdict will set the precedent in such cases.

Manan Agrawal . 5 years ago

You can never really stop “tax avoidance”. The tax experts are wanted in India to help avoid taxes only. But, nevertheless, a good start will be to first simplify India’s tax laws using a balance of “principles” (which tell you whats the “substance”) and “mechanical rules” (which eliminate subjective judgement). Thats the only solution which will eliminate uncertainty.

Lifting The Corporate Veil To Test Tax Avoidance — Possible?

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