The Vodafone - Hutchison Case And Its Implications

The Vodafone - Hutchison Case And Its Implications

By Shantanu Surpure

  • 06 Oct 2008

The tax season just ended in India with the end of the year tax assessments on September 30 and many companies were busy with their filings. 

The recent sale of Hutchison Telecom International’s (HTIL) stake in Hutchison Essar Limited (HEL) for approximately $11.1 billion to Vodafone International Holdings BV (Vodafone) came under the radar of the Indian income tax authorities (the IT Department) earlier this year.  The case has attracted attention from investors because it involves a transaction between two foreign companies and a potential tax liability of approximately $1.7 billion. 

The case has potentially far-reaching implications because a successful tax claim may result in any merger and acquisition activity conducted anywhere in the world being partially taxable in India if the disposing entity has a subsidiary or permanent establishment in India.


The IT Department has claimed capital gains under section 9(1)(i) of the Income-Tax Act (the Act) as it is of the view that the transaction involved (i) transfer of an Indian asset and (ii) profit made by HTIL from the sale of shares to Vodafone was generated in India. Therefore, according to the IT Department, Vodafone had an obligation to pay withholding tax in India before making the payment of the purchase price to HTIL.

On this basis the IT Department sent a notice to the new Vodafone entity in India, Vodafone Essar Limited (VEL) that VEL should have withheld taxes before making payment to HTIL.  The IT Department appears to be treating VEL as an agent of HTIL pursuant to section 163 of the Act.  The matter is currently before the Mumbai High Court.

While the matter was being debated in the Mumbai High Court, an amendment was made to the Act, to the effect that if the seller of the shares did not pay tax in India, the buyer is bound to pay the same and imposed a retrospective interest penalty for not withholding such tax.


A resident Indian company is liable to pay income tax on its worldwide profits, whereas a non-resident company is taxed only on income earned in India. All Indian companies and companies whose control and management is situated wholly in India are treated as resident. A person resident in India for a period more than 183 days in a year is deemed to be an Indian resident.

The tax rate applicable to foreign companies is approximately 40%. However, such rate becomes applicable mainly where a nonresident has a Permanent Establishment ("PE”) in India. If the nonresident company has no PE in India, the tax rate depends on the nature of income (dividends, capital gains, royalty, etc) and the provisions of the relevant double taxation avoidance agreements (DTAA).

It is a common practice among multinational companies (MNCs) to establish a special purpose vehicle (SPV) in tax-efficient jurisdictions such as Mauritius or Cayman Islands for holding shares in a downstream Indian company. Generally, the transfer of shares of an SPV established outside India by the MNC is not taxable in India, as the transfer pertains to shares of a foreign company by a non-resident. However, the recent notice sent by the IT Department appears to change the position and appears to result in extra-jurisdictional taxation.


VEL has challenged the show cause notice issued by the IT Department regarding a levy of capital gains tax and filed a writ petition in the Mumbai High Court. VEL contends that capital gains accruing from the sale of shares of did not satisfy any of the conditions for it to be taxable in India as the transfer of shares of CGP (Holdings) Limited, a Cayman Islands company, took place between a Dutch company owned by Vodafone and HTIL, a company registered in Cayman Islands, both being outside the jurisdiction of India. 

The Vodafone defense is that it does not have any responsibility to withhold tax from the consideration paid to HTIL for the acquisition of the shares of CGP.   

Several legal issues arise from the case:


(i) whether a non-resident seller (Vodafone International) is liable to tax in India on sale of shares of the foreign SPV?

(ii) is a non-resident purchaser (HTIL) liable for deduction of tax on purchase of shares of the foreign SPV while making payment to the non-resident seller?

(iii) whether an Indian company can be treated as ‘agent’ of the non-resident purchaser and held liable for deduction of tax?


(iv) can the law impose tax retrospectively?

Scope of Taxable Income of a Non-resident:

 Pursuant to Section 5(2) of the Act, the taxable income of a non-resident includes income “received or deemed to be received in India” and income that “accrues or arises or deemed to accrue or arise in India”. However, it does not include income that accrues or arises or is deemed to accrue or arise outside India. Pursuant to Section 9 (1) of the Act, income is deemed to accrue or arise in India if such income is due to transfer of an asset situated in India or through or from business connection in India.

Pursuant to Section 195 of the Act every person paying any sum, which is chargeable to tax in India to a non-resident must deduct income-tax at source at the time of payment or credit.  The liability to deduct tax applies to non-residents as well as residents. The IT Department has argued that this transfer represents a transfer of beneficial interest in the shares of the Indian company and hence, any gain arising from it would attract tax in India. 

In the case of transfer of shares in an Indian company by companies established in certain countries such as Mauritius, Cyprus and Singapore withholding tax on capital gains is not liable to be levied in India pursuant to the relevant DTAA. 

CGP (the company that was sold to Vodafone) was a Cayman company and there is no India-Cayman DTAA.  It is an interesting question as to whether the sale of Mauritius SPV would attract a similar tax notice or whether a Mauritius intermediate SPV interposed between the Cayman SPV and the Indian subsidiary would act as a successful blocker entity. 

Who is an Agent:

According to Section 160(1) of the Act, ‘agent’ of the non-resident is ‘representative assessee’, and Section 161 discusses the liability of representative assessee. Section 163 defines agent to include a person who has a business connection with the non-resident.

Passing of Laws Retrospectively:

In the 1975 Hindustan Machine Tools case, the Supreme Court held that the legislature could pass laws retrospectively, with the exception that this power could be challenged if the law was discriminatory. This same principle was reaffirmed in 1997 in Arooran Sugars Ltd case, where the Supreme Court that if the law does not discriminate, it may be retrospective.

This is perhaps the first time tax authorities are attempting to tax a transaction between two foreign companies involving transfer of an Indian asset. If the tax liability is established, it could result in a tax liability of approximately $1.7 billion. Investors will be keeping a close eye on the upcoming Mumbai High Court verdict. Either way, the next battle may be fought in the Supreme Court.


(Shantanu Surpure is Managing Attorney at Sand Hill Counsel, a law firm with offices in Mumbai and Silicon Valley. He focuses on venture capital and private equity transactions. Shantanu holds a BA from Brown University/London School of Economics, an MA Juris from Oxford University and a Juris Doctor from Columbia Law School and is admitted to practice law in India, California, New York and England and Wales. He can be reached at

Shantanu was assisted by Anand Kumar of Sand Hill Counsel.

This column is meant for public discussion and informational purposes only and is not to be construed as legal advice.

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