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The “Vodafone Case”

The “Vodafone Case”

By Chaahat Khattar

Edited by  Nandita Singh, Senior editor, The Indian Economist

On 11 February 2007, the world’s second biggest telecom player Vodafone Group Plc. based out of United Kingdom, agreed to acquire 67% controlling stake of Hutchison Telecommunications International Limited in Hutch‐Essar, for USD 11.1 Billion. Soon after the deal closed in April 2007, the Income Tax Department of India slapped Vodafone with a USD 2.5 Billion tax notice in context with the capital gains Vodafone made out of the entire deal. Vodafone proclaimed that the claim of Income Tax Authorities was totally baseless as the entire deal was out of national jurisdiction.

The Structure of Hutchison Essar:

Hutchison Essar Limited, India, was a company partly owned by Hong Kong based Li‐Ka Shing promoted Hutchison Telecom and India based Essar Group promoted by Ruia brothers. Since Vodafone acquired the entire stake held by Hutchison Telecom, the tax authorities aimed at the capital gains it made out of the entire deal. The prime reason for such a move by tax authorities was the structuring of Hutchison’s stake in Hutchison Essar. Hutchison held 67% stake in Hutchison Essar through its wholly owned subsidiaries based out of the Cayman Islands and Mauritius. Vodafone acquired all the shares of CGP, Hutch’s holding company in the Cayman Islands. The biggest problem for Indian authorities was that India has Double Taxation Avoidance Agreements (DTAA) with 83 nations including Mauritius and Cayman Islands. As a part of DTAA, capital gains arising from the sale of shares are taxable in the country of residence of the shareholder and not in the country of residence of the company whose shares have been sold. Therefore, a company resident in Mauritius (the local subsidiary companies of Hutchison Telecom in the mentioned case) selling shares of an Indian company (Hutchison‐Essar Telecom Limited) will not pay tax in India. Since there is no capital gains tax in Mauritius, the gain will escape tax altogether. Making the best possible use of this treaty, Vodafone by‐passed capital gains over USD 2 Billion raising an alarm for Indian tax authorities.

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However, this does not mean that Vodafone took undue advantage of the treaty. It means (supplemented by Supreme Court of India’s ruling in the case) that the DTAA India has with various nations contains several loopholes, and Vodafone along with its merger and acquisitions (M&A) advisors capitalised over the same. An intelligent move by Vodafone in 2007 was the one in which it took all the required permissions and approvals for the takeover move from Foreign Investment Promotion Board of India, which further gave the green signal to Vodafone to go ahead with the takeover.

Income Tax authorities started their proceedings in the biggest corporate tax ruling of the country, which in 2008 was brought forward to the Bombay High Court. The Bombay High Court ruled that Vodafone should have withheld taxes on the purchase price it paid to Hutch as the deal was not a mere transfer of shares of a foreign company, but in reality a transfer of a compendium of rights, including effective control and management, which constituted the totality of Hutch’s rights into an Indian company.

Vodafone certainly acted against the ruling of the Bombay High Court and appealed it further, taking the case to the apex body in the Indian judiciary, the Supreme Court of India. Everyone knew that the entire ruling would be one of its kind and thus, the ruling was headed by a bench of 3 senior most judges that included Chief Justice of India Shri S. H. Kapadia, Justice K. S. Radhakrishnan and Justice Swatanter Kumar. The hearing went on for four weeks and even included sessions of Fridays, a day that the Supreme Court primarily reserves for hearing fast track cases. The hearing went on for 26 days spanning over 2 months. Vodafone not only paid over a crore per day to noted lawyer Harish Salve for presenting its case, but it also presented its view and proofs on tonnes of pages which required 3 trucks for transport. The Supreme Court of India referred to 3 major resources before giving the final verdict. It referred to previous rulings of the court‐ McDowell and Co Ltd. v. Commercial Tax Officer (1958) and Union of India v. Azadi Bachao Andolan (2003). The other major source it referred to is the famous Section 9 (1)(i) of the Income‐tax Act, 1961, which states that income accruing or arising directly or indirectly from the transfer of a capital asset situated in India is deemed to accrue/ arise in India in the hands of a non‐resident. The Supreme Court observed that since the capital assets which Vodafone acquired were not located in India, the section was not applicable on the same and on 20 January 2012, it gave its final verdict in favour of Vodafone, making this a landmark judgment in the entire Indian corporate system.

The story does not end here. Losing the case and INR 2,200 crore plus interest (principal which Vodafone had paid along with interest the tax authorities are supposed to pay), the Income‐tax Authority of India forced the government to introduce a retroactive tax policy on every transaction since 1961, which naturally includes Vodafone’s takeover. Vodafone and noted analysts slammed this move of the government. Although the government has agreed to implement this policy, it has yet to send a notice to Vodafone for claiming over USD 3.5 Billion in taxes and penalties. Vodafone in response, is all set to opt for international arbitration if it is met with any such notice.

The past 3‐4 years have been a corporate mayhem for various multinational corporations trying to enter India with due help from the policies and agreements, which the present and past ruling parties of government have drafted.

The judiciary on the other hand, has been the saving grace for not only firms, but for the millions of shareholders which stay glued to stock exchanges all day long, as well as analysts around the globe monitoring, commenting and judging India’s economic policies.

Chaahat Khattar is an ardent economist and is working with an international consultancy firm. He is an MBA and pursuing Masters in Business Laws. He is also a Harvard University alumnus and a certified financial modeller. He has keen interest and experience in authoring research papers and case studies and have contributed to various renowned journals. Chaahat can be reached at [email protected]


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