The landmark judgement was made by the Supreme Court of India in Vodafone
International Holding (VIH) v. Union of India (UOI).
In the transaction
dated 11.2.2007 between VIH and Hutchinson Telecommunication International
Limited or HTIL, the Bench consisting of Chief Justice S.H Kapadia, K. S. Radha
krishnan and Swatanter Kumar quashed the order of the High Court of claim for Rs
12000 crores as capital gain tax and exempted VIH from responsibility for
payment of Rs 12000 crores as capital gain tax(non-resident company for tax
The court held that the Indian revenue authorities do not have authority to tax
an offshore transaction between two non-resident companies where the
non-resident company is purchased in the transaction in order to control the
interest in the (Indian) resident company.
After the proposals made by Prof. Kaldor to levy tax on benefits arising from
any transfer or selling of the specified non-stock resource, i.e. non-inventory
properties, the introduction of CGT in India goes back to 1956. As it stands
today, CGT is collected on the transfer of any Capital Asset (other than held as
stock-in-exchange / trade) due to steady growth, which is done with the
appropriate mechanism referred to in Sections 45-55A of the IT Act. Section 2
(14) of the Act on Income Tax, characterizes the expression "Capital Assets".
It is defined as combining any kind of property, regardless of whether set,
streaming, dynamic, steady, substantive or immaterial, and whether used with his
company's final target and calling. Rejections under Section 2 (14) of the IT
Act are likewise calculated. Capital gains are usually assessable in the year in
which the transfer of capital assets has taken place. The word 'transfer' is
specified by section 2 (47) of the Income Tax Act.
Sale, relinquishment, swap, or any compulsory acquisition of the asset or
extinction of any rights in that asset is included in the word 'transfer' in
relation to Capital Asset. The capital assets are split into two groups with the
overall aim of computing income tax:
- Long Term Capital Assets
- Short Term Capital Assets
It is important that the procedure for measuring taxable income and the speed
of assessments for all forms of capital gains are diverse. Momentary or Short
Term Capital Assets refers to any asset owned by an assesse for a period not
exceeding three years, quickly preceding its transfer date. Then again, Long
Term Capital Assets applies to any asset owned by an assesse for more than three
years, quickly prior to its transition date.
However, the above rule of three years has certain extraordinary
circumstances wherein such period is taken as years i.e. 12 months are as
Case Of Vodafone: The Realistic Review
- Securities like debentures, etc. which on a recognized stock exchange is
- Equity or preference shares which may be quoted or unquoted of a company
- Units of a Mutual funds, etc.
In February 2007, the Dutch group Vodafone International Holding (VIH) purchased
100 % of the shares in CGP Investments (Holding) Ltd (CGP), a Cayman Islands
group, from Hutchison Telecommunications International Limited for USD 11.1
billion. 67% of Hutchison Essar Limited (hereinafter HEL), an Indian Company,
was governed by CGP through various transitional organisations / authoritative
courses of action. The acquisition resulted in Vodafone acquiring control over
CGP and its subsidiaries downstream, including eventually Hutchison Essar
Limited. HEL was a joint effort between the gathering at Hutchison and the
gathering at Essar. As of November 1994, it had obtained telecom licences to
provide cell contact in different circles in India.
In September 2007, Vodafone Company received a show-cause notice from the Indian
Tax Department to explain why tax was not withheld on payments made to HTIL in
connexion with the transaction in question above. The tax department argued that
the aforementioned transaction involving the sale of CGP shares had an effect on
the aberrant or indirect sale of India-based properties. Among other items,
Vodafone filed a petition with the Bombay High Court questioning the
jurisdiction of the tax authorities in this matter, where the Court held that
the Indian income tax authorities had jurisdiction over this matter. In the
Supreme Court of India, the order was then appealed.
In 2009, the Court ordered the tax authorities to decide initially, by appeal in
the present case, on the jurisdictional question presented before the court. The
tax authorities announced in May 2010 that they were entitled to continue
proceedings against Vodafone on account of their alleged failure to withhold tax
on instalments made under Section 201 of the Income Tax Act. This order was
challenged in the Bombay High Court by Vodafone.
Vodafone 's appeal against the order was dismissed by the Bombay High Court. In
compliance with Article 136 of the Indian Constitution, Vodafone then filed a
Special Leave Petition (SLP) against the High Court's decision before the
Supreme Court. The SLP was approved and admitted in November 2010, and Vodafone
was also ordered by the Supreme Court to deposit a total of INR 25000 million
within three weeks and to provide a bank guarantee of INR 85000 million within
two months from the date of the order.
Should the indirect transfer of India - based capital assets be subject to
With regard to Section 9, which states that income is considered to accrue or
arise in India if it accrues to or arises from a transfer of capital assets in
India or to a non-resident, the Court observed that there is an omission under
Section 9(1)(i) of the word 'indirect transfer.'
If the word 'indirect'
used is read with the phrase' Capital asset
located in India 'on the off chance, then it would be made worthless. And there
is no 'look through' clause in Section 9(1)(i) and can therefore not be expanded
to include indirect transfers of capital assets located in India. Therefore, the
transfer of shares to CGP did not result in the transfer of capital assets
located in India and was not subject to taxation.
Transfer of HTIL�s property rights by extinguishment through SPA?
The tax authorities claimed that HTIL's control and management rights over HEL
constituted property rights which had been extinguished under the Selling and
Purchase of Shares and Loans Agreement (SPA) signed on 15 October 2007. This led
to the transfer of the taxable capital assets in question. The Supreme Court
ruled that due to the transfer of the Capital Asset and due to the separate SPA
clauses, the rights were extinguished.
In addition, the Supreme Court held that the primary justification for CGP was
not merely to own stakes of subsidiary businesses, but also to allow a smooth
transition in business to take place. It could not be said in this way that CGP
had no market or corporate content. The tax authorities claimed, as the case may
be, that the transfer of the CGP share was not in itself sufficient to fulfil
the intent of the transfer between HTIL and Vodafone Company and that the
essence of the transfer was not sufficient to fulfil the transfer of other
rights and privileges. It was additionally arguedthat such rights and privileges
established Capital Assets and gains from such transfer are liable to taxation.
The Court observed that if a non-resident renders an indirect transition by
mistreatment of the corporate structure or legal form and without a fair and
valid commercial purpose, resulting in tax shirking or tax withholding evasion,
the tax authorities may, at that point, deny the type of plan or operation
reproved through the use of holding companies and may re-describe the type of
plan or operation reproved through the use of holding companies.
Interpretation of Section 5 and 195 of IT Act?
The income obtained worldwide (counting any income that is real or perceived to
be accrued / arise / received) of a person living in India is included within
the definition of total income under Section 5(1) of the IT Act. Under section
5(2) of the IT Act, compensation that is assessable or taxable for a
non-resident is compensation that accrues or exists or is deemed to have
incurred or occurred or earned or is deemed to have earned in India.
Vodafone argued and urged the Court to follow an understanding of Section 195 in
compliance with the existing principles of law enforcement and authoritative
intent, as it agreed that Section 195 was not applicable to seaward persons
making payments / payments from seaward or offshore.
The Court henceforth held that chargeability and enforceability are unique and
distinct legal terms and provided certain guidelines by which Section 195 is to
be viewed, such as the two conditions suggested by that section, first, there
must be a reimbursement / payment made to a non-resident, and such payment must
be an aggregate chargeable under the Act, the duty to deduct charge arises.
Information which led to the dispute:
The two non-resident firms are Vodafone International Holding (VIH) and
Hutchison Telecommunication International Limited, or HTIL. These companies
entered into a deal whereby HTIL exchanged the share capital of its Cayman
Island-based subsidiary business, i.e. CGP International or VIH CGP.
As a result of this acquisition, VIH or Vodafone gained a 67 percent controlling
interest in Hutch on Essar Limited or HEL, which was an Indian joint venture
firm (between Hutchinson and Essar), whereas CGP owned the above 67 percent
interest prior to the above contract.
A show cause notice was given by the Indian Revenue Authorities to VIH as to why
it should not be treated as 'assesse in default' and requested a clarification
as to why the tax was not deducted from the sales consideration of this
Via this, the Indian revenue authorities tried to tax capital gains resulting
from purchases of CGP's share capital on the basis that CGP had Indian assets
In the High Court, VIH lodged a written petition seeking the authority of the
Indian revenue authorities. The High Court denied this written petition and VIH
appealed to the Supreme Court, which referred the case to the Revenue Authority
to determine if the revenue had jurisdiction over the matter. The tax authority
agreed that they had control over the issue and so the matter went to the High
Court, which also agreed in favour of taxation and then finally Special Leave
petition was filed in the Supreme Court.
Issue before the Supreme Court
The issue before the Apex court was whether the Indian Revenue Authority had
power to tax a sale of shares between two non-resident companies on an offshore
transaction whereby the controlling interest of a resident Indian corporation is
purchased on the basis of that transaction.
Arguments of Revenue Claims
The revenue argued that the entire trade of HTIL's selling of CGP to VIH was in
the substance transfer of capital assets in India and therefore triggered
capital gain taxes, which culminated in the transfer of all direct/indirect
rights in HEL to VIH, and that the entire selling of CGP was a tax evasion
scheme, and the court would use a dissecting approach to investigate the
material and not 'look at' it.
Observations made by the Supreme Court
Multinational corporations also set up corporate structures or associate
branches or joint ventures for separate market and financial reasons, mainly
aimed at supplying customers with greater returns and allowing the organisation
Therefore, the responsibility is solely on the revenue to prove that all merger,
consolidation and redistribution have been compromised for dishonest reasons in
order to defeat the legislation or evade taxation.
Even the Ministry of Corporate Affairs acknowledges certain frameworks
consisting of holding companies and subsidiaries under which the holding company
can have ample voting stock in the subsidiary to control the management and also
suggested that many transnational investments are made mainly in tax-neutral /
investor-friendly countries in order to prevent double taxation or plan
operations in order to achieve the best returns to investors.
Due to better investment opportunities, many overseas businesses invest in
countries such as Mauritius, Cayman Island, and these are carried out for sound
business and sound legal tax planning and not to hide their revenue or
properties from the tax jurisdiction of the home country, and such mechanisms
have been accepted by India.
Such offshore investments or such offshore financial hubs do not inherently lead
to the presumption that tax avoidance requires them.
Holding and Subsidiary Companies
The corporate act agreed that the subsidiary corporation is a different legal
body and while the holding company manages the subsidiary companies and the
company's respective sector within a community, the idea that the subsidiary
sector is different from the holding company is resolved.
The properties of the subsidiaries will be held by the parent corporation as
collateral, but these two are both independent companies and the holding firm is
not legitimately responsible for the actions of the subsidiaries. except in few
circumstances where the subsidiary company is a sham.
The holding company and the subsidiary companies may form a pyramid of
arrangements in which the subsidiary company may retain majority interests in
other parent companies.
Shares and controlling interest
The sale of shares and the sale of controlling interest can not be deemed to be
two distinct activities including the purchase of shares and the transfer of
Unless otherwise specified in the Statute, the controlling interest is not an
identifiable or separate capital asset independent of the ownership of shares
and is inherently a statutory right and not a right to property which can not be
considered as a transfer of property which capital assets.
The purchase of securities may be subject to the transfer of controlling
interest, which is a strictly economic term and which is imposed on sales and
not on their results.
Despite their distinct legal identities, the concept of raising the corporate
veil can also be applicable in the relationship between the holding firm and the
subsidiary corporation where evidence show that questionable tax avoidance
practises have been implemented.
The revenue authorities should look at the transaction in a holistic way and
should not proceed with the issue that tax deferment / saving equipment is the
The revenue authorities may invoke the concept of the dissolution of the
corporate veil only after they have been able to determine, on the basis of the
facts and circumstances concerning the transaction, that the transaction at
issue is a scam or tax evasion.
Tax planning/ tax evasion/tax avoidance
It is universal rule that a tax payer is entitled to coordinate his affairs in
order to mitigate the tax burden and the fact that the purpose for the operation
is to prevent tax does not invalidate it unless a clear enactment is so given.
It is important that, in order to be successful, the transaction should have
some economic or commercial content.
Without a law to help, the income will not tax a subject and any tax payer is
entitled to plan his affairs so that his taxes are as low as possible and he is
not obligated to select the method that will replenish the treasury.
All tax planning is not illegal and it was acknowledged that, in the case of
McDowell, the majority ruled that tax planning is valid given it is within the
legal context and that colourful instruments should not be part of tax planning.
Role of CGP
Controlled Goods Program Registration was still part of HTIL's organisational
structure, and the selling of CGP 's shares was a genuine economic operation and
a strategic judgement that was not questionable and in the interest of customers
and corporate bodies.
The site of shares of CGP
CGP shares have been registered on Cayman Island and Cayman Law therefore does
not accept the multiplicity of registers and, thus, the location of the shares
and the movement of shares is located in Cayman and shall not be transferred to
Extinguishment of rights of HTIL in HEL
The sale of CGP shares has immediately resulted in a number of ramifications,
including the sale of control interest.
And without legislative action, controlling interest can not be dissected from
the CGP share.
The controlling interest may also be passed on to the shareholder along with the
shares upon the sale of the shares of the holding firm, and this controlling
interest may have percolated down the road to the operating firms, but the
controlling interest remains essentially contractual and not a property right
until the statue guarantees otherwise.
The purchase of shares which entail the purchase of controlling interest and
this is strictly a financial term and the tax can only be imposed on the sale
and not on its impact and, subsequently, Vodafone has gained possession of eight
Mauritian companies on the conversion of CGP shares to Vodafone and this does
not mean that the site of CGP shares has shifted to India for the purposes of
charging the shares.
Section 9 of the income tax act
The tax is levied on the basis of the source and this source is the location
where the selling process takes place in regard to sales and not where the item
of product that was the focus of the process is derived or purchased from.
HTIL and VIH are both overseas companies and the sale also takes place outside
India, so the source of revenue is outside India unless this trade is protected
The income laws have to be fairly construed and tax should not be collected
withoutclear words indicating the intention to lay the burden.
The provision on charging shall be narrowly construed and Provision 9(1)(i) must
not be expanded to include, by interpretation, the indirect movement of capital
assets to India.
There must be a clear relation between the earnings of income and the territory
which seeks to impose tax for taxation.
Section 9 does not have an inbuilt "check in" function and the concept of "check
around" shall not move asset locations. Only by explicit clause in this respect
may this be achieved.
The Legislature in case wanted to tax �income� which arises indirectly from the
assets; the same must have been specifically provided so. The court cited the
example of Section 64.
The tax involvement must be regarded in the sense of the activity at issue and
not in regard to an external matter.
In the event of transfers made by residents to non-resident firms and not by two
non-resident companies, section 195 applies.
It is important to analyse the legal existence of transactions.
The present transaction was carried out between two non-resident persons in a
contract conducted outside India where the consideration was also rendered
outside India and VIH is therefore not legally obligated to respond to the
notice referred to in section 163 relating to the purchaser's care as a
Decision of the Court
The selling of HTIL's CGP shares to Vodafone or VIH does not lead to the
transfer of capital assets under the scope of Section 2(14) of the Income Tax
Act and therefore does not attract capital gains tax on all rights and
entitlements resulting from the shareholder agreement, etc., which form an
integral part of CGP 's shares.
The order of High Court of the demand of nearly Rs.12, 000 crores by way of
capital gains tax would amount to imposing capital punishment for capital
investment and it lacks authority of law and therefore is quashed.
In Vodafone International Holding v. Union of India
, the supreme court
released a landmark judgement and explained the ambiguity with regard to the
imposition of taxes. Through this judgement, the apex court recognized:
The tax planning rules.
In the absence of any legislative stipulation prohibiting the same, business
entities or individuals may arrange the affairs of their business to decrease
their tax liability.
Corporate structures are mostly established by international corporations and
all of these structures should be established for corporate and economic
In cases where evidence and circumstances indicate that the transaction or
corporate structure is sham and designed to evade taxes, the corporate veil can
Transactions should be viewed holistically and not dissentingly, and the
existence of corporate structures in tax-neutral / investor-friendly countries
should not contribute to the inference that taxes are supposed to be avoided.
Finally, it can be said that this judgment helped to remove complexities with
regard to the imposition of taxes and agreed that the concept that the object of
the transaction is to escape tax does not necessarily lead to the hypothesis of
tax evasion and the Supreme Court embraced the view of legitimate tax planning.
Written By: Saif Ali Ansari
- Galgotias University, Greater Noida
E-mail: [email protected]