Vodafone Controversy: An Introduction

One of the most controversial areas in taxation under the Indian Income Tax Act, 1961 (“the Act”) in recent days has been the Vodafone tax controversy. Several important questions of law in the area of taxation of non-residents – pertaining to both chargeability and machinery provisions – are at issue in the Vodafone controversy. The Bombay High Court in its recent judgment in Vodafonehas commented on the merits of some of these issues (please see Vodafone InternationalHoldings BV v. Union of India, WP No. 2550 of 2007 (Bombay High Court). The case provides a useful backdrop for anchoring the theoretical arguments on the taxation of non-residents. For a detailed discussion of the theoretical arguments, reference may be made to Geoffrey Loomer, ‘The Vodafone Essar Dispute’ (2009) 21 (1) National Law School of India Review 89. In the following couple of posts, I will look at the various arguments on both sides of the debate. In this introductory post, I will only briefly outline the factual position.

A non-resident company, Hutchinson International, held 67% shares in an Indian company named Hutchinson-Essar. This Indian company was a joint venture between Hutchinson International and Essar. The 67% shareholding in the Indian company was not a direct shareholding. Hutchinson held 100% shares of a foreign company, which in turn held 67% shares in the Indian company. Hutchinson transferred this shareholding of the foreign company to Vodafone. Thus, indirectly, the interest in the 67% shareholding was also transferred to Vodafone. The question which arose was, whether the income accruing to Hutchinson as a result of the transaction could be deemed to accrue or arise in India by virtue of section 9 of the Act. Under Section 9, income received through the transfer of a capital asset ‘situate in India’ is taxable in India. The shares of a Mauritius company are situate in the Mauritius, not in India. Hence, the Revenue’s argument is that the transaction is not a sale of shares simpliciter, but is (in substance) the sale of a capital asset situate in India. The two main justifications advanced by the Revenue are based on lifting of the corporate veil over the Mauritius company on principles of corporate law; and over the application of general substance-over-form doctrines used in taxation.

On the face of it, the transaction was simply for the sale of shares in a foreign company. The Indian Income Tax Department issued a show cause notice to Vodafone asking it to show cause as to why action should not be taken against it for failing to deduct tax at source under Section 195 of the Act while making payment of the consideration to Hutch. This show cause notice was challenged by Vodafone in a writ petition before the Bombay High Court under Article 226 of the Constitution of India. The issues which arose were, inter alia:

(a) Whether the transfer of the shares of a foreign company by a non-resident to a non-resident results in income being deemed to accrue or arise in India under Section 9 by virtue of the fact that the foreign company in turn held shares in an Indian company effectively resulting in controlling interest in an Indian company being transferred?

(b) Whether, assuming that the income could be said to have deemed to accrue or arise in India, there was any liability on Vodafone – the buyer/payer – to deduct tax at source? In other words, does Section 195 have an extra-territorial application so as to cast an obligation on Vodafone to deduct tax at source?

The Bombay High Court held in a detailed judgment (per Radhakrishnan and Nirgude JJ.) that the writ petition challenging the show cause notice was premature, as the petitioner had an effective alternate remedy available; and that prior to the facts being established, the High Court could not conclusively determine the issue. Nonetheless, the Court went on to make observations on the merits based on the facts available on the record. It answered all the issues against Vodafone.

The decision was sought to be appealed by way of special leave before the Supreme Court of India. Interestingly, although Vodafone’s appeal was not admitted by the Court, the observations in the order dismissing the Special Leave Petition brought some relief to Vodafone (see Vodafone International Holdings BV v. Union of India, SLP (Civil) No. 464/2009 (Supreme Court of India). The Court held (per Sinha and Sharma JJ.) relying on a previous decision, that ordinarily in Income Tax jurisprudence, it is not open to the High Court to venture into questions of fact. Further the agreement between Vodafone and Hutchinson was not before the High Court. Therefore, it was ordered by the Supreme Court that the question in relation to the “jurisdictional issue” must be re-agitated before the Assessing Officer, and can be challenged before the High Court. The question of law was, to that extent, kept open. Thus, the Supreme Court seems to have clarified that the High Court’s decision should not be read as deciding on the merits of the case, but must be confined to the issue of maintainability. In these circumstances, the controversy provides a good opportunity to examine the law relating to the taxation of non-residents.

The jurisdictional authority to whom the matter was remanded decided the case against Vodafone, and Vodafone has challenged this decision – in terms of the Supreme Court order – before the High Court. Thus, the ball is once again in the court of the Bombay High Court; and the matter is scheduled for hearing on 2^nd August.

In the next post, I will describe the Department’s arguments in the matter; and subsequently, will turn to Vodafone’s possible arguments.