Vdafone: Assessee's case

In this post I consider the assessee’s arguments (on chargeability) in Vodafone; and in the next post, I will consider the Department’s view accepted by the High Court.

1 The company law point:

It is a well established principle in the law of property that one cannot pass a better title than one possesses. Further, ever since the decision in Salomon v. Salomon, it is well accepted that a company is a legal person and has an existence independent of its shareholders. A shareholder has no interest in the property of the company. In Guzdar v. CIT, the Supreme Court of India has held that there is nothing in Indian law that provides any basis whatsoever for the assumption that a shareholder who holds shares, holds any interest in the property of the company. Also, a person holding by himself or through nominees all the shares of a company cannot be regarded as having become owner of the company’s business or assets.

In the Vodafone case, the Department essentially tried to lift the veil over the intermediary foreign company, therefore holding that the transfer of the shares of that intermediary company in fact amounted to the transfer of a capital asset situated in India. Indian law recognizes that the doctrine of lifting the corporate veil is only an exception to the principle of separate legal personality, it is not the rule. None of the requirements for this exception to come onto operation were fulfilled in the facts of Vodafone. In fact, a similar situation had already been considered by the Delhi High Court in Carrasco Investments v. Special Director, Enforcement Directorate. In that case, the Court refused to categorize the sale of the shares of a parent company outside India as a sale of shares of the subsidiary company within India. Arguments to lift the corporate veil must all fail in similar fact situations.

First, simply because a set of companies function as a group, it cannot be said that the corporate veil between them is to be lifted (Adams v. Cape Industries). The fact that a parent holds 100% of the shares of the subsidiary is no ground for lifting the corporate veil between the parent and the subsidiary. This is particularly important in cases where non-residents have Indian subsidiaries – the legal form of the separate existence of the two cannot just be wished away.

2 The substance-over-form point:

One can now turn to the issues surrounding motive to avoid tax. The question of motive is the one which goes to the heart of the substance-over-form debate. Where exactly is the line to be drawn between tax avoidance and planning and tax evasion? The Supreme Court has categorically held that the fact that an otherwise legal action is taken because of a tax-saving motive, is in itself not sufficient to lift the corporate veil and ignore the intermediate entity said to have been created for a tax-saving purpose. A corporation otherwise qualified should not be disregarded as a façade merely because it was purposely created and operated to gain tax benefits.

In CIT v. Raman & Co., the Supreme Court stated that avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. Thus, the form in which a transaction is entered into cannot be ignored. The decision in McDowell v. CTO does not change this legal position; particularly given the interpretation placed on McDowell by the Supreme Court in Azadi Bachao Andolan. The fact that a particular course adopted by an assessee is a device to avoid tax is irrelevant. The fact that motive for a transaction is to avoid tax is not sufficient to invalidate a transaction unless a particular enactment so provides. Unless that device is itself illegal, it cannot be disregarded. The decision of the Supreme Court in McDowell cannot be interpreted as meaning that every attempt at tax planning is illegitimate. This has been made explicitly clear by the in Azadi Bachao Andolan v. Union of India, while clarifying the decision of the Constitution Bench in McDowell v. CTO, it was held, “The highest authorities have always recognised that the subject is entitled so to arrange his affairs as not to attract taxes imposed… In doing so, he neither comes under liability nor incurs blame.” Once a transaction has been entered into by the parties, it is not open to the revenue authorities to rewrite the agreement under the guise of looking at the substance thereof. Particularly in the context of capital gains tax, capital gains is based on legal concepts of property and contract and is, in essence, a matter of legal form rather than economic substance. Thus, conceptually, applying “substance over form” doctrines such that the form is altogether ignored is inconsistent with the nature of tax on capital gains.

It is the true legal relation arising from the transaction alone that determines the taxability of a receipt arising from a transaction. The doctrine of looking at the substance and not the form of the transaction applies when there is a colourable or illegal transaction which has to be ignored. In the instant case, the transaction in question was perfectly legal. When the transaction itself is plain and admits of no ambiguity, there is no case for looking at the substance of the form ignoring the transaction. The Bombay High Court itself in an earlier case had stated that to look at the substance while completely ignoring the form is to substitute the “uncertain and crooked cord of discretion” for the “golden and straight mete wand of the law.” (Provident Fund Investment Co. v. CIT)

Due to these reasons, the form of the transaction – that the transaction was of the shares of a company, by a company, and to a company; all outside India – cannot be ignored. Therefore, in Vodafone, it was not open to the Department to contend that the substance of the transaction involved the transfer of a capital asset situated in India, while ignoring that the transfer was in legal form merely of the shares of a foreign company.

(The Department’s arguments and the Bombay High Court’s discussion of this issue will be seen in the next post)