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Tax sword looms on cross-border M&As
December, 17th 2008
Since August last year, the world has been watching. It all began with a show cause notice issued to Vodafone BV (based in the Netherlands ), holding it to be an assessee in default for not withholding tax at source when it made payments to a Hutchison Group company (based in Cayman Islands) for acquiring shares of another Cayman Island company. Such change in shareholding resulted in a change in the controlling interest of an operating Indian cellular services company. True, the tax demands raised ran into several millions, $2 billion approximately. But this is not the reason for the attention that this case has attracted. The main reason is that the very foundation of international tax norms appeared shaken. It has been a well accepted view that while gains arising to a non resident from transfer of shares in an Indian company are liable to tax in India (subject to tax treaty provisions as in some tax treaties the gain is not taxable in the source country), the gain arising to a non resident from transfer outside India of shares of a foreign company to another non resident would normally not be chargeable to tax in India. This is the case, even if the underlying value is derived from assets belonging to an Indian subsidiary of the company , whose shares are transferred. Vodafone BV (Vodafone NL), a Dutch subsidiary of Vodafone UK, entered into an agreement with Hutchison Telecommunications Cayman Island (HTIL) for acquiring share capital of CGP Investments (CGP), which is a company incorporated in Cayman Islands . Through CGP, HTILthe sellerowned 67% controlling interest in Hutch Essar Ltd (HEL, now Vodafone Essar Ltd a JV between the Hutch and Essar group), engaged in cellular services business in India. When it got the show cause notice, Vodafone NL filed a writ petition before the Bombay High Court, which now stands dismissed. The HC made several observations while dismissing it. It did not accept the argument of Vodafone that the transaction was between two foreign companies involving transfer of shares of another foreign company, and had no nexus or tax implications in India. In the view of the high court, prima facie, the transaction attracted capital gains tax liability in India as the sole consideration and the predominant object of the transaction was transfer of business or economic interest or controlling interest in the telecom company in India. According to the high court, post transfer, the Vodafone group acquired interest in the telecom license, brand and goodwill, right to appoint board of directors , apart from acquiring entry into the telecom business segment in India. The transaction was regarded as achieving effective substitution of Vodafone Group in the place of Hutch Group in the joint venture / partnership which the Hutch Group had with Essar Group in India. The transfer of shares of a foreign company was held to be mode of achieving the transfer of valuable assets in India, attracting tax implications. The high court remarked In the instant case, the subject matter of transfer as contracted between the parties is not actually the shares of a Cayman Island company, but the assets situated in India . The high court also emphasised that representations made before the FIPB and regulatory authorities in the US and Hong Kong made it clear that the Hutch Group was transferring its controlling interest in the Indian companies. The high court has made fairly strong observations on the petitioner having failed to furnish agreements relating to the transaction, either to the tax department or to the court, despite repeated requestsin absence of which it was not possible to appreciate the true nature of the transaction and it was left with no option but to draw an adverse inference against Vodafone NL. The high court emphasised that the writ jurisdiction is discretionary and that, only in extraordinary cases a mere show cause notice seeking explanations can be struck down as invalid. In the light of the developments, the question which now arises is: merely because the Indian company is held by a special purpose vehicle, could such parent company be regarded as the owner of assets belonging to the underlying Indian company? Reference may also be made to the Supreme Court decision in the case of Mrs Bacha F Guzdar (27 ITR 1), which held that the company is a legal entity, separate and distinct from its shareholders and there is nothing in the Indian law to warrant the assumption that a shareholder who buys shares buys any interest in the property of the company. In the course of its submissions, Vodafone NL did point out on the absurdity of the views of the revenue authorities . To illustratewould purchase of 1,000 shares of XYZ Inc, a multinational company, with global operations, on the New York stock exchange be tantamount to transfer of assets (underlying value) of the Indian subsidiary? The high court appears to have been guided by cumulative appreciation of the facts of the case viz that, in the facts on hand, there was acquisition of a business presence. But, even assuming that what was transferred was controlling interest , the term does not find any reference in tax law pertaining to capital gains and is not an asset separate from shares. In absence of a specific provision in the Indian law, taxation in respect of such a transaction should ordinarily not arise in India , when shares of a foreign company are transferred between two non-residents , merely because on such transfer there is an indirect shareholding in an Indian business entity. It should be noted that, even today, transfer of shares in an Indian company by a Mauritius companywhich submits tax residency certificatedoes enjoy exemption from capital gains in India , as in this case the treaty provides that the taxing rights of the capital gains vest with the country of residence and not the source country (where capital gains arise). The SC, in Azadi Bachao Andolan case (263 ITR 706), has held that an act which is otherwise valid in law cannot be treated as non est (non tenable) on the basis of the underlying motive. While the high court has not given any definite conclusion, it has made observations that may be followed by the revenue authorities in assessing similar transactions. Such actions, if any, could spell uncertainty for and cause anxiety in respect of all genuine international takeovers merely because there may be a change in controlling or business interest in the underlying Indian subsidiary.
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