Mohan R. Lavi

Once a while, a marquee case lands in the Income-Tax department which invariably stares at a huge tax claim. The Vodafone case appears to be one such in 2007. Taking over Hutchison Essar for $11.1 billion after a tense wait at the door of the Foreign Investment Promotion Board (FIBP), Vodafone is faced with a tax demand for $2 billion .

A reply to the demand notice and a stay petition in the Mumbai High Court by Vodafone has confirmed that a protracted legal battle is ahead. The Department appears to have been prompted by Section 163 of the I-T Act which defines an agent to mean any person in India who is employed by or on behalf of the non-resident, or has any business connection with the non-resident or from or through whom the non-resident is in receipt of some income whether directly or indirectly or who is the trustee of the non-resident and includes also any other person who, whether a resident or non-resident, has acquired by means of a transfer, a capital asset in India.

The words any business connection has apparently led the department to eye a goldmine in terms of tax. Section 160 of the I-T Act ensures that an agent is treated as a representative assessee for the purposes of taxation.

The subtlety of the deal ensured that both the acquirer and the acquired were abroad, but the target company was physically situated in India. The ubiquitous Double Tax Avoidance Agreement which normally irons out these issues was conspicuous in its absence with Hong Kong, where the acquirer was based. Taxation laws in quite a few countries initially turned a blind eye to tax havens such as Mauritius and later blessed them too.

The main argument which Vodafone would have is that if this transaction had occurred in Mauritius or any country with a DTAA with India, the I-T demand would not have arisen, thereby making the main transaction exempt regardless of the circumstances or place where the transaction occurred.

Section 5(2) of the I-T Act, a charging section, defines the taxable income of a non-resident to include income received or deemed to be received in India and income that accrues or arises or deemed to accrue or arise in India, thereby exempting income that accrues or arises or is deemed to accrue or arise outside India.

Just to ensure that asset-based transfers do not go tax-free, Section 9(1) of the I-T Act postulates that income is deemed to accrue or arise in India if it is from transfer of an asset situated in India or through or from business connection in India. The Department seems to have the impression that since the approval of the FIBP was applied for, there was a business connection with India, making the acquirer an agent and thereby a representative assessee.

The FIBP approval is a statutory process which would need to be taken irrespective of whether the transaction is exempt or otherwise. In case the transaction is taxable, the dreaded sections of tax deducted at source (for capital gains) would come into play and the amount of tax as well as penalty and interest would have been sufficient for Vodafone to finance another small acquisition.

There could have been instances earlier wherein such acquisitions had occurred but had escaped the taxmans eye for the simple reason that the effort to collect the tax would have cost more than the tax itself.