India's tax authorities claim that capital gains tax is due on Vodafone's acquisition of Hutchison Essar in 2007 for 10.9 billion U.S. dollars. Previously, the Bombay High Court had rejected the companies' argument that the transaction took place outside of India and was therefore not subject to tax. Daksha Baxi, a Mumbai-based Executive Director with Khaitan and Co., spoke with us about the questions before the Supreme Court.
Daksha Baxi first outlined the facts that lay behind the dispute. There was a very substantial value of a business, which was established in India. This business was owned by several companies in Mauritius, which were in turn owned by a company in the Cayman Islands, which in turn was held by another company in the Cayman Islands. By virtue of a transaction, this Cayman Islands company's shares were transferred by Hutch International to Vodafone. What really happened was that the control of the Indian company's business moved from Hutchison to Vodafone.
"Many such transactions, where the shares of an intermediary company, which holds several investments, one or all of which may be Indian, have been sold, have happened over the years in several jurisdictions. India's case is specifically very interesting because India is one of the few larger countries, which are not a member of the OECD, which have a source-and-residence based taxation. So a non-resident is taxed on income, which is sourced in India. So as far as the Indian Tax Department is concerned, the controlling interest of a very substantial business in India changed hands. Therefore, the capital gain that the seller realises should be treated as income, which is sourced in India. It is a thought that any tax authority would like to implement. The issue however, is whether the law permits it, or whether it was only because the transaction has such a huge value that they were taxing it.
"The interesting thing in this case is that the entity involved is based in the Cayman Islands with whom India does not have a tax treaty. Therefore, the provisions of the Income Tax Act apply." Section 9(1)(i) of the Income Tax Act, 1961, which talks about the sourcing of income for non-residents, uses the words "directly" and "indirectly". "All the arguments that we have seen, in the Bombay High Court and in the Supreme Court, are not harping on this language. They are going round trying to understand why this has happened, who is the taxable entity when there is a parent company which rules the manner in which the subsidiary should be doing its transactions, and what really was the cause for the transaction. I would hope that the Supreme Court would also interpret the language in Section 9(1)(i) so that we can put at rest the question of what the legislative intention was when it drafted it like that. If you interpret the language to include assets situated in India through an intermediary, then there is a legal basis for taxing such a transaction. So in view of all of that, we really look forward to the Supreme Court laying down the rules with respect to the source rule for when there is a direct transfer and when there is a transfer through vertical structures when you have several subsidiaries in between and at some level, the transfer of shares takes place and results effectively in changing control of the Indian company's business as well. The question then arises is if you do want to interpret it as directly and indirectly meaning this, then where do you stop? Does it mean that all the companies which have an indirect interest in India, when they do their business reorganisation or when they transfer some of their business to another non-resident, India will ask for a piece of the capital gains that they realise out of those transactions? And how will you allocate? What if that intermediary has more than one asset, which involves assets located in several other jurisdictions including in India? Where do we draw a line? The current law does not clarify that. The proposed Direct Tax Code does attempt to clarify that by saying, if the assets of that intermediary has more than fifty per cent of their value derived from Indian assets, then it will be considered taxable in India. That is a good benchmark at least that is being given - there can be arguments as to whether fifty per cent is sufficient threshold and there can be a variety of other questions that may arise out of that, but at least there is some recognition of the fact that you cannot say that any indirect transfer would result in taxation in India. That would put India in a position where anyone who is doing business with and in India is going to be completely uncertain about how they are going to be taxed in India.
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tax guru weekly 11-10-08by kcjv2008563 views
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