The Income Tax Department has, in a 761-page order, asserted its jurisdiction to tax Vodafone Group Plc’s $11.2 billion deal with Hutchison Telecommunications International in 2007, saying the deal was designed to hoodwink tax authorities by showing it had taken place abroad.

“The transaction was structured in a way to show as if it was a transfer of a Cayman Island company, a subsidiary of Hutchison, for which payment was made outside India. This was designed in this manner so as to claim that Indian tax authorities had no jurisdiction,” a senior I-T department source said.

The lengthy order, based on dozens of agreements between Vodafone, Hutchison and Essar, also said Vodafone is the beneficial owner of Asim Ghosh and Analjit Singh’s stake in the telecom company.

The tax dispute concerns the England-based Vodafone Group’s acquisition of 67% stake in Hutchison Essar from the Hong Kong-based Hutchison Telecommunications International in February 2007.

The I-T department is of the opinion that the transaction is taxable by it, which is being disputed by Vodafone Essar.

Hutchison Telecommunications International, the seller, controlled its Indian subsidiary through companies that finally led to a Cayman Islands-registered entity to receive the payment from the Vodafone Group of England.

Arguing that the Indian authorities have no jurisdiction to tax it over the deal, Vodafone had moved the Supreme Court in January 2009, but the apex court had refused to intervene in the matter and had directed the I-T department to revert on its jurisdiction.

The I-T department passed an order saying it has the jurisdiction to tax Vodafone, since the deal concerned the sale of 66.98% of interest in Hutchison-Essar, which was an Indian company.

“The undisputed conclusion which has emerged from the factual and legal matrix outlined in the order is that the deal was the telecommunication operations of the Hutchison group in India along with all accompanying assets, interests, rights, whether tangible or intangible, which was sold by Hutchison Telecom International to Vodafone by virtue of the sale and purchase agreement dated February, 2007,” the I-T department source said.

Having concluded that the income is chargeable to tax in India, Vodafone was under an obligation to deduct tax at source at the time of making payment of sale consideration to Hutch Telecom in terms of Section 195 of the Act.

The facts narrated in this order clearly prove that on the date of payment i.e. on May 8, 2007, Vodafone had sufficient nexus and presence in India and it cannot claim that it was not bound by Indian laws including tax laws and the withholding tax provisions contained in Section 195 of the Act, the department said.

The provisions of section 195 were clearly attracted and the plea of payment being from one non-resident to another is not sustainable.

Here are some key excerpts from the 761 pages Income Tax Department Order:

1. Bharti Airtel’s ‘no objection’ to the acquisition of interest in HEL by Vodafone group was also in compliance to one of the requirements of press note 1( 2005 series) issued under the Indian Telecom Policy.”

2. It is not surprising that E&Y ( which conducted due diligence for Vodafone ) by their own admission have observed that limited information only was made available to them about CGPC and accordingly they were not in a position to comment on the tax risks associated with this company & advised that a warranty be sought from the vendors to protect from unforeseen tax consequences.

3. If in actual fact the transaction related only to the sale and purchase of one share of US$1 of CGPC, why was there a need to stipulate in Clause 1.18 of the Agreement that in the case of a claim, the value of the claim will be translated into US$ at the RBI Reference Rate.

4. Vodafone was going to acquire a ‘bundle of rights’ from HTIL which includes:

(a) Direct and indirect 51.96% equity ownership of HEL

(b) A right to acquire (through call options) further 15.03% equity ownership of HEL subject to future change in FDI Rules

(c) Preference shares in TII and Jaykay

(d) Liabilities of USD 630 million in various subsidiaries

(e) Assumption of liabilities of the Group Companies and

(f) Various intangibles such as control premium, use and rights to the Hutch brand in India and a non-compete agreement with HTIL.

5. A Tax Deed dated 8th May 2007 was executed between HTIL and Vodafone, pursuant to the SPA dated 11th February 2007. Clause (4) of this deed describes Reciprocal Secondary Liabilities Indemnities and provides in its sub-clause (1) that HTIL agrees to pay to Vodafone among others, any amount on account of taxation for which a Wider Group Company becomes liable, in consequence of failure by any member of HTIL Group to discharge taxation primarily attributable to that member of HTIL Group

Soon after “completion” of the transaction, Vodafone entered into “Framework and Other Agreements” with Mr. Asim Ghosh, Mr. Analjit Singh and IDFC Group of Companies. The main effect of these agreements was that Vodafone could acquire the shares held by Mr. Asim Ghosh, Mr. Analjit Singh, and the IDFC Group of companies by paying a pre-determined price, lower than the market price. It was necessary for Vodafone to enter into these elaborate agreements/arrangements in order to safeguard its interests and exercise control of HEL and its subsidiaries, again highlighting the fact that the subject matter of the transaction was the acquisition of 66.9848% interest of HEL.

7. Thus, it is abundantly clear that by virtue of the option agreements entered into by HTIL with Mr. Asim Ghosh and Mr. Analjit Singh it was HTIL who was the beneficial owner of the interest held in the name of  Mr. Asim Ghosh and Mr. Analjit Singh. These option agreements were subsequently transferred by HTIL to Vodafone and formed part of the consideration paid by Vodafone to HTIL on completion of the transaction. The eventual exercise of the options at the predetermined price, much below the market price goes to show that the options agreements were loaded in favour of first HTIL and then Vodafone and enabled them to exercise actual control over HEL and its subsidiaries.

8. The fact that vide Confidential Memorandum dated 21st September 2007, Vodafone group stood guarantee for raising a huge loan of US$ 3590 million for Essar from Standard Chartered Bank only goes to show the extent to which Vodafone was willing to accommodate its Indian JV Partner for safeguarding its interest in the Indian Telecom Business.

9. The correspondence between Vodafone, HTIL and Mr. Asim Ghosh/Mr. Analjit Singh/IDFC which resulted in signing of option agreements by Vodafone has not been submitted.

10.  It is also apparent that post transaction and particularly after the proceedings have been initiated by the undersigned, numerous letters and emails have been exchanged between HTIL and Vodafone, of which not all have been submitted on the grounds that they are not relevant. In this connection, it is stated that unless full documents are submitted, it is not possible to decide their relevance or otherwise. It also needs to be noted that only “relevant extracts” of the due-diligence report prepared by Ernst & Young have been submitted by Vodafone and not the entire report on account of commercial secrecy.  It is thus clear that Vodafone has not been fully forthcoming in submitting the documents requisitioned.

11. Further, section 5(2)(b) clearly uses the terms ‘accrue or arises or is deemed to accrue or arise’.  Full effect to all the words employed in section 5(2) has to be given.  The term ‘accrue or arise’ forming the first part of section 5(2) refers to income that in the ordinary course can be regarded as accruing or arising in India without taking recourse to the provisions of section 9(1). Merely because section 9(1) separately covers the situation where income accrue or arises whether directly or indirectly through the transfer of capital asset situated in India, it cannot be concluded that section 5(2) cannot cover a situation of the transfer of a capital asset when that results in income accruing or arising in India.

12. The foregoing discussion reveals that the separate independent structure of the intermediate subsidiaries has neither been recognized nor maintained by HTIL. The conduct of the parties to the SPA shows that HTIL has functioned as a single entity and for all intent and purposes it has regarded the downstream companies as its own extended hands. Revenue need not lift the corporate veil which has already been discarded by the Vendor (HTIL).

13. It further needs to be noted that Vodafone has not led any evidence to indicate any commercial activity performed by CGPC. Its financial statements upto December 2006 could not be produced, as admittedly they were not prepared. So it can be very well be inferred that no commercial activity whatsoever was carried by CGPC.

14.  On the date of payment, that is, on 8th May, 2007, Vodafone had a presence in India and it cannot claim that it is not bound by Indian laws including tax laws and the withholding tax provisions contained therein.

15. In their letter dated 6th March 2007 addressed to FIPB, the Essar Group raised objections to the proposed purchase of interest in HEL by Vodafone on the ground that the proposed transaction seeks to link two competing interest on account of Vodafone Group’s involvement with Bharti Airtel Group, thereby jeopardising the interests of Essar Group, as HEL and Bharti Airtel are competitors. Thus Essar requested the FIPB that since it was a stake holder, ‘no objection’ was required to be obtained under press note 1 and foreign investment policy of Government of India….. By its letter dated 14th March 2007 Essar Group informed FIPB that they had evaluated the proposed transaction between HTIL and Vodafone and on due consideration had given consent to the investment proposal of Vodafone in HEL. It may be mentioned that a Settlement Agreement dated 15th March 2007 between Essar and Hutch Groups was entered into whereby HTIL agreed to pay USD 415 million to Essar in return for Acceptance of the SPA between HTIL and Vodafone.

16.  Whatever be the nature of the given structure, the fact remains that what was negotiated between the parties to the transaction and what was finally transferred from HTIL to Vodafone was not the single share of an inconspicuous holding company in the Cayman Islands but the participation in HEL as a joint venture and all other rights associated with such venture.  The transfer of a single share of a Cayman Islands company was simply one of the possible modes selected for the conveyance of the rights agreed to be transferred between the parties.

17. CONCLUSION:

i. From the detailed analysis in this order it is apparent that the transaction between HTIL and Vodafone did give rise to income chargeable to tax in India under the provisions of sections 4, 5(2) and 9 of the Income tax Act, 1961.

ii. This is a case where the existence of separate corporate entities has not been recognized by the Vendor, HTIL itself and if one looks through the corporate veil, the conclusion with regard to the real nature of the transaction is inescapable.

iii. Having concluded that the income is chargeable to tax in India, Vodafone was under an obligation to deduct tax at source at the time of making payment of sale consideration to HTIL in terms of section 195 of the Act. The facts narrated in this order clearly prove that on the date of payment i.e. on 8th May, 2007 Vodafone had sufficient nexus and presence in India and it cannot claim that it was not bound by Indian laws including tax laws and the withholding tax provisions contained in section 195 of the Act. The provisions of section 195 were clearly attracted and the plea of payment being from one non-resident to another is not sustainable.

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