An Insight Into Tax Avoidance, Backed By Recent Developments

Atmadeepa Sen*

Abstract

Tax avoidance, the legal manipulation of the tax system to minimize tax liabilities, has sparked significant debate within fiscal policy and legal spheres. This paper provides a comprehensive analysis of the evolving nature of tax avoidance, highlighting the thin line between legitimate tax planning and abusive tax avoidance schemes. Through the lens of landmark judicial rulings, such as McDowell & Co. Ltd. v. CTO and Vodafone International Holding B.V. v. Union of India, this research traces the development of tax avoidance jurisprudence in India. Additionally, the paper also delves into the recent amendments brought to different provisions of the Income Tax Act, 1961 and the increasing scrutiny of multinational corporations, which highlights the government’s proactive stance. The study underscores the fine balance between ensuring tax compliance and maintaining a conducive environment for international investment, providing a timely insight into how governments are adapting to modern tax challenges.

Keywords:

Tax Avoidance, Tax Evasion, Tax Planning, Tax Jurisprudence, International Taxation, Tax Compliance, Tax Reform, Legal Framework, Vodafone Case

Introduction

What is tax avoidance and how does it differ from tax evasion?

As Justice Reddy[1] calls Tax avoidance “the art of dodging tax without breaking the law”

Tax avoidance is nothing but using legal means and methods to minimize or escape the huge amount of income tax burden levied on an individual or a business during a particular assessment year. It relies on the authority of canons of statutory interpretations[2], which emphasizes that tax avoidance is permissible as long as it inclines towards the right side of the law.[3]  On the contrary, tax evasion is illegal and involves deliberate misrepresenting or concealing income to avoid paying taxes.

The assessees or taxpayers take the benefit of tax avoidance by claiming various credits, making deductible expenses, and utilizing the exemptions and exclusions provided by the Government for reducing the taxable income. To list a few advantages[4]:

• Child Tax Credit and other available tax credits. Currently, there is no dedicated child tax credit in the nation, but the government provides for various valuable tax benefits that act as tax relief and exemptions for families bearing children to pay taxes;
• Investment made into a retirement account and maximising out of the annual contributions;
• Health Savings Account;

However, the debate between tax avoidance and tax evasion, based on the implications and perspectives of different individuals, including scholars, puts these two terms in a complicated global situation to deal with.[5] At the end of the day, both practices ultimately involve manipulating the system to pay less in taxes owed to the government. And thus, some believe that there lies no difference between tax avoidance and tax evasion since, in both cases, the behaviour of the taxpayers remains factually similar.[6] Had there been no moral obligation to pay taxes at all, then how does it make a difference if it’s the case of tax evasion or tax avoidance?[7]

THE VODAFONE CASE 

To delve into how anti avoidance measures have evolved in India, the infamous Indian case[8] that forms the basic foundation of it needs to be highlighted, discussed, and known to the readers of this article before proceeding further.

The highly publicized and now increasingly global, context of anti-avoidance stepped into judicial interpretation and consideration before the Honorable Supreme Court of India in the well-known case of Vodafone International Holdings BV v. Union of India (herein referred to as the “Vodafone case”).

Facts:

• Hutchison Telecommunications International, Hong Kong, a foreign company (hereafter referred to as the “Hutchison”) invited bids from several investors for auctioning its investments made in a Cayman Island Company named CGP Investment Holding Ltd. (hereafter referred to as the “CGP”). The former company was holding 100% shares of the latter’s.
• CGP held 100% shares of a Mauritius company (Hutchison, Mauritius), which in turn was holding 67% of the shares of an India based company named Hutch Essar. Thus, Hutchison, Mauritius, was acting as the intermediary company between CGP and Hutch Essar, India, leading to CGP acting as the holding company for Hutch Essar as well.
• Through the auction, Vodafone International Holdings BV (hereby referred to as the “Vodafone”), through its Dutch subsidiary, Netherlands, purchased shares of the CGP from Hutchison for around USD 11 billion, thereby indirectly acquiring 67% of the shares of the Indian company, Hutch Essar.
• After this transaction was made, the Indian Revenue produced a show cause notice before the Vodafone-Essar in India, demanding requisite information about the purchase so made that includes gaining control over the Indian Company indirectly without getting the tax deducted at source from the Hutchison at the time the purchase was made.
• The show cause notice was produced on the ground that Section 9 of the Indian Income Tax Act, 1961, precisely states that if assets of a business are situated in India, i.e., Indian assets, are being sold, then capital gains tax accumulated on the purchase of such business’s assets for the particular assessment year needs to be levied on and paid.
• Hutch Essar’s assets, as previously mentioned, were based in India, thus resulting in a capital gains tax of around USD 1.7 billion accumulated on the same to be payable by the Vodafone-Essar (as now acquired by Vodafone) since it is in accordance with Section 9 of the Indian Income Tax Act, 1961.
• Vodafone challenged the Indian Income Tax authority before the Bombay High Court by filing a writ petition, seeking an injunction over the said action.

Legal Issues contended:

• Applicability of Section 9 of the Income Tax Act, 1961 which states that
• Transfer of shares of the Hutch Essar, India, to Vodafone through indirect means. Huthchison is liable to pay tax since tax was not deducted at source during such transfer.
• Since Vodafone-Essar (the new Indian entity) is acting as an agent of Hutchison, it is liable to pay the due amount of tax in India as a representative assessee (as defined under Section 160 of the Indian Income Tax Act, 1961) of Hutchison in India.
• Scope and applicability of Section 201 of the Income Tax Act, 1961 which talks about assessee in default.
• Territorial Jurisdiction of Indian Tax Authorities and scope of Indian Income Tax Act, 1961 over non- resident.
• Validity of the issued show cause notice
• Capital assets and tax to be levied on indirect transfer of capital assets

Held:

Bombay High Court Ruling[9]

• Before the Bombay High Court, the Income tax authorities had laid down a strong prima facie case:

The purpose of acquiring shares of CGP was not just and mere; the main intention was to acquire the Indian entity by way of Indian tax avoidance. Since Cayman Island is considered to be a tax haven island (low or nil taxation) and Vodafone acquired CGP (Cayman Island Company), tax was not required to be deducted at source for the purchase of the shares of the CGP.  CGP was just a mere dummy entity whose shares were purchased to acquire Hutch Essar, India, without being charged for capital gains tax of India since the CGP was a foreign company situated in Cayman Island and not in India.

• On the contrary, Vodafone failed to produce requisite relevant documents before the court to uphold the true nature and intention of the transaction. It also failed to demonstrate that the show cause notice produced was non-existent in the eyes of law for the absolute want of the jurisdiction of the authorities.

In light of the above stated, the Bombay High Court dismissed the writ petition with costs to the tax authorities and held Vodafone liable to the cause and to produce all the requisite documents so demanded by the income tax authorities.

Supreme Court Ruling[10]

The Supreme Court overturned the decision made by the Bombay High Court with regard to this case and passed a contradictory statement.

The crux of the judgment is discussed below in points:

• The apex court observed that Vodafone India should get the shield of Section 195 of the Indian Income Tax Act, 1961, as it clearly states that if only Indian assets are being sold, tax is to be levied on, and thus, Section 195 of the said act only applies to residents and cannot act beyond the territorial jurisdiction.
• The transaction in question has taken place between such two companies which are non- residents of India as per the Income Tax laws of the country, and the transaction took place outside the India’s territorial jurisdiction. Therefore, no direct nexus or proximity with India can be established.
• Section 9(1)(i) of the Indian Income Tax Act, 1961, comprises only those incomes which arise out of the direct transfer of the capital assets but stays silent on the said issue of indirect transfer of capital assets in India. Hence, the apex concludes that the mere acquisition of control interest over an Indian property indirectly through the transfer of shares of a company not situated in India cannot be subjected to Indian tax under the Income Tax Act, 1961.
• Acquisition of control interest arises out of contractual rights and obligations and thus might act as supplementary to share acquisition. It forms an inviolable part of shares and cannot be made taxable owing to control interest.
• The court concluded that most offshore companies situated in Mauritius, Cayman Island and such other countries due to better investment opportunities undertakes these kinds of arrangements for legitimate tax planning and not to conceal or avoid tax. The arrangement of transfer made between Hutchison and Vodafone in respect of CGP was bona fide and in good faith and should not be seen as a concealment or usage of a colourable device to escape tax.
• The holding and subsidiary companies might be in a pyramid form of structure whereby such subsidiary company is being the parent company of other companies by having control interest in them.
• The doctrine of lifting of corporate veil can be made applicable in cases where the facts reveal that the constitution of such holding and subsidiary companies (having separate legal identities of their own) is because of the dubious act of evading tax.
• The apex court reversed the Bombay High Court’s decision and held Vodafone not obligated to revert back to the tax authorities under Section 163 of the Income Tax Act, 1961.
• Since the decision was made in favour of the Vodafone, it gained protection against all kinds of liabilities (including the liability to pay capital gains tax of around Rs.12,000 crores as imposed by the authority) in this case.

The Finance Bill, 2012 – The Beginning of Contingency

Post the Supreme Court judgment in favor of the Vodafone, the Finance Bill of 2012[11] was introduced by the then Indian Government with the consent of President Pranab Mukherjee, where the following amendments were made to the provisions of the Income Tax Act, 1961:

• Section 2(14) of the Income Tax Act, 1961—Explanation—”Property”

The explanation of this section was expanded by including any right associated with an Indian company, including rights of management and control, within the meaning of “property”.

• Section 2(47) of the Income Tax Act, 1961—Explanation 2—”Transfer”

Explanation 2 was added to the section. It inferred that any asset; directly or indirectly; absolutely or conditionally; voluntarily or involuntarily; by way of an agreement (entered into or outside India), or otherwise shall be implied as a “transfer”.

• Section 9(1)(i) of Income Tax Act, 1961— Explanation 5—”Substantial Value of Indian Assets” and “Retrospectivity”

Explanation 5 was inserted. It stated that whenever there is a transfer of shares deriving a substantial value from an Indian asset, such transfer shall be made taxable in India as per the Indian Income Tax Act, 1961. The amendment brought in by the insertion of Explanation 5 to Section 9(1)(i) of the Income Tax Act, 1961, shall have retrospective effect since 1962.

• Section 195 of Income Tax Act,1961 — Explanation — “Scope”

The scope of Section 195 was broadened by the expansion of its explanation. It is now made applicable to both residents and non-residents, having a business connection or whatsoever, to mandatorily deduct tax at source.

Permanent Court of Arbitration

A Bilateral Investment Treaty (BIT) was signed between India and Netherlands whose Article 9 stated that if there is any dispute between an investor of one contracting party with the other contracting party, then to resolve such dispute, parties can move to permanent court of arbitration if such dispute is in connection with the investment being made in the territory of the other contracting party.

Since Vodafone company had its base in Netherlands and the dispute was regarding the retrospective effect of the amendments brought into in respect to the investment indirectly made by the Vodafone in an Indian entity (Hutch Essar, India), Vodafone moved for arbitration in accordance with the provisions of BIT. It did so as back in 2016 many BITS between India and other countries were terminated by India itself.[12]

The permanent court of arbitration issued its award in favour of the Vodafone by not only disregarding the retrospective nature of the amendment and the tax so charged in pursuance of it but also imposing a liability of around INR 40 crore to be paid to the Vodafone by the Indian Government as an obligation to compensate the legal costs so incurred by the Vodafone.[13] It held that the imposition of taxes through a retrospective amendment is clearly in violation with Article 4(1) of the BIT on just, fair, and equitable ground. The said amendment has limited the scope of the treaty and the carte blanche approach got replaced.[14]

Cairn Energy-Government Dispute

The Cairn-Income Tax department dispute[15] stems from the much-debated retrospective taxation issue. In 2015, after audits, the income tax authorities decided that Cairn UK had made capital gains, so it ought to pay capital gains tax of around 245,000 million.

The Cairn interpreted Indian laws on capital gains differently, and refused to pay the retrospective taxes. It argued that the retrospective amendment of taxation goes against the investment agreement and hence, not liable to pay tax. Due to different interpretations, Cairn presented its case before the Income Tax Appellate Authority where it was defeated. Aggrieved by the same, in 2017, Cairn dragged this case to Permanent Court of Arbitration where it was held that the Indian Government’s retrospective demand was “in breach of the guarantee of fair and equitable treatment”. Cairn Energy won the arbitration award on 23^rd December, 2020.

The Indian authorities stated that it needs to analyse the Cairn Tax dispute before appealing to higher authorities. By this, the Indian Government hinted that the only possible solution for both parties to avoid further litigation was for Cairn Energy to agree to the Government’s tax amnesty scheme and dispute resolution mechanism.

The Taxation Law (Amendment) Bill, 2021

The Amendment of 2021 was required to nullify the retrospective tax demands proposed and brought in by the Finance Bill of 2012.

Main Issues with the Finance Bill, 2012:

The problems with the proposed retrospective tax demands of 2012 were:

• The principle of tax certainty got into a tangle as criticized by the assessees, mostly investors, both domestic and foreign.
• The reforms and regulations introduced in the financial and economic sectors to promulgate a positive, healthy environment for the investors, domestic and foreign, suffered a backlash owing to tax uncertainty.
• Foreign investment plays a pivotal role to a large extent, especially post-pandemic, to combat the economic challenges, growth, and employment. The retrospective tax demands laid down by the Finance Bill of 2012 became a threat for the potential investors, who now took a step backward from making investments in India. India’s reputation in the global market as an attractive destination suffered damage.

To come up with a solution for the above stated problems, the Taxation Law (Amendment) Bill, 2021, was introduced by the present Minister of Finance, Ms. Nirmala Sitharaman, in August 2021.

Key Takeaways of the Taxation Law (Amendment) Bill, 2021:[16]

— Clause 2 of the Bill – amended Section 9 of the Income Tax Act, 1961.

Tax demand to the effect of retrospective tax amendment of 2012 shall not be raised in the future for any indirect transfer of an Indian asset if such a transfer has been transacted before May 28, 2012.

The tax demand raised (on retrospective basis) for all those transactions that were undertaken before May 28, 2012 will be invalidated and nullified on the fulfilment of certain conditions, as stated below:

• Any legal proceeding for arbitration, conciliation, mediation, or any other legal proceeding or suit pending before any court of law with respect to such retrospective tax law demand needs to be withdrawn; and an undertaking should be furnished mentioning the same and
• An undertaking shall also be furnished that no claim for cost, damages, interest, etc. be charged thereby.

The bill proposed that the amount paid in these cases be refunded without any interest thereon.

—Clause 3 of the Bill – amended Section 119 of the Finance Act, 2012

The validation of the retrospective tax demand under Section 119 of the Income Tax Act, 1961, shall cease to apply if the conditions, such as an undertaking (withdrawing legal proceedings pending before any court of law with respect to such tax law demands) shall be furnished and to such effect that no claim for cost, damages, interest, etc. is charged thereby.

• On August 13, 2021, the Taxation Law (Amendment) Bill, 2021, was implemented after receiving presidential assent for the same to amend the Income Tax Act, 1961, and the Finance Act of 2012.

Critical Analysis and Conclusion

Tax avoidance is used as a legal cornerstone by the tax dwellers to make arrangements for their affairs in a manner to escape tax while falling within the purview of law. Retrospective amendments in tax leave scope of ambiguity for the taxpayers as well as the foreign investments as they remain in contingency as to how much tax burden will be bore by them. The Taxation Law (Amendment) Act, 2021, aims to address these issues by providing more clarity and transparency in tax laws. It also seeks to discourage tax avoidance practices by introducing stricter penalties for those who try to evade taxes through legal loopholes. Overall, the implementation of this act is expected to bring about a more fair and efficient tax system that will benefit both the government and assessees alike.

While the Taxation Law (Amendment) Act, 2021, may aim to provide more clarity and transparency in tax laws, it could also potentially increase the burden on taxpayers and deter foreign investments due to the stricter penalties for tax avoidance. Additionally, the complexity of the new laws could create confusion and compliance issues for taxpayers.

It is important for the government to strike a balance between cracking down on tax evasion and ensuring that the tax system remains fair and manageable for taxpayers. The implementation of the Taxation Law (Amendment) Act, 2021, will require thorough education and support for taxpayers to navigate the changes effectively. With proper guidance and assistance, taxpayers can adapt to the new regulations and contribute to a more transparent and effective tax system in the long run; or, if not put a check then may be, it will become the reason for tax avoidance in the long run.

Notes:

[1] McDowell v. Commercial Tax Officer, (1985) 154 ITR 148 (Supreme Court of India)

[hereinafter “McDowell”].

[2] The most important judicial authority on the point that is repeatedly cited by all scholars – legal, moral or economic – is the famous US opinion by Judge Learned Hand, the of the Second Circuit, in Helvering v . Gregory, 69 F 2d 809 (2nd Cir 1934), later affirmed by the US Supreme Court in Gregory v. Helvering, 1935 SCC OnLine US SC 6 : 79 L Ed 596 : 293 US 465 (1935), where Justice Sutherland (for the Court) held, (at 469), “The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether

[3] This body of literature argues that the Courts only interpret the law and a transaction falls into the category that is permitted by the law then the matter ends there and it is for the Legislature to make the law so that certain transactions on which they would like to see the tax law applied are covered within the ambit of the law . For those who subscribe to this school of thought disregard any argument made by the revenue authorities on the grounds of the transaction being against “The Spirit of The Law” . See Carter (n 2) at 82, 83 and 89

[4]Kagan J., What is tax avoidance? types and how it differs from tax evasion, Investopedia (June 20, 2024, 12.30PM), https://www.investopedia.com/terms/t/tax_avoidance.asp

[5] James T. Carter, “Tax Saving versus Tax Evasion” 20 Va . L . Rev . 307 (1934); Montgomery B . Angell, “Tax Evasion and Tax Avoidance” (1938) 38 Colum . L . Rev . 80; Anil Kumar Jain, “Tax Avoidance and Tax Evasion – The Indian Case” (1987) 21 Modern Asian Studies 233, Zoe Prebble and John Prebble, “The Morality of Tax Avoidance” (2009) 43 Creighton L . Rev . 693

[6] Zoe Prebble and John Prebble, “The Morality of Tax Avoidance” (2009) 43 Creighton L . Rev . 693, 702

[7] Robert W . McGee, “Three Views on the Ethics of Tax Evasion” (2006) 67 Journal of Business Ethics 15

[8] Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613.

[9]2009(4) BomCR258, (2008)220CTR(Bom)649

[10] (2012) 6 SCC 613.

[11] The Finance Bill, 2012, Bill No. 11 of 2012, u5(March 16,2012) .

[12] BIT, Department of economic Affairs, (June 27, 2024, 9.00PM),

https://www.dea.gov.in/bipa .

[13] Mukesh Butani and Tarun Jain, “What Next after the Vodafone Tax Arbitration?”, FORTUNE INDIA (June 30, 2024), https://www.fortuneindia.com/opinion/what-next-after-the-vodafone-tax-arbitration/104758

[14] Relevant excerpts from Art. 3 of India’s revised BIT model state:

“3.1 No party shall subject investments made by investors of the other party to measures which constitute a violation of customary international law through: (i) denial of justice in any judicial or administrative proceedings; or (ii) fundamental breach of due process; or (iii) targeted discrimination on manifestly unjustified grounds, such as gender, race or religious belief; or (iv) manifestly abusive treatment, such as coercion, duress and harassment.

3.2 Each party shall accord in its territory to investments of the other party and to investors with respect to their investment’s full protection and security. For greater certainty, ‘full protection and security’ only refers to a party’s obligations relating to physical security of investors and to investments made by the investors of the other party and not to any other obligation whatsoever.”

[15] 2021 SCC OnLine Blog Exp 15

[16] The Taxation Laws (Amendment) Bill, 2021, Bill No. 120 of 2021, (August 6, 2021)

***

*Author: Atmadeepa Sen is pursuing BBA.LLB Hons. (Specialization: Taxation Law) from UPES University, Dehradun and presently in 4th year of 5 years’ course (2021-2026).