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COMMENT: Lessons to learn from Vodafone

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The Supreme Court’s Vodafone judgment is a momentous decision not only for India but also for a large number of foreign investors anxious to be a part of India’s growth story.

From the outset, by ruling that the Indian tax authorities have no jurisdiction in the case, the Supreme Court has held that transfers of shares outside India that indirectly transfers Indian shares are not eligible to be taxed in India.

This is especially significant as a number of indirect transfers of Indian shares between non-residents were drawn into tax litigation in India in the days after the Bombay High Court’s decision in Vodafone from October 2010. Additionally, the tax department was looking to re-open a number of cross-border mergers on the strength of the decision of the high court, including the Kraft-Cadbury and GE-Genpact deals. Friday’s decision brings much needed certainty to the taxation of such deals in India which will go a long way to attracting more foreign investment.

Friday’s verdict also dispels the fears about not just the legality of tax planning but the use of intermediate jurisdictions and treaty shopping. The ruling shows that the use of holding companies and investment structures in this instance was primarily driven by business/commercial purpose and that the use of these elements in international structuring should not always imply tax avoidance.

The decision will give taxpayers certainty and will enable multinationals to more efficiently plan their Indian operations.

As far as the government is concerned, the next step is the draft Direct Taxes Code (DTC) Bill 2010.One element of the DTC focuses on the topic of the taxation of offshore transactions that involve an indirect transfer of Indian asset (Indian shares or Indian businesses). But as the DTC is unlikely to come into effect from April 1 this year, it is quite possible that the government might introduce such provisions in the forthcoming Finance Bill which will be presented by the finance minister to Parliament on March 16.

Key lessons

  • Taxpayers need to be careful of their obligations in India. Far from putting one’s guard down, one should note from this protracted litigation, the government’s aggression on revenue collection, and the extent they would go to claim it.

  • India is a heavily source-driven country and its withholding regime is a crucial element of its tax collection tool. Taxpayers need to be aware that interest and penalties for failing to comply withholding obligations can be very large, A key point to remember is that Vodafone was a buyer in this case, and not the party who made the gains.

  • One concern is that the concurring judgment states that when a non-resident pays to another non-resident, the withholding provisions are not applicable unless the payer has some kind of presence in India. But  a quick read of the law contrasts with this and taxpayers should expect the revenue to continue to argue this point.

  • The tax department will continue to be aggressive and will continue its investigations into non-resident companies. This will lead to an increase, and not a reduction in litigation.

  • When planning transactions, you need to think about how a court would view the structure. Taxpayers should consider the fact that most of the judges at the higher courts are not tax trained. This means you cannot rely on technical defences but instead rely on strong arguments that a judge could understand. 

  • Taxpayers need to control how much information on a transaction is made public. The revenue is not scared to use any little bit of information to support their argument. 

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