This content is from: Direct Tax

India: Vodafone’s tax woes continue to linger

Ajay Rotti and Saurabh Shah of Dhruva Advisors discuss why the Indian government’s reluctance to accept the Vodafone ruling could have a detrimental effect for the international investor community.

The Vodafone issue is perhaps the most discussed tax controversy in India that has garnered attention from investors across the globe.

The primary question of law in this case concerns whether gains made by Hutchison on the sale of an Indian telecom network to Vodafone, through an offshore share transfer deal, were taxable in India or not, and whether Vodafone had any consequential obligation to withhold Indian taxes on payment to Hutchison.

The Supreme Court unequivocally decided the matter in favour of Vodafone. It held that although the subject matter of the transfer was the underlying Indian telecom business, the Indian tax laws did not have any enabling provisions by which such offshore share transfer deals could be brought to tax in India.

When Vodafone won the lengthy tax battle in the Supreme Court, it was widely expected that the Indian government would respect the judgment of the Supreme Court. On the contrary, the Indian government retrospectively amended the law from 1961 by clarifying that offshore share transfer deals were always intended to be taxed in India, if those shares derived their value substantially from underlying assets in India.

Such an amendment had come unexpectedly, as it not only undermined the basic tenets of stability and certainty in any tax system but also undermined the judiciary. Quite predictably, the move created an uproar and elicited criticism from the global tax and business community, and affected India’s credibility as an attractive destination for foreign investments.

It was only to be expected that Vodafone would challenge the stand of the Indian government through arbitration under the India-Netherlands bilateral investment treaty (BIT) to say that such a retrospective change in law was not fair and equitable, and was inconsistent with the provisions of the BIT. Given that tax is a sovereign subject, it was the stance of the Indian government that the BIT did not extend to tax matters, and that the international court had no jurisdiction on this subject.

India thereafter also proceeded to terminate several BITs, including its BIT with the Netherlands, given that it had already seen an increase in the number of claims put forth by investors on various matters, including taxes. Thereafter, tax matters were categorically excluded from India’s model BIT.

Vodafone’s tax position stands vindicated by the Permanent Court of Arbitration at The Hague. The court recently ruled in favour of Vodafone, holding, inter alia, that it not only has the jurisdiction to deal with this issue under the BIT, but also that the retrospective amendment made by the Indian government is tantamount to breach of guarantee of fair and equitable treatment, despite the favourable Supreme Court judgment in place.

The road ahead

When the incumbent government had come into power in 2014, they made clear assertions that they were not supportive of amending the tax laws retrospectively. Yet, this particular retrospective amendment continues in the statute book and has not been withdrawn.

A press release issued by the government recently states that “the government will consider all options and take a decision on further course of action including legal remedies before appropriate fora”.

Interestingly, the High Court of Delhi has asked the government to clarify its stance on this as it would impact the parallel arbitration proceedings which were initiated by Vodafone under the India-UK BIT, which is pending.

Accepting the arbitration award would result in another dichotomy, wherein the charge of tax subsists in the domestic tax laws but is not enforced by the government. The same could also impact various other arbitration proceedings on similar issues which are pending.

India should regard this as an opportunity to exorcise this ghost of retrospective amendment. More importantly, the matter comes at a time when there are a multitude of focused efforts to make India an attractive destination for foreign direct investment, especially given the anti-China sentiments.

The Indian government could opt to accept the verdict and end the saga. This would manifest strong statesmanship and also significantly enhance India’s credibility and standing in the international investor community. Such an action will go a long way in assuaging the concerns that investors have and restore the credibility of the Indian tax and judicial system.

Ajay Rotti
T: +91 22 6108 1000

Saurabh Shah
T: +91 22 6108 1034

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