TAX MANAGEMENT

EFFECTS OF VODAFONE CASE ON MERGER AND ACQUISITIONS

Submitted by:-

Tanmay Gangwar (091202064)

Submitted to:

Mr.Bharatish Ballal

Background and facts of the case

Vodafone International BV (“Vodafone”), a Dutch resident company acquired interest of

Hutchison Telecommunications International Limited (“Hutch”) (a company registered in the

Cayman Islands) in CGP Investments (Holdings) Ltd (“CGP Investments”) also registered in

Cayman Islands. CGP investments, through a host of intermediate companies, held a 67

percent equity interest in Hutchison Essar Limited (“HEL”), an Indian telecom company. The

Indian Revenue authorities issued show cause notice to Vodafone arguing that they had failed

to discharge withholding tax obligation with

respect to tax on gains made by Hutch on sale of shares to Vodafone. Vodafone filed a writ

petition in the Mumbai High Court challenging the jurisdiction of the Revenue department.

Key Questions before the High Court

Whether the show cause notice issued by the Revenue authorities was without

jurisdiction as Vodafone could not be said to be liable under section 201 of the

Income tax Act 1961( “Act”) for not withholding tax ?

Whether the provisions relating withholding tax obligation under section 195 of the

Act have extra territorial application and a non resident without presence in India has

an obligation to comply with it?

Whether the transaction per se resulted in income chargeable to tax in

India?

Vodafone’s Petition and Arguments

It was not in default (under section 201) for not withholding tax as the law applied to

situations where tax had been withheld and not deposited. Hence, to impose an

obligation where no withholding had been made was unconstitutional. Tax is the

primary obligation of the payee. Unless the payee had defaulted in making payment of

taxes, on demand by the Revenue authorities, tax could not be recovered from the

payer.

Giving a contextual interpretation, “person” liable to withhold tax (in section 195)

could not include a non resident having no presence (in India), since such an

interpretation would amount to treating unequal’s as equal by imposing onerous

compliance obligations as applicable to residents or non- residents having a presence

in India.

The transfer was with respect to ownership of shares in a foreign company and not a

capital asset in India. Further, change in controlling interest in Indian companies was

only incidental to change in foreign shareholding.

Vodafone also challenged the constitutional validity of retrospective amendments to sections

191 and 201 of the Act, motivated to impose an obligation on payer to withhold tax.

VERDICT

In a landmark ruling the Bombay High court said Vodafone Group Plc is liable for an

estimated $2.6 billion in taxes for its 2007 acquisition of one of India's largest mobile phone

companies.

The American principle of Doctrine of Effects was referred to by the court. According to this

doctrine, any country may impose liabilities, even upon persons not within its allegiance, for

conduct outside its borders that has consequences within its borders which the country

represents.”

Vodafone ‘s argument that its international company had merely acquired a Cayman Islands

company which in turn held shares in the Indian company was not accepted by the court

which said it found this argument too simplistic. It held that Vodafone’s basic objective

appeared to be acquisition of a business interest in India.

What also went in favour of the Revenue Department was its argument that Vodafone’s

transaction could not have been a mere acquisition of shares overseas as it was conditional

upon approval of Indian regulatory authorities like the Foreign Investment Promotion Board.

The Revenue Department also cited statements made by the Chief Executive Officer of

Vodafone, the company’s annual reports and the interest acquired by Vodafone in joint

venture with Essar, in the telecom licenses issued by the Department of Telecommunications.

IMPLICATIONS OF VODAFONE CASE

Impact on cross-border transactions:

This ruling seems to suggest a fundamentally different approach to taxation of transactions where there is a transfer of controlling interest in India regardless of the fact that such transfer is effected by way of sale of shares of an overseas company. This will create a degree of uncertainty in respect of similar transactions , which have already taken place and where the revenue department will make an attempt to take support of the Bombay High Court judgement to tax those transactions. Having said this, in cases which can be distinguished on facts and especially in those situations where there is no transfer of business or other valuable commercial rights in India it will still be possible to argue against taxation arising in India. For example, where there is not an outright sale of business in India but a large interest in the Indian company is indirectly transferred through shares of a foreign company, the earlier position should prevail i.e., sale of a foreign company not being subject to tax in India.

Direct Taxes Code 2010 (DTC):

DTC which will come into effect on April 1, 2012 specifically spells out the conditions under which indirect transfer will be subject to tax in India. The tax policy direction seems to be to tax only those transactions where there is sale of substantial business interests in the Indian company and not where there is either portfolio sale or a sale of a block of shares not resulting in outright sale of the business in India. India has thus joined China , amongst other countries, in attempting to tax indirect transfers and to this extent cross-border transactions will need to factor in the current view of Revenue as well as proposed changes in the DTC so as not to be caught by surprise at a later stage.

IMPACT ON FDI’s

The Vodafone case, in turn, could apply the brakes on cross-border deal-making in the country. According to the United Nations Conference on Trade and Development (Unctad), India was all set to become the No. 2 destination for foreign direct investment (FDI) -- the major component of which is M&A -- by December 2012, pushing the U.S. down to the No. 4 place in the process. That could be at risk now.

SEVERAL LEGAL ISSUES ARISE FROM THE CASE:

(i) Whether a non-resident seller (Vodafone International) is liable to tax in India on sale of shares of the foreign SPV?

(ii) Is a non-resident purchaser (HTIL) liable for deduction of tax on purchase of shares of the foreign SPV while making payment to the non-resident seller?

(iii) Whether an Indian company can be treated as ‘agent’ of the non-resident purchaser and held liable for deduction of tax?

(iv) Can the law impose tax retrospectively?

IMPACT ON M&A

The Vodafone issue has been around for the past three years most M&A transactions

[since then] have been very careful in structuring the deals. It is not that people will

drop an M&A deal if India is involved.

The return expectation is now going to be higher. This is because there is a higher tax

risk weightage which will be assigned to India as a tax jurisdiction. But this is also

going to give more clarity on how the Indian government is going to tax such deals.

Therefore, while you may ascribe a higher risk weightage because there is going to be

higher tax, there will no uncertainty.

In a 200-page order delivered on September 8, the Bombay High Court ruled that the

Vodafone-Hutchison deal is taxable in India. But the implications are wider, experts

point out. The court has stated that the purchase of shares of a foreign company by

one non-resident from another non-resident attracts Indian tax if the object is to

acquire the Indian assets held by the foreign company.

The key issue in case of Vodafone is not the stated law but the substantive nature of

the transaction and the growing tendency of tax authorities worldwide to disregard

structures not having commercial substance.

Conclusion:

The high court ruling came as foreign firms show renewed interest in acquiring Indian companies, lured by growth prospects in the world’s second-fastest growing major economy. But the decision may prompt overseas firms to be more cautious about plans to enter India through acquisitions.“This will make the deals costlier for strategic buyers and private equity firms,” said Jagannadham Thunuguntla, equity head of SMC Capital. “Investors who are planning to enter into India hoping there will be no tax liability will think twice.”Vodafone, fighting a tax bill in India from its 2007 purchase of Hutchison Whampoa Ltd’s mobile business in the country, had filed an appeal with the court in June challenging the tax department’s jurisdiction over the bill.The Supreme Court on 27th September 2010 refused to offer any immediate relief to Vodafone, which has challenged the Bombay High Court order allowing the government to tax the company's USD 11billion deal with Hutch. The tax department had raised a demand for Rs. 12,000 crore as tax on the 2007 deal. While refusing to stay the high court order, the apex court issued notices to the tax authorities directing them to decide within four weeks the liabilities of Vodafone.

The Vodafone case is being keenly followed in other countries that still don't have their

legal position clear.

The case may lead to diversion of FDI’s and further cross border deal from INDIA to other countries leading a loss to economy as a hole.

The image of India would be impacted in global scenario as of now the Indian government is now recognized as someone who is laying down the rules for source taxation.