Introduction
On 25th September 2020, the 13-year long dispute between the Union of India (UOI) and Vodafone International Holdings B.V. (VIH) came to an end with an award from an International Arbitral Tribunal declaring that VIH is not liable to pay any taxes claimed by the Government of India. This means that India will not receive the $2.2 billion in capital gains tax, that they were expecting from VIH. Instead, India also has to pay an estimated Rs. 85 crores to Vodafone for legal costs and taxes.[1]
Vodafone was represented by Senior Counsel Harish Salve, Toby Landau QC and DMD Advocates who got the unanimous decision from the tribunal who stated that any further attempt to enforce tax demand would be a violation of India’s international law obligations. The decade long argument saw way too many high-level disagreements and points of dispute due to India’s unwillingness to let go of the tax. There is a chance still that this dispute isn’t over, the Indian government may decide to dispute the award on technicalities or appeal in the high court with the continuing claim that matters of tax do not come under the ambit of bilateral investment treaties. [2]
This decision saw the share value of now Vodafone Idea jump on the Indian stock market, as the counsels claimed Vodafone got justice for the second time, once from the Supreme Court of India and now from the Permanent Court of Arbitration. Most other experts also believe that Vodafone well deserved this victory, as certainty in tax laws is an important aspect that international companies look at before investing in a country. Advisors even look forward to an amendment in the laws to accommodate this new perspective which will boost investor sentiment, which is extremely critical for India today.
Reasons for Dispute and a Timeline of Events
It all began in 2007 as the Netherlands based company VIH purchased a Cayman Islands-based company called CGP Holdings Limited (CGP) from Hutchinson Telecommunications International Limited (HTIL) which was based in Hong Kong. They did this to gain the controlling interest of 67% in the Indian telecommunications giant Hutchinson Essar Limited (HEL), which was previously owned by CGP. Since the amount paid to HTIL for the acquisition of CGP was in fact paid for the acquisition of HEL, the tax department of India claimed that VIH shall be liable to pay capital gains tax in India.[3]
A case was made out in Bombay High Court which held VIH liable to pay taxes in 2010. Vodafone, in turn, filed a Special Leave Petition in the Apex court which overruled the previous judgement in 2012, stating that the reason for the purchase of the Cayman Island company was not solely to gain control over HEL. Now VIH was not liable to pay any tax on that transaction.
Soon after, the Indian Parliament passed the Finance Act, 2012 which made it clear that any transaction taking place among companies even outside India, if affect directly or indirectly the share or interest in assets of a company in India, the transaction will be taxed in India. They even made this amendment retrospective in nature, to bring VIH under liability even after the Apex court had declared that no payment was required.[4]
Vodafone reacted by invoking Arbitration under International Tribunal of Arbitration (ITA) for a violation of the India-Netherlands Bilateral Investments Treaty (BIT) in 2012. Later in 2017, Vodafone Group Plc. based in the UK, parent company of VIH, invoked a second ITA dispute against India under the India-United Kingdom BIT because India seemed to be dragging its feet in the previous arbitration.[5]
India finally decided to buckle up and called for an injunction on Vodafone from filing any more arbitration claims, as an arbitration procedure was already going on in the matter. Finally, the ITA declared Vodafone not guilty, and hence not liable to pay any sum to the tax department of India.
Case in the High Court of Bombay
Soon after the transaction between HTIL and VIH, the Indian Revenue Authorities (IRA) issued a notice to VIH to show cause as to why they did not pay tax on the sale consideration of this transaction. The IRA believed that VIH was liable to pay capital gains tax on the capital gains that CGP received on its assets in India which were transferred to VIH as they purchased CGP. Capital gain is the difference between the price at which an asset was purchased and the increased price at which the asset is later sold. Capital gains tax hence is the amount of tax to be levied on the positive difference between the sale price and the original purchase price.[6]
VIH went on to file a write petition in the High Court, challenging the jurisdiction of the IRA on questioning a transaction that took place outside of India. This petition was dismissed by the high court, and an appeal was filed with the Supreme court, which held that the revenue authorities will decide if the matter is under their jurisdiction or not. The IRA found that this entire transaction was designed in a way to avoid the tax that VIH would be liable to pay u/s 195 of the Income Tax Act, 1961 (ITA) had the transaction taken place directly between VIH and HEL.[7]
The main issue at hand was whether the income tax (IT) department can ask a foreign company to pay tax in India, for the purchase of another foreign company that holds a subsidiary in India. While the IT department contended that the transaction was liable for tax payment, VIH argued that both the companies in the transaction were foreign and that the deal itself to a place outside of India. The High Court of Bombay, giving the IT department jurisdiction over this matter, held VIH liable to pay the taxes and the penalty for the avoidance of said taxes. Analysts said that this verdict would make foreign players more cautious while investing in India. [8]
The court also provided Vodafone with 8 weeks to review the judgement and to consider what their next steps would be. No final order would be provided by the tax authorities in this duration.[9]
Appeal in The Supreme Court of India
After seeking legal advice, Vodafone decided to make an appeal in the Apex court of India. The same issue of jurisdiction was carried on, but the arguments and observations this time were stronger. As both parties stuck to their original high court contentions, but Vodafone came up with strong case laws, to prove that their actions were not those of tax avoidance but simple tax planning, which is not a crime. They claimed that the CGP Holding was not a sham just created for the transfer of HEL, and was a real legal holding company based in the Cayman Islands.[10]
The case of CIR v. Duke of Westminster (1981)[11], it was held that every taxpayer is entitled to arrange his affairs in a way that his taxes are as low as possible, and he is rightfully bound to choose the pattern that keeps the hole in his treasury smallest. They also claimed that genuine tax planning should be looked at by the tax authorities as per Craven v. White (1988)[12]. If a foreign company tries to abuse the process by making indirect transfers via sham companies only to avoid tax, the tax authorities have all the right to step in, but the onus to prove the same too lies on the tax authorities.[13]
The supreme court took into consideration all the arguments and made detailed observations on every topic raised in dispute. They acknowledged the abuse of the existence of corporate structures to avoid taxes, but also explained that they are primarily aimed to streamline operations, so the onus to prove the abuse would lie on the tax authorities. Many foreign companies invest in countries that provide better tax benefits, but these offshore financial centres aren’t necessarily methods of tax evasion since the aim isn’t to conceal income or assets, but just for tax planning.
Since controlling interest is an intangible asset and can only be felt by the transfer of shares, the two cannot be considered as separate transactions, and taxing these two interactions separately would only mean double jeopardy. When shares of a holding company are transferred, the controlling interest down the line, in the operating companies is also transferred to the purchaser, but the controlling interest still remains purely a commercial concept. The fact that VIH gained controlling interest over 8 companies when they purchased CGP also goes to point out that CGP was not a sham company created just to evade tax in India.
Thus, tax can be levied on the transaction of the transfer of the shares but not on the effect of the transfer i.e. the shift in controlling right. So, Vodafone can be taxed on the purchase of shares in CGP in the country of the transaction, but they can’t be taxed for capital gains that they received as an effect of the transfer of shares. Since CGP was already a part of HTIL’s corporate structure, its sale was a genuine business transaction in the interest of its investors and not a sham to help anybody avoid paying taxes anywhere.
The apex court also observed that in the McDowell case[14], it was held with a majority opinion that tax planning is the act of arranging one’s affairs so as to reduce the liability of tax which is different from tax evasion or tax avoidance and is legitimate when within the framework of the law. The court was even asked to pierce the corporate veil, but it was observed that the principle could only be applied after the authorities establish the facts and circumstances of the alleged scam.
Finally, the Supreme Court observed the wordings and explained the intention of section 9 and 195 of the Income Tax Act. They explained that tax is imposed based on the source, which in relation to income means the place where the transaction takes place. Since neither HTIL nor VIH are Indian companies, and the transaction between them too took place outside of India, tax cannot be imposed on any part of the transaction without clear words in the statute indicating that the act is taxable. The court also explicitly observed that section 9(1)(i) cannot be extended to cover the indirect transfer of capital assets. The claim u/s 195 too was dismissed because section 195 shall only apply in case of a payment made by a resident to a non-resident, while the current transaction was between two non-resident entities via a contract executed and consideration paid outside of India. They also mentioned that VIH is no legally obliged to reply to the notice under section 163 of the act for a related reason.[15]
As a result of all these observations and findings, on 20th January 2012, the Apex court gave its decision to discharge VIH of the tax liability. They held that the purchase of the shares in question to Vodafone did not amount to a transfer of capital asset under the definition given u/s 2(14) of the Income Tax Act. They also stated that the capital gains tax demand of almost Rs. 12,000 crores could be misunderstood as a punishment for capital investment and that the tax department and IRA lack the authority of law to impose such tax. In conclusion, the apex court directed the authorities to refund the INR 25 billion deposited by Vodafone in terms of the interim order dated 26th November 2010, along with interest at 4% p.a.[16] This was a landmark judgement and would have a major impact on future foreign transactions cleared the uncertainties with respect to the imposition of taxes and endorsed the view of legitimate tax planning.[17]
Finance Bill 2012
The Indian parliament of the time could not accept this defeat and came up with the idea to amend the very laws on which the Supreme Court had based their entire judgement. Not only did they amend section 9 and section 12 of the Income Tax Act, 1961 but also made the amendment retrospective in nature all the way back till 1961, essentially invalidating the decision of the Apex court in the matter.[18]
Among other amendments, they added two explanations to section 9(1)(i) of the act stating that the term “through” has always meant ‘by means of’, ‘in accordance of’ or ‘by reason of’ and the second explanation being “an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India”.
The 2012 Amendment also clarified that the term “transfer” includes and shall be deemed to have always included “disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights had been characterized as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India”. [19]
These changes directly contradicted the very recent judgement in the Vodafone case where it was held that section 9(1)(i) cannot be extended to cover the indirect transfer of capital assets.
These amendments were made by the government to stop the abuse and seal the loophole that let companies get away with tax evasion via the indirect transfer of Indian assets.[20] Even though acting with an overall good intention, the goal of the government seemed like juicing the $2.2 Billion from VIH by hook or by crook. This left Vodafone with no choice but to invoke arbitration under the India-Netherlands BIT through a notice of dispute dated April 17, 2012.
Arbitration under BIT
A Bilateral Investment treaty, as the name suggests is an agreement between two nations to uphold the mutually decided terms and conditions regulating private investments made by individuals and business entities from one of the countries to the other. India signed its first BIT in 1994 with the United Kingdom and has signed 84 BITs[21] since then with the main goal of safeguarding investments made by and to different countries. Over time, the necessity of treaties has reduced as the international investments are made under binding contracts with existing dispute resolution clauses. Out of the 84 BITs that India has signed since 1994, only 14 still remain in force.[22]
The India-Netherlands BIT in its Article 4.1 provided that investors shall be accorded fair and equitable treatment at all times. Vodafone claimed that the imposition of tax claims through the retrospective amendment even after the final award from the Supreme Court was a violation of this article.[23] The government of India till date takes the stand that tax matters do not come under the ambit of the BIT.[24]
When Vodafone Group Plc., the UK based parent company of VIH realized that the Indian Government is going to drag this case out, they filed a second ITA dispute on the same matter, this time under the India-UK BIT. To which India responded by an application in the High Court of Delhi[25], seeking an injunction on the initiation of parallel proceedings by Vodafone. They claimed this an abuse of process by Vodafone because the arbitration was already in process on the same matter. The Delhi High Court issued an ex-parte interim order on 22 August 2017, ordering Vodafone to not take forward the Arbitration under the India-UK BIT. But during arguments, the court observed that they don’t have jurisdiction over BIT proceedings, the Arbitration and Conciliation Act, 1996 does not apply to BIT Arbitrations, and that it is not an abuse of process if there exist substantial reasons to bring about two sets of proceedings in a matter. Also, the fact that Vodafone was willing to consolidate the two proceedings for the convenience of the Government of India pushed the High Court of Delhi to eventually dismiss the entire plea on May 7, 2018.[26]
The award unanimously passed by the International Tribunal on 25th September 2020, has not been made public yet. The operative part of the award holds that the tribunal has the jurisdiction to deal with the present issue, that the Indian government’s conduct with respect to the imposition of the tax, interest and penalties despite the Supreme Court’s order is in breach of the BIT, that India should stop harassing Vodafone in the said matter and that India is liable to pay a percentage of legal costs and fees to Vodafone amounting to nearly Rs. 85 crores.[27] Had Vodafone lost in this arbitration, they would have had to pay an amount almost equal to the value of its entire stake in the Vodafone Idea merger.
The Indian government still may still approach the High Court of Singapore to set aside the arbitral award or approach the International Court in Hague. But experts are of the opinion that it is time to let go of this matter because it has already been stretched long enough on the basis of technicalities. Also, dragging a company in international arbitration for the tax that multiple authorities have declared unnecessary doesn’t really reassure investors looking to put money in India.[28]
Implications of the Award
This award taught the government of India and International companies some very important lessons to keep in mind in the event of international events. The first one being that countries must keep in mind not to harass investors if they want to uphold their reputation as an economic hotspot and attract new investments. But at the same time, we also learnt that foreign investors have access to many means of remedy through international laws and treaties in case a nation tries to dupe them.[29]
Even though the Vodafone case did not arise out of any contract with the government of India or any party situated in India, Vodafone had the right to appeal in and eventually did get justice from Indian courts, proving fair treatment in the judiciary. They could have gone ahead and applied to the supreme court again to contest against the constitutionality of the retrospective tax legislation, but it chose to make it an international matter which also seems to have worked out well for them.
The new government that came to power in 2014, has not supported retrospective amendments which create new liabilities. At the same time, they went on to terminate a majority of the BITs through 2016[30], claiming that they are a tool to favour big corporations against the interests of third world countries. But this case shows how a third world state playing the victim card can also abuse its public power to try to undermine international rule of law. So, it seems like a good step for all parties that the BITs have been terminated and each investment has its own set of terms as per the contract, and any other dispute may rely on customary international laws.[31]
A retrospective amendment seems like dishonouring an agreement by changing the terms after a party has already acted on the previously agreed terms, and punishing them for the act. The Delhi High Court judgement clearly shows how the Indian government pulled at every straw to drag the dispute over the smallest technicalities. This does not portray India in a good light to potential investors looking to make safe investments.
Concluding Comments
If India truly wants to attract more Foreign Direct Investment (FDI), they must respond to the award, not by challenging it, but by accepting it and working alongside the precedent to restore India’s credibility as an investment destination. The current government as they said during their pre-election speeches, must try to distance themselves from the actions of the previous government and prove to the international markets once again our strong commitment to dealing with all partners in fairness and equity.[32]
Reforms in the system are necessary to ensure that the sovereign states are not cheated by corporations, but at the same time, these reforms must also hold accountable the states for their unprincipled acts. If the rules are made only for one party in a deal, fair international order will never be achieved.[33]
After all the research and reading of material from all relevant angles, this case, as mentioned multiple times before seems like an unnecessary stretch because of the amount of money involved. The tax authorities were not willing to let go in the beginning because of what they truly believed to be tax fraud, but post the apex court judgement, it was just the ego and pride of the UOI that led us into the pit of wasting crores of rupees in legal costs and fees. To continue this argument any further would be a waste of energy, and only create more issues for India as a developing nation.
The facts of the case are clear, and some times one just needs to accept that they were wrong, but the amendment in the ITA as mentioned above, still stands. What we have learned from the mistake, we have already implied in our rulebook. So, the same incident will not occur in the future, and that is one win that we get to keep.[34]
References:
Affairs, Department of Economic. Bilateral Investment Treaties (BITs)/Agreements. n.d. 07 October 2020. <https://www.dea.gov.in/bipa>.
Anand, Pushkar. Vodafone v. India – End of a Saga? 26 September 2020. <https://thewire.in/business/vodafone-india-end-of-a-saga-investment-treaty-arbitration>.
Beniwal, Rajendra and Kumar Sumit. Bilateral Investment Treaty and Investment Arbitration: A Critique from India Perspective. 26 June 2020. <https://www.scconline.com/blog/post/2020/06/26/bilateral-investment-treaty-and-investment-arbitration-a-critique-from-india-perspective/>.
Bureau, FE. International Arbitration: Vodafone wins Rs. 22,000-crore retrospective case against tax department. 26 September 2020. <https://www.financialexpress.com/industry/international-arbitration-vodafone-wins-rs-22000-crore-retrospective-case-against-tax-department/2091905/>.
Commissioners of Inland Revenue v. Duke of Westminster . No. All ER 259 (H.L.). 1935.
Craven v. White. No. UKHL TC_62_1 . 21 July 1988.
Income deemed to accrue or arise in India (Section 9 of ITA). n.d. 08 October 2020. <https://www.incometaxindia.gov.in/_layouts/15/dit/pages/viewer.aspx?grp=act&cname=cmsid&cval=102120000000071006&searchfilter=%5B%7B%22crawledpropertykey%22:1,%22value%22:%22act%22,%22searchoperand%22:2%7D,%7B%22crawledpropertykey%22:0,%22value%22:%22incom>.
Jain, Abhinandan, et al. Vodafone Tax Case Study. 30 August 2018. <https://www.slideshare.net/tathagataprofessional/vodafone-international-holding-vs-union-of-india-case-study>.
Kagan, Julia. Capital Gains Tax. 30 April 2020. <https://www.investopedia.com/terms/c/capital_gains_tax.asp>.
Mc Dowell & Company Limited vs The Commercial Tax Officer. No. 1986 AIR 649; 1985 SCR (3) 791. Supreme Court of India. 17 April 1985.
Modani, Kshama Loya and Vyapak Desai. VODAFONE INVESTMENT TREATY ARBITRATION AWARD – PART I. 05 October 2020. <https://nishithdesai.com/information/news-storage/news-details/article/vodafone-investment-treaty-arbitration-award-part-i.html#:~:text=On%20September%2025%2C%202020%2C%20the,Vodafone%20International%20Holdings%20BV%20v.&text=The%20Vodafone%20award%20stim>.
PTI. Government weighs legal options in Vodafone tax arbitration case. 04 October 2020. <https://www.livemint.com/industry/telecom/government-weighs-legal-options-in-vodafone-tax-arbitration-case-11601786342725.html>.
—. Govt weighs legal options in Vodafone tax arbitration case. 04 October 2020. <https://m-timesofindia-com.cdn.ampproject.org/c/s/m.timesofindia.com/business/india-business/govt-weighs-legal-options-in-vodafone-tax-arbitration-case/amp_articleshow/78472558.cms>.
—. High Court dismisses Vodafone tax case. 08 September 2010. <https://www.thehindu.com/business/companies/High-Court-dismisses-Vodafone-tax-case/article15907554.ece>.
Ranjan, Prabhash and Pushkar Anand. Vodafone Versus India – BIT by BIT, International Arbitration Becomes Clearer. 17 May 2018. <https://thewire.in/business/vodafone-versus-india-bit-international-arbitration>.
Shah, Rohan. Vodafone Arbitration Award: Opportunity To Enhance India’s Investment Credibility. 29 September 2020. <https://www.bloombergquint.com/opinion/vodafone-arbitration-award-opportunity-to-enhance-indias-investment-credibility>.
Union Of India vs Vodafone Group Plc United Kingdom. No. CS (OS) 383/2017 ; I.A.No.9460/2017. Delhi High Court. 07 May 2018.
Upadhyay, Payaswini. Vodafone Wins Arbitration Against India In Retrospective Tax Case. 26 September 2020. <https://www.bloombergquint.com/law-and-policy/vodafone-wins-investment-treaty-case-against-government-of-india>.
Vodafone International Holding vs Union of India. n.d. 07 October 2020. <https://www.lawsenate.com/case-studies/vodafone-international-holding-vs-union-of-india.html>.
Vodafone International Holdings … vs Union Of India . No. W.P. No.2550 of 2007. Bombay High Court. 3 December 2008.
Vodafone International Holdings … vs Union Of India & Anr. No. C.A. No.733 of 2012 ; arising out of S.L.P. (C) No. 26529 of 2010. Supreme Court of India. 20 January 2012.
[1] (Upadhyay)
[2] (Bureau)
[3] (Jain, Kumar and Sarbadhikary)
[4] (Modani and Desai)
[5] (Anand)
[6] (Kagan)
[7] (Jain, Kumar and Sarbadhikary)
[8] (PTI)
[9] (Vodafone International Holdings … vs Union Of India )
[10] (Vodafone International Holding vs Union of India)
[11] (Commissioners of Inland Revenue v. Duke of Westminster )
[12] (Craven v. White)
[13] (Jain, Kumar and Sarbadhikary)
[14] (Mc Dowell & Company Limited vs The Commercial Tax Officer)
[15] (Vodafone International Holding vs Union of India)
[16] (Modani and Desai)
[17] (Vodafone International Holdings … vs Union Of India & Anr)
[18] (Anand)
[19] (Modani and Desai)
[20] (PTI, Government weighs legal options in Vodafone tax arbitration case)
[21] (Affairs)
[22] (Beniwal and Sumit)
[23] (Anand)
[24] (Bureau)
[25] (Union Of India vs Vodafone Group Plc United Kingdom)
[26] (Ranjan and Anand)
[27] (Shah)
[28] (PTI, Govt weighs legal options in Vodafone tax arbitration case)
[29] (Modani and Desai)
[30] (Affairs)
[31] (Ranjan and Anand)
[32] (Shah)
[33] (Ranjan and Anand)
[34] (Income deemed to accrue or arise in India (Section 9 of ITA))
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