TheCorporateblog: VODAFONE-ESSAR CASE- A PARADOX OF PROVISIONS!!!!!

A long time speculation was put to end on 20^th January 2012 by the Apex Court in the matter dealing with the taxability of cross border transactions. The Vodafone-Essar deal taxability was one of the most speculated and awaited decisions by the corporate fraternity and a game changing decision for sure.

Over the years the number of cross border transactions all across the globe have paced up, reasons for which may be attributed to the steeply escalating reserves with the corporate giants as well as the cut throat competition in the emerging markets like India.

Vodafone-Essar deal serves to be one case study in itself as it involves the basis of interpretation of the existing provisions of the legislation governing the event as well as explicitly points out the lacuna in the existing legislation and the need for a structured legal framework to deal with such similar situations in the future.

THE CONCEPT OF A TAX HAVEN:

To understand this deal, one has to begin with understanding what a ‘Tax haven’ is, and how it works. As against the normal perception that a ‘Tax haven’ is a place where there are no taxes, the real understanding of the concept of a tax haven is that a state where in he undeclared objective of the government to help the rich people in the world to avoid taxes in various parts of the world. Now how this is done is the crucial game.

One state, Republic of Malta, decided to be a tax haven. The government intended to revlutionalize the concept of a tax haven but also wanted to make it appear to be completely legal and regular. The government came up with a tax policy that the of shore companies will be charged nominal taxes but, the government will pay off the tax, so collected, back to the shareholders of the same company within 24 hours. Isnt this a smart way to have a win-win situation? This is how a tax haven works. It is not in the policy of the government but in the conduct thereof, that helps deciding the actual intention of the tax haven and qualifies it to be one.

THE DEAL:

One company CGP Investments (for the time being we will refer to this as ‘CGP’)registered in Cayman Islands that is a Tax haven held 67% stake in the Indian Company Hutchison Essar limited ,which was eventually renamed as Vodafone Essar limited(for the time being we will refer to this as ‘VEL’). This Indian company operated the Vodafone telecommunication within the territory of India.

Hutchison telecommunications international limited (for the time being we will refer to this as ‘HTIL’) was a Hong Kong based Company. CGP was a 100% subsidiary of HTIL.

Vodafone International Holdings BV (for the time being we will refer to this as ‘VIH’) was a company registered in Netherlands.

In 2007 the deal happened between HTIL and VIH to sell the 100% stake in CGP to VIH thus effectively transferring the 67% holding in VEL that CGP held at the time of the deal.

THE LEGAL JARGON.

Show case notice was served to VHL to deduct tax on the consideration of $11.2 bn that was paid by VHL to HTIL. VHL instead of replying to the notice, files a writ petition with the HC of Bombay. The petition is dismissed. The IT dept slaps the VHL with a liability of Rs. 11000 cr as a penalty for avoiding tax.VHL files a petition with the apex Court under Art 136 of the Constitution. The Apex Court referred the case to the IT department till the time it investigates over the matter. The Apex Court heard the case from August 2011 and finally passed the judgment on 20^th January 2012 in favor of VHL.

THE ISSUES FORMING BASIS OF JUDGMENT.

The case involved many issues that were interpreted in revolutionary fashion during the hearing of the case. The Apex Court did place some support over the earlier decided cases like the ‘ Aazaadi Bachao Andolan¹’ case and the ‘McDowell’s’² case, and eventually opined in favor of VHL.

One of the most critical issues that were dealt with in the case is the interpretation of the section 9 of the Income Tax Act. The Section 9 of the act deals with the Income deemed to be accrued / arising in India.

Now to understand this logic applied by the Apex Court, one has to understand the difference in the perspectives of interpreting the provision. One perspective to look at it is the ‘Form over Substance’ perspective. As per this logic, the ‘Letter’ of the law is to be considered while interpreting any provision of law. This establishes that the law be read ‘As it is stated’ and to not plunge deep into the intentions and the perceptions of the lawmakers. This logic, In fact, places heavy dependence on the intelligence of the lawmakers. Thus, it says that the law be followed, adhered to as the word of the law is. A ‘Literal’ interpretation of law to put in simple form.

The second form of interpreting the provision of the law is the ‘Substance over the Form’ way of looking at it. This perspective emphasizes upon giving a wider interpretation to the provision of an act. Thus, it should not be interpreted only as per the letter of the statute but should consider the intention of the lawmakers and be interpreted accordingly. This thought places dependence on the ‘Subject matter’ of the provision instead of interpreting it only as per the letter of the law. Simply put, it is the ‘liberal’ interpretation of law.

To understand this basic difference of perspectives, we will consider an example. Let’s assume that there is a ‘Warehouse’ holding 10,000 tons of Wheat. Now, there are ‘Transfer Receipts’ of this warehouse, to transfer the wheat therein. Here, if the wheat is to be transferred from one party to another then the same can be easily done by merely changing the names of the buyers and the seller in the ‘Transfer Receipts’. This does not mean that there is an actual transfer of the 10,000 tone of wheat from one seller to another physically. Thus, to understand the form and substance, it can be inferred that, the change in the name as per the ‘Transfer Receipts’ is the ‘FORM’ and the actual transfer of the wheat, physically, will be the ‘SUBSTANCE’ of the transfer.

The counsel for VHL contended that the Section 9 does not explicitly restrain deals that are executed outside the territory of India. In the instant case, the counsel contended that the transaction is outside the purview of the section and hence the section is silent upon the transaction and the taxability of the same. The counsel relied heavily on the doctrine established by the ‘Azadi Bachao Andolan” that the Law to be read in its ‘Form’ and not substance.

The counsel for the IT department contended that the section 9 of the Act be read in it holistic form and not in isolation. Thus the section should be widely and liberally interpreted. In the instant case, the department contended that while determining the jurisdiction of the department the Court should be liberal and should not restrict its interpretation to the mere ‘words’ of the law but instead should adhere to the ‘spirit’ of law.

THE LIFTING AND PIERCING OF THE CORPORATE VEIL.

The Concept of the corporate veil in corporate law is as old as the concept of a Company itself. Perhaps, the concept of a Company came to life with the concept of a distinct legal entity. The famous ‘Solomon vs Solomon³ put to rest the now established structure of the concept of the Corporate Veil. But following the same logic and as held in various case laws like ‘the Dinshaw Pattite⁴’ case and similar others, the concept of corporate veil cannot be used to hide the unlawful/irregular activities by a company. Thus in such situations, the court shall part the veil to arrest the activities that the company is involved in, which are irregular or violative of any concerned, existing laws.

In the instant case, the counsel on behalf of the department contended that the court should pierce the corporate shield as sheltered by the Company to avoid taxation in India. It was further contended that the Company established in the Cayman Islands i.e. the CGP holdings was incorporated ‘Solely’ to fuel the tax avoidance. Further, that the said transaction involved clear tax avoidance by the parties and thus the department had the jurisdiction to levy tax on the parties to the transaction.

The council on behalf of the Company argued that the CGP Holdings Company had been in existence for almost a decade before the transaction. Hence the question that the company was incorporated with the intention to avoid the tax is quashed instantly. More so, now to be technical with our opinions, it is interesting to know that the said transaction was between the ‘Hong Kong’ company and the Vodafone BV Company. The transfer of the 100% holding in the CGP holdings nowhere mentioned that the transfer was actually of the 67% holding that the CGP had in the Indian company.

To simplify, let us consider the example of the warehouse again. Here the transfer has happened between the parties but there did not happen a physical transfer of the wheat from one warehouse to another. Now assume that if a tax is imposed on the ‘Actual’ or ‘Physical’ transfer of the wheat from one warehouse to another, will the parties be made liable in this case?? There lies the answer to our case. Well, in the above mentioned situation the parties will not be made liable, reason being there ahs happened no ‘actual’ transfer of the wheat from one place to another.

THE IMPACT OF THE JUDGMENT:

Now there have been many speculations and expectations attached to this case. Many cases like the one between GE and Genpact or the one between AT&T and TATA to sell its share in Idea Cellular or the Sesa goa deals, will be put to rest by this judgment. The law has been unsettled on this issue, and still the legislation has not come up with any substantial law to combat such situations, but the sources claim that the budget this year will involve some conclusive rules as to these issues.

More so, the judgment has sent a positive vibe in the International business fraternity and makes India a hot property to invest in. There appears that the Government has initiated its second phase of opening up of its economy. The FDI policies, the courts judgments, the regulations et al holistically give a picture of a healthy and more liberal economy.

Interestingly there has been unknown fact about this case that were not highlighted by the media like the assessing officer who opened the case, was within two years, promoted to be the Chief Commissioner of Income Tax. Well, interesting enough to raise eye brows. Logically, there could have been a deal between the CGP holdings and the Vodafone BV directly thus avoiding the Hong Kong Company which would have avoided this entire tax juggle, but was not, for most unknown reasons, not opted.

In the end, it was a tough call for the apex court to decide upon the case as, much more than just the case was at stake. Both the contentions, counsels were extraordinarily convincing and that there existed no specific rule/ legislation pertaining to this issue made it even more interpretative and subjective. But the stage is now set, the rule is now made, this one to be one of the most remarkable judgments, in the History of Indian judiciary.