A three Judge Bench of the Supreme Court comprising of Chief Justice of India (CJI) S. H. Kapadia, Justice Swatanter Kumar and Justice K.S. Radhakrishnan in the matter of Vodafone International Holdings B.V. vs Union of India & Anr. Civil Appeal No.733 Of 2012, passed a Judgment dated 20-01-2012 and held that in the present case, the Offshore Transaction, i.e. a contract of outright sale of shares in an Indian company for a lump sum consideration paid by Vodafone, Netherlands, fell outside India’s territorial tax jurisdiction, hence not taxable.
1) Vodafone International Holdings B.V. (Vodafone) is a company resident in Netherlands.
2) Vodafone acquired entire share capital of CGP Investments (Holdings) Ltd. (CGP), a company resident of Cayman Islands (a British Overseas Territory), vide Transaction dated 11-02-2007.
3) Vodafone agreed to acquire companies that in turn controlled a 67% interest in Hutchison Essar Limited (HEL), a company resident of India (headquartered in Hong Kong).
i) Vodafone-acquired CGP, a subsidiary of HEL, indirectly held through other companies 52% shareholding interest in HEL as well as Options to acquire a further 15% shareholding interest in HEL i.e. a total of 67% interest in HEL, subject to relaxation of FDI Norms.
ii) Provided that Bharti Airtel (in which Vodafone had less than 5% shareholding) allowed Vodafone to make a bid on Hutch.
iii) Accordingly, Airtel gave its NOC on 09-02-2007 to Vodafone to purchase a direct / indirect interest in HEL (i.e. Vodafone acquiring 67% interest in HEL through Vodafone-acquired CGP)
iv) On 11.02.2007, Vodafone and HEL’s parent company- Hutchison Telecommunications International Limited (HTIL) entered into an Agreement for Sale and Purchase of Share and Loans (SPA):
(a) HTIL agreed to procure the sale of the entire share capital of CGP for Vodafone and took responsibility of loans owed by CGP,
(b) Vodafone agreed to acquire controlling interest in HEL and all those companies that controlled 67% interest in HEL, such as Essar Teleholdings Ltd (Essar), an Indian Company that held 11% in HEL.
(c) Vodafone offered around USD 10.708 Billion for acquiring the aforesaid 67% interest.
v) On 20-02-2007, Vodafone applied for approval of Foreign Investment Promotion Board (FIPB) for acquiring 67% interest in HEL, India through CGP and acquiring other companies that had controlling interest in HEL.
4) But as per Income Tax Authorities / Revenue, Vodafone acquired 67% controlling interest in HEL.
5) Thus, the Revenue sought to tax the capital gains arising from the sale of share capital of CGP on the basis that CGP, whilst not a tax resident in India, holds the underlying Indian assets.
6) On 31.05.2010, an Order was passed by the Income Tax Department under Sections 201(1) and 201(1A) of the Income Tax Act, 1961 [IT Act] declaring that Indian Tax Authorities had jurisdiction to tax the transaction.
7) Aggrieved, Vodafone filed Writ Petition No. 1325 of 2010 before the Bombay High Court which was dismissed vide Order dated 8.09.2010.
8) Aggrieved, Vodafone filed Civil Appeal No.733 of 2012 before the Supreme Court.
Supreme Court Observations
The Apex Court passed a Judgment dated 20-01-2012 and made the following observations:
66. The Indian Income Tax Act, 1961, in the matter of corporate taxation, is founded on the principle of the independence of companies and other entities subject to income-tax. Companies and other entities are viewed as economic entities with legal independence vis-a-vis their shareholders/participants. It is fairly well accepted that a subsidiary and its parent are totally distinct tax payers.
69.. (Under Section 9 of the Income Tax Act 1961- Income deemed to accrue or arise in India) It was, therefore, argued that if transfer of a capital asset situate in India happens “in consequence of” something which has taken place overseas (including transfer of a capital asset), then all income derived even indirectly from such transfer, even though abroad, becomes taxable in India. That, even if control over HEL were to get transferred in consequence of transfer of the CGP Share outside India, it would yet be covered by Section 9.
73. At the outset, we need to reiterate that in this case we are concerned with the sale of shares and not with the sale of assets, item-wise.
There is a conceptual difference between preordained transaction which is created for tax avoidance purposes, on the one hand, and a transaction which evidences investment to participate in India.
In order to find out whether a given transaction evidences a preordained transaction in the sense indicated above or investment to participate, one has to take into account the factors enumerated hereinabove, namely, duration of time during which the holding structure existed, the period of business operations in India, generation of taxable revenue in India during the period of business operations in India, the timing of the exit, the continuity of business on such exit, etc.
After 11.02.2007 (SPA between Vodafone and HEL), taxes for HEL are being paid by VIH ranging from `394 crore to `962 crore per annum during the period 2007-08 to 2010-11 (these figures are apart from indirect taxes which also run in crores). … Thus, it cannot be said that the structure was created or used as a sham or tax avoidant.
In a case like the present one, where the structure has existed for a considerable length of time generating taxable revenues right from 1994 and where the court is satisfied that the transaction satisfies all the parameters of “participation in investment” then in such a case the court need not go into the questions such as de facto control vs. legal control, legal rights vs. practical rights, etc.
74..subsidiaries. They are not to be dictated by the parent company if it is not in the interests of those companies (subsidiaries). The fact that the parent company exercises shareholder’s influence on its subsidiaries cannot obliterate the decision-making power or authority of its (subsidiary’s) directors. They cannot be reduced to be puppets. The decisive criteria is whether the parent company’s management has such steering interference with the subsidiary’s core activities that subsidiary can no longer be regarded to perform those activities on the authority of its own executive directors.
78. The main contention of the Revenue was that CGP stood inserted at a late stage in the transaction in order to bring in a tax-free entity (or to create a transaction to avoid tax) and thereby avoid capital gains.
79. When a business gets big enough, it does two things. First, it reconfigures itself into a corporate group by dividing itself into a multitude of commonly owned subsidiaries. Second, it causes various entities in the said group to guarantee each other’s debts. A typical large business corporation consists of sub-incorporates. Such division is legal. It is recognized by company law, laws of taxation, takeover codes etc. On top is a parent or a holding company. The parent is the public face of the business. The parent is the only group member that normally discloses financial results. Below the parent company are the subsidiaries which hold operational assets of the business and which often have their own subordinate entities that can extend layers. If large firms are not divided into subsidiaries, creditors would have to monitor the enterprise in its entirety. Subsidiaries reduce the amount of information that creditors need to gather. Subsidiaries also promote the benefits of specialization. Subsidiaries permit creditors to lend against only specified divisions of the firm. These are the efficiencies inbuilt in a holding structure. Subsidiaries are often created for tax or regulatory reasons. They at times come into existence from mergers and acquisitions. As group members, subsidiaries work together to make the same or complementary goods and services and hence they are subject to the same market supply and demand conditions. They are financially inter-linked. One such linkage is the intra-group loans and guarantees. Parent entities own equity stakes in their subsidiaries. Consequently, on many occasions, the parent suffers a loss whenever the rest of the group experiences a downturn. Such grouping is based on the principle of internal correlation. Courts have evolved doctrines like piercing the corporate veil, substance over form etc. enabling taxation of underlying assets in cases of fraud, sham, tax avoidant, etc. However, genuine strategic tax planning is not ruled out.
80…VIH agreed to acquire companies and the companies it acquired controlled 67% interest in HEL. CGP was an investment vehicle.
The SPA was entered into inter alia for a smooth transition of business on divestment by HTIL. As stated, transfer of the CGP share enabled VIH to indirectly acquire the rights and obligations of GSPL in the Centrino and NDC Framework Agreements. Apart from the said rights and obligations under the Framework Agreements, GSPL also had a call centre business. VIH intended to take over from HTIL the telecom business. It had no intention to acquire the business of call centre. Moreover, the FDI norms applicable to the telecom business in India were different and distinct from the FDI norms applicable to the call centre business. Consequently, in order to avoid legal and regulatory objections from Government of India, the call centre business stood hived off. In our view, this step was an integral part of transition of business under SPA. (i.e. for Vodafone to acquire interest in HEL)
81…the sole purpose of CGP was not only to hold shares in subsidiary companies but also to enable a smooth transition of business, which is the basis of the SPA. Therefore, it cannot be said that the intervened entity (CGP) had no business or commercial purpose.
82…. According to the Revenue, since CGP was a mere holding company and since it could not conduct business in Cayman Islands, the situs of the CGP share existed where the “underlying assets are situated”, that is to say, India. That, since CGP as an exempted company conducts no business either in the Cayman Islands or elsewhere and since its sole purpose is to hold shares in a subsidiary company situated outside the Cayman Islands, the situs of the CGP share, in the present case, existed “where the underlying assets stood situated” (India). We find no merit in these arguments.
Under the Indian Companies Act, 1956, the situs of the shares would be where the company is incorporated and where its shares can be transferred. In the present case, it has been asserted by VIH that the transfer of the CGP share was recorded in the Cayman Islands, where the register of members of the CGP is maintained. This assertion has neither been rebutted in the impugned order of the Department dated 31.05.2010 nor traversed in the pleadings filed by the Revenue nor controverted before us. In the circumstances, we are not inclined to accept the arguments of the Revenue that the situs of the CGP share was situated in the place (India) where the underlying assets stood situated.
84. As regards the Term Sheet dated 15.03.2007, it may be stated that the said Term Sheet was entered into between VIH and Essar. It was executed after 11.02.2007 when SPA was executed. … Firstly, as stated the Term Sheet was entered into in order to regulate the affairs of HEL and to regulate the relationship of the shareholders of HEL. It was necessary to enter into such an agreement for smooth running of the business post -acquisition.
Secondly, we find from the letter addressed by HEL to FIPB dated 14.03.2007 that Articles of Association of HEL did not grant any specific person or entity a right to appoint directors. The said directors were appointed by the shareholders of HEL in accordance with the provisions of the Indian Company Law. Under the Company Law, the management control vests in the Board of Directors and not with the shareholders of the company. Therefore, neither from Clause 5.2 of the Shareholders Agreement nor from the Term Sheet dated 15.03.2007, one could say that VIH had acquired 67% controlling interest in HEL. (Vodafone / VIH had acquired only interest in economic value of HEL through CGP and was not part of the Board of Directors of HEL, so Vodafone did not have ‘controlling interest’ in HEL)
85. As regards the question as to why VIH should pay consideration to HTIL based on an enterprise value of 67% of the share capital of HEL is concerned, it is important to note that valuation cannot be the basis of taxation. The basis of taxation is profits or income or receipt. In this case, we are not concerned with tax on income/ profit arising from business operations but with tax on transfer of rights (capital asset) and gains arising therefrom… In the present case, the Revenue cannot invoke Section 9 of the Income Tax Act on the value of the underlying asset or consequence of acquiring a share of CGP.
86. The present case concerns an offshore transaction involving a structured investment. This case concerns “a share sale” and not an asset sale. It concerns sale of an entire investment. A “sale” may take various forms. Accordingly, tax consequences will vary. The tax consequences of a share sale would be different from the tax consequences of an asset sale. A slump sale would involve tax consequences which could be different from the tax consequences of sale of assets on itemized basis. “Control” is a mixed question of law and fact. Ownership of shares may, in certain situations, result in the assumption of an interest which has the character of a controlling interest in the management of the company. A controlling interest is an incident of ownership of shares in a company, something which flows out of the holding of shares. A controlling interest is, therefore, not an identifiable or distinct capital asset independent of the holding of shares. The control of a company resides in the voting power of its shareholders and shares represent an interest of a shareholder which is made up of various rights contained in the contract embedded in the Articles of Association. The right of a shareholder may assume the character of a controlling interest where the extent of the shareholding enables the shareholder to control the management.
VIH acquired Upstream shares with the intention that the congeries of rights, flowing from the CGP share, would give VIH an indirect control over the three genres of companies. (i.e. CGP, HEL and GSPL)
Acquisition of the CGP share which gave VIH an indirect control over three genres of companies evidences a straightforward share sale and not an asset sale.
On 19.03.2007, FIPB sought a clarification from VIH of the circumstances in which VIH agreed to pay US$ 11.08 bn for acquiring 67% (economic value) of HEL when actual acquisition was of 51.96%.
67% of the economic value of HEL is not 67% of the equity capital.
Thus, VIH did not acquire 67% of the equity capital of HEL, as held by the High Court.
The High Court ought to have applied the look at test in which the entire Hutchison structure, as it existed, ought to have been looked at holistically. This case concerns investment into India by a holding company (parent company), HTIL through a maze of subsidiaries… As a general rule, in a case where a transaction involves transfer of shares lock, stock and barrel, such a transaction cannot be broken up into separate individual components, assets or rights such as right to vote, right to participate in company meetings, management rights, controlling rights, control premium, brand licences and so on as shares constitute a bundle of rights… VIH has rightly contended that the transaction in question should be looked at as an entire package.
Merely because at the time of exit, capital gains tax becomes not payable or eligible to tax, would not make the entire “share sale” (investment) a sham or a tax avoidant…. The transaction remained a contract of outright sale of the entire investment for a lump sum consideration.
Summary of Findings
90. Applying the look at test in order to ascertain the true nature and character of the transaction, we hold, that the Offshore Transaction herein is a bonafide structured FDI investment into India which fell outside India’s territorial tax jurisdiction, hence not taxable. The said Offshore Transaction evidences participative investment and not a sham or tax avoidant preordained transaction. The said Offshore Transaction was between HTIL (a Cayman Islands company) and VIH (a company incorporated in Netherlands). The subject matter of the Transaction was the transfer of the CGP (a company incorporated in Cayman Islands). Consequently, the Indian Tax Authority had no territorial tax jurisdiction to tax the said Offshore Transaction.
As a result, the High Court Order dated 8.09.2010 was set aside.
(1) This case involved an offshore transaction i.e. a contract of outright sale of shares in an Indian company (HEL) for a lump sum consideration paid by Vodafone, Netherlands.
(2) This investment in Indian company (FDI) was made by Vodafone through a subsidiary, CGP Investments (Holdings) Ltd. (CGP), Cayman Islands.
(3) The aforesaid transaction was in the nature of acquisition of economic value of the Indian company and not purchase of equity capital. Thus, Vodafone did not have ‘controlling interest’ in HEL.
(4) Further, valuation of a company cannot be the basis for taxation. The basis of taxation is profits or income or receipt.
(5) In this case, the Income Tax Authorities claimed that (i) ‘in consequence of’ acquisition of 100% shareholding of CGP by Vodafone and (ii) subsequent acquisition of economic value of HEL by Vodafone through CGP, there was transfer of control over HEL to Vodafone, which is deemed to be transfer of capital asset in terms of Section 9 of Income Tax Act 1961. Hence, the Revenue claimed that Vodafone would be liable to pay tax on transfer of rights (capital asset) and gains arising therefrom.
(6) But the Apex Court held that there was no transfer of capital assets / sale of asset in the present case, in fact there is only transfer / sale of shares of HEL to Vodafone through its foreign subsidiary CGP. Further, under the Indian Companies Act, 1956, the situs of the shares would be where the company is incorporated and where its shares can be transferred. In the present case, the transfer of the CGP share was recorded in the Cayman Islands, where the register of members of the CGP is maintained. Thus, the Bench dismissed the argument of the IT Authorities that the situs of the CGP share was situated in the place (India) where the underlying assets stood situated.
(7) Hence, the Bench held that the Revenue cannot invoke Section 9 of the Income Tax Act on the value of the underlying asset or consequence of acquiring a share of CGP.
(8) Thus, the Bench held that the aforesaid Offshore Transaction fell outside India’s territorial tax jurisdiction, hence not taxable. The said Offshore Transaction evidences participative investment and not a sham or tax avoidant preordained transaction. Consequently, the Indian Tax Authority had no territorial tax jurisdiction to tax the said Offshore Transaction.
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