vodafone india case study

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Vodafone Case Analysis

Introduction

Vodafone’s journey in India has been a significant case in retrospective amendment made to tax laws. The decision made by the Supreme Court in this case and subsequently the decision made by PCA in Cairn UK case following Vodafone case amounts to a huge loss to the government as the reserve of the government depends upon the collection of tax. Tax avoidance has become a common practice today. Tax avoidance is considered as “legitimate tax planning”. Only after this case, strict provisions to govern tax evasion by non-resident companies through indirect transfers were made. Agreeing to the fact that there must be liberal tax policies in order to attract foreign investment, India need not stoop down too low to attract FDI. Moreover, tax laws in the country must be stabilized and strong tax laws must be enacted to cover these types of transactions in order to help the government. This case is a learning experience to know about indirect transfer of assets, taxability of capital gains, retrospective amendments to tax laws and clarity of tax laws in the country. Though various amendments to tax laws have been made, it has been a continuous defeat to the country regarding these offshore transfers.  This is a landmark judgment pronounced by the Supreme Court of India. It was a 3-judge bench decision consisting of Chief justice S.H Kapadia, Swatanter Kumar and K.S. Radha Krishnan. The case was originally dealt by the Bombay HC.

BOMBAY HIGH COURT

Vodafone India Services Pvt. Ltd vs Union Of India, Ministry Of Finance and Anr. EQUIVALENT CITATION: 2009(4) BomCR258, (2008)220CTR(Bom)649

Vodafone International Holdings (VIH), a Dutch Company procured 100% shares in CGP Investments (Holding) Ltd a company situated in Cayman Island, for USD 11.1 billion from Hutchison Telecommunications International Ltd in the year 2007. CGP, through different organizations and actions controlled 67% of Hutchison Essar Limited (HEL), an Indian Company. Vodafone got command over CGP and its downstream the subsidiaries including HEL through the acquisition. It had acquired telecom licenses to give cell communication in various circles in India starting from November 1994. In September 2007, a show-cause notice was given to the Vodafone Company by the Indian Tax Department to clarify the reason for why tax was not retained on instalments made to HTIL in connection to the above said transaction as said transaction of transfer of shares in CGP had an impact of aberrant or indirect transfer of assets in India. 3

Whether the transfer of shares between two foreign companies, resulting in extinguishment of controlling interest in the Indian Company held by a foreign company, amounted to transfer of capital assets in India and whether such transaction is chargeable to tax in India?

Sec 2(14) of Income Tax Act-Capital Asset

Sec 2(24) of Income Tax Act- Definition of Income Sec 5 of Income Tax Act-Scope of total income

Sec 9 of Income Tax Act- Income deemed to accrue or arise in India Sec 45 of Income Tax Act-Capital gains

Sec 191 of Income Tax Act-Direct Payment Sec 195 of Income Tax Act-Other sums

Sec 201 of Income Tax Act-Consequences of failure to deduct or pay

MAINTAINABILITY

The respondent contended that the writ petition is not maintainable because the petitioner had an effective alternative remedy available under Income Tax Act. 4 The petitioner cannot invoke the writ jurisdiction as there is a failure on part of the petitioner as they did not invoke the jurisdiction under tax law. It was held that where a statute creates a right or liability and gives a special remedy when enforced, the remedy provided by that statute only must be availed of. In the present case, the Act provides for a complete machinery to challenge an Order of assessment, therefor the order can only be challenged by the mode prescribed by the Act and not under Article 226 of the Constitution of India.

CONSTITUTIONAL VALIDITY

The respondent contended that the petitioner has not produced the important documents that are essential for determination of tax charges in India and thereby, the petitioner cannot challenge validity of provisions in issue. It was held that even if the burden of proof does not lie on a party, the Court may draw an adverse inference if he withholds important documents in his possession which can throw light on the facts at issue. 5 Therefore, when the Petitioner has challenged the constitutional validity of the Amendment to Sections 191 and 201 of the

I.T. Act by the Finance Act, 2008, then the same must be in context of certain facts pleaded and proved by evidence in the form of documents on record and not in vacuum or in the abstract.

Section 9 of the Act provides the formal source rule which provides for taxing gains that arise from the transfer of capital assets that are in India. In this case, Hutchison’s gain arose from the sale of shares of CGP, a capital asset located in Cayman Islands. Therefore Hutchison’s gain was not chargeable to tax in India; thereby, Vodafone BV in not required deducting tax at source under the Act.

Chapter X of the Act does not provide to tax all amounts involved in a particular transaction, which are otherwise not taxable. Before bringing any transaction for charging tax, a taxable income must arise. Therefore ordering to pay tax to amounts involved in International Transaction tantamount to imposing a penalty for entering into a transaction as no taxable income has been incurred.

It emphasized that the law restricted the courts from imposing tax liabilities on the basis of economic substance of the transaction. The legal form of the transaction was that Hutchison had transferred shares of a Cayman Island company. Since, the shares were situated in Cayman Islands, the “formal source rule” failed to capture the Hutchison gains in India’s tax net. To sum it up, Petitioner simply argued that it was not legally right to hold that Hutchison gains were taxable in India.

The issue of shares by the Vodafone to its holding company and receipt of consideration of the same is a capital receipt under the Act 6 . Capital receipts cannot be brought to tax unless specifically/ expressly brought to tax by the Act 7 . It is well settled that capital receipts do not come within the ambit of the word ‘Income’ under the Act, save when so expressly provided as in the case of Section 2 (24) (vi) of the Act. This brings capital gains chargeable under Section 45 of the Act, to tax within the meaning of the word ‘Income’. 8

In this case, attention was drawn to the definition of `Income’ 9 in the Act which includes in its scope amounts received arising or accruing within the provisions of section 56(2) (vii)(b) of the Act. The definition applies to issue of shares to a resident in India. This order relies on the meaning of International Transaction provided in Explanation (i) to Section 92B of the Act. It is submitted that Explanation (i) to Section 92B of the Act only states that capital financing transaction such as borrowing money and/or lending money to AE would be an International Transaction. However, what is brought to tax is not the quantum of amount lent and/or borrowed but the impact on Income due to such lending or borrowing. Similarly, Explanation to Section 92B of the Act, which covers business restructuring, would only have application if said restructuring/ reorganizing impacts income. If there is any impact of income on account of business restructuring/reorganizing, then such income would be subjected to tax as and when it arises whether in present or in future. 10 In this case, such a contingency does not arise as there is no impact on Income which would be chargeable to tax due to issue of shares. 11

The issue of Chapter X of the Act being applicable is no longer an untouched matter because similar provision as provided in Section 92 of the Act was also provided under Section 42(2) of the Income Tax Act, 1922. The Supreme Court held that the action of revenue in seeking to tax a resident in respect of profit which he would have normally made but did not make because of his close association with a non-resident. It observed that it is open to charge tax on notional profits and impose charge on the resident. 12 The aforesaid provision of Section 42(2) of the 1922 Act was incorporated in its new avtar as Section 92 of the said Act. It was thus emphasized that the legislative history supports the stand of the respondent-revenue that even in the absence of actual income, a notional income can be brought to tax. 13

Section 92(1) of the Act uses the word ‘Any income arising from an International Transaction’. Accordingly, we see that, the income of any party to the transaction could be subject matter to charge tax and it does not provide that the income of resident only is taxable. In case of Chapter X of the Act, the matter of real income concept has no applicability. Therefore, the difference between ALP and the contracted price would be added to the total Income.

Chapter X of the Act is a complete code by itself and not merely a machinery provision to compute the ALP 14 . Chapter X of the Act applies wherever the ALP is to be determined by the A.O 15 . The Petitioner itself had submitted to the jurisdiction of Chapter X of the Act by filing/submitting Form 3-CEB, declaring the ALP 16 . It is the hidden benefit in the transaction which is being charged to tax. Therefore, the charging section is inherent in Chapter X of the Act.

OBSERVATION

No express legislation on capital account transaction:

Section 92(1) of the Act states that an income from an international transaction is a condition precedent for the applicability of Chapter X. The meaning of income will not include capital receipts unless it is specifically mentioned as provided in Section 2(24)(vi) of the Act. So, capital gains to be taxed under Section 45 of the Act are deemed to be income under the Act.

Income pre requisite for applicability of Section 56(1):

For application of Section 56 of the Act , an income must arise which can be taxed. Issuing of shares at a premium is on capital account gives rise to no income.

Charge and measure of tax entirely different:

The tax can be charged only on income and in the absence of any income arising, the application of the measure of ALP to the transfer value does not arise. Chapter X of the Act provides that a transaction can be taxed only after working out the income after finding the ALP of a transaction.

No relevance of Section 92(2) in the present case:  

Section 92(2) of the Act deals with a situation where two or more AEs enter into an arrangement whereby they are to receive any benefit, service or facility. This provision is not applicable in this case as there is no situation where there is no allocation of any cost or expense between the petitioner and the holding company.

The transaction entered by the Petitioner amounts to transfer of a capital asset and not a transfer of controlling interest ipso facto in a corporate entity and is chargeable to tax in India.

It was held that any profit or gain arising from the transfer of a company in India has to be considered as a profit and gains of the company which actually owns and controls it. In this case, the income from the transfer is accrued by the HTIL and not Cayman Island Company (CGP). Therefore, the recipient was HTIL. Therefore the interest of the recipient is divested to the petitioner and hence is liable for capital gains tax.

The Effects Doctrine Extra-territorial operation of Section 195 of the I.T Act provides that any state may impose liabilities, even upon persons not within its territory, for conduct outside its borders that has consequences within the borders of its state. Hence, the dominant purpose of entering into agreement by the two foreign companies is to acquire the substantial interest and of which one foreign company is held in the Indian company the municipal laws of the country would be applicable and hence Indian Tax laws will be applied.

If the Hutchison gains were held not to be taxed in India, India would forfeit its right to tax as the country of source. Thereby the taxpayers will try to exploit the unintended loopholes in India’s tax law.

If the Hutchison gains were held taxable in India it would fortify India’s taxing rights as a source country- if you earn value from India, you shall be taxed in India. The entire value earned by HTIL “was only on account of the fruits of the investment made by HTIL in India, goodwill/brand value generated by HTIL for the Hutch brand in India, the telecom licenses granted in India, customer base in India and the prospect of future development and expansion in India 17 .” In the context of capital gains on company’s shares, the settled legal principle is that shares are located where the company’s share register is maintained, normally the place of its incorporation 18 . Rendering Hutchison gains taxable in India would entail imposing “substantial tax liabilities, after the fact, on entities that would avoid such liabilities according to this formal rule” 19 .

SUPREME COURT

Vodafone International Holdings … vs Union Of India & Anr

CITATION-[2012] 1 SCR 573

Whether the Indian Revenue Authority can tax a sale of shares between two non-resident companies on an offshore transaction where the controlling interest of an Indian corporation is purchased on the basis of that transaction?

PRINCIPLES DEALT BY SUPREME COURT

Piercing the corporate veil

Companies are separate legal entities that are independent from its shareholders and management. This is the foundation for company and tax laws. It is a general principle that a holding company is not liable for the acts of the subsidiary.

The Supreme Court held that it is the duty of the court to find the nature of the transaction and when doing it; it must look at the whole transaction and must not deal the elements of the transaction separately.

Considering the facts and circumstances of the transaction, the court must determine whether the transaction made primarily to evade taxes. It can be justified by piercing the corporate veil.

The Supreme Court held that strategic foreign direct investment (FDI) into India must be seen in a holistic manner.

By application of this doctrine, the Supreme Court held that the major purpose in Vodafone was to transfer the shares of CGP and not transferring the rights in HEL (situated in India). The court held that corporate can be pierced and the principal company can be held liable for the acts of the subsidiary company when it is shown that the company has misused to achieve certain wrongful objectives. 20

Tax avoidance and tax planning

The Supreme Court made a detailed difference between tax evasion and tax planning. The court held that tax planning is not illegal, illegitimate or impermissible. The debate over the validity and legality of the decision in Union of India v Azadi Bachao Andolan ((2004) 10 SCC 1)) and its departure from McDowell and Co Ltd v CTO ((1985) 3 SCC 230) on the specific issue of tax avoidance has been settled in this case.

The Court clarified that Justice Reddy’s observations extended only to artificial and colourable devices. Thereby it is wrongful to understand that mean all tax planning is illegal, illegitimate or impermissible.

Limitation Of Benefits clause.

Justice Radhakrishnan (in his concurring judgment) held that in case of absence of LOB clause in the Treaty, and in light of the existence of CBDT Circular No. 789 of 2000 and a TRC certificate, the Revenue cannot at the time of sale, disinvestment or exit from FDI in India, deny benefits to Mauritian companies by stating that the FDI was routed through a Mauritius company from somewhere else.

Tax Residency Certificate

In this case, the court held that the treaty and circular will not restrict the Revenue from denying Treaty benefits, when it is proven that the Mauritian company at the time of disposal of shares, made the transaction with intent to avoid tax. The court also referred to the memorandum of understanding (MOU) signed between India and Mauritius which is to track down transactions tainted by fraud and financial crimes. The court held that Mauritius is a clean jurisdiction to route investments into India and, provided the transaction is not found to illegal or colourable which was designed to evade tax.

Section 9 of the Act  

The Supreme Court explained that section 9(1)(i) gathers in one place various types of income that are deemed to accrue or arise in India. It includes: “All income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India”.

“The Supreme Court noted that the words “directly or indirectly” in section 9(1)(i) of the Act refer to the income and not the transfer of a capital asset (property). It held that to apply the words “directly or indirectly” to the transfer of a capital asset (such as HEL) “would amount to changing the content and ambit of section 9(1)(i). We cannot re-write section 9(1)(i). The legislature has not used the words indirect transfer in section 9(1)(i).” It noted that, “if the word indirect is read into Section 9(1)(i), it would render the express statutory requirement of the 4th sub-clause in section 9(1)(i) nugatory” 21

The court also made reference to the fact that the Direct Taxes Code Bill 2010 (DTC) proposes the taxation of offshore share transactions, which leads to the inference that indirect transfers are not presently covered by section 9(1)(i).

Transfer of HTIL’s property rights by extinguishment  

The court held that the case concerned the sale of shares and not the sale of assets. The court adopted the “look at” approach (as opposed to the “dissecting” approach) and held that the facts and circumstances of the present case must be viewed holistically. Hutchison has been part of Indian telecom business since 1994, and had been paying income tax in India.

Therefore, the transaction entered into cannot be considered sham or colourable. The court was of the view that the transaction took place only with intent to invest in India and not evade tax. The court also held that non-compete rights and the use of the Hutch brand were not property rights and it could not be subject to tax in India.

Withholding tax obligations: sections 195 and 163 of the Act

The transaction entered into by the companies is between two non-resident entities and was executed outside India. Consideration was also passed outside India. The court held that when a payment is made between two non-residents situated outside India, then the transaction has no nexus with the underlying assets in India. Therefore, Vodafone was not legally obliged to respond to the section 163 notice issued which declares a purchaser of an asset as a “representative assessee”.

The tax is levied on the basis of the source and the source is the location where the sale takes and not where the product is derived or purchased from.

HTIL and VIH are foreign companies and the sale takes place outside India, so the source of revenue is outside India. It could be taxable only when this trade is protected by legislation. The tax laws must be strictly construed and tax can be laid only when the language of the statute unambiguously states so. The provision for charging income tax must not be expanded to impose a tax burden which would otherwise be non-taxable. Therefore indirect movement of capital assents cannot be included by expansion of the provision. The present transaction was carried out between two non-resident persons in a contract conducted outside India where the consideration was also rendered outside India and VIH is therefore not legally obligated to respond to the notice referred to in section 163 relating to the purchaser’s care as a representative measure.

The selling of HTIL’s CGP shares to Vodafone or VIH amount to transfer of capital assets under the scope of Section 2(14) of the Income Tax Act and therefore not chargeable under capital gains tax on all rights and entitlements resulting from the shareholder agreement, etc., which form an integral part of CGP ‘s shares. The order of High Court of the demand of nearly Rs.12, 000 crores by way of capital gains tax would amount to imposing capital punishment for capital investment and it lacks authority of law and therefore is quashed.

GROUNDS ON WHICH THE ORDER CAN BE REVERSED

1. On bringing the retrospective amendment which states that any income which arises either directly or indirectly by means of or by reason of transfer of assets in India shall be deemed to accrue or arise in India and can be

2. The explanation inserted by finance Act 2012 to sec. 9(1)(1) in its 2 nd exception provides that CGP Investments is a 100 % subsidiary company of Hutchison company and is wholly controlled by the latter company. Therefore the exception provided in the explanation is not applicable and hence capital gain arising through sale is taxable at source.

The SC through its landmark judgment has removed certain uncertainties revolving around the imposition of taxes in the country. By means of this verdict certain principles have been established and recognized by the SC including:

• Principles relating to tax policies and plans
• The validity of tax avoidance by providing the taxpayers the right to reduce their liabilities to a maximum extent by legitimate arrangement of their income and business affairs provided nothing contrary to such act is specified in the enactments.
• The establishment of corporate structures by multinational companies for business and commercial purpose.
• The application of the principle of lifting of the corporate veil in all transactions done with an objective of evading taxes.
• Lastly the need for a holistic view or approach when dealing with cases involving companies having made investments in tax neutral countries. It further urges to avoid the misconception that presence of corporate structures in tax free countries is necessarily a scheme for avoiding tax.

In short, the SC through its judgment has distinguished tax avoidance from tax evasion and along with certain other significant principles recognized tax avoidance as a legitimate activity while penalizing tax evasion, further highlighting its view on the need for a legitimate tax planning.

CRITICISMS TO THE SC JUDGEMENT:

The judgment pronounced by the SC in this case has been to subject to severe criticisms. The SC is loathed for providing such a verdict. It is argued that SC has set a precedent that brings into jeopardy thousands of crores of potential revenue.it was also pointed out that tax avoidance through artificial devices is now a days very much prevalent in the industry and many large firms gain huge sums of money through such schemes. It was opined that the judgment in McDowell though reverted by 2 other decisions (Azadi Bachao Andholan and Wallfort) has dealt with the issue in the right perspective. The Mauritius companies are considered to be ‘post box companies’ and its remarked that the benign attitude of the tax authorities has led to a blatant evasion of taxes. The SC is blamed for not setting right the mistake it made by transgressing the McDowell judgment in the Vodafone verdict. The SC verdict is condemned on the basis that despite being aware of the transaction’s true nature as being transfer of Indian asset the SC has shown ignorant behaviour by providing such a verdict. This act of SC is viewed as a welcoming gesture for the foreign companies to evade taxes in India, jeopardizing crores and crores of potential revenue to the country and the attitude of courts towards such artificial tax evading devices. This judgment as a contract to the judgment in the 2G scam is considered to be arbitrary in nature.

CASES IN WHICH VODAFONE CASE HAS BEEN CITED

1. M/S Shri Vishnu Eatables (India) … vs Deputy Commissioner Of Income … on 3 October, 2016

“It is necessary for the Assessing Officer to decide the issue of objection to applicability of chapter X, if raised by the assessee, before referring the transaction to the TPO as it is a basic issue and would prevent loss of man hours on both sides in computing the ALP if it is finally concluded that Chapter X is not applicable.” 22 [3]

2. Income Tax Appellate Tribunal – Mumbai

Exind Trading P. Ltd, Mumbai vs Ito 6(2)(4), Mumbai on 7 November, 2019 It was held that the Vodafone case and CBDT Circular was not applicable in this case.

3. Income Tax Appellate Tribunal – Mumbai

Income Tax Officer-1(3) (2), … vs Singhal General Traders Private … on 24 February, 2020

“The premium on share issue was on account of a capital account transaction and does not give rise to income and hence, not liable to transfer pricing adjustment.” 23

4. Allahabad High Court

Rakesh Mahajan vs State Of U.P. And 4 Others on 4 December, 2019

“The legal relationship between a holding company and WOS is that they are two distinct legal persons and the holding company does not own the assets of the subsidiary and, in law, the management of the business of the subsidiary also vests in its Board of Directors.” 24

5. Income Tax Appellate Tribunal – Delhi

M/S. New Delhi Television Ltd., … vs Dcit, New Delhi on 14 July, 2017

“If an actual controlling Non-Resident Enterprise (NRE) makes an indirect transfer through “abuse of organisation form/legal form and without reasonable business purpose” which results in tax avoidance or avoidance of withholding tax, then the Revenue may disregard the form of the arrangement or the impugned action through use of Non-Resident Holding Company, re-characterize the equity transfer according to its economic substance and impose  the tax on the actual controlling Non-Resident Enterprise.”25 [4]

INTERNATIONAL LAW AND VODAFONE CASE

The Permanent Court of Arbitration in The Hague, Netherlands, held that an amendment to Indian tax laws was in violation India and the Netherlands agreement.

The international arbitration proceeding was initiated by Vodafone International Holdings

B.V. (VIH or Vodafone) against the government of India regarding the retrospective amendment made to Indian tax

Permanent Court of Arbitration (PCA) held that the imposition of taxation through a retrospective amendment to domestic tax laws for imposition of tax, was in violation of “fair and equitable treatment” provided under the Agreement between the Republic of India (India) and the Kingdom of Netherlands (Netherlands). Moreover, any attempt to enforce tax demand on Vodafone would amount to breach of international obligations.

The objective of the agreement is for Promotion and Protection of Investments (India- Netherland BIT). This award does not mark the end of dispute as the Indian Government has the opportunity to challenge it before the High Court of Singapore.

The full text of the arbitration award is not in public domain. But it is known that the imposition of a tax liability based on a retrospective amendment is held to be breach of fair and equitable treatment laid down in Article 4(1) of the India-Netherland BIT.

Permanent Court of Arbitration at The Hague ruled that the demand made by India for Rs 22,100 crore by retrospective amendment as capital gains and withholding of imposition of tax for a 2007 deal on Vodafone Company was breaching the provision of agreement regarding fair and equitable treatment.

Recently, the Indian government has challenged the arbitration award in Singapore Court. The government is of the opinion that the matter of taxation is not covered under the treaty and taxation is a sovereign right of the country.

CAIRN’s DISPUTE

Cairn UK Holdings Limited, a company incorporated in the U.K. (Cairn UK), had a wholly- owned subsidiary, Cairn India Holdings Limited, a company incorporated in Jersey (Cairn Jersey). Cairn Jersey owned subsidiaries in India. In the year 2006, Cairn UK transferred its entire shareholding of Cairn Jersey to Cairn India. Subsequently, Cairn India acquired the entire business of the Cairn group in India.

In 2014, pursuant to a survey action carried out at the premises of Cairn India, the Indian income-tax authorities was of the view that the transfer of shareholding in Cairn Jersey had the effect of transferring the business in India and therefore, in view of the retrospective amended income-tax laws, Cairn UK was liable to pay capital gain tax in India. This action was challenged by Cairn UK and is currently sub-judice before the High Court of Delhi in India. While the proceedings were ongoing in India, Cairn group also initiated arbitration proceedings against the Indian Government under Article 9 of the Agreement between the Government of the Republic of India and the Government of Great Britain and Northern Ireland for Promotion and Protection of Investments (India-UK BIT).

BINDING FORCE OF VODAFONE CASE

The “Doctrine of Stare Decisis,” as prevalent in common law legal systems. It means “to abide by the precedents and not to disturb settled points.” There is no similar doctrine in civil law systems or under International Law. The International Centre for Settlement of Investment Disputes (ICSID) and the UN Commission on International Trade Law (UNCITRAL) provides that the award shall be final and binding upon the parties to the dispute. In absence of any prevalent rule of binding precedent of earlier awards, the international arbitration tribunals, functioning under ICSID and UNCITRAL, do consider previous awards to have a persuasive value.

Whether the Vodafone arbitral award would have any persuasive value in arbitration proceedings of Cairn UK would depend upon the factual matrix in both the cases.

Both cases involved indirect transfer of Indian assets prior to retrospective amendment in 2012 coming into effect.

Thereby the case was decided in favor of Cairn UK and it was not liable for capital gains tax.

CONSEQUENCE OF THE CASE

The government has got excessive flak for retaining India’s “retrospective” tax on asset transfers after it recently lost a case against Vodafone in an international arbitration court. Two broad critiques are important to note.

1. Governments should never make tax changes with retrospective

2. Tax laws must be stable in order to attract foreign (or even domestic) investment.

3. Vodafone must have been aware that asset transfers in India would attract capital gains By shifting the relevant jurisdiction to a tax haven, it seems to have got a lower price from Hutchison, a majority owner of the telecommunications company. Therefore, the objective appears to be a case of tax avoidance by using a grey area in Indian tax law.

Professionals have said that there is a need for clarity and certainty in tax laws to attract foreign investments. A liberal tax policy would attract Foreign Direct Investment into India. Some professionals say that the SC could have considered this issue and that is the reason why the decision is in favour of the foreign investor (Vodafone).

The arbitration tribunal also held that the terms of the agreement was not complied by India and it is established that India has contravened the provisions of the agreement. Therefore, the government must stop taking measures to recover tax from Vodafone.

AMENDMENTS IN TAX LAW RELATING TO VODAFONE CASE

In 2012, the government of India changed the Supreme Court’s decision by proposing an Amendment to the Finance Act, which gave the power to Income Tax Department to retrospectively tax such deals.

RETEROSPECTIVE TAXATION

Retrospective taxation gives the state a power to make a rule on taxing certain products, items or services and deals and levy tax on companies even before the date the Act was passed.

Most of the countries use this method to rectify any gaps in their taxation laws that existed and allowed companies to take advantage of such loopholes. Many countries have retrospectively charged tax on companies.

Retrospective amendments are generally given to taxation laws to “clarify” the previously existing laws. It ends up hindering companies which interpreted the rules, knowingly or unknowingly in a different way. These retrospective amendments had been criticised by various investors as, this type of change in laws would affect foreign fund flow into India.

In this case, the Parliament passed the amendment to the Finance Act in 2012, by retrospective effect and subsequently made Vodafone liable for tax payment. Thereby, this case was called ‘retrospective taxation case’.

EFFECT OF RETROSPECTIVE AMENDMENT:

The onus to pay taxes fell on Vodafone after the government enacted the retrospective amendments. This amendment was criticized by investors globally. The amendment was held to be a badly drafted law as it had affected to nullify the decision of the highest court of the Nation. Following such criticisms India tried to settle matters amicably with Vodafone but all its attempts faced failure.

Does the legislature have the right to declare any decision of the court of law to be void or of no effect?

In Shri Prithvi cotton mills limited and another v. Brouch Borough Municipality and others 6 1969(2) SCC 283 the court remarked that even if the legislature has competence it cannot merely pass a law to which the verdict of the court shall not bind as such an act is a tantamount to reversing the decision of the court by exercise of judicial power which the legislative authority does not possess. A court’s decision can only be altered when unless it is fundamentally incorrect.

In Cauvery water disputes Tribunal, a constitutional bench held that legislature is authorized to change the basis of the verdict and thus the law in general affecting a class of persons at large but the legislature cannot bring any laws overriding the court’s decision such that it affects the rights and liabilities of an individual person.

Similarly, in State of Tamil Nadu v. State of Kerala and another 9 (2014)12 SCC 696 the court held that as per the doctrine of separation of powers enriched in the constitution all the 3 organs are independent and thus a law can be set aside only when it breaches the principles of equality as enriched in the article 14 of the constitution. Further it declared that the HC and SC are empowered to determine the validity of any law of the legislature.

From the above decisions its clear that the legislature cannot bring into effect any law which overrides court’s verdict and affects the rights of an individual alone as in the landmark case of Vodafone. But it has the right to effect laws affecting a class of people in general.

As the Supreme Court decided in favor of Vodafone, subsequent amendments to the Act were brought in by the legislative authorities to reverse the judgment. The Act was amended such that it provides for the following:

INCOME THROUGH TRANSFER OF CAPITAL ASSET SITUATED IN INDIA: –

SECTION 9: it provides that the following income shall be deemed to accrue or arise in India:

All income arising directly or indirectly

• Through any business connection in India or
• From or through any property in India or
• Through any asset or source of Income in India or
• Through the transfer of capital asset situate in

The following explanations 4, 5, 6 and 7 was inserted through Finance Act 2012 to section 9(1)(1).

Explanation 4 : it clarifies that the word “through” shall mean and include and shall be deemed to have always included “by means of”, “in consequence of” or “by reason of”.

Explanation 5 : through this it is clarified that an asset or capital asset being shares or interest in a company or entity registered or incorporated outside India shall 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.

But in order to make explanation 5 operational the Finance Act 2015 provided certain clarifications:

Explanation 6 : For the purpose of this clause, it is hereby declared that-

1. Substantial – any share or interest of a foreign company shall be deemed to derive its value substantially from the assets situated in India, if on specified date the value of Indian assets-

• Exceeds the amount of 10cr rupees; and
• Represents at least 50% of all the assets owned by the company or

2. Value of asset – the value of the asset shall be fair market value of such asset without reduction of liabilities, if any in respect of the

3. Specified date – it is the date on which the accounting period of the company or entity ends preceding the date of transfer. If on the other hand the book value as on date of transfer of the assets exceeds at least 15% of book value as on the last balance sheet date preceding the date of transfer, than instead of the date mentioned above the date shall be the specified date of valuation.

4. Mode of determining FMV: the fair market value will be determined as per the rules prescribed.

5. Taxation on proportional basis: the capital gains arising out of the transfer of shares of assets located outside India of any company registered outside India will be taxed proportionally as specified in the

Explanation 7 provides for certain exceptions; they are as follows:

Exemption in case foreign company or entity (whose share or interest get transferred) directly owns Indian assets

Exemption shall be available to the transferor of a share of, or interest in, a foreign entity if the transferor (along with its associated enterprises), at any time in the twelve months preceding the date of transfer,

a. Neither holds the right of control or management of such foreign company or entity;

b. Nor holds voting power or share capital or interest exceeding 5 per cent of the total voting power or total share capital of such foreign company or entity;

Exemption in case foreign company or entity (whose share or interest get transferred) indirectly owns Indian assets

 In case the transfer is of shares or interest in a foreign entity which does not hold the Indian assets directly then the exemption shall be available to the transferor if the transferor (along with its associated enterprises), at any time in the twelve months preceding the date of transfer-

a. Neither holds the right of management or control in relation to such foreign company or the entity

b. Nor holds any rights in such company which would entitle it to either exercise control or management of the company or entity that directly owns the assets situated in India or

c. Nor entitle it to voting power exceeding 5 percent of total voting power of the company or entity that directly owns the assets situated in India.

Impact of the explanations on the final verdict:

From explanation 4 added it can be deduced that any income which arises either directly or indirectly by means of or by reason of transfer of assets in India shall be deemed to accrue or arise in India and is taxable in the hands of Hutchison company, Hong Kong.

Similarly, explanation 5 brings within its scope the transfer of shares of CGP investments, Mauritius being a company incorporated outside India. It provides that the shares are situated in India as such and shares derive its substantial value from the business of a company located in India.

This way through such amendments the coverage of section 9(1)(1) has been increased retrospectively to include indirect transfers.

Impact of the exemptions given in Explanation 7:

As the Vodafone case revolves around indirect transfers the second exemption provided is of importance. From the second exemption it can be seen that to be relieved from tax burden in case of transfer of shares of a foreign entity, here which is shares of CGP Investments, Mauritius, which indirectly holds Indian assets the transferor or the seller in the given case being Hutchison, Hong Kong must not manage, control or hold any rights which may provide for such control over the foreign entity whose shares are being transferred i.e., CGP Investments.

But, CGP Investments being a 100 % subsidiary company of Hutchison, Hong Kong is completely controlled by the latter and thus, Hutchison does not come within the scope of this exception. Hence, any capital gain arising from sale of the shares of CGP Investments is taxable at source in its hands.

Thus, in a way it can be concluded that the amendments brought about through the finance act 2015 become rationally comprehensive in budget 2012. Thereby, through such amendments the coverage of section 9(1)(1) has been increased retrospectively to include indirect transfers to cancel the effect of the SC verdict.

SECTION 2(14) 0F THE INCOME TAX ACT

“ capital asset” means property of any kind held by an assessee, whether or not connected with his business or profession, but does not include:

(i) Any stock- in- trade, consumable stores or raw materials held for the purposes of his business or profession;

(ii) For personal effects, that is to say, movable property (including wearing apparel and furniture, but excluding jewellery) held for personal use by the assessee or any member of his family dependent on him.

(iii) Agricultural land in India, not being land situate-

(iv) 6 per cent Gold Bonds, 1977, or 7 per cent Gold Bonds, 1980, or National Defence Gold Bonds, 1980, issued by the Central Government;

(v) Special Bearer Bonds, 1991, issued by the Central Government;

(vi) Gold Deposit Bonds issued under the Gold deposit Scheme,1999.

Both the Bombay High Court and the Supreme Court held in this case that “controlling interest” is not a capital asset. The Finance Bill added the following Explanation:

The following explanation was added to the existing provision

Explanation: For the removal of doubts, it is hereby clarified that

1. ‘property’ includes and shall be deemed to have always included

2. Any rights in or in relation to an Indian company,

3. Including rights of management or control or any other rights whatsoever”

Therefore, as per the amendment , the rights of the Hutchison Hong Kong in Indian company shall be included in the term capital asset under section 2(14) including the right of management and control (i.e.,) right to appoint directors , right to access to hutch brand in India and non-competing agreement . Hence, in this case the capital asset in India has been transferred by Hong Kong to Vodafone.

SECTION 2(47) IN THE INCOME TAX ACT

Transfer”, in relation to a capital asset, includes, (i)the sale, exchange or relinquishment of the asset; or

(ii) the extinguishment of any rights therein; or

(iii) the compulsory acquisition thereof under any law; or

(iv) in a case where the asset is converted by the owner thereof into, or is treated by him as, stock- in- trade of a business carried on by him, such conversion or treatment; or

(v) any transaction involving the allowing of the possession of any immovable property to be taken or retained in part performance of a contract of the nature referred to in section 53A of TOPA Act ; or

(viii) Any transaction (whether by way of becoming a member of, or acquiring shares in, a co- operative society, company or other association of persons or by way of any agreement or any arrangement or in any other manner whatsoever) which has the effect of transferring, or enabling the enjoyment of, any immovable property.

For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed always to have 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 has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company incorporated outside India.”

Therefore, as per amendment, in this case, the transfer made by Hutchison Hong Kong to Vodafone is of the rights of Indian company including rights of management and control, as it has by transferring the shares of CGP Mauritius, disposed of or parted with the rights of the Indian company and through indirect means, created interest of Vodafone in Indian company. It has done this by way of agreement .Transfer of rights take place by way of transfer of shares by a company incorporated in Mauritius.

SECTION 195 OF THE INCOME TAX ACT- Other sums

(1) Any person responsible for paying to a non- resident, not being a company, or to a foreign company, any interest shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income- tax thereon at the rates in force.

Explanation 2 has been inserted in section 195(1) to clarify the obligation to comply with section 195(1) and to make deduction thereunder applies and shall be deemed to have always applied and extends and shall be deemed to have always extended to all persons, residents, non-residents, whether or not the non- resident has: –

(i) A residence or place of business or business connection in India.

(ii) Any other presence in any manner whatsoever in India.

Therefore as per amendment, the presence of Vodafone establishment in India or the residence or place of business of Vodafone or its business connection in India is not necessary for deduction under section 195 but Vodafone had sufficient nexus in India.

Retrospective amendments are amendments which have backwards operation i.e., they come into effect from a past date. In India the finance minister has recognized the power to legislate retrospective laws and amendments. But the question as to the constitutional legitimacy of such amendments is a debatable question; though it is held valid in certain situations majorly it is held to be inconsistent. Thus, as a check on such amendments their use is restricted only to exceptional cases.Vodafone was considered to be one such exceptional case were the amendments introduced in Finance act 2012 were given effect from the past date. It was a revolutionary but a clever move made by the GOI to tax the Vodafone company which faced severe criticism from the global investors. The arbitration also held it to be violative of the India-Netherlands BIT.

The Senior advocate and architect behind Vodafone’s win Harish Salve opined his view on the retrospective amendments being a crusher of India’s image in the minds of the overseas investors and citizens. He criticized the instability shown by our government. He stated that the prosperity of the country depends upon the economic and political institutions of the country, on their stability and transparency.

Hence, though the government is granted the power to legislate laws and amendments with retrospective effect, its scope is restricted to exceptional cases and so before making any retro operative law consideration of its necessity, applicability and effects by the government is vital.

Vishnupriya. B | 4 th year B.B.A.LL. B(Hons) SASTRA Deemed to be University. Thirumalaisamudram | [email protected]

Abirami. A. B | 4 th year B.B.A LL. B (Hons) SASTRA Deemed to be University. Thirumalaisamudram | [email protected]

Nithya Parvathy.RG

Soundarya .A.

3 http://ramauniversityjournal.com/law/pdf_dec2019/03.pdf

4 Institute of Chartered Accountants of India v. L.K. Ratna & Ors (1986) 4 SCC 537

5 Krishnaji Ketkar vs Mahomed Haji Latif & Ors on 19 April,1968 AIR 1413, 1968 SCR (3) 862

6 Bombay High court Judgment para 14(f)

7 Cadell Weaving Mill Co. P. Ltd. vs Commissioner Of Income-Tax on 6 February, 2001

8 Section 45 Income Tax Act

9 Section 2(24) (xvi) Income tax Act

10 Bombay High court Judgment para 13(e)

11 Bombay High court Judgment para 16(i)

12 Mazagaon Dock Ltd. V. CIT [1988] 34 ITR 368

13 Taxation of notional income: a comparison of tax regimes-Manu Patra

14 Bombay High Court Judgment para 18(f)

15Bombay High Court Judgment para 6(g)3

16 Bombay High Court Judgment para 18(b)

17 Writ Petition No. 1325 of 2010, decision delivered on September 8, 2010 paragraph 54

18 Brassard v. Smith 39 (1925) AC 371 as quoted in paragraph 95 of the Judicial    Opinion

19 Weisbach, David A. 2002. “An Economic Analysis of Anti-Tax-Avoidance Doctrines”

20 United States v. Bestfoods [141 L Ed 2d 43: 524 US 51 (1998)]

21 Victory for Vodafone in Indian Supreme Court: the final conclusion or another twist in the tale? by Aditi Mukundan and Mansi Seth, Nishith Desai Associates

22 Judgment para 16

23 Judgment para 7

24 Judgment para 68

25 Judgment para 5.12

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Retrospective taxation: the Vodafone case, and the Hague court ruling

Topics Covered: Important International institutions, agencies and fora, their structure, mandate.

Retrospective taxation: the Vodafone case, and the Hague court ruling:

In a unanimous decision, the Permanent Court of Arbitration at The Hague has ruled that:

• India’s retrospective demand of Rs 22,100 crore as capital gains and withholding tax imposed on Vodafone for a 2007 deal was “in breach of the guarantee of fair and equitable treatment”.
• India should not to pursue the tax demand any more against Vodafone Group.

What is the case?

• In May 2007, Vodafone bought a 67% stake in Hutchison Whampoa for $11 billion.
• In September that year, Indian government raised a demand of Rs 7,990 crore in capital gains and withholding tax from Vodafone, saying the company should have deducted the tax at source before making a payment to Hutchison.
• Vodafone challenged the demand notice in the Bombay High Court, which ruled in favour of the Income Tax Department.
• Then, Vodafone challenged the judgment in the Supreme Court, which in 2012 ruled that Vodafone Group’s interpretation of the Income Tax Act of 1961 was correct and that it did not have to pay any taxes for the stake purchase.
• But, the same year, the then Finance Minister, the late Pranab Mukherjee, circumvented the Supreme Court’s ruling by proposing an amendment to the Finance Act, thereby giving the Income Tax Department the power to retrospectively tax such deals.

The case had by then become infamous as the ‘retrospective taxation case’.

What happened after India passed the retrospective taxation law?

The Act was passed by Parliament in 2012 and the onus to pay the taxes fell back on Vodafone.

• Later, Vodafone Group invoked Clause 9 of the Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995.

Article 9 of the BIT says that any dispute between “an investor of one contracting party and the other contracting party in connection with an investment in the territory of the other contracting party” shall as far as possible be settled amicably through negotiations.

What is the Bilateral Investment Treaty?

The BIT was signed for promotion and protection of investment by companies of each country in the other’s jurisdiction.

• The two countries would, under the BIT, ensure that companies present in each other’s jurisdictions would be “at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other”.

What did the Permanent Court of Arbitration at The Hague say?

• It ruled in favour of Vodafone. Because, the taxation was in violation of the BIT and the United Nations Commission on International Trade Law (UNCITRAL).
• The tribunal also said that now since it had been established that India had breached the terms of the agreement, it must now stop efforts to recover the said taxes from Vodafone.
• It also directed India to pay £4.3 million ($5.47 million) to the company as compensation for its legal costs.
• What is retrospective taxation?

As the name suggests, retrospective taxation allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time behind the date on which the law is passed.

• Countries use this route to correct any anomalies in their taxation policies that have, in the past, allowed companies to take advantage of such loopholes.
• While governments often use a retrospective amendment to taxation laws to “clarify” existing laws, it ends up hurting companies that had knowingly or unknowingly interpreted the tax rules differently.

InstaLinks :

Prelims Link:

• PCA- composition, functions and members.
• Are PCA rulings binding on parties.
• Clause 9 of the Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995.
• Overview of UNCITRAL.

Mains Link:

Discuss the functions and significance of PCA.

Sources: the Hindu and Indian Express.

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Vodafone International Holdings BV vs Union of India – Case Analysis

Introduction.

Tax is a vital component for any economy since it is the determinant of development for the country. Taxes are levied not only on individuals but also on companies and other corporate bodies. It is, therefore, necessary to have in place the best and most comprehensive laws and policies on taxation, so that the levy and collection of the same can be done with ease. It is also important that the tax-payer, along with the tax-collector, is well-versed with the laws on taxation so as to avoid any fraud. It is a right of the government to collect tax in order to pursue developmental goals, but at the same time, harassment and misery on part of the government just to collect taxes is not acceptable. In India, the Constitution gives the government powers in terms of collection of tax, not only prospectively but retrospectively as well, through required amendments. This provision in itself disputes the very basic characteristics of a tax – that a tax should be certain, i.e. a certain amount, and that the tax should be in continuity, and not abruptly collected at any given time. Retrospective collection of tax essentially signifies the collection of a tax by going back in time, that is, through past transactions. This goes against the nature of a tax, but there was an instance when the government of India amended the tax law and allowed for retrospective collection of taxes. The legislature attempted to distort a judgement of the Supreme Court in the infamous case of Vodafone International Holdings BV vs Union of India [1] , to charge retrospective capital gains tax from certain companies. This move of the Indian government met with widespread criticism which ultimately led to the revocation of the practice of retrospective taxation. To understand how it took effect, it is important to first understand the case law involved within.

Facts of Vodafone International Holdings BV vs Union of India Case

The Indian government in the year 1999 introduced a new licensing regime, the New Telecom Policy, in lieu of the old one which directly benefitted telecommunication companies. It encouraged healthy competition in the market and allowed other companies to set up their networks in India. Owing to this, one company, namely Hutchison Telecom International Limited, set up a subsidiary company in India with the name of Hutchison Essar Limited. Hutchison Telecom International was the parent company and had a 67% stake in the subsidiary company it established. This stake was transferred to and controlled by a holding company of the Hutchison group, namely the CGP Investments Holdings Limited, situated in Cayman Islands .

However, in 2007, Hutchison decided to exit the Indian telecom market. At that time, another telecom giant, from the United Kingdom, Vodafone International Holdings, wanted to enter the Indian telecom sector. This prompted an agreement between the two companies, Hutchison and Vodafone, whereby it was agreed that CGP Investments would transfer the 67% stake it had in Hutchison Essar Limited to Vodafone International, the latter being a holding company of the Vodafone group in Netherlands. The transaction would result in Vodafone entering the Indian market and Hutchison receiving 11.1 billion dollars.

Since the companies were non-resident at the time of the transaction and the transaction itself took place outside India, it was believed that the Indian government would not charge capital gains tax from the transaction: a tax that would otherwise be levied had the companies been resident or the transaction taking place within the territory of India. Further, there was no existing law which stated that a company had to pay capital gains tax for a transaction involving assets taking place outside India.

When the said transaction came into the knowledge of the Indian government, the tax authorities issued a show-cause notice to the now existing company, Vodafone Essar Limited, under Sections 165, 201(A) and 201(1A) of the Income Tax Act, 1961. These sections put Vodafone Essar under the category of an assessee of Vodafone International, and also as an assessee-in-default because of failure to pay tax. Discontented with the move of the Indian government, Vodafone reached the Bombay High Court through a Special Leave Petition which challenged the jurisdiction of the tax being levied on it.

Bombay High Court’s Judgement on Vodafone International Holdings BV vs Union of India Case

The Bombay High Court ruled on the following points:

It observed that the transfer of shares between Hutchison International and Vodafone resulted in a transfer of controlling interest, which meant that the transfer is not merely that of shares but also of certain rights and entitlements.

These rights and entitlements fall within the scope of Section 2(14) of the Income Tax Act, which makes them capital assets.

The court also observed that even though the transaction took place between foreign companies outside the territory of India, the subject matter of the transfer is an Indian asset, therefore giving right to the Indian tax authorities to levy tax on the assessee.

The court went on to state that since there was an indirect transfer of an Indian asset and it resulted in an income from a business connection, the transaction also attracted section 9(1)(i) of the Income Tax Act.

The court held that in order to levy tax, there needs to be established a nexus between the transaction and the law. This nexus was established because the subject of the transaction was an Indian asset, and thus, Section 195 of the Act would also be applicable. This nexus, once established, can operate against non-residents and the Income Tax Act has extraterritorial operation.

Thus, the Bombay High Court dismissed the petition of Vodafone International and held that the Indian tax authorities had jurisdiction in the matter. However, the High court suggested that if the company could agitate before the tax authorities that it had reasonable cause that it was not liable to deduct tax at any given stage, the penal liability could be avoided. But Vodafone approached the Supreme Court of India against the order of the Bombay High Court.

Supreme Court’s Judgement on Vodafone International Holdings BV vs Union of India Case

As opposed to the position taken by the Bombay High Court, the Supreme Court of India stated that the transfer of assets and the transfer of controlling interest could not mean different things because they were a part of one transaction only. In fact, the transfer of controlling interest was an inherent part of the transfer of shares because controlling interest is not a property right but a mere contractual one which cannot be rendered taxable.

The Apex court also held that Section 195 of the Income Tax Act did not have extraterritorial jurisdiction and only applied to residents. As a result, this transaction did not have the nexus as stated by the Bombay High Court because the companies were foreign residents and the transaction took place outside India. Further, the scope of Section 9(1)(i) is limited to incomes arising from transactions involving a capital asset within India, and did not include indirect transfer of any capital asset. Moving on, the Court also stated that this act of Vodafone International Holdings was very much a move based on tax planning, just as other companies follow this arrangement for legitimate tax planning reasons. The Court determined on the doctrine of piercing the corporate veil, which holds liable a company when that corporate entity is involved in committing unlawful acts. On this point, the Court stated that this doctrine could only be applied when it stands proved that the transaction is a sham, unlike this transaction.

Therefore, the Supreme Court ruled in favour of Vodafone and held that the tax authorities had no authority to impose tax on the company.

The Finance Bill of 2012

In March 2012, the Indian government came out with a new finance bill, which sought to amend the existing tax regime and introduce retrospective taxation on any transaction involving shares of non-Indian companies being transferred to Indian holding companies, after 1962. The amendment changed all the sections involved in the Vodafone International Holdings Limited case to fit the purpose of levy and collection of retrospective taxes, and as a result, it nullified the Supreme Court’s judgement on the matter. The sole and baseless reason given for this amendment was to increase tax collection and benefit genuine taxpayers.

Faced with yet another challenge, the Vodafone International Holdings Limited BV moved to the permanent court of arbitration situated in The Hague, Netherlands, under Article 9 of the India-Netherlands Bilateral Investment Treaty. This Article allowed parties to move the permanent court of arbitration when disputes regarding investors of the contracting parties regarding an investment arose.

Permanent Court of Arbitration

Vodafone argued that the amendment for retrospective legislation violated the principles of equitable and fair treatment as mentioned in the treaty, under Article 4.1. It also argued that the government did not respect the decision of the apex court of the country and introduced such a legislation that would deliberately thwart that decision, thus creating an unstable and unpredictable business environment, which also was a violation of Article 4.1.

In 2014, Vodafone again initiated proceedings against India, this time under the India-United Kingdom Bilateral Investment Treaty. Even though the Indian government succeeded at getting an anti-arbitration injunction order by the High Court of Delhi, it was later dismissed on the ground that it was an abuse of process.

The Permanent Court of Arbitration delivered its award in favour of Vodafone International Holdings Limited BV, stating that the Indian government had violated Article 4.1 of the India-Netherlands BIT, and directed it to pay 5.5 million US dollars to Vodafone to compensate for legal costs.

Another day, another bill: the Indian government faced multiple defeats, both in their home country as well as internationally, which led it to come up with another Finance Bill in 2021, so that retrospective taxation could be removed from the economy. This time, however, amendments were done only in two sections, namely, 9(1)(i) and 119. The basis given for this bill was that earlier amendments invited a lot of criticism and affected the stakeholders negatively. This amendment waived the tax levied on Vodafone International Holdings Limited BV.

The above case highlights the ways a government can target companies and levy taxes through obstinate and negative measures. These practices hinder economic growth as well as degrade existing laws. The Supreme Court, in its judgment of the case, viewed that foreign direct investment flows towards a strong governance infrastructure with an effective and appropriate legal system. The rule of law implies certainty, and it forms the basis of any fiscal system. Retrospective taxation not only promotes uncertainty, but also affects foreign investments in a way that would hinders their flow. Retrospective taxation should only be introduced in the rarest of the rare cases, and only to either correct procedures or to protect the tax base.

Since the earliest of times, property has been regarded as an essential and inalienable right. And to boost economic growth, property rights must be strong, protective, and well-structured with efficient remedies. If one is not sure of the ownership regarding one’s own property, then it would be useless to spend on that property because ultimately someone else might benefit from that property.

The Vodafone International Holdings BV vs Union of India case is not alone; the way the government reacted to the situation has been seen before as well, in various cases involving FDIs. In cases like these, to save private ownership from encroaches of the state should be the stance of the courts, as displayed by the Supreme Court of India but not so much by the High Court of Bombay. Moreover, the Supreme Court of India being the highest judicial body, its decisions should be respected and abided by, instead of going against them. Finally, enactments that expressly go against fair dealings and showcase arbitrary powers of the state should be quashed.

What is retrospective taxation? What are its drawbacks?

Retrospective taxation means the collection of a tax by going back in time, i.e., through past transactions. Retrospective taxation exists but only in specific situations because it takes away the certainty and continuity factors of a tax. Its major drawback is that it goes against the very nature of a general tax because it is collected from a back date, thus breaking its continuity and also erasing the lines of certainty.

What was the main contention of Vodafone International Holdings Limited before the permanent court of arbitration?

The main contention put forward by Vodafone International Holdings was that the amendment for retrospective legislation violated the principles of equitable and fair treatment as mentioned in the treaty, under Article 4.1. It also argued that the government did not respect the decision of the apex court of the country and introduced such legislation that would deliberately thwart that decision, thus creating an unstable and unpredictable business environment, which also was a violation of Article 4.1.

How did the Finance Bills of 2012 and 2021 differ from one another?

While the finance bill of 2012 was introduced with the sole purpose of thwarting the judgement of the Supreme Court in the case of Vodafone International Holdings Limited by enhancing the scope of several sections in the Income Tax Act, the Finance Bill of 2021 revoked the retrospective taxation brought about by the Bill of 2012. The Bill of 2012 was uncalled for and a deliberate move of the government, whereas the bill of 2021 was introduced to tackle the criticism generated from the former bill.

[1] (2012) 6 SCC 613.

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Zara Suhail Ahmed

Zahra is a student at Aligarh Muslim University, pursuing a 5-year B.A. LLB course. Currently in her 4th year, Zahra opted for Law after completing most part of her schooling from Cambridge School, New Delhi. Zahra has interned under a few lawyers and firms, participated in various moot courts and similar events, and is proficient in research and written content. A strong believer that education is the greatest virtue, Zahra seeks to learn from every platform and individual, whether working alone or as a team. Although Zahra is keenly interested to pursue ADR (Alternate Dispute Resolution) as a career, she has kept her options open and is interested in examining the different career prospects that her profession has to offer. Zahra has diversified interests apart from her professional life as well. Not only a successful lawyer, but she also aspires to become a productive human being.

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Win Against India: The Vodafone Case

Published by vidhit chandan on 20/10/2020 20/10/2020, introduction.

On 25 th 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 20 th 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 25 th 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)

[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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Retrospective taxation: the Vodafone case, and the Hague court ruling

The court has also asked india not to pursue the tax demand any more against vodafone group..

In a unanimous decision, the Permanent Court of Arbitration at The Hague on Friday ruled that India’s retrospective demand of Rs 22,100 crore as capital gains and withholding tax imposed on the British telecommunication company for a 2007 deal was “in breach of the guarantee of fair and equitable treatment”. The court has also asked India not to pursue the tax demand any more against Vodafone Group.

What is the case?

In May 2007, Vodafone had bought a 67% stake in Hutchison Whampoa for $11 billion. This included the mobile telephony business and other assets of Hutchison in India. In September that year, the India government for the first time raised a demand of Rs 7,990 crore in capital gains and withholding tax from Vodafone, saying the company should have deducted the tax at source before making a payment to Hutchison.

Vodafone challenged the demand notice in the Bombay High Court, which ruled in favour of the Income Tax Department. Subsequently, Vodafone challenged the High Court judgment in the Supreme Court, which in 2012 ruled that Vodafone Group’s interpretation of the Income Tax Act of 1961 was correct and that it did not have to pay any taxes for the stake purchase.

The same year, the then Finance Minister, the late Pranab Mukherjee, circumvented the Supreme Court’s ruling by proposing an amendment to the Finance Act, thereby giving the Income Tax Department the power to retrospectively tax such deals. The Act was passed by Parliament that year and the onus to pay the taxes fell back on Vodafone. The case had by then become infamous as the ‘retrospective taxation case’.

The ruling in favour of Vodafone signals a setback for the country's retrospective taxation policies. It also raises the possibility of other cases under arbitration being decided on similar lines.

What is retrospective taxation?

As the name suggests, retrospective taxation allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time behind the date on which the law is passed.

Countries use this route to correct any anomalies in their taxation policies that have, in the past, allowed companies to take advantage of such loopholes. While governments often use a retrospective amendment to taxation laws to “clarify” existing laws, it ends up hurting companies that had knowingly or unknowingly interpreted the tax rules differently.

Apart from India, many countries including the US, the UK, the Netherlands, Canada, Belgium, Australia and Italy have retrospectively taxed companies, which had taken the benefit of loopholes in the previous law.

Also read | Govt may have to shell out Rs 85 crore if it decides not to appeal

What happened after India passed the retrospective taxation law?

Once Parliament passed the amendment to the Finance Act in 2012, the onus to pay the taxes fell back on Vodafone. The amendment was criticised by investors globally, who said the change in law was “perverse” in nature.

“The retrospective amendment that overturned the decision of the highest court of the land was badly drafted in its wide generalities and carried a perverse sense of vindictiveness,” said Nigam Nuggehalli, Dean of the School of Law at BML Munjal University.

Following international criticism, India tried to settle the matter amicably with Vodafone, but was unable to do so. After the new NDA government came to power, it said it would not create any fresh tax liabilities for companies using the retrospective taxation route.

By 2014, all attempts by the telco and the Finance Ministry to settle the issue had failed. Vodafone Group then invoked Clause 9 of the Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995.

Also read |  Explained Ideas: What can the government do to revive India’s telecom industry?

What is the Bilateral Investment Treaty?

On November 6, 1995, India and the Netherlands had signed a BIT for promotion and protection of investment by companies of each country in the other’s jurisdiction.

Among the various agreements, the treaty had then stated that both countries would strive to “encourage and promote favourable conditions for investors” of the other country. The two countries would, under the BIT, ensure that companies present in each other’s jurisdictions would be “at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other”.

While the treaty was between India and the Netherlands, Vodafone invoked it as its Dutch unit, Vodafone International Holdings BV, had bought the Indian business operations of Hutchinson Telecommunicaton International Ltd. This made it a transaction between a Dutch firm and an Indian firm.

The BIT between India and the Netherlands expired on September 22, 2016.

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What did the Permanent Court of Arbitration at The Hague say?

One of the major factors for the Court of Arbitration to rule in favour of Vodafone was the violation of the BIT and the United Nations Commission on International Trade Law (UNCITRAL).

In 2014, when the Vodafone Group had initiated arbitration against India at the Court of Arbitration, it had done so under Article 9 of the BIT between India and the Netherlands.

Article 9 of the BIT says that any dispute between “an investor of one contracting party and the other contracting party in connection with an investment in the territory of the other contracting party” shall as far as possible be settled amicably through negotiations.

The other was Article 3 of the arbitration rules of UNCITRAL, which, among other things, says that “constitution of the arbitral tribunal shall not be hindered by any controversy with respect to the sufficiency of the notice of arbitration, which shall be finally resolved by the arbitral tribunal”.

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In its ruling, the arbitration tribunal also said that now since it had been established that India had breached the terms of the agreement, it must now stop efforts to recover the said taxes from Vodafone.

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Vodafone versus India: A Never-Ending Saga

by Swarnendu Chatterjee† and Anwesha Pal†† Cite as: 2022 SCC OnLine Blog Exp 82

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Introduction

The Supreme Court is the Apex Court of the country, it is called the sentinel on the qui vive. However, what if someone is not satisfied with its ruling? What if there is some scope left through a party that can win the case? Under municipal laws, there is no further recourse. However, for cases, under the domain of international law, the concept changes and varies. International courts provide for the further steps that may be resorted to, if a party so wishes. The increasing burden and delay in the courts have led to the emergence of arbitration. Such proceedings are relied upon as they are said to be more compatible and convenient. One of the most long-running cases, the Vodafone case also sought the option of proceeding to the Permanent Court of Arbitration (PCA).

The first instance that took place, in this case, sets back to the year 2007. It was not much obvious that the amendment in the taxation laws in the year 2012 will make the parties proceed to PCA. The cases where the parties are of more than one country, cases are often carried out through arbitration. Recently, in September 2020, the award was passed by PCA in favour of Vodafone Holdings Ltd. as the case was against the Indian Government, it is now of utmost importance that what will be the next step of the Indian Government. The case that is decided by PCA is Vodafone International Holdings BV v. Govt. of India . 1

Background of the case

The bilateral agreement between Hutchison Essar Limited (Indian company) and Vodafone International Holdings (VIHBV) (an entity of Netherlands) was signed in 2007, in which a Hong Kong based entity through a series of subsidiaries sold its stake and led to the bilateral agreement. The agreement was a result of holding the shares of Indian company to the Netherlands entity for approximately eleven billion as consideration.

The profit that the Hong Kong entity earned through this deal, triggered the Indian Government, which demanded tax payment by VIHBV for the acquisition of the stake of the Indian company. The tax was being demanded as per Section 195 of the Income Tax Act, 1961 . On the failure of payment by the VIHBV, a case was initiated against the company. However, the decision of the Supreme Court 2 supported the VIHBV and quashed the order concerning the demand for payment of INR 25 billion by the company.

The judgment triggered the Government which in turn led to the retrospective amendment of the taxation law. The amendment clarified that the payment of taxes by VIBHV was now necessary. The arbitration proceeding then started, as the VIBHV was aggrieved by the retrospective amendment. A notice was issued by the PCA to the Indian Government as per India-Netherlands bilateral investment treaty (BIT).

The proceedings started in the year 2014. However, the Indian Government also filed a suit in the Indian court for restraining Vodafone from initiating arbitration proceedings. However, this did not work, and the arbitration proceedings took place which continued till 25-9-2020. On this date, PCA passed the Vodafone award. The award is controversial and as per reports, Central Government is considering filing an appeal against the said award.

Bilateral investment treaty between India and Netherlands

The retrospective amendment that took place in 2012 could have been challenged in India. However, the arbitration proceedings were chosen with the reasoning, that the articles of BIT between India and Netherlands were being violated. Also, the company needed to take this step as it was found that in the year 2016, many of the BITS between India and other countries were terminated by India itself. 3

The treaty that was signed between India and the Netherlands stated the “fair and equitable standard”. However, it was noted that the amendment has limited the scope, and this is now available only in limited situations. This has replaced the carte blanche approach. 4 However, the articles that are present in the treaty cannot be revoked in such a manner as it will lead to situations that will cause losses to both the parties and further, forms the basis of the treaty.

Indian retrospective tax legislation — Amendments to the Income Tax Act consistent with global initiatives to tax indirect transfer of assets

After the judgment of the Supreme Court in Vodafone case 5 in 2012, the Indian Parliament passed the Finance Act, 2012 , which gave inter alia to the addition of two clarifications in Section 9(1)( i ) of the Income Tax Act (2012 Amendment). The principal clarification explained the importance of the expression “through” which stated that “For the removal of doubts, it is hereby clarified that the expression ‘through’ will mean and incorporate and will be considered to have consistently implied and included ‘by means of’, ‘in accordance of’ or ‘by reason of’. The subsequent clarification explained that ” an asset or a capital asset being any share or interest in an organisation or element enlisted or consolidated external India will be and will consistently be considered to have been arranged in India, if the offer or premium determines, straightforwardly or by implication, its worth considerably from the resources situated in India”.

The 2012 amendment additionally explained that the term “transfer” incorporates and will be considered to have consistently included discarding or leaving behind a resource or any premium in that, or making any revenue in any resource in any way at all, straightforwardly or in a roundabout way, totally or restrictively, wilfully or automatically, via an arrangement (regardless of whether went into in India or outside India) or something else, despite that such exchange of rights had been portrayed as being affected or subordinate upon or moving from the exchange of an offer or portions of an organisation enlisted or consolidated external India.

The amendment was basically acquainted by the Government to plug a hole that existed in the Indian income tax system. While capital increases charge was payable on exchange of resources situated in India, there was vagueness in regard of whether capital additions charge was payable even in situations where an offer buy exchange between foreign entities that did not bring about an immediate exchange of the resources situated in India.

For instance, in Vodafone case 6 , the resources in India were held by a shell organisation in the Cayman Islands and the offer to buy exchange among Vodafone and Hutchison identified with acquisition of the single portion of this shell organisation. The exchange of resources in India occurred by implication. Although the Supreme Court in the long run held that capital increases expense could not be demanded on quite a circuitous exchange of resources, the contrary view — that capital additions duty could be collected on offer buy exchanges that in a roundabout way and successfully brought about an exchange of resources in India — was additionally conceivable on a translation of the applicable arrangements of the Income Tax Act.

The PCA award

After thirteen years of long and disputed procedure, the award was passed by PCA on 25-9-2020. The award favoured Vodafone and stated that the amount of tax that was demanded by the Indian Government was not payable, as per the treaty. The amount was approx. INR 22,100 crores. The key aspects which form a part of the award are as follows: 7

Netherlands was entitled to have the benefit of fair and equitable treatment under the treaty.

The challenge put forth by the Indian Government to the final judgment and order of the Supreme Court constituted a breach of the agreement.

The breach was not avoidable and might lead to international responsibilities on India

India needs to pay an amount to Vodafone, as damages.

The award is interestingly a complex one, including the emphasis on Article 4(1) of the BIT. Along with the explanation of the BIT, it has also included the scope of India’s legislature and its duty. The order that was passed by the Supreme Court which was sought to be overruled by the amendment has been mentioned as a breach. There has been a similar case in 2011 8 , which was in favour of White Industries and was against India. Also, there have been maritime awards that have been passed in 2014 which were also against India.

The Tribunal has directed India for reimbursing INR 850 million to Vodafone as legal costs. The entire award is not available for the public as it is the choice of parties in arbitration if they want to keep the award public or private. The award seems to be beneficial for India too. The model of BIT has been revised by India. Several clauses of the BIT model have been revised so that no further complications arise when India enters BIT with other countries 9 .

The matter has been in news and has been also discussed amongst the personnel of the Government. There have been different pieces of information coming out through different sources. The Tribunal has stated the Government has time till 24-12-2020, to send a reply regarding the award. It has been reported the reply of the Centre is not confirmed, as there are two points, and the Centre can rely on any one of them.

The two probable views are related to India’s position for other future BITs or to reserve India’s right of taxation. However, as per media reports, the Solicitor General of India is in support of filing an appeal and Singapore is being chosen as the place of appeal. 10 The views are of utmost importance as it will affect the future treaties of India.

Also, the creation of a proper corporate structure is needed which has been revealed through various instances. The cases in which India terminated the BIT are to be considered as a lesson after this case. The revised model of BIT is also being considered as a step that has been taken after the passing of the Vodafone PCA award.

The shift of the case from India to international arbitration shows that the international parties rely more on the proceedings of arbitration. The retrospective amendment which sought to overrule the judgment passed by the Supreme Court led to the inclusion of PCA in the case. It is very important to keep in mind all the points that would affect the position of the country in the outside world. India endeavours and can possibly be a speculator investor-friendly jurisdiction and whether India will have the option to accomplish this objective will rely upon the advances that the public authority will make in its authoritative structure. The methodology of India to venture interventions should be returned to as the current position is indicating an opposite pattern. The endeavours of the public authority and the legal executive cannot be overlooked notwithstanding, regardless of these endeavours, India has not had the option to accomplish its objective of turning into the most favoured destination for investment. A general improvement in the arbitrational environment will positively affect the simplicity of working together which will, in the end, prompt more foreign investments.

The judgment conveyed by PCA will have a material bearing on comparable cases, wherein such issues are included and tax collection from foreign institution investors will be affected because of the Vodafone decision. India is engaged with over twelve comparable situations where review charge cases and retraction of agreements are being referred to and this decision will likewise influence those situations where the duty interest of India is genuine. One may likewise contend that the decision of PCA is a colossal misfortune for India as it included a considerable issue of unfamiliar financial specialists meeting their expense commitments

The award has been passed by the PCA. Now it is important to see what will be the next step that Indian Government will take in order to safeguard its interest. The step that will be taken at this point of time will have an effect in the future treaties too. Such decisions need to be taken after consideration of all the possible situations that can take place. It is also a lesson that before the decisions taken regarding the amendments, the articles of the BIT must be kept in mind. The appeal (as per media reports) is pending, and we need to await whether India will be able to safeguard its interests.

†Advocate-on-Record, Supreme Court of India.

††PhD Scholar and Teaching Assistant WBNUJS, Kolkata.

1. PCA Case No. 2016-35 (Dutch BIT Claim).

2. Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613 . (2012) 6 SCC 613.

3. BIT, Department of economic Affairs

< https://www.dea.gov.in/bipa >.

4. Relevant excerpts from Art. 3 of India’s revised BIT model state:

“3.1 No party shall subject investments made by investors of the other party to measures which constitute a violation of customary international law through: ( i ) denial of justice in any judicial or administrative proceedings; or ( ii ) fundamental breach of due process; or ( iii ) targeted discrimination on manifestly unjustified grounds, such as gender, race or religious belief; or ( iv ) manifestly abusive treatment, such as coercion, duress and harassment.

3.2 Each party shall accord in its territory to investments of the other party and to investors with respect to their investment’s full protection and security. For greater certainty, ‘full protection and security’ only refers to a party’s obligations relating to physical security of investors and to investments made by the investors of the other party and not to any other obligation whatsoever.”

5. (2012) 6 SCC 613 .

6. (2012) 6 SCC 613 .

7. Mukesh Butani and Tarun Jain, “What Next after the Vodafone Tax Arbitration?”, 30-9-2020

< https://www.fortuneindia.com/opinion/what-next-after-the-vodafone-tax-arbitration/104758 >.

8. In the Matter of an Uncitral Arbitration in Singapore under the Agreement Between the Government of Australia and the Government of the Republic of India on the Promotion and Protection of Investments

9. Tarun Jain, Shankey Agrawal, “Investment Treaties Interjecting Taxation’s Realm: The Latest in Vodafone’s India Saga”, October 13-10-2020 [See HERE ]

10. “Vodafone Arbitration Award: Issue Discussed with PM Modi; Centre may Challenge Case”, 1-12-2020

< https://www.businesstoday.in/latest/corporate/story/vodafone-arbitration-award-issue-discussed-with-pm-modi-centre-may-challenge-280247-2020-12-01 >.

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Vodafone Wins Rs 20,000 Crore Tax Arbitration Case Against Government

The tax dispute involving rs 12,000 crore in interest and rs 7,900 crore in penalties stems from vodafone's acquisition of the indian mobile assets from hutchison whampoa in 2007..

Vodafone won the arbitration against India the international tribunal in The Hague.

Telecom giant Vodafone on Friday won a significant ruling against the Indian government in an international court over Rs 20,000 crore in dues which it had described as unfair.

The international arbitration tribunal in The Hague ruled that the Indian government's imposition of a tax liability on Vodafone is in breach of the investment treaty agreement between India and the Netherlands, sources told news agency Reuters.

The tribunal, in its ruling, said the government must cease seeking the dues from Vodafone and should also pay over Rs 40 crore to the company as partial compensation for its legal costs, the source said.

"Vodafone has finally got justice. The government of India came with a retrospective amendment trying to recover the tax which the Supreme Court had struck down... The tribunal has today said that this action is violative of the bilateral investment treaty," Anuradha Dutt, managing partner of DMD Advocates, a New Delhi-based firm which argued for Vodafone, told NDTV.

Government sources said that tribunal's ruling meant that "no damages have been awarded against Government of India" but conceded that they will have to pay about Rs 40 crore which is 60 per cent of the tribunal's administrative cost while the rest 40 per cent would be borne by Vodafone.

"Also, Government of India may have to refund the tax collected, which is about Rs 45 crore, only if it does not go for appeal against the award. Therefore, the total outgo would be around Rs 85 crore only. It is learnt that the award is under study by Indian authorities and its legal counsels who would seek suitable legal remedies at appropriate forums," sources said.

The tax dispute involving Rs 12,000 crore in interest and Rs 7,900 crore in penalties stems from Vodafone's acquisition of the Indian mobile assets from Hutchison Whampoa in 2007. The government said Vodafone was liable to pay taxes on the acquisition, which the company contested.

In 2012, India's top court ruled in favour of the telecom provider but the government later that year changed the rules to enable it to tax deals that had already been concluded.

In April 2014, Vodafone initiated arbitration proceedings against India.

India is entangled in more than a dozen international arbitration cases against companies, including Cairn Energy, over retrospective tax claims and cancellation of contracts. The exchequer could end up paying thousands of crores in damages if it loses.

In a different case, the heavily indebted telecoms firm had won some reprieve earlier this month as the Supreme Court gave mobile carriers 10 years to settle thousands of crores in government dues.

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India's telecom providers have to pay the Department of Telecom nearly 3-5 per cent of their adjusted gross revenue (AGR) in usage charges for airwaves and 8 per cent of AGR as licence fees. They have long disputed the definition of AGR but last year the Supreme Court upheld the government's view that the AGR should include all revenue.

(With inputs from Reuters)

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Vodafone Case Study

Introduction.

Vodafone Case study describes the situation when  Idea Cellular and Vodafone after the entrance of JIO. So, here is the Vodafone case study which describes the position of Vodafone and Idea Cellular before and post-merger, reasons for the merger, how did merger take place and critical analyses of the merger.

About Vodafone 

Vodafone company came from the UK based Vodafone Group plc. It is a multinational service provider of telecommunications in 22 different countries as of 20th November 2020. And, in India Vodafone has its headquarter in Mumbai, Maharashtra. Vodafone is the third largest telecommunication provider in the country. Vodafone

At the beginning of the year, 1992 Vodafone started its company in India from Bombay(now Mumbai). After the entry of JIO in the year 2016. Afterwards, our Vodafone case study begins, Vodafone and Idea announced their merger in March 2017. And as of 31st August 2018, it is known as Vodafone Idea Limited.

Vodafone Idea Merger Case Study

Vodafone case study explains the reason and the situation of the merger of Vodafone and Idea. This merger was first announced in March 2017. Afterwards, in July 2018, the department of telecommunication gave the approval for the merger. Finally, on 31st Aug 2018, the merger was completed and it is announced as Vodafone Idea Limited.

And this merger was the largest telecom merger in India. As per this merger, Vodafone holds a 45.2% stake, Aditya Birla Group holds 26% and the remaining stakes were held public. So, to understand the Vodafone case study, let’s understand the reasons for the Vodafone Idea merger case study.

Reasons For Vodafone Idea Merger

So, while understanding the Vodafone case study lets us understand the reason for the Vodafone Idea merger. 

• The main reason for the Vodafone-Idea merger is to Handel the rising dominance of Reliance Jio in the Telecom industry. As Jio announced to provide free services in the first 6 months. As a result, it started to capture the maximum part of the market.
• Secondly, the free services from the Jio started the price war between the companies in the telecom sector( as it in an oligopoly market structure ).
•  As a result in case of a price war merger brings confidence in companies with synergy benefits. 
• At last, the combined entity of Vodafone and Idea was expected to hold a strong position in the industry . Such as in some circles it became the largest cellular service provider and in some circle, it was the second-largest after Bharti Airtel. So, a joined company can focus on being the service provider in pan India.

So, these were the reasons in Vodafone case study for the merger of Vodafone and Idea.

Vodafone Idea Integration

According to the past in the telecom industry, major telephone operators believes the merger is a strong tool to be in the lead position. As Airtel acquires the Telenor, it acquires the scope and business from other small telecommunication companies like Augere Wireless, Videcon, Tikona(4G Spectrum) etc. 

Also, Reliance Communication (R Com) merged with Aircel and acquire MTC. Plus the Tata Telecom also started the process of merging with R Com. As a result in a period of seven months telephone operators numbers went down to seven from twelve.

However, the announcement of the merger creates a negative image in the public, when the Vodafone and Idea merger was announced the Idea prices started to drop . And the share price of Idea declines from Rs. 97.70 on 20th March 2017 to Rs. 81.81 on 6th Sep 2017.

But the merger was important it gave support to the two companies, which were struggling to survive in the industry. Combined resources will help to compete with only the two biggest brands(Jio and Airtel).

So, these were the challenges of Vodafone and Idea merger in case of Vodafone case study.

Critical Analysis Of Vodafone Case

The merger of Vodafone and Idea in Vodafone case study gave higher stakes to the Idea promoters as compared to Vodafone. So, in long run, both companies can gain access to equal shares in the future. 

Here are the few takeaways from the Vodafone Idea merger in Vodafone case study: 

• The very first thing was the acquisition of 4.9 per cent shares of Vodafone by Aditya Birla . This would amount to a total of Rs. 3874 crore wherein each share is worth Rs. 108 . This would be helpful in increasing the shareholding capacity of Idea to 26 per cent .
• While in the case of Vodafone case study, Vodafone holds 45.1 per cent of the shares in the merger, Idea would be allowed to buy another 9.6 per cent but at a cost of Rs. 130 per share in the period spread over the next four years. However, if Idea is unable to come up equal to the shareholding percentage of Vodafone, it can go forward and buy the number of shares required further but at the price prevailing in the market.
• And, the chairperson of the newly formed enterprise would be Kumar Mangalam Birla . On the other hand, Vodafone had appointed the Chief financial officer . As, after that new CEO was named under both the companies.
• Lastly, the promotors of both entities have the right to nominate three members for the board . Also, there are 12 members out of which 6 are independent on the board in the Vodafone case study of Vodafone and Idea merger. 

Idea Positioning Before Merger

In Vodafone case study of Vodafone and Idea merger, now lets understand the Idea Cellular Limited is an Aditya Birla Group company. Founded in 1995, the company was incorporated as Birla Communications Limited and had a license of GSM-based services in Gujarat and Maharashtra Circle. In the following years, the organization started to expand its business with Tata Group, Birla and AT&T group of the US in joint venture form. 

In August 2015, Idea announced the rollout of its 4G services. It was now competing with Airtel and Vodafone – in a non-monopolistic market. The company relaunched its “What an Idea” campaign taking 4G to the rural areas and empowering people through the usage of 4G services.

But in the year 2016 sudden announcement from Mukesh Ambani about Reliance Jio disrupted the Indian telecom sector. Below pie chart shows the market share of different telecom players before the entry of Jio.

As the Indian market is very sensitive towards price and Jio used it to make most of the profits. So, Jio started to make its all services free for the first six months. Afterwards, they made the services of voice calls, data extremely cheap. As a result, JIO captured a significant share of the telecom industry. Here is the pie chart of the post-Jio market share of various telecom players.

Vodafone Idea Merger

This transaction required various approvals from government authorities including SEBI, dept. of Telecom and Reserve Bank of India among others. The Department of Telecommunications (DoT) has given the green signal for the merger of Vodafone India and Idea in our Vodafone case study, the largest Merger and Acquisition agreement in the sector, which has displaced Bharti Airtel from top position after over 15 years. The approval conditions, which were given over a year after the agreement, were announced in March 2017 which included an advance payment of Rs 7,268 crore. 

Idea Contributon

Promoters Aditya Birla Group infused Rs 3,250 crore in Idea Cellular , which separately raised Rs 3,000 crore ahead of a planned merger with Vodafone India. Following the equity infusion by Idea’s promoters, their stake in India’s third-largest telecom operator rose to 47.2% from 42.4% now. Idea contributed its assets which included standalone towers with 15,400 tenancies and a stake in Indus towers Ltd of 11.5%. 

The entry of Reliance Jio Infocomm Ltd in September 2016, with free services for almost seven months and cheap tariffs, had eroded margins and impacted the revenue of rivals. The contribution of Vodafone will be Vodafone India along with standalone towers with 15,400 tenancies without including an 11.5% stake in Indus Towers. According to the agreement between Idea and Vodafone.

Vodafone will contribute more amount of net debt, about Rs 2,480 crore than Idea at the completion of the merger. Post-termination of both companies, the combined entity will be a joint venture between Vodafone and Idea in the Vodafone case study. Which will account for the under the equity method, controlled by both Aditya Birla Group and Vodafone.

Idea promoters hold the rights to acquire a 9.5% additional stake from Vodafone under the agreed deal to equalize shareholdings over time as per the following proposition

Vodafone: 45.1% – 9.5% = 35.6%

Idea: 26% + 9.5% = 35.6%

Impact of Merger on Telecom Industry

There are also several other implications that this merger of Vodafone case study will bring forth on the telecom industry.

1. Firstly, there can be initiatives based on the renewal of price discipline for the disruptive entry by Jio has caused some serious misbalance

2. Secondly, the poor financial health of the telecom sector can be observed. And through such mergers, there will be an infusion of health and life. Since India is the fastest-growing market in terms of subscriber base .

3. Through the merger, Vodafone and Idea will overcome their debts and a large sum of credit will be infused into the system

4. The deal has also saved both the telecom companies from selling off their business . As was being planned by them initially and this would directly impact the quality of services being provided by different players in the industry

The merger in the Vodafone case study will surely boost the pace of the telecom sector. It has also been found that the savings, synergies and also the spectrum will have a substantial impact on the escalating growth. 

There will be a saving of over 60 per cent of the cost of the operation and this will aid in improving the quality and performance of the service through investments from the saved money.

Enhancement in network infrastructure will be observed while the operational efficiencies have a chance to reach excellence. Moreover, the revenue market share is expected to rise for all the locations and the spectrum of the entity would exceed the initial caps.

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The Legal Lock

MAKING LAW SIMPLE!

Mergers and Acquisitions: Case Study of Vodafone Idea Merger

By: Vaidehi Sharma

Introduction to mergers and acquisition  

‘Mergers and acquisitions’ is a technical term used to define the consolidation of two or more companies. When two companies are combined to form one unit, it is known as a merger, while an acquisition refers to the buying of one company by another one, which means that no new company is formed, only one company has been absorbed into another. Mergers and Acquisitions are an important component of strategic management, which comes under the head of corporate finance. The subject concerns buying, selling, dividing, and combining various companies. It is a  type of restructuring to have rapid growth and increase profitability. 

Mergers and acquisitions are part of the strategic working of any business or working group. It involves the joining of two businesses with the object to increase market share and profits and to have an influential impact on the industry. Mergers and Acquisitions are complicated processes that require preparation, analysis, and deliberation. There are a lot of parties who might be affected by a merger or an acquisition but before a deal is finalized, all parties need to be taken into consideration, their concerns should be addressed, and all possible hurdles that can be avoided must be avoided. 

The term ‘Merger’ has not been defined under the Companies Act, 2013 or  Income Tax Act, 1961 , but as a concept ‘merger’ is a combination of two or more entities into one; with the accumulation of their assets and liabilities, and coming together of the entities into one business. 

The other word for Merger is ‘Amalgamation’. Under The Income Tax Act, 1961  (ITA) ‘amalgamation’ is defined as the merger of one or more entities with another company, or the merger of two or more entities forming one company. It also mentions other conditions to be satisfied for an ‘Amalgamation’ to benefit from the beneficial tax treatment. 

For example -A company called and a company called B merge to form a new company called C . This is called a merger. 

The effect of the merger is that the assets and liabilities of both companies will now be shared and they will cease to exist as independent companies . 

Benefits of Mergers 

⮚ Profit and resource sharing – The resources of both companies are pooled together which increases the profit outcome.

⮚ Access to New Markets – Entering into new markets can be challenging for any company even for established companies. While setting up a subsidiary  or branch is always an option, a merger or acquisition can save companies a  significant amount of time, effort, and money compared to starting from  scratch  

⮚ More Economic Strength and Competitive Edge – mergers and acquisitions mean financial strength for both companies. It can help them to become more powerful in the market, attract more customers and create more resources. 

⮚ Powerful Human Resource -The biggest asset any company can hold is its employees. A skilled and effective stall generates a lot of profit for the company. Therefore in mergers and acquisitions, the human resources of both companies are pooled together. 

⮚ Better infrastructure and Fixed Capital -In mergers and acquisitions the resources of both companies are shared which means access to better infrastructure for the poor company. Big machines and other resources can also be used up for better production. 

Mergers and acquisitions in the telecom industry in India 

Introduction  .

India is currently ranked as the world’s second-largest telecommunications market with more than 1.20 billion subscribers and has shown strong growth in the past one and a half decades. 

The Indian telecom industry is growing at a rapid pace. In 2020-2021 the telecom industry contributed 6% to India’s Gross Domestic Product (GDP). The telecom  sector is set to grow at a Compound Annual Growth Rate (CAGR) of 9.4% from  

2020 to 2025. However, with a CAGR of 15.9% throughout the forecast period, the smartphone industry in India will have the fastest growth. By 2025, India’s digital economy will be worth $ 1 trillion. 

The industry has increased primarily due to favorable regulatory conditions, low prices, increased accessibility, and the introduction of Mobile Number Portability  (MNP), expanding 3G and 4G coverage, and changing subscriber consumption patterns. The deregulation of Foreign Direct Investment (FDI) rules has made the telecom sector one of the fastest-growing sectors in the country and a huge means of employment opportunity generator in the country too.

The subsectors of the telecommunication sector include infrastructure, equipment,  Mobile Virtual Network Operators (MNVO), white space spectrum, 5G, telephone service providers, and broadband. 

It is predicted that 5G technology will boost the Indian economy by $ 450 Bn between 2023 and 2040. According to the Global System for Mobile  Communications (GSMA), there is an excellent opportunity for investment in this sector as India will have almost one billion installed smartphones by 2025 and 920  million unique mobile customers, including 88 million 5G connections. 

Importance of the telecom industry  

The importance of the telecommunication industry is highlighted by the fact that it enables global communication. The relevance of this industry has increased significantly after the pandemic. Services offered by this industry are more frequently used since it allows for a continued virtual connection. The smartphone market will continue to increase as more people are expected to purchase them in the coming years. Given that government reforms have eliminated ambiguity and risks and established a stable investment environment, India’s telecom sector is projected to receive investments totaling $ 25.2 Bn over the next two years. 

Mergers and acquisitions in the telecom industry  

The recent trend of mergers and acquisitions can be widely seen in the telecom sector too. This recent trend in the world of the telecommunications market has been caused by the ongoing regulatory liberalization and privatization of the industry.  These changes have brought about fierce competition and ensuing decreases in profit in both the domestic and international telecommunications service markets. 

Mergers and acquisitions in the telecom sector are considered to be horizontal mergers because both companies deal in the same line of business. In the majority of developed and developing countries, mergers and acquisitions in the telecommunications sector have increased which also resulted in the creation of jobs. 

The legal Framework of Mergers and Acquisitions in the telecom sector  

• ⮚ National Telecom Policy formed in 2012 hasimplifiedde M&A in Telecom  Service Sect, ensuring adequate competition and allowing  100% FDI.
• ⮚ The merger in the case of licenses shall be done for the respective service category. Access to service license allows the provision of internet service and so the merger of ISP license with services license shall also be  
• permitted. 
• ⮚ In a service area, the market share of the merged entity should not be more than 50%. If it is more, it has to reduce it below 50% in an annum. 
• ⮚ The total spectrum held by the merged entity should not be more than 50%  in a service area. If it is excess, it has to be surrendered within an annum. 
• ⮚ The corporation which acquires will have to pay the difference between the market price determined in the auction & the administrative price if an acquired company has got spectrum after paying the administrative price. 
• ⮚ If due to a merger or transfer of license in any service area business,  corporation or entity becomes an important market power, then TRAI’s  Telecommunication Act of the year 2002 will come into place. 

Case study – Merger of Vodafone and Idea 

History of both the companies  , history of the merger  .

In March 2017, it was announced that Idea Cellular and Vodafone India would merge. The merger got approval from the Department of Telecommunications in July 2018. On 30 August 2018, National Company Law Tribunal gave the final nod to the Vodafone-Idea merger. It was completed on 31 August 2018, and the new entity was named Vodafone Idea Limited. Under the terms of the deal, the  

Vodafone Group held a 45.2% stake in the combined entity, the Aditya Birla  Group held 26% and the remaining shares were to be held by the public. 

Reasons for Merger of Vodafone and Idea   

Dominance over the market by JIO- The main reason for the merger of Vodafone and the idea was the dominance of the Jio company. The companies saw a major downfall as Jio announced free internet services for the first 6 months. As a result price war began between companies. the companies began to see losses, and as a result, a merger between Vodafone and Idea happened. 

Key takeaways  

• ⮚ Under the plan submitted to Indian regulators, Vodafone will initially hold a  50 0% stake in the combined entity, while the Aditya Birla Group and public shareholders will hold 21.1% and 28.9%, respectively. Vodafone will then divest a 4.9% stake to the Aditya Birla Group, which would increase the latter’s stake from 21.1% to 26%, thus crossing the threshold for an open offer. 
• ⮚ Vodafone and Idea had individual spectrum holdings of 411 MHz and 316  MHz respectively. The amalgamation of the companies would give, it was expected, the merged company a hold of 728 Mhz increasing the chances of the merged company to rank number one or two in India. 
• ⮚ The merger ratio was 1:1. This ratio was based on the price of Idea at 72.5  per unit. Implied enterprise value for Idea and Vodafone was INR 72  thousand crores and INR 82 thousand and 8 hundred crores respectively.  The agreement had a break fee of Rs 3,300 crore payable upon certain conditions. 
• ⮚ Aditya Birla also has the right to acquire up to 9.5% additional shareholding from Vodafone Group throughout three years post-closure of the deal for an agreed price of INR 130 per share. But these rights by Aditya Group will be exercised based on the growth achieved and the market price of the combined entity .
• ⮚ Idea and Vodafone will have joint control over the appointment of CEO and  COO, the exclusive rights to appoint a CFO is with Vodafone. So Vodafone is not just a major shareholder but also has more financial rights. 
• ⮚ If at the end of 3 years, Aditya Birla Group fails to purchase any stakeout of the additional stake of 9.5%, then they will be given the last opportunity to purchase the stake at the prevailing market price for share equalization. 
• ⮚ Vodafone contributed net debt of Rs 55,200 crore to the merged entity,  whereas Idea contributed Rs. 52,700 crore. Vodafone contributed net debt of Rs. 2,500 crore more than Idea . 
• ⮚ In September 2020, Vodafone – Idea rebranded itself. The company used the initials to rebrand itself as ‘Vi’. The rebranding took place after almost two years of the merger, however, it shows the spirit of integration. 
• ⮚ In the financial year 2022, Vodafone Idea Limited earned revenue of 386.5  billion Indian rupees.

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