Vodafone Case & Related Provisions

First of all we should know what this Vodafone case was and what the​​ point of contention was.​​ Vodafone International Holdings B.V (Vodafone or VIH), a Dutch entity, had acquired 100 per cent shares in CGP Limited (CGP), a Cayman Islands company from Hutchinson Telecommunications International Limited (HTIL). The actual purpose of acquiring CGP was to control the business of Hutchison Essar Limited (HEL, a joint venture between Hutchinson and Essar Group), an Indian Company, engaged in the business of providing cellular telephony services in different Parts (Circles) in India​​ as CGP controlled 67% of the HEL through various intermediate companies/subsidiary companies/contractual arrangements. By Acquiring shares through this route the Vodafone India (HEL) avoided the capital gains tax by taking the benefit of section 9(1)(i) because till that time indirect transfer of indian assets by two Non-Resident were not covered hence the Central Government amended the Act retrospectively to avoid any future transactions of such type to cover indirect transfer as well.

The main points of​​ dispute were: -

• Does sale of shares by HTIL to Vodafone resulted in capital gains liable for tax in India?

• Does this transaction require deduction of tax at source by Vodafone on payment to HTIL?

In September 2007, the tax department issued a show-cause notice u/s 201 to Vodafone to explain why tax was not withheld on payments made to HTIL in relation to the above transaction and why it should not be treated as Assessee in default for not deducting tax u/s 195. The tax department contended that the transaction of transfer of shares in CGP had the effect of indirect transfer of assets situated in India and hence liable for capital gains tax. Vodafone filed a writ petition in Bombay High Court challenging the legal validity of the show cause notice.​​ 

Bombay High Court dismissed the writ petition of the Vodafone, that transaction was sale of shares of CGP Limited, a company registered in Cayman Island only, on the ground that it was camouflage to acquire the controlling stake in the business of HEL situated in India (and that is the main purpose of this transaction) and therefore would certainly be subject to Indian Income Tax Act, 1961. It was held that the income is deemed to accrue or arisen in India falling within the preview of section 9 of the Income Tax Act, 1961 and hence chargeable to tax as capital gains tax.

Later on Vodafone filed the review petition in Supreme Court and by reversing the order of the Bombay High Court, Supreme Court held that

Lack of proper regulatory laws, leads to uncertainty and passing inconsistent orders by Courts, Tribunals and other forums, putting Revenue and taxpayers at bay. It is often said that insufficient legislation in the countries where offshore financial centres operate gives opportunities for money laundering, tax evasion etc. and, hence, it is imperative that Indian Parliament would address all these issues with utmost urgency. Direct Tax Code Bill (DTC) 2010, proposed in India, envisages creation of an economically efficient, effective direct tax system, proposing GAAR. GAAR intends to prevent tax avoidance, what is inequitable and undesirable.

To mitigate the effect of this order the Government of India retrospectively amended the Income Tax Act, 1961 to cover these types of transactions. The Finance Act, 2012 amended the following sections

• Section 2(47) to amend the definition of Transfer by adding​​ 

Explanation 2.—For the removal of doubts, it is hereby clarified that "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 has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India;

• Section 2(14) to amend the definition of capital asset by adding

“Explanation.—For the removal of doubts, it is hereby clarified that "property" includes and shall be deemed to have always included​​ any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever;”

• Deemed income definition u/s 9

• Explanation 4.—For the removal of doubts, it is hereby clarified that the expression​​ "through" shall mean and include and shall be deemed to have always meant and included "by means of", "in​​ consequence of" or "by reason of".

• Explanation 5.—For the removal of doubts, it is hereby clarified that​​ 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:

A number of representations have been received by the Board stating that the purpose of​​ introduction of Explanation 5 was to clarify the legislative intent regarding the taxation of income accruing or arising through transfer of a capital asset situate in India. Apprehensions have been expressed about the applicability of the Explanation to the transactions not resulting in any transfer, directly or indirectly of assets situated in India.​​ It has been pointed out that such an extended application of the provisions of the Explanation may result in taxation of dividend income declared by a foreign company outside India. This may cause unintended double taxation and would be contrary to the generally accepted principles of source rule as well as the object and purpose of the amendment made by the Finance Act 2012.

The Explanatory Memorandum clearly​​ provides that the amendment of section 9(l)(i) was to reiterate the legislative intent in respect of taxability of gains having economic nexus with India irrespective of the mode of realisation of such gains. Thus the amendment sought to clarify the source rule of taxation in respect of income arising from indirect transfer of assets situated in India as explicitly mentioned in the Explanatory Memorandum. Viewed in this context, Explanation 5 would be applicable in relation to deeming any income arising outside India from any transaction in respect of any share or interest in a foreign company or entity, which has the effect of transferring, directly or indirectly, the underlying assets located in lndia, as income accruing or arising in India.

Declaration of dividend by such a foreign company outside India does not have the effect of transfer of any underlying assets located in India. It is therefore, clarified that the dividends declared and paid by a foreign company outside India in respect of shares which​​ derive their value substantially from assets situated in India would not be deemed to be income accruing or arising in India by virtue of the provisions of Explanation 5 to section 9( I ) (i) of the Act.

Explanation 6.—For the purposes of this clause, it​​ is hereby declared that—

• • the share or interest, referred to in​​ Explanation 5, shall be deemed to derive​​ its value substantially from the assets​​ (whether tangible or intangible) located in India, if, on the specified date, the value of such assets—

• • exceeds​​ the amount of ten crore rupees;​​ and

  • represents at least fifty per cent of the value of all the assets owned by the company or entity, as the case may be;

• • the value of an asset shall be the fair market value as on the specified date, of such asset without reduction of liabilities, if any, in respect of the asset, determined in such manner as may be prescribed;

  • "accounting period" means each period of twelve months ending with the 31st day of March:

Provided​​ that where a company or an entity, referred to in​​ Explanation 5, regularly adopts a period of twelve months ending on a day other than the 31st day of March for the purpose of—

• • complying with the provisions of the tax laws of the territory, of which it is a resident, for tax purposes; or

  • reporting to persons holding the share or interest,​​ 

then, the period of twelve months ending with the other day shall be the accounting period of the company or, as the case may be, the entity:

Provided further​​ that the first accounting period of the company or, as the case may be, the entity shall begin from the date of its registration or incorporation and end with the 31st day of March or such other day, as the case may be, following the date of such registration or incorporation, and the later accounting period shall be​​ the successive periods of twelve months:

Provided also​​ that if the company or the entity ceases to exist before the end of accounting period, as aforesaid, then, the accounting period shall end immediately before the company or, as the case may be, the entity, ceases to exist;

• • "specified date" means the—

• • date on which the accounting period of the company or, as the case may be, the entity ends preceding the date of transfer of a share or an interest; or

  • date of transfer, if the book value of the assets of​​ the company or, as the case may be, the entity on the date of transfer exceeds the book value of the assets as on the date referred to in sub-clause (i), by fifteen per cent.

Explanation 7— For the purposes of this clause,—

• no income shall be deemed to​​ accrue or arise to a non-resident from transfer, outside India, of any share of, or interest in, a company or an entity, registered or incorporated outside India, referred to in the​​ Explanation 5,—

• • if such company or entity directly owns the assets situated in India and the transferor (whether individually or along with its associated enterprises), at any time in the twelve months preceding the date of transfer,​​ neither holds the right of management or control in relation to such company or entity, nor holds voting power or share capital or interest exceeding five per cent of the total voting power or total share capital or total interest, as the case may be, of such company or entity; or

  • if such company or entity indirectly owns the assets situated in India​​ and the transferor (whether individually or along with its associated enterprises), at any time in the twelve months preceding the date of transfer, neither holds the right of management or control in relation to such company or entity, nor holds any right in, or in relation to, such company or entity which would entitle him to the right of management or control in the company or entity that directly owns the assets situated in India, nor holds such percentage of voting power or share capital or interest in such company or entity which results in holding of (either individually or along with associated enterprises) a voting power or share capital or interest​​ exceeding five per cent of the total voting power or total share capital or total interest, as the case may be, of the company or entity that directly owns the assets situated in India;

• in a case where​​ all the assets owned, directly or indirectly, by a company or, as the case may be, an entity referred to in the​​ Explanation 5,​​ are not located in India, the income of the non-resident transferor, from transfer outside India of a share of, or interest in, such company or entity, deemed to accrue or arise in India under this clause, shall be only such part of the income​​ as is reasonably attributable​​ to assets​​ located in India and determined in such manner as may be prescribed;

• "associated enterprise" shall have the meaning assigned to it in​​ section 92A;

AMALGAMATION AND​​ DEMERGER-------- EXEMPTED IF FALLS WITHIN THE PREVIEW OF SECTION 47(viab) and 47(vicc)

(viab) any transfer, in a scheme of amalgamation, of a capital asset, being a share of a foreign company, referred to in the​​ Explanation 5​​ to clause (i) of sub-section (1) of​​ section 9, which derives, directly or indirectly, its value substantially from the share or shares of an Indian company, held by the amalgamating foreign company to the amalgamated foreign company, if—

• at least twenty-five per cent of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company; and

• such transfer does not attract tax on capital gains in the​​ country in which the amalgamating company is incorporated;

(vicc) any transfer in a demerger, of a capital asset, being a share of a foreign company, referred to in the​​ Explanation 5​​ to clause (i) of sub-section (1) of​​ section 9, which derives, directly or indirectly, its value substantially from the share or shares of an Indian company, held by the demerged foreign company to the resulting foreign company, if—

• the shareholders, holding not less than three-fourths in value of the shares of the demerged foreign company, continue to remain shareholders of the resulting foreign company; and

• such transfer does not attract tax on capital gains in the country in which the demerged foreign company is incorporated:

Provided​​ that the provisions of sections 391 to 394 of the Companies Act, 1956 (1 of 1956) shall not apply in case of demergers referred to in this clause;

Government of India has put an obligation on Indian Company relating to reporting of certain information to Income Tax Authority and w.e.f. 1st​​ Day of April a new section 285A has been inserted after section 285 of the Income-tax Act, namely:—

"285A.​​ Furnishing of information or documents by an Indian concern in certain cases.—Where any share of, or interest in, a company or an entity registered or incorporated outside India derives, directly or indirectly, its value substantially from the assets located in India, as referred to in​​ Explanation 5​​ to clause (i) of​​ sub-section (1) of section 9, and such company or, as the case may be, entity, holds, directly or indirectly, such assets in India through, or in, an Indian concern, then, such Indian concern shall, for the purposes of determination of any income accruing​​ or arising in India under clause (i) of sub-section (1) of section 9, furnish within the prescribed period to the prescribed income-tax authority the information or documents, in such manner, as may be prescribed.".