Opinion Why the SC is right about Vodafone

The tax dispute in the Vodafone case was described by Chief Justice Kapadia in Para 2 of his judgment,in the following words:

‘‘2. This matter concerns a tax dispute involving the Vodafone Group with the Indian Tax Authorities [hereinafter referred to for short as “the Revenue”,in relation to the acquisition by Vodafone International Holdings BV [for short “VIH”,a company resident for tax purposes in the Netherlands,of the entire share capital of CGP Investments (Holdings) Ltd. [for short “CGP”,a company resident for tax purposes in the Cayman Islands [“CI” for short vide transaction dated 11.02.2007,whose stated aim,according to the Revenue,was “acquisition of 67% controlling interest in HEL”,being a company resident for tax purposes in India.”

Under the Income Tax Act,only the income which accrues or arises in India alone can be taxed. In the Vodafone case,the question related to tax on capital gains and the two sections of the Income Tax Act which were relevant are Section 45 and Section 9.

Section 45 of the Income Tax Act provides for Income Tax on capital gains and describes the tax in the following terms:

“45 (1) Any profits or gains arising from the transfer of a capital asset effected in the previous year shall,save as otherwise provided in sections… be chargeable to income-tax under the head “capital gains” and shall be deemed to be the income of the previous year in which the transfer took place.”

When such profits and gains arising from the transfer of a capital asset would be deemed to accrue or arise in India,so as to become liable to tax by the tax authorities in India,has been dealt with in Section 9 (1) (i) in the following words.

“9(1) The following incomes shall be deemed to accrue or arise in India :

(i) 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 any asset or source of income in India or through the transfer of a capital asset situate in India.”

As seen above,the capital assets transferred were the entire shareholding of CGP Investments (Holding) Ltd.,a foreign company resident in Cayman Island,incorporated on January 12,1998. The capital assets were purchased by another foreign company resident in Netherlands,namely Vodafone International Holdings BV.

Even the tax authorities accepted that this shareholding could not be regarded as a capital asset in India under Section 9. In fact,the Supreme Court bench rightly dealt with Section 9 in Para 257 (judgment) in the following words:

“257. Section 9 on a plain reading would show it refers to a property that yields an income and that property should have the situs in India and it is the income that arises through or from that property which is taxable. Section 9,therefore,covers only income arising from a transfer of a capital asset situated in India and it does not purport to cover income arising from the indirect transfer of capital asset in India.”

The high court in its judgment and Prashant Bhushan in his article have however,argued that as the object of the transaction was to get indirect control on the Indian company,the Courts should regard the transaction as a device to avoid paying capital gains tax amounting to Rs 12,000 crore and it should have been regarded as the transfer of the shares of the Indian subsidiary company namely HEL. This reasoning is totally fallacious and has no support in law.

The corporate structure of the Hutchison Group and the incorporation of the holding company C.G.P. in 1998 was clearly not for the purpose of this transaction of 2007,and could not possibly be regarded as a device for avoiding capital gains tax on their transaction of 2007. In this connection it is also useful to note that both the transferor,the Hutchison Group and the transferee,the Vodafone group have been paying full taxes on the operation of their venture in India and,as stated by Chief Justice Kapadia in Para 91 of his judgment,have paid an amount of Rs 20242 crore by way of direct and indirect taxes during the eight years from 2002-03 to 2010-11.

It is clear from the Supreme Court judgment that they correctly understood the judgment of the Constitution Bench in the McDowell case as the relevant passages from their judgment extracted below would show:

“64. The majority judgment in McDowell held that “tax planning may be legitimate provided it is within the framework of law” (Para 45). In the latter part of Para 45,it held that “colourable device cannot be a part of tax planning and it is wrong to encourage the belief that it is honourable to avoid payment of tax by resorting to dubious methods”. It is the obligation of every citizen to pay the taxes without resorting to subterfuges. The above observations should be read with Para 46 where the majority holds “on this aspect one of us,Chinnappa Reddy,J. has proposed a separate opinion with which we agree”. The words “this aspect” express the majority’s agreement with the judgment of Reddy,J. only in relation to tax evasion through the use of colourable devices and by resorting to dubious methods and subterfuges. Thus,it cannot be said that all tax planning is illegal/illegitimate/impermissible. Moreover,Reddy,J. himself says that he agrees with the majority. In the judgment of Reddy,J. there are repeated references to schemes and devices in contradistinction to “legitimate avoidance of tax liability” (Paras 7-10,17 & 18). In our view,although Chinnappa Reddy,J. makes a number of observations regarding the need to depart from the “Westminster” and tax avoidance — these are clearly only in the context of artificial and colourable devices. Reading McDowell,in the manner indicated hereinabove,in cases of treaty shopping and/or tax avoidance,there is no conflict between McDowell and Azadi Bachao or between McDowell and Mathuram Agrawal.

214. One of the tests to examine the genuineness of the structure is the “timing test”,that is,timing of the incorporation of the entities or transfer of shares etc. Structures created for genuine business reasons are those which are generally created or investment is made,at the time where further investments are being made at the time of consolidation etc.”

On the facts of the Vodafone case,however,the Supreme Court reached the only possible conclusion as contained in pr. 163 and 268 of the judgment which are extracted below:

“163. Voting arrangements in SHAs or pooling agreements are not “property”. Contracts that provide for voting in favour of or against a resolution or acting in support of another shareholder create only “contractual obligations”. A contract that creates contractual rights thereby,the owner of the share (and the owner of the right to vote) agrees to vote in a particular manner does not decouple the right to vote from the share and assign it to another. A contract that is entered into to provide voting in favour of or against the resolution or acting in support of another shareholder,as we have already noted,creates contractual obligation. Entering into any such contract constitutes an assertion (and not an assignment) of the right to vote for the reason that by entering into the contract: (a) the owner of the share asserts that he has a right to vote; (b) he agrees that he is free to vote as per his will; and (c) he contractually agrees that he will vote in a particular manner. Once the owner of a share agrees to vote in a particular manner,that itself would not determine as a property.

268. Section 9(1)(i),therefore,in our considered opinion,will not apply to the transaction in question or on the rights and entitlements,stated to have transferred,as a fall out of the sale of CGP share,since the Revenue has failed to establish both the tests,Resident Test as well the Source Test.”

Before concluding,I would also like to make a brief mention to a writ petition which was filed in the Supreme Court asserting that Chief Justice Kapadia should have recused himself from hearing the Vodafone case. In my opinion there could not be a more atrocious suggestion. The law of recusal is well settled. If there are facts,on which a reasonable person could conclude that a judge may not be able to dispense dispassionate justice in a particular case,the judge should recuse himself. The relevant facts are now in the public domain. It is crystal clear that on these facts,no reasonable person could have concluded that Chief Justice Kapadia would not dispassionately hear and decide the Vodafone tax case. The writ petition,in my view,was totally unjustified and has been rightly dismissed by a bench of Justice Aftab Alam.

The writer is a senior advocate in the Supreme Court and a former Union law minister