The tax aviodance debate - V Venkatesan - from The FrontLine

The Supreme Court judgment in the Vodafone case, which has come under scrutiny, brings to the fore the issue of tax avoidance.
PTI

Installing the Vodafone logo at the company's office in Mumbai in September 2007, after the deal with Hutchison Essar was completed.

“We now live in a welfare state whose financial needs, if backed by the law, have to be respected and met. We must recognise that there is behind taxation laws as much moral sanction as behind any other welfare legislation and it is a pretence to say that avoidance of taxation is not unethical and that it stands on no less moral plane than honest payment of taxation.... It is neither fair nor desirable to expect the legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and... to avoid the devices for what they really are and to refuse to give judicial benediction.”

– Supreme Court Judge O. Chinnappa Reddy in McDowell and Company Limited vs Commercial Tax Officer (1985).

TAX revenues are an indispensable source of funding a government's development initiatives in an era in which governments often lament the lack of resources to secure for all citizens the right to an adequate means of livelihood and to minimise the inequalities in income.

Therefore, when individuals and companies resort to the use of illegitimate devices to avoid tax and find the political and legal climate conducive to that, it ought to arouse the nation's social conscience if only because plugging loopholes in tax collection cannot be left entirely to the executive and the legislature.

When the government understands its commitment to collect legitimate taxes but is not successful in convincing the judiciary to endorse it, it should mean a serious institutional failure on the part of the judiciary to safeguard the constitutional philosophy.

The Supreme Court's judgment in the Vodafone case, delivered on January 20, is an instance of such failure. Put simply, here was an unprecedented tax demand by the income tax authorities on Vodafone (to the tune of Rs.11,000 crore), on the basis of an equally unprecedented transaction between Vodafone and Hutch, with a clear nexus to the sale of the latter's assets in India.

As happens in any case, two legal views are certainly possible over whether the Indian tax authorities have jurisdiction to tax Vodafone for the transaction. The Bombay High Court had ruled in 2010 that the Income Tax Department had jurisdiction to tax Vodafone. The Supreme Court's judgment on January 20 set that aside, giving huge relief to Vodafone. The question being asked in legal circles is, if two equally valid but conflicting legal interpretations are possible, why not adopt the one that could help the government earn the requisite tax revenues rather than the one that has the potential to weaken governance and leave the citizens to the mercy of market forces.

It is possible to suggest, as some tax lawyers who defend Vodafone have done, that the law does not change if the tax demand is a large amount. But in the same breath, some of them suggest that if the Vodafone case had a tax implication of just Rs.10 crore, the case would have been over before the Income Tax Appellate Tribunal itself and would not have engaged the valuable time of the High Court and the Supreme Court.

It is precisely for this reason that it needs to be asked why Vodafone did not first approach the Tribunal for redress. As the stakes are high, both the transaction and the manner in which the judiciary understood and interpreted the issue are bound to come under intense scrutiny. And because it has huge implications (and possible setbacks for the I.T. Department in future) for similar tax demands involving foreign transactions with nexus to India, experts anticipate revenue losses to the Central government running into more than Rs.1 lakh crore.

This is not to suggest that the Supreme Court's judgment is scandalous; far from it. The government's advocates who argued the case before the Supreme Court and independent lawyers like Prashant Bhushan have refrained from calling it so. By convention, apex court rulings carry huge respect even among those disagreeing with them. Yet, it is essential to subject the Supreme Court's judgment to serious and well-informed criticism if only to prepare the ground for its review.

Put in this context, Justice O. Chinnappa Reddy's observations in the McDowell case, quoted above – delivered six years before the beginning of the era of liberalisation and economic reforms in 1991 – are prescient. Clearly, Justice Chinnappa Reddy envisaged a proactive role for the judiciary to see through the fraudulent tax avoidance devices employed by taxpayers at the cost of social justice.

Now in his nineties, Justice Chinnappa Reddy must be ruing the manner in which the Supreme Court misinterpreted twice (the first time in 2003 in the Azadi Bachao case and now in the Vodafone case) in the past 10 years his holding on how the court should be smart enough to expose the legal devices that companies adopt to avoid paying tax.

Justice Chinnappa Reddy was judge of the Supreme Court from 1978 to 1987, and was among the most distinguished members of the judiciary. His decision in the McDowell case was one of the most admired judgments on tax evasion.

McDowell case

McDowell was a licensed manufacturer of liquor in Hyderabad. The company had failed to disclose the excise duty paid on liquor sold by it to wholesalers. The taxing authority, through a notice, called upon the company to show cause why assessments made should not be reopened. The company challenged the validity of this notice and argued that the excise duty paid by the buyer did not become a part of the company's turnover.

The five-judge Constitution Bench dismissed McDowell's appeal through two judgments: one by four judges and another concurring, detailed and separate judgment by Justice Chinnappa Reddy.

Justice Ranganath Misra, on behalf of himself and three other judges on the Bench, namely, Chief Justice Y.V. Chandrachud and Justices D.A. Desai, and E.S. Venkataramiah, held as follows:

“Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.”

Following this holding, the Bench said in Paragraph 27:

GURINDER OSAN/AP

FEBRUARY 14, 2007: Vodafone chief executive officer Arun Sarin, right, and Hutchison Essar CEO Asim Ghosh at a press conference in New Delhi after Britain's Vodafone Group PLC had agreed to buy a 67 per cent controlling interest in Hutchison Essar Ltd for $11.1 billion.

“On this aspect one of us, Chinnappa Reddy, J., has proposed a separate and detailed opinion with which we agree.”

The above sentence became the bone of contention in arriving at the ratio of the McDowell case. Did the four judges agree entirely with Justice Chinnappa Reddy, or only with regard to his observations against the use of colourable devices to avoid payment of tax? The Supreme Court has held in the Vodafone case that the ratio of McDowell is that the four judges agreed with Justice Chinnappa Reddy only in the context of use of colourable devices to avoid payment of tax. Justice Chinnappa Reddy, however, in his separate opinion, has clearly underlined the need to depart from the “Westminster” principle and tax avoidance.

According to this British principle (laid down in Inland Revenue Commissioners vs Duke of Westminster, 1936), every man is entitled if he can to order his affairs so as to diminish the burden of tax. Justice Chinnappa Reddy held that the principle of Westminster had been given a decent burial and in that very country where the phrase ‘ tax avoidance' originated, the judicial attitude towards tax avoidance had changed and the smile, cynical or even affectionate though it might have been at one time, had now frozen into a deep frown. No one could now get away with a tax avoidance project with the mere statement that there was nothing illegal about it, he had said.

In the Vodafone case decided by the Supreme Court's three-judge Bench on January 20, the McDowell ghost returned to haunt the judiciary. The Bench comprised of Chief Justice of India S.H. Kapadia and Justices Swatanter Kumar and K.S. Radhakrishnan. In two separate judgments (Chief Justice Kapadia and Justice Swatanter Kumar delivering one and Justice Radhakrishnan authoring the second), the Bench set aside the Bombay High Court judgment in the Vodafone case.

Vodafone case

Briefly, the case concerns a tax dispute between the Vodafone Group and the Income Tax Department (hereafter referred to as Revenue) over the acquisition by Vodafone International Holdings BV (VIH), a company resident for tax purposes in the Netherlands, of the entire share capital of CGP Investments (Holdings) Ltd. (CGP), a company resident for tax purposes in the Cayman Islands on February 11, 2007.

According to Revenue, the aim of this transaction was to acquire 67 per cent controlling interest in Hutchison Essar Limited (HEL), a company resident in India. Revenue, therefore, sought to tax capital gains, arising from the sale of the share capital of CGP on the basis that CGP, while not a tax resident in India, holds the underlying Indian assets. The tax demand was a whopping Rs.11.000 crore.

VIH, on the contrary, argued that it acquired companies which, in turn, controlled a 67 per cent interest but not controlling interest, in HEL. Further, VIH contended that CGP held indirectly through other companies 52 per cent shareholding interest in HEL as well as Options to acquire a further 15 per cent shareholding interest in HEL, subject to relaxation of foreign direct investment (FDI) norms.

High Court verdict

The Bombay High Court Bench comprising Justices Dr D.Y. Chandrachud and J.P. Devadhar on September 8, 2010, upheld the Central government's contention that the Vodafone-Hutch transaction had a significant nexus with India. Once the nexus is established, income tax may extend to that person in respect of his foreign income, the Bench said. Such a nexus can be based on residence or business connection within the taxing state or the situation within the state of an asset or source of income from which the taxable income is derived, the Bench explained.

“Even though the revenue laws of a country may not be enforceable in another, that does not imply that the courts of a country shall not enforce the law against the residents of another within their own territories,” the High Court Bench held.

While concluding so, the High Court simply relied on the perception of Hutchison Telecommunication International Ltd. (HTIL), Cayman Islands, which had its shareholdings in HEL in terms of HTIL's Annual Report for 2007. The High Court found that for HTIL the transaction represented a discontinuation of its operations in India (paragraph 123).

In paragraph 124, the High Court went into the nature of the transaction from the perspective of how VIH BV looked at the events that led to the sale-purchase agreement dated February 11, 2007. The Bench then went on to analyse the relevant documents.

In paragraph 132, it concluded that it would be simplistic to assume that the entire transaction between HTIL and VIH BV was fulfilled merely upon the transfer of a single share of CGP in the Cayman Islands. “The commercial and business understanding between the parties postulated that what was being transferred from HTIL to VIH BV was the controlling interest in HEL…. HEL was at all times intended to be the target company and a transfer of the controlling interest in HEL was the purpose which was achieved by the transaction,” the Bench noted.

More important, the High Court Bench also relied on the due diligence report of Ernst & Young to emphasise that the object and intent of the parties was to achieve the transfer of control over HEL. The transfer of the solitary share of CGP, a Cayman Islands company, was put into place subsequently at the behest of HTIL as a mode of effectuating the goal.

In paragraph 134, the High Court was very specific: “The transactional documents are not merely incidental or consequential to the transfer of the CGP share, but recognised independently the rights and entitlements of HTIL in relation to the Indian business which were being transferred to VIH BV.”

In paragraph 135, the High Court further noted: “The transaction between VIH BV and HTIL was a composite transaction which covered a complex web of structures and arrangements, not referable to the transfer of one share of an upstream overseas company alone. The transfer of that one share alone would not have been sufficient to consummate the transaction.”

In the Supreme Court

Unfortunately, the Supreme Court found no merit in the High Court's findings. In order to rebut these findings, the Supreme Court resorted to an academic discussion on why this case concerns “a share sale” rather than an “asset sale”.

The Supreme Court's judgment favours a “look at” test in which Revenue looks at the entire Hutchison structure as it existed, holistically, and not adopt a dissecting approach. In other words, Revenue should not ask whether the transaction is a tax deferment/saving device, but apply the “look at” test to ascertain its true legal nature.

The court then stretched this “look at” test to be applied to every strategic FDI coming to India, as an investment destination, in a holistic manner. While doing so, it said, Revenue/courts should keep in mind six factors, namely, the concept of participation in investment; the duration of time during which the Holding Structure exists; the period of business operations in India; the generation of taxable revenues in India; the timing of the exit; and the continuity of business on such exit. The onus is on Revenue to identify the scheme and its dominant purpose, it said.

The Supreme Court frowned upon the High Court's “look through” test because, it claimed, it was inconsistent with tax policy certainty, which was crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner.

While examining the question whether the Supreme Court must have chosen the “dissecting/look through test” of the High Court rather than the “look at” test, a return to the question of the ratio of the McDowell judgment is imperative. Delivered as part of the five-judge Constitution Bench, Justice Chinnappa Reddy's separate but concurring judgment in that case must have been considered binding on Supreme Court Benches comprising fewer than five judges.

Azadi Bachao case

In 2003, in the Azadi Bachao Andolan case, a two-judge Bench of the Supreme Court upheld the government's appeal against the Delhi High Court judgment quashing Circular No.789 of April 13, 2000. This circular stated that the Mauritius Tax Residency Certificate issued by the Mauritius Tax Office was a sufficient evidence for accepting the status of residence and beneficial ownership for applying the Convention on the Avoidance of Double Taxation between India and Mauritius executed on April 1, 1983.

The then National Democratic Alliance (NDA) government had issued the circular because the tax authorities in India had issued notices to some shell companies incorporated in Mauritius with the purpose to invest funds in India. But these companies were controlled and managed from countries other than India and Mauritius. The circular was ostensibly aimed at instilling confidence among foreign investors who used the Mauritius route.

In the Vodafone case, the Central government submitted before the Supreme Court that the two-judge Bench wrongly decided the Azadi case. The government continues to insist that Circular No.789 is legally valid. But it is unhappy that the Bench in the Azadi case applied the McDowell ratio incorrectly while restoring the circular.

The McDowell ratio is that artificial tax avoidance devices must be brought within the tax net. Both the Azadi and Vodafone Benches of the Supreme Court, however, interpreted the ratio to mean that only colourable tax avoidance devices could be brought within the tax net. If the tax authorities try to prove precisely that a particular device is colourable by adopting a “look through” test, the effort fails as in the Vodafone case. Therefore, there is considerable force in the Central government's plea that the Supreme Court decided wrongly the Azadi and Vodafone cases by its flawed interpretation of the McDowell ratio. If a device is apparently meant to avoid tax, then it should be brought under the tax net no matter whether it is colourable or not.

There is one more reason to worry about the Supreme Court's judgment in the Vodafone case. The court has held that the offshore transaction is a bona fide structured FDI investment into India which fell outside India's territorial tax jurisdiction and was hence not taxable.

In its review petition filed before the Supreme Court, the Central government pointed out that the Vodafone transaction did not involve any inflow of monies into India because the sale consideration was paid outside India and therefore was not a case of FDI into India at all. The government has pointed out that the court failed to appreciate that the FDI policy of the Government of India was unrelated to the instant case because it did not involve any investment or inflow of money into India. The government made it clear that its FDI policy and the interpretation of taxation statutes operate in two different realms.

Whatever the outcome of this review petition in the Supreme Court, the Vodafone judgment, with its myriad aspects, will have a profound influence on Indian tax jurisprudence.

It makes sense to conclude with what Justice Chinnappa Reddy said in the McDowell judgment: “There is the sense of injustice and inequality which tax avoidance arouses in the breasts of those who are unwilling or unable to profit by it…. Last but not the least is the ethics (to be precise, the lack of it) of transferring the burden of tax liability to the shoulders of the guileless good citizens from those of ‘artful dodgers'.”

To the defenders of the Vodafone-Hutch deal, these observations of Justice Chinnappa Reddy may appear to be totally unnecessary to decide the facts of the McDowell case. To many, however, he had the foresight to anticipate that tax avoidance could take ingenious forms, and that it was unfair to accord it any legitimacy.'via Blog this'

Of judges and their philosophies - From The Frontline

Of judges and their philosophies:

V. VENKATESAN
Interview with Prof. Mohan Gopal, director, Rajiv Gandhi Institute for Contemporary Studies, New Delhi.



PROFESSOR Mohan Gopal, director of the Rajiv Gandhi Institute for Contemporary Studies, (RGICS), New Delhi, is concerned about the implications of the Vodafone judgment for governance. He is well known for his scholarship in constitutional, and his previous tenures, as the head of the National Law School, Bangalore, and the National Judicial Academy, Bhopal, have been inspiring to both students and practitioners of law. Excerpts from an interview he gave Frontline:

What, according to you, are the legal flaws in the Vodafone judgment?

The issue is not whether the judgment is legally flawed. A sound legal argument can be canvassed in support of the two opposing contentions in this case – as is seen in the quite brilliant judgment of Justice Dhananjay Chandrachud in the Bombay High Court on the one hand, and in the erudite, succinct and tightly reasoned judgment of the Chief Justice of India on the other – both excellent judgments although they reach opposite conclusions.

What distinguishes the two judgments is in fact the bona fide differences in judicial approaches of the two judges as individuals, not the state of the law or the facts of the case. Justice Chandrachud's judgment is acutely concerned about judicial deference to the legislature in a democracy. He writes:

“Judicial doctrine which is designedly intended by the Constitution to be isolated from the rough and tumble of democratic accountability to electoral colleges must, therefore, be structured so as not to intrude upon the field of legislative policies which lies within the domain of Parliament.”

Justice Kapadia's judgment takes careful account of the business environment and foreign direct investment needs.

Justice [K.S.] Radhakrishnan, in his concurring judgment, writes, “FDI… is indispensable for growing economy like India [ sic]”.

The fact of the matter, well recognised in the jurisprudential school called legal realism, is that the individual approach of the judge is even more decisive in judicial decisions than the law or the facts.

What would have happened if, hypothetically, in this case, Justice Chandrachud had been in the Supreme Court and Justice Kapadia and Justice Radhakrishnan in the High Court? The consequences for the country would have been enormous. We may have been able, for example, to receive billions of dollars of additional tax revenue and bridge a part of the affordability gap for universal coverage in the food security policy.

If this is the case, has not the time now come in India for us also to engage with the issue of the personal approach and philosophy of judges more openly and directly – as other democracies do? How long will we stick to the legal fiction that the personal background and the social, economic and political philosophies of judges do not enter their judicial decision-making?

Judges should be firmly committed to the values and philosophy of our Constitution (not to the government or party of the day) because they have assumed for themselves the role of guardians of the Constitution.

ATUL YADAV/PTI

CHIEF JUSTICE OF INDIA S.H. Kapadia and (below) Justice Dhananjay Y. Chandrachud of the Bombay High Court.

What is the relevance of the constitutional philosophy to this judgment? I would argue that the Bombay High Court judgment is more in line with the constitutional philosophy than the Supreme Court judgment for two reasons. First, the passage from Chandrachud shows a conscious judicial deference to the legislature, based explicitly on the constitutional vision. Second, the Bombay High Court judgment is more in line with the constitutional scheme of the role of the state as a proactive guardian of the public interest (rather than a state that yields excessively to the market). It provides greater latitude for the state to safeguard public interest in collecting taxes (badly needed for development) by “looking through” rather than merely “looking at” complex financial arrangements in a globalised world in which not only investment and growth but crime and embezzlement are also on the rise.

The Supreme Court judgment, on the other hand, reveals an approach that is concerned about limiting tax investigation and encouraging investment flows into the country.

SHASHI ASHIWAL


Neither judgment, in my view, adequately reflects the constitutional philosophy towards the obligation of citizens and corporates in a poor country to pay taxes to the fullest extent required by law, rather than plan to avoid or evade them.

What are the consequences of the judgment for tax revenue and development?

The Supreme Court judgment places important limitations on the revenue authorities. The “look at/look through” framework is in my view, neither valid nor justifiable, and as the Supreme Court itself suggests, this is a matter of legislative policy. This should be corrected. Equally, the excessively narrow interpretation of the tax nexus with India will also have to be corrected. Unless this is done, the consequences for revenue and development will be negative without any prospect of commensurate growth in investment – except perhaps growth in the number of well-disguised fraudulent tax schemes that will hide coyly behind “look at” limits!

It is pointed out that the principle of recusal is not relevant in this case because the Chief Justice's son, Hoshnar Kapadia, joined Ernst & Young – a firm which advised Vodafone on its tax dispute – after the February 2007 deal, and that he joined E&Y India and not E&Y U.K. It is also pointed out that the Income Tax Department used E&Y U.K.'s report as evidence against Vodafone.

I do not know the facts. From what I have seen in the media, the conflict of interest argument seems far-fetched in terms of currently accepted judicial standards for recusal. Chief Justice Kapadia has a well-deserved and hard-earned reputation for the highest integrity. We should avoid raising questions about the integrity of public officials so lightly.

The judges seem to have reached the decision by their curious interpretation of the McDowell judgment (Para 64). Is their interpretation of the McDowell judgment, especially Justice O. Chinnappa Reddy's observations on the need to depart from the “Westminster” principle, correct?

I am not persuaded by the Supreme Court's interpretation of McDowell in this case. In my view, Justice Chinnappa Reddy and the majority were equally clear in their decision to depart from the Westminster principle, and the Vodafone judgment erred in not following Justice Chinnappa Reddy's holding in this regard.

Did the Bench miss the subtle distinction between tax planning and tax avoidance and tax avoidance and tax evasion?

Not all tax planning is bona fide. I hope the judgment will not be read as giving a green signal to all tax planning even if the plan is to evade or avoid taxes.

As a matter of political philosophy derived from Gandhian values that underlie our Constitution, I would argue that tax reduction, avoidance and evasion should all be considered illegitimate. The purpose of the Constitution and the state it constitutes is to bring about a social revolution to bring swaraj to the masses. This has been well recognised, including by the Supreme Court of India (see for example the judgment in the S.P. Gupta case). The state has inadequate resources to improve the lot of the poorest, as we are repeatedly told. If this is the case, the policy of the state and the duty of corporates must be to collect, and to contribute, as much tax as possible under the law. Business transactions must be designed to achieve business goals. Tax avoidance, evasion or reduction may be a relevant business goal in rich countries, but not in India. This vision should guide Indian courts. The blind adoption by courts of British tax jurisprudence in this regard without due consideration of the differences in the role and need for taxes in a poor country such as India, and our constitutional values, is unfortunate.

Narrow interpretation

The exclusion of “indirect transfers” from Section 9 of the Income Tax Act and, as a consequence, the refusal to consider it as a “look through” provision was another setback to the I.T. Department. Was the Supreme Court correct in interpreting Section 9 in the manner that it did?

The excessively narrow interpretation of Section 9 is not in my view adequately justified in the judgment. There was no intention on the part of the legislature to exclude indirect transfers. It is not clear how this provision was in effect “read down”. This matter may need to be corrected legislatively.

In Paragraph 73, the Bench seeks to distinguish between preordained transaction (created for tax avoidance purposes) and a transaction which evidences investment to participate. In the latter, a dissecting approach is not warranted. Is the Bench correct in its emphasis on the “look at” approach rather than on the dissecting approach?

It is not clear how the tax authorities would be able to determine whether a transaction is intended for tax avoidance or evasion or for investment to participate unless the transaction is first “looked through” carefully and “dissected”. The Supreme Court judgment itself appears to “dissect” the impugned transaction in some detail, rather than merely “look at” it, before concluding that it was not intended for tax avoidance. After the dissection, the judgment seems to suggest that the transaction should be analysed “as a whole” rather than its individual elements looked at in isolation.

Again, if individual elements clearly show a plan for tax evasion, it is not clear how they can be ignored by the tax authorities. These distinctions appear interesting from a theoretical point of view, but may be very difficult to apply.

Do you think ‘Azadi' was incorrectly decided?

In the relevant part of the Azadi judgment the Supreme Court overturned a Delhi High Court judgment that [to use the Vodafone terminology] upheld a “look through” approach and struck down a “look at” approach that was mandated by an impugned circular. In so doing, the Supreme Court limited the role of the tax authorities, who have duties and responsibilities to investigate the true nature of transactions. However, in that case, the “look at” limit came from the executive itself in the form of the impugned circular, rather than from the judiciary. As a result, the Supreme Court cannot be faulted in the Azadi case for upholding a policy choice – erroneous as it may have been – made by the executive.

The “look at”/“look through” distinction should be removed and the tax authorities should be fully empowered to investigate transactions as needed (with adequate safeguards against harassment and corruption).

Justice Radhakrishnan has held in paragraph 90 of his judgment that the principle of Duke of Westminster is still valid. Your comments.

The concurring judgment does not quite say that the Westminster case is still valid. It simply says, in effect, that it is not fully dead. So we may conclude that the “Duke of Westminster” case is in a deep coma and hence not of any functional relevance.

In any case, the time has come, 65 years after Independence, for us to develop the confidence to decide our tax cases without relying on whether or not old English decisions are dead, alive or in a coma.

'via Blog this'

Vodafone tax case: Implications of the SC judgment on pending cases - Moneylife Personal Finance site and magazine

Vodafone tax case: Implications of the SC judgment on pending cases - Moneylife Personal Finance site and magazine:

'via Blog this'

The Vodafone tax case was conceded as a ‘test’ case, but diverse issues raised by the I-T department, who seek to render exigible to tax similar cross-border transactions, remain to be adjudicated on a case-by-case basis, including ‘treaty shopping’, which did not arise in the Vodafone case

The Supreme Court verdict in the Vodafone tax case has far-reaching ramifications on diverse cross-border transactions sought to be brought within the tax dragnet, including Sanofi Aventis-Shanta Biotech, Sabmiller-Fosters, Idea Cellular-AT&T, whose challenges to demands by the Indianrevenue department are pending before courts of law in India. The verdict of 20 January 2012 marks a closure to the tax demand of Rs11,218 crore in the form of withholding taxes and interest, plus Rs7,900 crore (towards penalties) from Vodafone following the international cross-border transaction by which it acquired the Indian telecommunication interests of Hutchison for $11.076 billion.

The Supreme Court, in its resounding validation of the settled legal principle that tax planning per se is neither illegal nor impermissible andrejected the stand of the Income Tax (I-T) department that the overseastransaction relating to the acquisition by a Netherlands-based subsidiary of Vodafone of share capital of an upstream company that wasincorporated by Hutchison in the Cayman Islands and ensconced within the corporate structure evolved in the course of effectuating telecommunications investments into India from 1992 onwards, was sham, fictitious and a means to evade tax exigible in India upon such transfer, entailing concomitant withholding tax obligations qua Vodafone inrelation to capital gains in the hands of Hutchison, since downstream companies held underlying assets situated in India, founded inter alia on a purposive interpretation of certain provisions of the Indian Income-tax Act, 1961.

As the final appellate court in the land, the Supreme Court has, through the majority judgment delivered by the Chief Justice SH Kapadia and Justice Swatanter Kumar, on the basis of Article 141of the Constitution of India which stipulates that “the law declared by the Supreme Court shall be binding on all courts within the territory of India” andon the enshrined doctrine of stare decisis, constitutes mandatory precedent, evolved key principles relevant to international tax jurisprudence, with courts of concurrent jurisdiction and/or inferior courts being thus bound.

The ratio decidendi or legal principles evolved and established in the Vodafone case, and thus capable of reliance advantageously by entities that have, in cross-border transactions, similarly acquired stakes in companies situated overseas with downstream assets in India, and faced with a tax demand on similar premise to that applied by I-T department to Vodafone, subject to individual fact matrices permitting them to fall squarely within its purview, broadly include:

I. In an offshore transfer of shares between two non-residents, no liability to capital gains tax arises in India, and correspondingly no obligation to deduct tax at source can arise in India;

II. Transfer of a capital asset situated in India does not occur indirectly in consequence of a transfer of capital asset overseas, so as to render income derived overseas to become taxable in India;

III. ‘Look at’ is the test vis-à-vis cross border transactions, rather than ‘look through’: ‘single consolidated bargain’, rather than resort to dissecting and challenges to commercial substance, particularly in circumstances where regulatory permissions have been secured from statutory authorities in India as a prelude to or in the course of infusing strategic foreign direct investment to participate in India;

IV. Surrounding circumstances of a transaction are key to evaluating whether it is a colorable device for distribution of earnings, profits and gains, and are thus liable to be viewed holistically;

V. An investment vehicle, which in addition to holding shares in a subsidiary company(ies), performs the function of facilitating smooth transition of business, does not per se lack business or commercial purpose;

VI. The mere exercise by a parent company of shareholder influence over its subsidiaries will not render subsidiaries as deemed resident of the State in which the parent company is incorporated and/or has its seat of business;

VII. ‘Controlling interest’ is an incident of ownership of shares in an entity, but not a distinct capital asset, capable of segregation from shares held;

VIII. ‘Situs’ of shares is located where the company is incorporated and its shares can be transferred, where its register of members is maintained, thus shareholding in companies incorporated outside India shall constitute property located outside India;

IX. Burden is on the tax department to establish tax avoidance, and ‘dominant purpose’ to be viewed in the context that foreign investmentsare oft routed through holding company structures, relating to which the duration for which it is in place, business operations have been conducted in India with corresponding revenue generation in India, as also the timing of an exit by an investor and continuity of such business, to be key in discerning whether it isa fictitious or sham scheme preordained with the purpose of tax evasion;

X. A non-resident, unless the place of accrual of income is within India, is not liable to be subjected to tax in India;

XI. Basis of taxation is profits or income or receipt, but not valuation of an enterprise;

XII. Absent transfer of a capital asset in India, an overseas buyer of shares cannot be held as “representative assessee” of an overseasseller;

XIII. A ‘look through’ in a statute or treaty has to be expressly stipulated and cannot be read in through resort to rules of purposive interpretation.

While the I-T department’s endeavors to re-visit the settled legal position in relation to the sacrosanct status accorded to Tax Residency Certificates pertaining to Mauritian entities through which foreign direct investment is legitimately routed into India (in the 2003 Azadi Bachao Andolan case), were squarely rejected in the Vodafone tax case, ‘round-tripping’ has been specifically carved out of the ambit of ‘foreign direct investment’.

The Vodafone tax case was conceded as a ‘test’ case, but diverse issues raised by the I-T department, who seek to render exigible to tax similar cross-border transactions, remain to be adjudicated on a case-by-case basis, including ‘treaty shopping’, which did not arise in the Vodafone case, but is due for adjudication by Supreme Court, in the AT&T case, shortly.