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Commentary

Vodafone Wins Case Against IT Dept

Vodafone has won the case against the Income Tax department, with the Supreme Court ruling that the IT department has no jurisdiction to tax Vodafone.

Vodafone had acquired Hutch a few years back for USD 11.2 billion, and the acquisition wasn’t in India; the owner of the Indian company was a Hong Kong company (Hutchison Group), and the transaction was in the Netherlands/Cayman Islands. Effectively since there was no money exchanged in India, no one should have been taxed by India. But the IT department maintained that this was effectively a sale of the Indian assets so capital gains would apply, and Vodafone would have to pay.

This is strange, for multiple reasons. Firstly, it is never true that a buying company is responsible for capital gains tax – it’s always the seller. The reason the IT department targeted the buyer – Vodafone – was that they couldn’t do a darn thing about the seller, which was a Hong Kong company. This is stupid because you don’t go after someone just because you can’t go after the real culprit.

As an aside: This reminds me of a story of three teams of cops – British, American and Indian – sent into a forest to capture a lion. The American team brings a lion within an hour. The British team comes back in 2 hours successfully, but there’s no sign of the Indian team even after 10 hours. Fearing the worst, the camera crews and rescue staff go into the forest to find the Indian cops roughing up a bear tied to a tree, saying, “Now admit you’re a lion”. ( “Bol Tu Sher Hai” )

That sounds like the IT department in this case – when it can’t find the real culprit, catch anyone in sight.

Secondly, the issue was about the Indian assets being transferred, by virtue of buying out the owning company. But similar tax rules should have applied when Merrill Lynch was acquired (effectively) by Bank of America – effectively, BoA should have paid the capital gain on whatever ML owned in India, even if the merger was between two companies abroad? And so on for every single merger? Doesn’t entirely make sense.

(Btw, these structures are also used when transferring property – use a company to buy a piece of property, and when you need to sell it, sell the company instead. The idea is to avoid the 5% to 7% stamp duty on property transactions.)

Also, since tax havens have been used, it could be that this deal is unique in that it is executed abroad purely for the sake of avoiding Indian tax. This will be a problem in the new Direct Tax Code, even if this particular judgement went for Vodafone. But the IT department will have to go and hit the “seller” for the tax, in this case, the Hutchison Group. I wonder why a case against them hasn’t been initiated already.

The win also positions Vodafone well for an Indian IPO that they are planning. Also, the clarity is useful in that buyers can’t be chased for cap gains – sellers may still be on the dock for it.

  • Kshitij says:

    Every intermediate Chartered Accountancy student knows that such a transfer of asset between 2 foreign entities is non-taxable in India.
    This move by the tax department has been known to be illegal. Corporate governance standards do not apply to the government. Harassment of honest taxpayers is a regular feature. This was a clear case of tax department “goondagirdi” and breaking the law.

  • Mehul says:

    Deepak,
    I am not sure, but the buying entity is supposed to withhold capital gains tax and credit it to the tax authority, so may be, IT dept. went after Vodafone on such premise. However, seems like more as a cover-up to actual intent to go behind Hongkong.
    Also, in property transactions happening thru company buy-out (dime a dozen of such transactions in real estate “industry”), although, there is no stamp-duty implication, such transactions do attract capital gains tax, if any (I mean, if shown any)

    • That’s the official explanation – that they should have deducted TDS, but honestly, no one’s supposed to know that a transaction outside India needs Indian TDS 🙂 It would have been better to go after the seller of course.
      Property transactions – I agree, I was sayign it was a way to avoid stamp duty even though it was technically a transfer of ownership (the property tax folks would be correct, then, to tax the transaction if they wanted, using the same logic). If an individual transfers ownership through a regular transaction, there will be stamp duty AND capital gains tax…so the company based method is primarily just a vehicle to avoid registration of the transfer.

  • Kshitij says:

    Just to clarify…………..the investment bankers in this deal were top notch. Not any Mickey Mouse firms. Do you seriously think they do not know tax laws? There are neither any precedents nor any section in IT law calling for taxing such transactions.
    AS PER I.T. LAW, these transactions are non-taxable !
    So there is no tax incident. Therefore there is no question of witholding a “non- existent” tax. The IT dept is just trying to cook laws to their own taste. This all illegal. They reason to harass Vodafone was because Hutch has no other business in India. So how do you extract the moneys out of them? So they decided to unlawfully harass Vodafone. There is simply nothing more to it ! ! ! Difficult to believe ? Believe it.