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Commentary

Vodafone Was Forewarned About Tax on Hutch

Business Standard notes that Vodafone was forewarned that their transaction with Hutchison would be taxed. This communication seems to have happened in March 2007, a few months before the Hutch transaction was completed in May 2007.

Finance Secretary R S Gujral had said in an interview with this newspaper on Monday that even before the transaction between Vodafone and Hutchison was completed, the companies were advised that the deal was liable to tax. A day later, Vodafone issued a statement that Gujral’s comments were completely untrue, as only Hutchison was contacted by the tax authorities prior to the closing of the transaction, but the communication did not give an indication that the authorities were re-interpreting the law.

Official letters exchanged between the tax department and HEL reviewed by Business Standard showed that in March 2007 the department wrote to the company, suggesting the Hong Kong-based Hutchison pay tax on capital gains from the sale of its stake in HEL to Vodafone. It was also said Vodafone was liable to deduct tax at source.

This is damning to Vodafone’s case that it is being taxed retrospectively – a retrospective tax is only bad if you had NO idea at the time of a transaction that it would be liable for tax later.

I believe strongly that Vodafone did the deal knowing that the structure was setup only to avoid tax. That is, the deal between a Dutch entity and one in the Cayman Islands was only to transfer the holding of Vodafone India – the entity being transferred had no other meaningful assets or operations. Since this transaction was purely to avoid tax, the Indian tax authorities have every right to say they will tax it; but the means they adopted were terrible.

They lost the case to Vodafone in the Supreme Court, on a technicality, and then instead of saying they learnt a lesson and will tax any FUTURE transactions of this type, the finance ministry amended the law retrospectively. This shakes business confidence because now, along with Vodafone, everyone else needs to be worried about any transaction they undertake. Who knows who will piss off the Tax Department in the future and therefore alter the tax treatment of whatever is done today.

And it’s not that Vodafone is the only party doing such deals. FIIs come in from Mauritius purely because there are no capital gains taxes there. This is again a transaction designed only to avoid tax, since the FIIs have no meaningful operations in Mauritius. It’s a misuse of a foreign treaty, and the tax department would be very wise to close that loophole. But if they did it retrospectively, regardless of the honourable nature of their argument, all hell would break loose.

Think of IT and SEZs. It was designed to only favour "new" transactions created from that SEZ. Many companies (even Infotech) set up units, closed existing contracts and created new ones with the same parties from the SEZ units, purely to avoid tax. If the finance ministry decides that all such contracts will be analysed, retrospectively, and taxed, what happens? (Clue: Everyone’s guilty)

However, with the revelation that Vodafone knew earlier that they should have withheld capital gains taxes from the Hutch payment and paid it to the government, the analysis changes again. It’s not a small amount of money – over 10,000 cr. was just the tax part. If the tax department has pre-analyzed the transaction and then asked Vodafone it needs to withhold tax, BEFORE the transaction even took place, then Vodafone’s outrage at the retrospective tax now is highly diluted.

I might sound like I’m making the debate for both sides, but my point is:

  • Vodafone-Hutch only structured that deal to not pay Indian tax
  • The fact that the govt. chased the case, lost in the Supreme Court and THEN did a retrospective tax to override that SC judgement is almost like slapping the SC on its face.
  • Plus, the retrospective nature is strange, because already too many laws are unclear – they can "clarify" something and then tax everything going back 10 years.
  • Vodafone though has no real leg to stand on, since it had been told even before the transaction that India intends to tax it.

So I don’t feel for Bodafone, but I feel for all those who now fear the uncertainty.

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