Wednesday, September 8, 2010

Vodafone International Holdings v. Union of India: Extracts and Initial Comments

The Vodafone judgment is available here. While we will discuss this in detail, the following appear to be the highlights of the decision (the extracts are not of the complete paragraphs). My initial comments are inserted as underlined, in square brackets:

On substance – over – form:
56. Indian Law recognises that an assessee, who engages in legitimate business activity and organizes business around accepted legal structures is entitled to plan his transactions in a manner that would reduce the incidence of tax. An assessee who does so, does not tread upon a moral dilemma or risk a legal invalidation. There is a recognition in our law of the principle that lawful forms of activity can legitimately be arranged by those who transact business to plan for tax implications.
63. The following principles are now firmly embedded in our jurisprudence :
(i) A transaction or arrangement which is permissible under law which has the effect of reducing the tax burden of an assessee does not incur the wrath of the law;
(ii) Citizens and business entities are entitled to structure or plan their affairs with circumspection and within the framework of law with a view to reduce the incidence of tax;
(iii) A transaction which is sham or which is a colourable device cannot be countenanced. A transaction which is sham or a colourable device is one in which the parties while ostensibly seeking to clothe the transaction with a legal form, actually engage in a different transaction altogether. A transaction which serves no business purpose other than the avoidance of tax is not a legitimate business transaction and in the application of fiscal legislation can be disregarded. Such transactions involve only a pretense and a facade to avoid compliance with tax obligations;
(iv) Absent a case of a transaction which is sham or a colourable device, an assessee is entitled to structure business through the instrument of genuine legal frameworks. An act which is otherwise valid in law cannot be disregarded merely on the basis of some underlying motive resulting in some economic detriment or prejudice. In interpreting a fiscal statute it is not the economic result sought to be obtained by making the provision which is of relevance and the duty of the Court is to follow the plain and unambiguous language of the statute.
66. The governing principle therefore is that tax planning is legitimate so long as the assessee does not resort to a colourable device or a sham transaction with a view to evade taxes
[Comment: The Court lays down these principles correctly; I am not sure that it in fact applies these to the facts at all.]

 On the nature of rights through shareholding:69. Ownership of shares may in certain situations result in the assumption of an interest which has the character of a controlling interest in the management of the Company. The extent of shareholding which is sufficient to vest in the holder of shares an interest which assumes the character of a controlling interest may again vary from case to case.
70. A controlling interest does not for the purpose of the Income Tax Act, 1961 constitute a distinct capital asset… the assumption of control is a right which emanates from the acquisition of a sufficient number of shares in the Company as would enable the holder of the shares to exercise a voting power of a degree and nature as would result in a control of the management. A controlling interest is an incident of the ownership of the shares in a Company; something which flows out of the holding of shares. A controlling interest is, therefore, not an identifiable or distinct capital asset independent of the holding of shares.
76. The position of law which has consistently held the field for over a hundred years in the U.K. and for well over five decades in India, is that the business of a corporation is not the business of its shareholders. The undertaking and the assets of a corporation are not the undertaking and assets of its shareholders. A corporation as an entity incorporated under legislation governing companies has a distinct juristic personality.
[Comment: So this clarifies that the Court has rejected the argument that controlling interest constituted a capital asset, resulting in capital gains liability. So the only other way to reach this conclusion is substance-over-form. It is also interesting in this regard that the Court does not at all discuss the law on lifting the corporate veil]

 On whether Section 195 applies:119. …In concluding this portion of the judgment, the principles which should govern the interpretation of Section 195 of the Income Tax Act, 1961 can be formulated as follows :
(i) Section 195(1) provides for a tentative deduction of income tax, subject to a regular assessment;
(ii) Section 195 postulates two requirements: Firstly, there is a person responsible for paying to a non resident, any interest or other sum. Secondly, the interest or other sum must be chargeable under the provisions of the Act, other than under the head of salaries;
(iii) The obligation to deduct tax arises where the sum payable to a nonresident is chargeable to tax under the provisions of the Act. For the obligation to deduct to arise, the entire sum payable need not be income chargeable under the Act. If the sum payable to a nonresident represents income or if income is hidden or otherwise embedded in it, tax is required to be deducted on the sum. The obligation of the assessee in that event is to deduct tax under Section 195 limited to the appropriate portion of income chargeable under the Act;
(iv) The liability to deduct tax arises if the tax is assessable in India. If the tax is not assessable in India, there is no question of TDS being deducted by an assessee;
(v) The general principle of fiscal legislation is that given a sufficient territorial connection or nexus between the person sought to be charged and the country seeking to tax him, income tax may extend to that person. The connection can be based on the residence of the person or a business connection within the territory of a taxing State or a situation within the State of the money or property from which the taxable income is derived;
(vi) TDS provisions which are in the nature of machinery provisions constitute an integrated Code under the Act of 1961 together with charging provisions. Hence, those provisions are not independent of the charging provisions which determine assessability to tax;
(vii) Whether a payment made by a foreign company in foreign currency abroad can be deemed to accrue or arise in India, would depend upon an examination of the facts and circumstances of each case.
(viii) Parliament, while imposing a liability to deduct tax has designedly imposed it on a person responsible for paying interest or any other sum to a non resident. Parliament has not restricted the obligation to deduct tax on a resident and the Court will not imply a restriction not imposed by legislation. Section 195 embodies a machinery that would render tax collection effective and must be construed to effectuate the charge of tax. There is no limitation of extra territoriality involved though Parliament is cognisant of the fact that the provisions of the law can be enforced within the territory to which the Act extends.
[Comment: Essentially, the Court has held that chargeability in itself is sufficient nexus. However, perhaps the only silver lining to this judgment – the Court seems to have refused to hold that chargeability is not essential for deduction, and has not followed the decision of the Karnataka High Court in Samsung]

 The conclusions on the factual position:132. The facts clearly establish 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. The transaction between HTIL and VIH BV was structured so as to achieve the object of discontinuing the operations of HTIL in relation to the Indian mobile telecommunication operations by transferring the rights and entitlements of HTIL to VIH BV. 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.
133. The true nature of the transaction as it emerges from the transactional documents is that the transfer of the solitary share of the Cayman Islands company reflected only a part of the arrangement put into place by the parties in achieving the object of transferring control of HEL to VIH BV.
[Comment: If the Court was in fact applying the principles on substance-over-form which it so lucidly elaborated upon earlier, it is hard to see the relevance of this]

135. 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. The transaction documents are adequate in themselves to establish the untenability of the Petitioner's submissions.
136. The submission of VIH BV that the transaction involves merely a sale of a share of a foreign company from one nonresident company to another cannot be accepted. The edifice of the submission has been built around the theory that the share of CGP, a company situated in the Cayman Islands was a capital asset situated outside India and all that was transferred was that which was attached to and emanated from the solitary share. It was on this hypothesis that it was urged that the rights and entitlements which flow out of the holding of a share cannot be dissected from the ownership of the share. The purpose of the discussion earlier has been to establish the fallacy in the submission.
[Comment: I am still unable to see where the Court applied the principles of law which it summarized in para 63 to the facts]

General Conclusions:
140. In assessing the true nature and character of a transaction, the label which parties may ascribe to the transaction is not determinative of its character. The nature of the transaction has to be ascertained from the covenants of the contract and from the surrounding circumstances.
141. In Hideo Yoshimoto vs. Canterbury Golf International Ltd, the Court of Appeal in New Zealand, adverted to an article of Lord Steyn in which the Law Lord has noted the distinct trend towards an objective theory of contract which gives effect to the reasonable expectations of honest people. The expectations which will be protected are those that are,in an objective sense, common to both parties. In this regard, there has been a shift away from a blackletter approach to questions of interpretation to a more purposive interpretation.
[Comment: First, the Court notes taxation principles of form-over-substance. Next, in para 135 it says that the transaction documents are adequate to demonstrate the fallacy of the submission of the Petitioner. Now, it says that the transaction documents are to be interpreted "in a shift away from the blackletter law". And this, on grounds of the objective theory of contract. If anything, the objective theory would give greater credence to legal form than not.]

The only relief to Vodafone:
146. After Mr.Salve had concluded his submissions, Dr.Singhvi submitted that the tax authority is not competent to treat the Petitioner as an assessee in default under Section 201, as amended by the Finance Act, 2008 and the amendment to Section 201 by the Finance Act, 2008 is unconstitutional. We have not considered it appropriate to adjudicate upon the submission… However, we clarify that it is open to the Petitioner to agitate before the tax authority that the Petitioner had reasonable cause and a genuine belief that it was not liable to deduct tax at source and that no penal liability can be fastened upon the Petitioner. In Eli Lilly (supra), the Supreme Court held that "the liability to levy of penalty can be fastened only on the person who does not have good and sufficient reason for not deducting the tax" the burden being on the person to prove the existence of good and sufficient reasons.


[General Comment: I apologise for the rather lengthy extracts; but I hope they will be of some benefit to readers. We will discuss this judgment in detail further, and we welcome the comments of our readers.]

1 comment:

Mihir Naniwadekar said...

Please note that the paragraphs which have a para number given are from the text of the judgment (subject to deletion of some sentences, no alterations are made in these). The headings and underlined comments in square brackets are inserted by me.