Tuesday, April 26, 2011

Lifting the Corporate Veil for Tax Purposes

The judgment of the Bombay High Court rendered last year in the Vodafone Case favours the revenue when it comes to imposition of tax by the Indian authorities on sale of shares in an offshore company that has a substantial stake in an Indian company. While an appeal in the Vodafone Case is pending before the Supreme Court, the Karnataka High Court recently had the opportunity to pronounce a judgment in Richter Holding v. The Assistant Director of Income Tax on a similar fact situation. Although the Karnataka High Court too sided the revenue, the reasoning substantially deviates from Vodafone.

Richter Holding (a Cyprus company) and West Globe Limited acquired 100% shares in Finsider International Company Limited (registered in the UK). Finsider in turn held 51% shares in Sesa Goa Limited, an Indian company. The Indian tax authorities sought to tax the transaction under the head of capital gains, and sought further information from the parties. In turn, Richter Holding filed a writ petition before the Karnataka High Court.

Richter Holding relied on the Vodafone Case to argue that acquisition of shares in an offshore company does not amount to acquisition of immovable property or control of management in an Indian company, and “it is only an incident of ownership of the shares in a company which flows out of holding of shares”. Moreover, it was argued that controlling interest in a company is not identifiable as a distinct asset capable of being held. The tax authorities, on the other hand, argued that the transaction resulted in an indirect transfer of 51% interest held by Finsider in Sesa Goa, which is subject to Indian taxation.

In its judgment, the Karnataka High Court refused to be drawn into the merits of the taxation dispute. The court left it to Richter Holding to urge contentions on the merit of taxation before the authorities. It also found that the agreement produced before the court was insufficient to determine the exact nature of the transaction. Most importantly, the court allowed the tax authority to lift the corporate veil to ascertain the true transaction:
It may be necessary for the fact finding authority to lift the corporate veil to look into the real nature of [the] transaction to ascertain virtual facts. It is also to be ascertained whether [the] petitioner, as a majority share holder, enjoys the power by way of interest and capital gains in the assets of the company and whether transfer of shares in the case on hand includes indirect transfer of assets and interest in the company.
There has been a great amount of discussion regarding the Richter judgment by commentators (here, here and here).

The aspect that deserves greater attention is that the Karnataka High Court demonstrates a keen interest in lifting the corporate veil. This has a number of implications. First, the Richter Holding Case extends even further the scope of the principles laid down in the Vodafone Case. For example, in Vodafone the Bombay High Court did not consider lifting the corporate veil to impose taxation in case of indirect transfers, as we have previously noted. In that sense, the Richter Holding Case arguably provides an additional ground to the tax authorities to tax indirect transfers. Second, it is not clear from the judgment itself whether the tax authorities advanced the argument regarding lifting the corporate veil and, if so, how it was countered by Richter Holding. Third, the Karnataka High Court appears to have readily permitted lifting the corporate veil without at all alluding to the jurisprudence on the subject-matter. Generally, courts defer to the sanctity of the corporate form as a separate legal personality and are slow to lift the corporate veil, as evidenced by Adams v. Cape Industries, unless one of the established grounds exist.

From a macro-perspective, the legal position seems to have been confounded even further, as a column on MoneyControl notes:
… While, the intention of the legislature to tax such transactions is clear, the implications under the current income tax law become critical for completed transactions and existing structures. Notices alleging liability to tax on such indirect transfers have already been issued to Sanofi, Tata, Vedanta, SABmiller, Cadbury etc. and appear to be a growing trend.

The changed approach of the tax department and the consequent uncertainty of taxation is creating apprehensions in the minds of the investors. Tax risks are increasingly being discussed at the time of concluding deals and are a cause of great concern. In the meantime, deal makers are opting for mechanisms like escrow accounts, insurance policy, etc. to conclude transactions already in pipeline.

However the prevailing tax uncertainty coupled with aggressive tax approach adopted by revenue authorities does not augur well for new investments into India. The actual impact of aggressive tax policies on inbound investment will need assessment and perhaps a relook, given the huge investment needs particularly in infrastructure sector.

As one moves ahead, the next hurdle to be crossed is the mechanism and basis of computing gains arising as a result of the transaction being taxable in India. This is going to be the next bout of litigation in case the tax authorities view is eventually upheld by the Courts.


Anonymous said...


I disagree with the view that the Karnataka HC has allowed an additional approach of veil lifting. The challenge was to a notice; and the Court seems to have rejected that it is possible that finally the facts are such that the veil can be lifted. The Court says veil can be lifted more in the sense of "it is possible" that in the sense of "it is permissible" - I say this because the Court has not examined the facts in detail as the issue was a challenge to notice. Whether veil is to be lifted or not (and even Cape Industries leaves open that possiblity in cases of facade/sham) will be a question dependant on specific factual findings which a writ court will not go into. Hence the appropriate remedy is in appeal once the facts are brought on record.

These cases (Vodafone and more particularly Richter) are in fact nothing but a warning that writ remedies should not be immediately resorted to in such cases, and assessees would do well to bring facts on record through the appellate process indicating that there is no sham/facade whatsoever; that corporate structures did in fact have sommercial purposes. If that is done, in actual assessment, Richter may well be decided in favour of assessee.

vswami said...

Keeping in mind the historical background, rather its origin, one feels that, neither Vodafone, being the first court case of its kind, nor any of the other Indian tax cases which have come to be widely discussed with reference to the Vodafone case, can be strictly regarded to have been considered by invoking the principle of - ‘lifting the corporate veil’ (in fact, the term often more appropriately used is – ‘piercing the corporate veil’). To put it differently, in most of these court cases of recent origin, the issue might be said to be rested on the controversy – whether or not the true nature of the given transaction(s) should be ascertained wholly and necessarily having regard to the actual / factual terms of the related contract agreement (s). Thus, the real ‘battle of wits’ is one of – Form vs Substance.
For an analytical study, and an appreciation of the above comment, the following material in public domain may be of help:
Lifting the corporate veil definition
Articles piercing the corporate veil
Fdcc quarterly piercing the corporate veil
Fdcc quarterly separate corporate personality piercing
Separate corporate personality articles