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VODAFONE INTERNATIONAL HOLDINGS B.V. V. UNION OF INDIA (UOI) AND ANR (2012) 6 SCC 613

 

VODAFONE INTERNATIONAL HOLDINGS B.V. V. UNION OF INDIA (UOI) AND ANR (2012) 6 SCC 613

FACTS

  • Vodafone International Holdings BV (VIH), a Netherlands-based company, acquired the entire share capital of CGP Investments (Holdings) Ltd. (CGP), based in the Cayman Islands, on 11.02.2007.
  • The transaction's stated aim, according to the Revenue, was the "acquisition of 67% controlling interest in HEL," an Indian company (Hutchison Essar Limited).
  • Vodafone disputes this claim, arguing that VIH agreed to acquire companies that indirectly controlled a 67% interest in HEL, not a controlling interest.
  • CGP, according to Vodafone, held indirectly, through other companies, a 52% shareholding interest in HEL, with options to acquire a further 15% shareholding interest subject to relaxation of FDI norms.
  • The Revenue seeks to tax the capital gains from the sale of CGP's share capital, asserting that although CGP is not a tax resident in India, it holds underlying Indian assets.
  • The Bombay High Court's decision in the above matter was in favour of the Revenue. They upheld the tax authority's position, ruling that Vodafone was liable to pay capital gains tax on the transaction involving the acquisition of CGP by VIH. The court concluded that the transaction indeed involved the transfer of an Indian asset, Hutchison Essar Limited (HEL), and thus fell under the jurisdiction of Indian tax laws.

ISSUE

  • The question before the court was whether Section 9(1)(i) of the Income Tax Act, 1961 could be interpreted as a "look through" provision, allowing taxation of income arising from indirect transfers of capital assets situated in India.
  • Was there a liability to deduct tax at source (TAS) from the payments made in the transaction?
  • What was the true nature of the offshore transaction, and was it taxable in India?

RULE

  • Section 9(1)(i) of the Income Tax Act, 1961 does not allow taxation of income arising from indirect transfers of capital assets situated in India. However, the amendment made by the finance act, 2012 have changed this scenario.
  • offshore transaction is a bonafide structured foreign direct investment (FDI) into India, falling outside India's territorial tax jurisdiction and hence not taxable.

HELD

  • The court concluded that Section 9(1)(i) of the Income Tax Act, 1961 is not a "look through" provision that covers indirect transfers of capital assets. The court reasoned that such an interpretation would go beyond the language and scope of the provision, as it specifically applies to transfers of capital assets situated in India. Additionally, the court noted that the Direct Tax Code (DTC) Bill, 2010 proposed taxation of offshore share transactions, indicating that indirect transfers were not covered by the existing provision. Therefore, the court held that Section 9(1)(i) cannot be extended to cover indirect transfers of capital assets/property situated in India.
  • The court ruled that a parent company can only exercise limited control over its subsidiary and that each subsidiary retains autonomy, except in cases of fraud. The directors of the subsidiary owe their duty to the subsidiary, not solely to the parent company. The court emphasized the importance of a smooth transition in the sale and purchase agreement (SPA) and analysing the commercial/business substance of the transaction. The SPA adjusted outstanding loans, established standstill arrangements, ensured a smooth transfer, and established fundamental terms. Finally, the sale of the investment to VIH through CGP did not result in the extinguishment of rights.
  • The court analysed Section 195 of the Income Tax Act, emphasizing that TAS is applicable only when the payment contains an element of income chargeable to tax in India. Since the transaction involved the transfer of shares between two non-residents outside India, there was no liability to deduct TAS.
  • The court concluded that the offshore transaction was a bonafide structured foreign direct investment (FDI) into India, falling outside India's territorial tax jurisdiction and hence not taxable. It emphasized that tax policy certainty is crucial for investors to make rational economic choices. 
  • The court also stressed the importance of examining the entire transaction holistically and rejected the idea of dissecting individual components.
  • The court set aside the Bombay High Court's judgment and directed the Department to return the deposited sum with interest. It emphasized the importance of legal certainty and stability in tax policy.

COMMENTARIES NOTE/ RATIO

  • Income through the transfer of capital asset situated in India (Sec. 9(1)(1)]- Any capital gain, within the meaning of section 45, earned by a person by transfer of any capital asset situated in India is deemed to accrue or arise in India.

 

AMENDMENT MADE BY THE FINANCE ACT, 2012-

 

The amendments. inter alia, included insertion of Explanation 5 in section 9(1)(i) with retrospective effect from the assessment year 1962-63. The Explanation 5 clarifies that an asset or capital asset, being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be situated in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.

 

Meaning of the expression 'substantially" - The Delhi High Court in the case of DIT v. Copal Research Ltd. [2014] 49 taxmann.com 125 (Delhi) examined the meaning of expression "substantially" and held that gains arising from sale of a share of a company incorporated overseas, which derives less than 50 per cent of its value from assets situated in India would certainly not be taxable under section 9(1)(i) read with Explanation 5 thereto.