Calm after the storm: Confidence returns following Vodafone ruling

Author: | Published: 1 Aug 2012
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In January, the Indian Supreme Court delivered its judgment against the Indian government on Vodafone's tax dispute with the Indian Tax Authority. For many legal practitioners and investors, the Supreme Court, during its deliberations, thoroughly considered international business norms, the economic growth of India, interpretation of the law, and nuances specific to holding structures. The case is regarded by many as one of the most significant tax disputes in the history of the corporate world. But it also marks a significant milestone for India's arbitration system.

The case

In May 2007, Vodafone International Holdings acquired 67% of the shares of Hong Kong-based Hutchison Holdings in India through companies based in the Netherlands and the Cayman Islands in a US$11.2 billion deal. Since the deal was conducted offshore, it was commonly understood that India did not have jurisdiction to tax the relevant parties to the transaction. However, the Tax Authority subsequently sought to obtain US$2.2 billion capital gains tax from Vodafone as the transfer of Indian assets were involved in the transaction.

Vodafone in this case was treated as a 'representative assessee' by the Income Tax Department and, in May 2010, it passed an order to treat Vodafone as an 'assessee in default' for its failure to deduct tax at source. Vodafone petitioned against the Department through the Bombay High Court, but it dismissed Vodafone's petition on September 8 2010. Vodafone was required to deposit Rs 25 billion (US$476 million) within three weeks and secure the rest of the Rs 85 billion (US$1.62 billion) tax demand through bank deposits.

Vodafone demanded that the Supreme Court review the case following the High Court judgment. On January 20 2012, the Supreme Court pronounced that the Indian government had no jurisdiction to tax a transaction between two offshore entities. The Indian Tax Authority was told to refund the Rs 25 billion that was earlier deposited by Vodafone plus 4% interest to the company.

The Indian government requested a review plea for the case following the Supreme Court judgment. The plea was dismissed by the Court on March 20 2012.

"This case has brought confidence to the Indian arbitration system as the judgment process clearly reflects the Supreme Court’s willingness in accommodating considerations related to international business practices"
Pallavi S Shroff, ?Amarchand Mangaldas

The impact

From a legal point of view, even when tax was legitimately chargeable, liability should have lay with Hutchison as the recipient party in the case. The Indian government, however, argued that Vodafone, as the merger party, had the responsibility to collect tax from Hutchison and to pay that amount to the Indian Tax Authority under the 'representative assessee' provision of the Income tax Act. In this case, and according to the government, Vodafone neglected its responsibility to collect tax from Hutchison, which made it legally liable to repay the amount that Hutchison should pay.

For investors, if Vodafone failed to win the court judgment, it would have had huge financial implications for other parties that are engaged in similar situations as it is almost impossible for merger parties to collect tax from related parties after transactions are completed. General Electric, AT&T, Sanofi Aventis and Vedanta are among other corporations engaged in similar legal disputes with the tax authorities.

It has been common practice among investors to conduct transactions offshore to reduce tax liabilities. Under the Indian-Mauritius Tax Treaty, which underpinned Mauritius as the dominant FDI route into India, it is stated that companies listed on a designated stock exchange are exempt from capital gains tax. There is a basic residence requirement for investing in India through the Mauritius route, which is similar to the provisions in the India/ Singapore treaty. The Indian government initiative to tax Vodafone, therefore, came as a surprise to many investors as Vodafone is just one of many corporations that have carried out offshore transactions to save tax. To many observers, the Indian government's decision to target Vodafone was unpredictable and incomprehensible. And investors remain worried that transactions could be targeted by the Tax Authority without objective legal considerations.

The Supreme Court has also stated in the final ruling that the Authority should differentiate between transactions that are genuine and transactions that are arranged with the sole objective of taking advantage of loopholes in the law – for example, when business transactions are used for circular trading or round-tripping, or to pay bribes. These objectives, set by the Supreme Court, have provided comfort to global investors as they clarify grounds for being legally challenged.

Khaitan & Co partner Sanjeev Kapoor says that this ruling is a groundbreaking judgment as it took into consideration interpretation of the law, business exigencies, international practices, nuances specific to holding structures and the economic growth of India. "The Apex Court has reiterated that genuine tax planning is a taxpayer's right. While the ruling is based on the facts of this case, it certainly helps in removing a number of uncertainties in cross-border transactions that involve offshore holding company structures and related aspects. This judgment is of high relevance for other offshore mergers and acquisitions and private equity transactions."

Pallavi Shroff, managing partner at Amarchand Mangaldas, adds: "This case has brought confidence to the Indian arbitration system as the judgment process clearly reflects the Supreme Court's willingness in accommodating considerations related to international business practices. The Court has also shown its willingness to support investment to India and to create an investment-friendly environment on the legal side."

Most cross-border arbitration cases are settled through the Singapore International Arbitration Centre (SIAC) because of the relative efficiency and comprehensiveness of the arbitration system in Singapore. But some Indian companies are looking to bring arbitration cases back to India in order to reduce the legal costs involved in dispute resolution.

Shroff says that it remains to be seen whether the Court will be mature enough in the near future to handle international arbitration cases. "At the moment, it is hard to tell whether the Court in India has thoroughly adopted a business and investment mindset, and it will take some time for the court system to mature." She adds: "Hopefully, we will see more arbitration cases going back to India in the near future."

AT&T is among a number of corporations engaged in legal disputes with India’s tax authorities

SIAC statistics

Total number of new cases handled by SIAC (2000-2011)

Number of international cases administered by arbitral institutions
Arbitral Institution 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
AAA-ICDR (USA) 510 649 672 646 614 580 586 621 703 836 888
ICC^ 541 566 593 580 561 521 593 599 663 817 793
CIETAC (China) 543 562 468 422 461 427 442 429 548 560 418
LCIA (UK) 87 71 88 104 87 118 133 137 213 272 237
SIAC (Singapore) 37 39 34 23 39 29 47 55 71 114 140
SCC (Sweden) 66 68 50 77 45 53 64 81 74 96 91
KCAB (South Korea) 40 65 47 38 46 53 47 59 47 78 52
VIAC (Vietnam) 23 16 19 16 32 22 23 21 26 25 37
BAC (China) 11 20 19 33 30 53 53 37 59 72 32
JCAA (Japan) 8 16 8 14 15 9 11 15 12 17 26
HKIAC*^ (China) NA NA NA NA NA NA NA NA NA 29 16
PDRC (Philippines) 0 1 2 0 0 0 1 1 0 4 1
KLRCA (Malaysia) 20 3 3 5 3 7 1 2 8 # #
BCICAC (Canada) 3 4 4 4 4 2 5 3 # # #

All statistics published here have been obtained from the respective institutions named.
^ The ICC International Court of Arbitration does not maintain separate statistics for international and French domestic cases administered by them.
# The statistics from these institutions are not available yet.
* HKIAC does not distinguish cases administered by them and those that they only provide physical services for. HKIAC starts administering cases from 2009 onwards.

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