The demand of tax authorities on Vodafone International Holding in relation to its Indian acquisition has proved to be one of the most controversial tax claims in recent times. The transaction involved the transfer of a controlling interest in a downstream Indian company as a result of the acquisition of an upstream holding company two levels above. The Bombay High Court has not directly ruled on the transfer of shares of the upstream Cayman subsidiary, but has ruled that the transfer of the controlling interest and IP as a result of the Cayman upstream company transfer (which resulted in control of the Indian company) was a transfer of control de hors the actual transfer of shares and hence liable to capital gains tax. The matter is before the Supreme Court for a final ruling to lay down the law.
The Karnataka high court has now added another twist to the tale in the debate on form over substance in the case of Richter Holdings, based on an old legal principle that the Indian income tax authorities have the power to lift the corporate veil in order to ascertain the real intent behind a transaction.
In 2007, Richter (a Cypriot company), together with Mauritius company West Globe, agreed to acquire the shares of UK company Finsider International from another UK company, Early Guard. Finsider held 51% of the shares of Sesa Goa (an Indian company). The income tax authorities issued a show-cause notice to Richter. In their view Richter had failed to deduct tax on the payments made by it to Early Guard for purchase of shares of Finsider which had led to the indirect transfer of control of Sesa Goa.
The tax authorities contended that the sale of the Finsider shares amounted to an indirect acquisition of 51% of Sesa Goa, and consequently an indirect transfer of a capital asset situated in India had taken place. Therefore Richter was liable to affect withholding tax on such purchase consideration.
The Karnataka high court observed that "it may be necessary for the fact finding authority to lift the corporate veil to look into the real nature of transaction to ascertain virtual facts", and gave tacit approval to the principal of substance over form. The observations of the high court will no doubt add to the prevailing uncertainty with regard to the taxability of the sale of shares between non-residents in India. This is further compounded by certain rulings made by the Authority for Advance Rulings in India which have taken a contrary view.
In the Azadi Bachao case, the Supreme Court had reinforced the principle of form over substance and recognised the right of a taxpayer to arrange his affairs in order to minimise tax incidence. However, the recent approach of the income tax authorities, and observations made in certain judgments, seem to be at variance with this settled law and seek to deviate from it.
The imminent Direct Taxes Code contains specific provisions which seek to tax such indirect transfers of shares in India which result from transfers of upstream holding companies. It remains to be seen as to what extent the tax authorities will be successful in taxing transfers which are effected in jurisdictions such as Mauritius and the Netherlands where the applicable double taxation avoidance agreements clearly specify that the capital gains from such transfers effected in those jurisdictions can only be taxed there, and not in India.