India SC judgement gives $4 billion relief in Vodafone case

In a hitorical judgemnet which was eagerly awaited by many foreign investors, Supreme Court of India ordered the Income tax department to refund $4 billion along with 4% interest to Vodafone. Here is what “The Economic Times” reported about the implications of the judgement in an excellent manner:

“Federal courts of many countries have been relying on Indian cases. The landmark judgement in case of Azadi Bachao Andolan, which reaffirmed the validity of India-Mauritius tax treaty, is a pleasure to read even today. So, what does this judgement mean for each of the stakeholders in the Indian economy?

FOR VODAFONE: This is the end of a long drawn legal battle for Vodafone and its battery of lawyers. The SC has asked the revenue to return the tax collected along with interest of 4% p.a. and vacating the bank guarantee. There must be a feeling of justice delayed but not denied in the Vodafone camp.

FOR OTHER LITIGANTS: Encouraged by the success in the preliminary round of litigation, the revenue has raised tax claim in several other cases where shares of overseas companies have been sold. This judgement is now law of the land. The revenue may not be able to collect tax on transfer of offshore holding companies with similar fact pattern. These companies will be spared of agony and legal costs. However, the SC has left a window open for the revenue to ‘look through’ the structures in case of sham.

FOR FDI INVESTORS: They can heave a sigh of relief. The SC has upheld the separate entity principle and recognised the need for holding structures. By enunciating the ‘look at’ principle this judgement asks that the revenue should look at the entire transaction to ascertain its true legal nature. Further, the onus has been placed on the revenue to identify a scheme and its dominant purpose. So, if an investor exits at the holding company level, it cannot be taxed in India on the basis that the underlying investment is in India. It is time to focus on building value in the business and not lose sleep over taxes.

FOR MAURITIUS INVESTORS: While the treaty was not the issue before the SC, The judgement sets to rest the controversy about Azadi Bachao Andolan case. In the absence of Limitation of Benefit provisions, treaty must be respected and the tax residency certificate can not be ignored unless the treaty is abused for fraudulent purpose of tax evasion.

This means that till the time treaty is amended, the capital gains tax exemption will be available to the Mauritius sellers. A word of caution for those who interpose treaty jurisdiction as an afterthought, just before the exit. In such a case, it might be viewed as a pre-ordained transaction and the revenue may challenge the treaty claim. Need for substance and razor sharp documentation cannot be undermined.

FOR PRIVATE EQUITY INVESTORS: Assurance of treaty benefits will bring in a lot more certainty. The options for exit will increase as now the buyers may be willing to buy offshore holding companies. The pressure from the buyers who were insisting on withholding tax or obtaining a nil withholding certificate will reduce. The big booster will be the reading down of Section 195 which provides for tax withholding on payments made to non-residents.

The judgement says that where the contract is executed outside India and the payment is made outside India by one non-resident to another, withholding tax burden cannot be imposed. While this is the view of Justice Radhakrishnan, in the absence of dissent note from the Chief Justice, this might be the verdict of SC.

FOR M&A ASPIRANTS: This would mean one less hurdle to cross before closing a transaction. Tax has been a deal breaker in several M&A deals. Negotiations around tax indemnities and escrows will reduce. Rule of law and clarity and certainty in tax policy will make India a worthy destination for new investors.

FOR REVENUE: While the verdict might have come as a huge disappointment, the tax administrators and their counsels have become a lot more sharper and agile. They almost had everyone convinced that Indian law was wide enough to bring indirect transfers in the tax net. Now all the focus will be on the upcoming finance bill and how the source rules can be rewritten and taxing jurisdiction can be established.

FOR GOVERNMENT: Certainty in law in dealing with cross border investment issues is critical in attracting foreign investment. In words of Justice Radhakrishnan, this case is an eye opener of where we lack in our regulatory laws and what measures need to be taken without sacrificing national interest.

We may see a renewed attempt to renegotiate the treaties and to bring in general anti avoidance rule or substance over form rule in the current statute.

FOR JUDICIARY: This is a huge leap of faith. The judiciary’s ability to interpret law without being swayed by the stakes involved will help India regain investor confidence.

FOR PROFESSIONALS: The anxiety of foreign investors and aggressive stance of revenue had led many professionals to be circumspect of advising on tax planning. Most chose to err on the side of caution and the level of confidence in expressing an opinion was on a sliding scale. This judgement should be helpful in future once general anti avoidance rule is introduced.”

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