The Vodafone case, involving the indirect sale of shares of an Indian company by upper tier non-Indian corporations, focused attention on the extraterritorial reach of India’s taxing power. While the decision is ostensibly a victory for taxpayers who do business in India, the case may be a harbinger of tax concerns in India and other countries.
The Vodafone Decision: The primary issue in the Vodafone case was whether India had jurisdiction to tax the indirect transfer of shares of an Indian company between two non-Indian companies. In 2007, Vodafone’s Dutch subsidiary acquired the stock of a Cayman Islands company from a subsidiary of Hutchinson Telecommunications International Ltd. (the subsidiary was also located in the Cayman Islands). The purchase price was $11.1 billion. The Cayman company acquired by Vodafone owned an indirect interest in Hutchinson Essar Ltd. (an Indian company) through several tiers of Mauritius and Indian companies. Vodafone represented in court proceedings that it bought a controlling interest in Hutchinson Essar via its purchase of the Cayman entity.
The Indian taxing authorities attempted to impose a $2.5 billion withholding tax liability on Vodafone. Indian tax law provided that India could subject a nonresident person to withholding tax on gain from the sale of a capital asset only if the asset was located in India. Their argument was that, because the transfer of stock involved an indirect interest in the Indian company, India had jurisdiction to tax the gain from the transaction.
The Indian Supreme Court held that India did not have jurisdiction to impose withholding tax on Vodafone for the purchase of Hutchinson Essar. In finding for Vodafone, the Court held that Indian tax law simply did not provide for taxation of gains from sale of an indirect interest in an Indian company. In addition, the Court did not find the transaction was a sham, in part because the corporate structures of both Vodafone and Hutchinson were in place for a substantial period of time before the transaction occurred and were not implemented solely to effect the sale. The Court emphasized that the structure at issue was bona fide and had business substance, and was not merely a device to deprive the Indian tax authority of revenue.
Commentators have praised the Court for its fairness in ruling for Vodafone, given that Indian tax law does not explicitly provide for taxation of capital gains on an indirect transfer of stock. In addition, the decision provides some measure of security for non-Indian investors who might have avoided India for fear of receiving an unexpected tax bill from an aggressive Indian taxing authority. Finally, the Court did not focus on the use of subsidiaries in tax-favored jurisdictions in making its decision, which may indicate that the tax structuring used by Vodafone will not be viewed intrinsically as a tax avoidance strategy by the Indian courts.
By contrast, the court battle demonstrates the Indian taxing authority’s persistence in pursuing tax dollars even where its authority may be questionable. India may challenge similar transactions that could generate tax revenue, perhaps in the case of transactions that implicate other areas of India’s tax law that are not clearly defined.
Vodafone Aftermath: Whether the Supreme Court was correct in its decision, it is clear that the Indian government believes it should be able to tax capital gains in a Vodafone-type transaction. The Indian taxing authority asked the Supreme Court to reconsider its decision, arguing that the Court’s decision resulted from the erroneous application of India’s tax laws (the Indian Supreme Court recently refused to reconsider its decision). In addition, the Indian legislature is considering a bill that would permit the taxation of capital gains on the indirect transfer of shares of an Indian company, where at least 50% of the assets of the transferor (directly or indirectly) consist of assets in India. Importantly, the bill may be retroactive, and would apply to transactions that occurred prior to the bill’s passage.
The Next Vodafone: While practitioners lamented India’s decision to tax Vodafone under these circumstances, other countries’ revenue departments expressed their support for India, and accordingly the Vodafone case may signal a trend to attempt to tax nonresidents on indirect transfers. Notably, China issued a notice that provides for a 10% withholding tax on capital gains derived by businesses outside China from the sale or exchange of shares in Chinese companies. And unlike India, China does not offer the same recourse through its courts to nonresident companies. Commentators indicate that China is using the notice to pursue sham transactions, rather than legitimate business deals, which may mean that China will not use the notice to pursue a transaction that has a substantial business purpose other than tax avoidance. However, China’s tax system is much more opaque than that of India, and therefore it is more difficult to assess the investor climate in China.
Doing business in India, China, and other non-U.S. jurisdictions are complex endeavors, and those who choose to invest in these markets should remain aware of these countries’ need to generate revenue in light of worldwide economic conditions. Remember to contact your local CBIZ MHM tax advisor when considering investments in countries where tax rules may create unexpected consequences.
 The purchase included 52% of the outstanding equity of Hutchinson Essar, and also included a control premium, use and rights to the Hutchinson brand in India, a non-compete agreement, non-convertible preference shares for the shareholders of Hutchinson Essar, assumption of $630 million in liabilities of other subsidiaries of the Cayman target, and the right to acquire an additional 15% of Hutchinson Essar. It is perhaps significant that “control” of Hutchinson Essar was defined as something other than equity interests.
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