Supreme Court Rules Offshore Transfer of CGP Shares by Vodafone Not Taxable in India, Sets Aside Bombay High Court Verdict

Landmark Judgment Clarifies that Indirect Transfer of Indian Assets via Foreign Holding Companies Does Not Attract Capital Gains Tax Under Income Tax Act, Emphasizes Need for Clear Legislative Provisions

In a significant decision impacting foreign direct investment and cross-border taxation, the Supreme Court of India on January 20, 2012, allowed the appeal of Vodafone International Holdings B.V. (VIH) and set aside the Bombay High Court judgment which had upheld the tax demand on Vodafone arising from its acquisition of a controlling interest in Hutchison Essar Limited (HEL) through the purchase of shares in CGP Investments (Holdings) Ltd., a Cayman Islands-based company.

The dispute revolved around whether the Indian Income Tax Department had the jurisdiction to tax capital gains arising from Vodafone's offshore acquisition of CGP shares, which indirectly controlled HEL, an Indian telecom company. The Revenue contended that the transaction involved the transfer of controlling interest in HEL and other rights and entitlements, which constituted capital assets situated in India, thereby making the transaction taxable under Sections 2(14), 5(2)(b), and 9(1)(i) of the Income Tax Act, 1961.

The Supreme Court thoroughly analyzed the complex corporate structure of Hutchison Group’s investments in India, including multiple tiers of subsidiaries incorporated in Mauritius and the Cayman Islands, and the various shareholders’ and framework agreements governing rights such as call and put options, subscription rights, non-compete clauses, brand licenses, and management controls.

Key Findings of the Supreme Court:

1. No Tax on Indirect Offshore Transfer: The Court held that Section 9(1)(i) of the Income Tax Act applies only to income arising from the transfer of a capital asset situated in India. The “look through” approach claimed by the Revenue—treating the transfer of shares in a foreign company holding Indian assets as a transfer of Indian capital assets—is not supported by the statute. The Court emphasized that indirect transfers are not covered under the existing law and such an extension requires explicit legislative provision.

2. Separate Legal Entity and Corporate Veil : Upholding the principle that companies are distinct legal entities, the Court rejected the Revenue’s argument that the transfer of CGP shares extinguished HTIL’s rights in HEL. It clarified that influence or control over subsidiaries does not equate to ownership of assets or legal control that would amount to a taxable transfer. The rights flowing from shares, including voting rights and management control, are inseparable from the shares themselves and cannot be dissected as separate capital assets.

3. Legitimate Business Purpose and Strategic Investment: The Court found that the offshore transaction was a bona fide structured foreign direct investment (FDI) and not a sham or a preordained tax avoidance scheme. The Hutchison structure had existed since 1994, contributed substantial tax revenues in India, and the transaction reflected a genuine commercial decision to exit the Indian telecom sector.

4. Non-Applicability of Section 195 and Representative Assessee Provisions: The Court ruled that Section 195, which mandates tax deduction at source on payments to non-residents, is not attracted in a transaction between two non-resident entities executed outside India without nexus to income arising in India. Further, Vodafone could not be treated as a representative assessee under Section 163 of the Income Tax Act in relation to the offshore transaction.

5. Situs of Shares: The situs of CGP shares was held to be the Cayman Islands, where the company was incorporated and where the share registry was maintained. The situs does not shift to India because of the location of underlying assets.

6. Valuation and Control Premium: The Court clarified that valuation of the enterprise at 67% interest included control premium and other intangibles but valuation alone cannot be a basis for tax. Control is a commercial concept and cannot be taxed separately from the shares.

7. Indo-Mauritius Treaty and Tax Avoidance Jurisprudence: The Court reaffirmed the validity of the Indo-Mauritius Double Tax Avoidance Agreement (DTAA) and the binding nature of Tax Residency Certificates issued by Mauritius. It rejected the Revenue’s call for overruling the well-settled principle of legitimate tax planning as held in Union of India v. Azadi Bachao Andolan and McDowell & Co. Ltd. v. Commercial Tax Officer.

The Supreme Court thus took a holistic approach, applying the “look at” test from English jurisprudence which requires the entire transaction to be considered in its commercial context rather than adopting a dissecting approach. It dismissed the Revenue’s claim that the offshore transaction should be taxed merely because it resulted in acquisition of controlling interest in an Indian company.

This judgment is expected to provide much-needed clarity and certainty to foreign investors in India, especially regarding the taxation of indirect transfers and the use of foreign holding companies in investment structures. The Court also urged the Indian legislature to enact clear laws addressing indirect transfers to avoid future disputes.

The Income Tax Department has been directed to refund Rs. 2,500 crores deposited by Vodafone with interest, and the Bank Guarantee given by Vodafone has been ordered to be returned.

Statutory provisions

Income Tax Act, 1961 Sections 2(14), 2(47), 5(2)(b), 9(1)(i), 45, 161, 163, 195, 201, 203, 203A

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This landmark judgment underscores the importance of respecting international corporate structures and treaties, limiting tax authorities to the clear language of the law, and recognizing the distinction between direct and indirect transfers for tax purposes in India.

Vodafone International Holding B.V v. Union Of India (SC) : Law Finder Doc Id # 345498