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Let's get to the root of the issue. Here is a foreign company incorporated in Hong Kong which sold its Indian telecom business by selling the holding company in Cayman Islands for about Rs 55,715 crore to another SPV in Cayman Islands owned by Vodafone. Because the sale was made overseas, no one paid any taxes. Now, under Section 9(1)(i) of the Indian Income Tax Act, if income arises directly or indirectly because you transfer a capital asset in India, you have to pay taxes. When you sell a tax haven company which owns an Indian business – and owns nothing else - do capital assets get transferred in India or not? In other words, was a capital asset transferred in India "in consequence of" the share transfer that occurred in Cayman Islands?
When you get past the legal gobbledegook, the question you have to ask is this: to understand what really happened here so that you can tax it, or not, will you "look at" the surface of this transaction or do you "look through" it at its real meaning? Put another way; are you interested in form or in content? On any other day, if this was between two equal private parties in India where you had no prejudices, I suspect you may say that you prefer substance over form. Who wants to be superficial anyway? Apparently, the English language press loved the superficial view.
The Supreme Court agreed, taking the view that it wasn't going to look through anything unless the law specifically asked it to do so. It observed that looking through was a matter of policy. It noted that Hutchison had paid a lot of domestic taxes in India for the thirteen years it operated in India.It concluded that this was not a case of a sham structure being created only to avoid taxes.
There was a second issue as well. Resident Indians have to pay taxes in India. If you own assets in India, you are deemed to be a resident. Vodafone was at all relevant times a shareholder of Bharti. Didn't that make it resident in India? Vodafone argued that tax presence has to be viewed in the context of the transaction. The entity that held the Bharti shares was not the entity that purchased the Hutchison shares. Basically it was saying that if you incorporate different companies to run different businesses, each of them have to be seen in isolation. Does that sound like slippery slick Willy logic? The Supreme Court didn't agree. It also held that it had to examine the "legal nature" of the transaction and not the indirect transfer of rights and entitlements in India.
It seems to me that the legal issue is pretty finely balanced. The same issue has been argued in courts around the world and the decision has gone both ways in different countries. Which country wants to be seen to be tricked out of its dues through fancy structuring? If you have no prejudices, you will see that there is a real issue here. It is of course true that traditionally, courts around the world have been comfortable taking any transaction for what it purported to be. Increasingly, in recent years, the mood has changed and courts are inclined to discern the true nature of what is going on in a variety of legal areas. As a result, slick ‘structuring' of transactions in order to avoid this or that legal implication is increasingly an uphill task. You could argue that the Supreme Court took the old fashioned view, which is not to say that it is not a highly credible view.
I expect the euphoria in the press has nothing to do with the tax law interpretation issue. Most people have no idea where tax jurisprudence is headed at a global level and couldn't care less. The response was largely emotional. We could as easily have been incensed, not jubilant at the tax discrimination. If a resident Indian had purchased the business in India without all this globetrotting and treaty shopping, he would have paid taxes in India. Why should a foreigner be better placed than an Indian? That apart, those who live here and work here and pay their taxes here could easily want everyone else to pay their taxes too. So when the press went "Ra Ra hurrah!" in January, were we all just congenital tax evaders getting high at some sort of convoluted tax dodgers parade congregating to celebrate the Supreme Court judgment?
Whatever the psychosis we were pandering to, the Finance Minister wouldn't have any of it. He has therefore proposed a new dispensation using three tools to capture this money. First, by a retrospective amendment, the minister wants to make controlling interest a capital asset with effect from April Fool's day 1962. Nice touch! Next he wants to retrospectively amend the meaning of "transfer" to take in transfers that occur as a result of the sale of shares of foreign companies. Finally, he attacks the problem of indirect transfers by legislating that an asset will be deemed to be situated in India if its value is substantially based on assets located in India.
Indian elites are incensed now. Retrospectively changing laws is being projected as somehow unethical. It's also being seen as circumventing and dishonouring the Supreme Court.
Whatever the ‘ethics' of retrospective changes, it certainly has worldwide popularity! Israel is probably not a good example but it promulgated laws after the Second World War which criminalized acts which occurred before Israel existed as a nation! Germany is probably a better example. The German constitution provides for the creation of such laws and I am told that Germany has even created new crimes retrospectively because they violate international laws. They haven't had quite the same luck with retrospective tax legislation with taxable events occurring in Netherlands and Denmark. These nationswent to the European Court of Justice which said that national legislation could not be created to offset foreign corporate tax. The result may have been very different if Germany was not a EU member.
It's the opposite in America. The US Supreme Court has ruled that retrospective civil and tax laws may be created but retrospective criminal laws may not. It's the same in Australia, Canada, Finland,France, Indonesia, Sweden, and a host of other countries.Several others around the world, notably Brazil, Iran, Ireland and Norway ban substantially all retrospective legislation. As a general proposition, most countries do not approve of sending people to jail for things they did which were not crimes when they did them. Most countries are quite happy to retrospectively apply civil and tax laws, and that includes India.
Section 20(1) of our Constitution bans the retrospective creation of crimes and penalties. As for tax amendments, in 1985, the Supreme Court ruled in the Hindustan Gum and Chemical case that a legislature was competent to overcome a legal decision by amending the law to change the basis of the judgment. In 2005, the Supreme Court also ruled in the RC Tobacco case that "A law cannot be held to be unreasonable merely because it operates retrospectively. Indeed even judicial decisions are in a sense retrospective. When a statute is interpreted by a court, the interpretation is, by fiction of law, deemed to be part of the statute from the date of its enactment." How true!
Besides, when it comes to taxes, we've been doing it all the time. Recall that in 1983, excise law was changed to capture tax based on the "Maximum Retail Price" as stated on the package of goods. In March 1987, the Central Excise Commission issued a show cause notice to ITC claiming that ITC was selling cigarettes at higher than its specified MRP. In the ensuing litigation, the department claimed that the company could not sell cigarettes at higher than MRP and it had to pay tax on the maximum price at which it actually sold them. In turn, the company claimed that the words ‘may be sold' occurring in the definition of sale price meant ‘capable of being sold', meaning that the price at which it actually sold cigarettes was not particularly relevant. The Supreme Court agreed with the Company. It held that the language of the notification was clear. Tax was paid on the price printed on the packet. It wasn't for the tax department to launch investigation on whether the cigarettes were actually sold at that price!
As you can guess, the Government wasn't about to tolerate this blatant violation of law's intent. In Jan 2005, in the wake of the judgment, it issued an ordinance empowering the revenue authorities to change excise rules retrospectively. It also enlarged the definition of ‘sale price' to mean "the higher of MRP or maximum selling actual price". Now, here is the dodgy part. Under Section 5 of the ordinance, the court's power to subject this section to a judicial review was excluded. As a general proposition, courts are not very happy to see their own jurisdiction excluded. But ITC wasn't going to pay lawyers twice, especially as retrospectivity is thin ice to skate on. It made a deal with the Government, letting go the Rs. 250 Crores it had deposited with the Government and keeping the Rs. 453 Crores more that the Government wanted it to pay. Sound like a blackmail payoff, doesn't it? I think you can make some very realistic assessment about what happens next in the Vodafone case because Vodafone has little to gain by a second round of litigation and the Government needs the money now, not in ten years.
The question we should be asking ourselves though is where our self interest lies. We know that globally, the Government's view is gaining in popularity. For sixty years, we have been cry-babies of the license permit quota raj asking for tax breaks before every budget. For sixty years, our general attitude has been to treat the Government like the local thug it really is. For sixty years, we have seen ourselves as smart when we ripped the Government off and slyly winked at our friends to say "le lee na?" We know that we cannot grow as a nation unless we spend money on public schemes. Somebody has to pay taxes or we are going nowhere. If we want change - and progress - how about changing our attitude? Like not being jubilant when the Government fails to collect taxes from exiting foreigners who've just made a fortune in our country and are off with the booty.
(The author is managing partner of the Gurgaon-based corporate law firm N South and author of the pioneering business book Winning Legal Wars. He can be contactedat [email protected]law.com)