The Hindu Business Line : Make M&A tax regime transparent

Liberalisation of foreign investment policy framework has made India emerge as an attractive investment destination. The Government has been proactive in introducing regulatory policies and amendments to attract foreign investment. At a time when globalisation is an accepted norm and M&A (mergers and acquisitions) restructuring activity happeningfrequently, there are several business considerations that investors factor in while making their investment decisions. Cer tainty in the tax regime of an investment destination is definitely one of them.

Cross-border deals

Recently, Indian tax authorities have attempted to tax certain cross-border transactions between offshore companies where the ultimate interest in an Indian business has been transferred, such as in the Vodafone deal. This is based on the premise that economic interest in the underlying property in the Indian entity is being transferred, though what occurred was the transfer of shares of an overseas company outside India between two foreign entities.

Action taken by the Indian tax authorities against Vodafone and other companies (Birla, AT&T, GE, Vedanta, SAB Miller, etc.) poses important questions that travel to the foundation of a just and transparent tax administration. Many similar transactions have taken place in the past which were never sought to be taxed in India.

Such a change in the interpretation of Indian tax law could expose many previous sellers and buyers of shares of overseas companies to significant amounts of tax and create uncertainty for such transactions. This proposition is not favourable for the investment climate.

In the Vodafone-Hutchison deal, Hutchison transferred shares of its Cayman Island entity to Vodafone Netherlands. By virtue of this transfer, Vodafone ultimately acquired an interest in the Indian telecom business of Hutchison.

The Indian tax authorities sought to tax this transfer as subject to capital gains tax and issued a show-cause notice to Vodafone for non-compliance of withholding tax provisions, disregarding the territorial limitation of such provisions. When Vodafone challenged the show-cause notice issued by the Indian tax authorities in a writ petition before the Bombay High Court, the court, in the absence of Sale Purchase agreement, held that, prima facie, the notice issued cannot be termed extraterritorial and, thereby, erroneous so as to require it to be quashed.

However, the court ruled that whether the transaction was taxable in India or not must be investigated by the Indian tax authorities. Subsequently, the Supreme Court (SC) directed the tax authorities to decide as a preliminary matter the issue of jurisdiction after taking into account the relevant agreements and documents. As per Section 1(2) of Income-Tax Act, the provisions of the Act apply to the whole of India.

Considering this, it needs to be decided whether the tax authorities have jurisdiction to tax the transaction, particularly when the transfer of shares of a foreign company was effected between two non-residents outside India, and where there was no direct business nexus with India. The clarity on applicability of jurisdiction will need to be determined.

It is important to note that neither the High Court nor the Supreme Court has given their verdict on the chargeability of the transaction to tax in India and have rendered their decision merely on maintainability of Vodafone’s writ petition.

This is likely to lead to protracted litigation as the apex court has permitted Vodafone to challenge in the High Court the Indian tax authorities’ preliminary finding as to jurisdiction.

As Indian tax laws have been in existence, such offshore acquisitions have not been subjected to tax in the country. This has been a well settled legal position and is in line with international tax standards.

Non-residents, amongst other situations, are also liable to tax when the income is deemed to accrue or arise in India. In the case of the transfer of a capital asset, such chargeability arises only if the capital asset is situated in India. It is well settled that shares are deemed to be situated where a company is incorporated.

In the Vodafone deal, the shares being transferred were not of an Indian company and, accordingly, Vodafone’s position is that on that basis, gains arising thereon should not be taxable in India. Irrespective of whether the transfer is ultimately taxable or not, it also needs to be decided whether Vodafone was at all required to deduct tax on such payments, particularly when the transfer was effected outside India between two non-resident entities, which probably did not have any direct business nexus with India?

There is a merit in the argument that Indian withholding tax obligations may not be applicable to Vodafone but this needs clarity from the courts.

The Supreme Court, in the Mrs Bacha F Guzdar (27 ITR 1) case, has also held that the company has a legal presence, distinct from its shareholders. It is the company which owns the property and not the shareholders. Accordingly, it cannot be said that when Vodafone acquired the shares of the overseas company which, through a number of indirect subsidiaries, held shares in the Indian company Hutchison Essar Ltd (now Vodafone Essar Ltd), that Vodafone acquired an interest in the property of HEL.

It has also been held that unless the transaction is a colourable device, the tax department must respect the legal form of the transaction. In the Vodafone case, the tax department stated in the Bombay High Court that the present transaction is neither a colourable device nor there has been any attempt for tax evasion.

The approach of the tax authorities seems divergent from the accepted standards of international taxation and puts India out of line with global fiscal norms. A study of the tax regulations in overseas jurisdictions (the UK, the US, France, China, etc) suggests that none of them tax transfers of overseas holding entities merely because the companies have underlying assets in these jurisdictions.

Some jurisdictions do have specific and overt legislative provisions which have been enacted prospectively to tax such gains in specific circumstances but Indian tax laws currently do not contain such provisions.

India, as a sovereign nation, is entitled to widen its tax net and tax overseas transactions as aforesaid. However, the same can be undertaken by means of a suitable prospective amendment in the law, as appropriate. This would ensure that the investors are aware of their tax obligations that would accrue to them at the time of entry/exit and are able to factor in this consideration while making their investment decision.

The global business community is closely following the Vodafone development and any adverse tax judgment may create uncertainty in the minds of investors. Equally with Indian companies now increasingly investing in various companies in foreign jurisdictions, tax positions should be consistent with global tax practices. As a competing destination for attracting foreign investment, India should provide a stable, fair and transparent tax regime.

(The author is Executive Director and Head of Tax, KPMG India Pvt. Ltd)

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