Vodafone and India’s Offshore Indirect Transfer Tax: The saga continues
Vodafone and India’s Offshore Indirect Transfer Tax: The saga continues
In September 2020, the Permanent Court of Arbitration at The Hague issued award in favor of Vodafone against India’s income tax department demand to tax gains arising from the offshore indirect transfers (“OIT”) law in light of retrospective amendments to the Income-tax Act, 1961.
The concept of OIT law in India was unheard of until the Vodafone case. By way of background, Hutchison Telecommunication International Ltd. (“HTIL”), Cayman Island incorporated, and its downstream companies held interests in mobile telecommunications business across the globe including India. CGP Investments (Holdings) Ltd. (“CGP”), 100% subsidiary of HTIL incorporated in Cayman Island as an ‘exempted company’. The investment was made by multiple Mauritius companies in an Indian company, Hutchison Max Telecom Ltd. (“HMTL”) – later renamed as HEL. CGP held investments in HEL through subsidiaries 42.3%, through joint venture 9.6%, trade rights (call options) 15%.
In 2007, Vodafone International Holdings BV (“Vodafone” or “Dutch Entity”) entered Sale Purchase Agreement with HTIL for transfer of share capital in CGP including all the rights in respect of its Indian investments for around $11.2 billion. The moot question was whether the gains arising from the transaction was chargeable to tax in India under Section 9 of the Income-tax Act (“ITA”) and if yes, then the taxes should have been withheld by Vodafone, failure to do so shall imply that Vodafone was deemed to be a default assessee under Section 201 of ITA. Interestingly, ITA did not have the provision of OITs and applicability of withholding tax provision for a transaction between the non-residents. The tax department raised notice to Vodafone for non-compliance under the ITA. As a matter of course, Vodafone filed a writ petition to the High Court for quashing the demand on the grounds of lack of jurisdiction. The High Court held the capital gains arising from the transaction was chargeable to tax in India and, hence, the proceedings under Section 201 are sustainable.
Vodafone filed an appeal to the Supreme Court which held that the transfer of shares of a foreign company having an Indian subsidiary does not amount to ‘transfer of any capital asset situated in India’ as such section is not a ‘look through’ provision. Further, the situs of shares is the place of incorporation of the company and not the place where underlying assets are situated. The apex court held that considering it was an offshore transaction between two non-resident companies, with the subject-matter being transfer of shares of a non-resident company, the Indian tax authorities had no territorial tax jurisdiction. In order to tax a transaction, it is necessary to establish the nexus principle with the jurisdiction. In case of abusive/sham transaction resulting in tax avoidance, the tax authorities are within their rights to pierce the corporate veil for re-characterizing the transaction in accordance with its economic substance including in cases of holding company-subsidiary relationship. The success was short-lived as post Supreme Court judgement, ITA was amended retrospectively to tax such transactions.
- Advent of India’s offshore indirect transfers
While introducing the amendments in the Finance Bill of 2012, it was explicitly stated that these are in the nature of ‘clarification’ so as “to restate the legislative intent as certain judicial pronouncements have created doubts about the scope and purpose”. Particularly, a validation clause was introduced in Finance Act 2012 to recover the taxes along with interest and penalty from Vodafone. Such validation clause was retroactive in nature as it was stated that notice issued for taxes levied prior to such clause shall be valid and this clause shall operate irrespective of the order of any Authority. Additionally, “substance over form” was codified in the form of General Anti Avoidance Rule (GAAR) law to empower the tax administration to lift the corporate veil in cases of abusive/sham transactions to address the issue of aggressive tax planning.
The adverse reactions to the amendments in the Finance Act 2012 led the Government to form an expert committee for examining GAAR provisions for clarity and consultation with the stakeholders Subsequently, such committee was also directed to also examine the implications of OIT law in the context of all non-resident taxpayers. The committee suggested that such provision should not be retrospective in nature as it is a measure to increase the tax base and it does not correct anomalies in the statute or remove technical defects for computation mechanism. However, Government did not reverse the decision of retrospective taxation, instead formed a committee consisting of CBDT members for invoking OIT law on transactions before April 1, 2012 with a rider that no notice or proceeding has been initiated implying that all new cases shall first be referred to the committee.
While presenting the Finance Bill 2012, the Finance Minister asserted that such provisions are applicable with the countries not having tax treaty with India implying that the OIT law shall not override the provisions of the tax treaty. On examining the provisions of tax treaty, only a handful of Indian treaties state that the capital gains should be taxed as per the domestic laws of the source country. This implies that such provisions shall be applicable as the provisions of tax treaty cannot make the domestic law static with respect to taxability of a particular income when unequivocally both have left it to the domestic laws of the countries. However, the other view held is by virtue of an amendment to domestic laws, the principle of good faith shall be breached as the other treaty partner may not be aware of such amendments.
- Application of offshore indirect transfers law
Post legislation of the OIT law, the high profile acquisition (30%) of Genpact by Private Equity Fund Bain caught the eyes of the tax department. Bain acquired shares of Genpact Ltd, a Bermuda incorporated company listed on the New York Stock Exchange having operations and income from over 80 countries. Genpact India is a subsidiary of Genpact Ltd. In terms of factual information, 80% of Genpact’s delivery happens from India, 67% of the revenues are generated from India and more than 70% of the employee workforce was based in India. Considering that India did not have a tax treaty with Bermuda, there were indications of OIT law being applied. Considering such deal, critical concerns were raised that should the law be applied to the listed entities and portfolio investors or foreign institutional investors.
Another prominent case is Cairn U.K Holdings Ltd (“Cairn Holding”). The facts being Cairn Holdings, a UK incorporated company, and WOS of Carin Energy PLC (“Cairn Energy”). Cairn Energy, a Scotland incorporated company that held various oil and gas assets in India by way of subsidiaries (direct and indirect). Cairn Holding and Cairn Energy had entered a transaction wherein the entire share capital of subsidiaries of Cairn Energy holding Indian assets shall be transferred to Cairn Holdings in exchange for the share capital of Cairn Holding. Subsequently, Cairn Holdings transferred its entire shareholding in 9 Indian subsidiaries to Cairn India Holding Limited (“Cairn India Holding”), Jersey incorporated company in exchange for the share capital (100%) of Cairn India Holding. Post which, Cairn India Limited (“Cairn India”) acquired 100% shareholding of Cairn India Holding from Cairn Holding by combination of cash and share swap arrangement. The tax department contended that the transfer of shares of Cairn India Holdings to Cairn India qualified as indirect transfer under the India-UK DTAA, liable to tax in India under OIT provisions amounting to USD 1.56 billion. Unlike Vodafone which waited to file for arbitration proceedings, Cairn Energy and Cairn UK Holding had filed arbitration proceedings under Article 9 of the India-UK Bilateral Investment Promotion and Protection Agreement (BIPA) in advance without waiting for the decision of the Tribunal. Though a request was made to the Tribunal to adjourn the proceedings until the proceedings were concluded at the International Court of Justice, which got rejected and the order was passed in the favour of revenue authorities.
However, in light of the amendments, the tax department disregarding the intent aimed to bring in various transactions within Indian tax net irrespective of whether such right was not provided by the tax treaty. One of the prominent cases is Sanofi Pasteur wherein the tax department is passionately contesting that Article 14(5) of India-France DTAA covers OIT provisions, which is currently pending at Supreme Court. The High Court held that Article 14(5) is in relation to the shares of the company which does not allow a ‘look through’ approach and such interpretation by the tax administration shall imply a unilateral amendment to the tax treaty. Typically, a ‘look through’ approach is found in the tax treaties only in relation to shares of a company deriving value from immovable property.
Despite the judgement in the case of Sanofi, the tax authorities made a similar interpretation in the case of Sofinawherein the tax authority argued that in case of OITs the holding company’s share deriving value from Indian assets shall be deemed to be an Indian resident. Such interpretation was rejected by the Tribunal.
- International overview of offshore indirect transfer law
Internationally OIT law is recognized by limited countries. For e.g. China has legislated the OIT law under anti-avoidance law. It is applicable in case of transfer of Chinese company indirectly through a sham arrangement. In Brazil, OIT law is legislated under statutory provisions which disregard intermediate company used for the transfer of assets in Brazil if the company does not have business purposes or bonafide purpose. In Israel, foreign companies are subject to tax under the OIT law if the asset located outside Israel gives the right (direct or indirect) to any asset/property.
Though the OITs provisions did not find a place in the OECD Model Convention or UN Model Convention. However post three highly publicized OITs (i) India’s judgment on Vodafone (ii) indirect sale of the Peruvian oil company Petrotech Peruana, and (iii) indirect sale by Zain of various assets in Africa including a mobile phone operator in Uganda led the Platform for Collaboration on Tax – a joint initiative of the IMF, OECD, UN and World Bank Group – to issue Toolkit on ‘Taxation of Offshore Indirect Transfers’. All these transactions had similarities in terms of these issues were faced by the developing countries wherein multinational companies escaped taxation in the source jurisdiction including the jurisdiction in which the underlying assets are located.
The OECD Model Convention 2017 does not address tax gains arising on the shares of the company in the source country, perhaps because it believes that such gains shall only be taxed in the owner’s resident state. However, taking note of the developed countries, the Twentieth Session of Committee of Experts on International Tax proposed insertion of a draft article concerning capital gains on OITs in the UN Model Tax Convention for addressing the issues. Post consultation, a note was released in the Twenty-First session for approval which included the recommendation by the stakeholders in order to be robust.
- Vodafone’s Arbitration Award and beyond
In view of the Supreme Court decision, against the retrospective amendments, Vodafone had various legal options such as (i) legal challenge to the vires of the validation clause, (ii) seeking solution under the Mutual Agreement Procedure (MAP) under India-Netherlands DTAA, etc. Instead, Vodafone filed arbitration proceedings under Article 4 of India-Netherlands BIPA claiming that attempt to recover taxes violated India’s commitment for fair and equitable treatment.
Due to the request for confidentiality, the detailed arbitration award has been not released. The operative part of the arbitration award holds that
- The Arbitral Tribunal has the jurisdiction to deal with the ‘retrospective tax issue’ which was challenged by the government
- Vodafone is covered with the scope of the ‘guarantee of fair and equitable treatment’ under Article 4(1) of India-Netherlands BIPA
- India breached this guarantee by asserting upon Vodafone the ‘liability to tax notwithstanding the Supreme Court judgment’
- India’s breach must be ceased or else would result into ‘international responsibility’; and
- India must reimburse the costs of legal representation to Vodafone.
The Vodafone award presents an interesting paradox as there is neither equity in taxation nor fair play in tax law, the sole purpose of which is to impose an exaction on the subject under the sovereign’s prerogative.The jury is clearly out on whether the tribunal is correct to conclude that the government has, for all times to come, qua a particular class of investors (who are covered within the scope of BIPA), conceded sovereign and legislative authority to impose any additional tax after the investment, a stance which the law officers of the government are bound to closely examine.
International investment agreements include investment treaties and tax treaties as the aim of both such instruments is to foster foreign direct investment. Depending upon the investment treaty, the tax issues (domestic or international) may be carved out from the applicability. Despite the current trend of limiting such categories of cases and the tendency to reject the applicability of most-favoured-nation and national treatment clauses to taxation matters, issues materially connected with the enjoyment of certain protective rights by an investor can still be decided through bilateral investment treaty mechanisms. The aim of investor protection under investment treaties is not to provide an alternative forum for the settlement of tax disputes, but rather for the prevention of inappropriate behaviour by governments and administrators infringing the legitimate expectations of the investor.
In the OECD Model Convention 2008, tax arbitration clause was introduced under Article 25 MAP. The prerequisite for invoking tax arbitration clause by the taxpayer was that the case has already been filed for MAP application and competent authorities were unable to reach an agreement to resolve a tax dispute and no court/tribunal of either state has rendered decision on such issue. The arbitration decision shall be binding on both states unless the taxpayer has objections.
Though this clause was introduced in the UN Model Convention 2011 which had a similar condition to invoke tax arbitration clause, however, the difference lied that unlike OECD allows the taxpayer to file, UN provides that only the competent authority are authorised to file for arbitration. Further, apart from giving the option to the taxpayer rejecting the decision, UN Model also provides the option to reject the arbitration decision in case both competent authorities agree on a different solution within six months of the decision.
Non-tax arbitration covers a wide range of categories of disputes, including disputes that may involve cross-border taxation. Regarding non-tax arbitration, an award is final and binding under respective bilateral investment treaties and UNCITRAL Arbitration Rules. Article 54(1) of the ICSID Convention, 2003 states that “Each Contracting State shall recognize an award rendered pursuant to this Convention as binding and enforce the pecuniary obligations imposed by that award within its territories as if it were a final”. Though India is not a signatory to the ICSID Convention, therefore, does not have an obligation to recognise and enforce BIT awards as final judgments.
Indian tax officials have been consistent in its position that tax cases are not covered under BITs. For resolving tax disputes, the dispute resolution mechanism is MAP under the tax treaty. Therefore, India has challenged the authority of the tribunal and the maintainability of the arbitral proceedings in the case of Cairn Energy and Cairn UK Holding. Even the Tribunal also disregarded the pending arbitration in the case of Cairn UK Holding on the grounds that tax disputes are outside the purview of BIPA. On a larger level, the Vodafone Arbitration award raises critical questions whether investment treaties overwhelm the taxation realm, does the execution of a BIT restricts the host State from revisiting its tax policies and laws. Does the untrammelled constitutional authority of Parliament to reinstate the law by legislatively overruling judicial decisions is restricted because the government has executed an investment treaty with another nation.
Post-Vodafone Arbitration award, the Government has gone on record to state “will consider all options and take a decision on further course of action including legal remedies before appropriate fora”. The Government has sought two weeks’ time from the Delhi High Court to decide whether it will challenge the award. Interestingly, in case the Government does not challenge the award, Vodafone will not pursue a second arbitration under the India-UK BIPA. The arbitration award in the case of Cairn Energy is awaited.
Considering it has been almost a decade since OIT law was legislated, the current provisions are not adequate as the Indian tax administration has been very slow in addressing the issues. The CBDT issued a circular in order to address the FAQ in respect of applicability of OIT which instead of providing clarity created uncertainty amongst the stakeholders. As a result of which such circular has been kept in abeyance. The exemption to the non-residents investing directly or indirectly, in Foreign Institutional Investor or specified category of Foreign Portfolio Investor was notified in the Finance Act 2017. Later the exemption to the investors of specified funds i.e. Venture Capital Company, Venture Capital Funds, Category I and II of Alternative Investment Funds was provided.
Unlike global practice wherein the OIT law is not applicable on the listed entities and business re-organization within the group subject to continuity of 100% ownership, India has not carved out such exceptions. Particularly, Indian OIT law has prescribed that non-applicability only in case the transferor satisfies that it does not hold the right of management/control and does not hold more than 5% of share capital of the company having underlying assets in India. These tests have to be checked not just individually but along with associated enterprises of such transferor as well. For e.g. an Indian non-resident shareholder holding investment of 5.5% share capital in a listed UK entity is planning to sell the shares on a recognized stock exchange. Such UK entity has subsidiaries across the globe including India. The practical problem lies whether such a minority shareholder will know whether such listed company is deriving value from Indian assets and whether the listed company will undertake valuation every time a minority shareholder is planning to divest its investments. Furthermore, such transferor has to check whether these tests are met by the associated enterprise as well.
Another issue is that in case of any transaction involving a change in the shareholding of foreign holding company, such transaction has to be mandatorily reported by the Indian entity. This is irrespective of the fact that the OIT law is not applicable to the transaction. Since the reporting obligation has been thrusted on the Indian entity, failure to comply shall attract penal provisions. It shall become a challenging exercise as the Indian entity would have to carry out a valuation exercise for every transaction in order to comply with the regulatory requirements and maintain prescribed documentation which can be burdensome and tedious. Particularly, in the case of multinational companies, valuation can be challenging in absence of required information.
Another key issue yet to be addressed is how will the tax credit mechanism work, as OIT law may lead to multiple taxation for the same transaction. Further, the credit for such taxes may not be available in the home jurisdiction. In absence of credit mechanism, such issues should be resolved by mandatorily by Mutual Agreement Procedure.
As a fact, in these COVID-19 times, during April to August, 2020 India has received total FDI inflow of US$ 35.73 billion which is the highest ever for first 5 months of a financial year and 13% higher as compared to first five months of 2019-20 (US$ 31.60 billion). In term of FDI equity inflow, US$ 27.10 billion has been received during F.Y. 2020-21 (April to August 2020) which is highest ever for first 5 months of a financial year and 16% more compared to first five months of 2019-20 (US$ 23.35 billion). As stated by Late S.H. Kapadia in Vodafone case “FDI flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law. Certainty and stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner”. Hence, India can think of selectively applying OIT law as an anti-abuse measure as it may have a negative impact on FDI.
 PCA Case No. 2016-35: Vodafone International Holdings BV (The Netherlands) v. India Award.
 Vodafone International Holdings B.V. v. Union of India  341 ITR 1 (SC)
 Memorandum explaining Finance Bill, 2012
 Notification, dated September 1, 2012
 Indian treaties with Canada, Israel, Namibia, South Africa, United Kingdom, Unites States of America, Zambia
Cairn U K Holdings Ltd. v. Deputy Commissioner of Income-tax (International Taxation)  79 taxmann.com 128 (Delhi – Trib.)
Sanofi Pasteur Holding SA v. Department of Revenue, Ministry of Finance  354 ITR 316 (Andhra Pradesh)
 Article 13(4) of OECD Model Convention, 2017 and Article 13(4) UN Model Convention, 2017
 Sofina S.A. v. Assistant Commissioner of Income-tax  116 taxmann.com 706 (Mumbai – Trib.)
 Public Notice  No. 7 issued by China’s State Administration of Taxation on 6 February 2015
 Indian Draft Report on Retrospective Amendments Relating to Indirect Transfer by Expert Committee (2012)
 Paragraph 30 of OECD Model Commentary 2017 (detailed) on Article 13
 See, Mukesh Butani & Tarun Jain, What next after the Vodafone tax arbitration? Available at https://www.fortuneindia.com/opinion/what-next-after-the-vodafone-tax-arbitration/104758
 Chapter 8, Arbitration Procedure and the Implementation of Arbitral Awards in Domestic Law of WU Tax Treaties and Procedural Law
 P. Pistone, General Report , in The Impact of Bilateral Investment Treaties on Taxation p. 41 (M. Lang et al. eds., IBFD 2017), Books IBFD.
 Art. 34 UNCITRAL Arbitration Rules.
 See Tarun Jain, Shankey Agrawal, Investment Treaties Interjecting Taxation’s Realm: The Latest in Vodafone’s India Saga , available at http://kluwertaxblog.com/2020/10/13/investment-treaties-interjecting-taxations-realm-the-latest-in-vodafones-india-saga/
 Supra note 22
 Circular No.41/2016 issued on December 21, 2016
 Circular No.28/2017 dated November 7, 2017
 Press Information Bureau on Foreign Direct Investment Inflow, Release ID: 1666101