Indian tax authorities do not have territorial jurisdiction to tax offshore transfer of shares.

The Honble Supreme Court in a landmark judgment in Vodafone International Holdings B.V. v. Union of India & Anr. [S.L.P. (C) No. 26529 of 2010, dated 20 January 2012] has decreed that offshores sale of shares will not chargeable to capital gains taxation in India. In the above case; the petitioner; Vodafone International Holdings B.V. (Vodafone) a Dutch entity acquired 100% shares in CGP Holdings Limited (CGP); a Cayman Islands company for USD 11.1 billion from Hutchinson Telecommunications International Limited (HTIL) another Cayman Islands company. CGP through a number of Mauritius entities directly and indirectly controlled 67% of Hutchinson Essar Limited (HEL); an Indian company. HEL a joint venture between Hutchinson and Essar group provided cellular telephony services in India. The tax authorities contended that the capital gains arising to HTIL from the transfer of shares of CGP was taxable in India since it led to the transfer of controlling interest and other assets located in India and hence Vodafone was liable to withhold taxes on the same under section 195 of the Act. The tax authorities issued a notice to Vodafone seeking to treat it as an assessee in default for failure to deduct tax at source and Vodafone approached the Honble Bombay High Court through a writ petition challenging the jurisdiction of Indian tax authorities to issue such a notice. The Honble Bombay High Court while dismissing the writ petition held as follows: The transaction between Vodafone and HTIL was not an innocuous transfer of shares of CGP but involved transfer of tangible and intangible interest in an Indian company. There was admittedly a transfer of controlling interest of HTIL in HEL which resulted in relinquishment and extinguishment of rights of HTIL in HEL and hence there was a transfer as defined in the Indian Income Tax Act, 1961 (Act). The shares of CGP were merely a mode of transfer of assets situated in India and the choice of a particular mode of transfer did not alter the character of CGP; which was essentially a shell entity and the transfer of CGPs shares was intended at resulting in transfer of assets situated in India. A writ petition against a show-cause notice can only be entertained if the notice was totally non est in law due to absolute lack of jurisdiction of the authority to even investigate into the matter. Vodafone failed to establish this absolute lack of jurisdiction in this case.

Vodafone then approached the Honble Supreme Court through a special leave petition against the order of the Honble Bombay High Court. While holding that the transfer of shares of CGP was not liable to tax in India; the three judge bench of Honble Supreme Court adjudicated on the following important issues (majority opinion delivered by Chief Justice and concurrent opinion delivered by Justice Radhakrishnan):

Tax avoidance in light of the apparent conflict between Mcdowell and Azadi Bachao.

On the apparent conflict between the constitutional bench decision in Mcdowell and the subsequent decision in Azadi Bachao by a smaller bench of the Supreme Court both the majority and Justice Radhakrishnan reached the same conclusion that Azadi Bachao remains good law but for different reasons. While the majority stated that the majority opinion in Mcdowell only agreed with Justice Chinnappa Reddys opinions with respect to colourable devices and shams therefore there was no conflict between Mcdowell and Azadi Bachao; on the other hand Justice Radhakrishnan held that the view taken by Justice Chinnappa Reddy was incorrect and his observations being in the nature of obiter there was no conflict between the majority opinion in Mcdowell and Azadi Bachao. The majority then went on to hold that the principle of Westminster was still valid in spite of the criticism in Ramsay and Furniss. The meaning of extinguishment under transfer as defined in Section 2(47) of the Act.

The Court held that a sale of shares not taxable cannot be dissected to make its component taxable. The intention of introducing the term extinguishment was to widen the scope of transfer to cover those transactions in which there is no sale in the ordinary sense. Therefore, the tax authorities cannot invoke extinguishment to tax a transaction of sale just because the sale was not taxable. The composite nature of various rights clubbed under a share in a company.

The Court held that as a general rule sale of shares cannot be broken up into separate individual components; such components not being separate capital assets. As regards the transfer of controlling interest through the transfer of shares of CGP; the Court held that controlling interest is an incident of ownership of shares and flows with the transfer of shares. Since, the controlling interest is not a distinct capital asset capable of being separated from the transfer of shares; the present transaction was simply a transfer of shares and not a transfer of underlying assets or rights. Given the fact that the chargeability of transfer of controlling interest has been introduced in the Direct Taxes Code Bill 2010 it is clear that such a transfer was not envisaged to be taxable under the Act. The nature of provisions of Section 9 of the Act (look at or look through).

The Court held that Section 9 of the Act does not provide for a look through provision. If such a provision is read into the said section; the whole concept of chargeability under the Act will change. Therefore, the starting point of tax authorities enquiry cannot be the determination of whether the transaction is a deferment or tax saving device and the tax authorities should instead look at the transaction in its proper context to ascertain its true legal nature. The Court took a practical approach to this issue and held that if a transaction makes use of a colourable or an artificial device then the tax authorities could disregard the

form of the transaction and go into its substance but this enquiry should not overshadow the corporate business purpose of the transaction. The Court observed that almost all FDI into India is through an interposed foreign holding or operating company. Cayman Isles and Mauritius are commonly used for business as well as tax purposes and to avoid lengthy approval and registration process. Since, under Company laws of India the situs of shares is the place where the company is incorporated; this fact could not be ignored. Therefore, whether a particular transfer of shares is a colourable or an artificial device will be determined having regard to the following factors: i. ii. iii. iv. v. vi. vii. viii. Concept of participation in investment Duration of existence of Holding entity Period of business operations in India Generation of taxable revenues in India Timing of exit Continuity of business on such exit Dominant purpose of transaction Corporate business purpose of the transaction

The Court on a detailed examination of facts and analysis of the circumstances surrounding the sale of shares of CGP found that the sale of shares of CGP had a genuine corporate business purpose and it was not a shell entity as contended by the tax authorities. Therefore, the sale of shares of CGP was not taxable in India. The liability of a non-resident to withhold taxes on payments made to non-residents outside India under section 195 of the Act.

The majority ruled that since the transfer of shares was not chargeable to capital gains tax in India the question of withholding tax under section 195 of the Act did not arise. Justice Radhakrishnan on the other hand went into detail on this issue. He held that Section 195 could not have been intended to cover payments by non-residents to other non-residents made outside India even though the language of the Section is wide enough to include nonresidents. Distinguishing the facts of Eli Lily where a non-resident employer was held to be liable to withhold tax on the salary paid to seconded employees rendering some part of their services in India and receiving some part of their salary in India; Justice Radhakrishnan categorically held that Section 195 of the Act will only apply to situations where a resident

makes payment to a non-resident and not when the payment is made by a non-resident to another non-resident outside India. Given the fact that the majority did not deign fit to go into this question and Justice Radhakrishnan stands alone on this issue; the precedential value of his views is likely to be hotly debated.