The decision of India’s Supreme Court in favour of Vodafone on 20 January is a ‘landmark decision’ for the foreign investment community and is ‘of even wider significance given what the judges said about tax avoidance,’ according to tax lawyers writing in this week’s issue of Tax Journal.
Nikhil Mehta, a tax barrister at Gray’s Inn Tax Chambers, and Gareth Miles, a tax partner at Slaughter & May, said a key feature of the decision was that ‘legitimate tax planning remains a valid exercise which the courts will respect’.
Tax advisers will regard much of what the judges said as an endorsement of offshore tax planning linked to foreign direct investment.
The judgment handed down on 20 January, which runs to more than 250 pages, is available on the Supreme Court of India’s website.
In February 2007 Hutchison Telecommunications International Limited (HTIL), a Cayman Islands-resident company, sold the entire share capital (a single share) of CGP Investments (Holdings) Limited (CGP), another Cayman Islands-resident company, to the Dutch company Vodafone International Holdings BV (VIHBV). The structure of the Hutchison Telecom group prior to the sale was set out in a chart on page 28 of the judgment.
Sarosh Homi Kapadia, the Chief Justice of India, held that the sale – the ‘offshore transaction’ – was ‘a bona fide structured FDI investment into India which fell outside India’s territorial tax jurisdiction, hence not taxable’. The transaction evidenced ‘participative investment’ and not a sham or ‘tax avoidant pre-ordained transaction’.
Chief Justice SH Kapadia
The Indian Revenue’s claim that it had the right to tax the gain had come as a ‘huge shock’ to tax advisers, said Baker Tilly partner Kevin Phillips. The Supreme Court’s decision would come as a relief to the Vodafone group and ‘a host of other large multinationals’ that had entered into similar deals, Phillips said.
The Times of India quoted Vodafone lawyer Harish Salve as saying, after the verdict was announced: ‘All this talk about uncertainty for foreign investment ... I hope for one area, this judgment clears the air.’
However, The Economic Times said the ruling was ‘a setback not only for India's fight against tax havens but also for taxation in general’. The Supreme Court had ruled that Indian tax authorities had no jurisdiction ‘as the deal was executed through sale of a holding company registered in the Cayman Islands’. India needed to ‘rewrite its tax laws’, the paper said, to ‘enable it to deal with commercial practice in a globalising world’.
‘If every ABC Ltd operating in India is henceforth not to be owned through a holding company registered in some tax haven or the other, so as to permit acquisition by XYZ Ltd through its holding company registered in another tax haven without paying any capital gains tax, the language of tax law will have to make it clear that what counts is whether value accrues to the company changing ownership because of its economic activity in India,’ it argued.
As Mehta and Miles note in their Tax Journal article, new legislation contained in the Indian Direct Taxes Code Bill is likely to reverse some of the impact of the Supreme Court’s decision for transactions implemented after the Bill is enacted.
Chief Justice Kapadia explained in the leading judgment that the Indian Revenue sought to tax capital gains arising from the sale on the basis that CGP, whilst not tax resident in India, held underlying Indian assets. If there was such a liability, VIHBV would be liable for withholding tax.
Indian income tax law was founded on the ‘separate entity’ principle – treating a company as a separate person, he said. It was ‘fairly well accepted’ that a subsidiary and its parent company were ‘totally distinct taxpayers’.
He observed that it was a common practice for foreign investors to ‘invest in Indian companies through an interposed foreign holding or operating company, such as a Cayman Islands or Mauritius based company’.
In doing so, he said, ‘foreign investors are able to avoid the lengthy approval and registration processes required for a direct transfer of an equity interest in a foreign invested Indian company’.
Every strategic foreign direct investment in India should be seen ‘in a holistic manner’, he said. In assessing whether there was tax avoidance, the Revenue should keep in mind ‘the concept of participation in investment, the duration of time during which the holding structure exists; the period of business operations in India; the generation of taxable revenues in India; the timing of the exit; [and] the continuity of business on such exit’.
The onus would be on the Revenue to identify the scheme and its dominant purpose.
The Hutchison structure had been in place since 1994, Kapadia noted, and the 2007 sale agreement indicated ‘continuity’ of the telecom business on the exit of the vendor. Thus it could not be said that the structure was ‘created or used as a sham or tax avoidant’.
Kapadia held that HTIL occupied only a ‘persuasive’ position over the downstream companies. The entire investment in the telecom business was sold to VIHBV through the investment vehicle CGP, and there was no extinguishment of rights in India as the Revenue had contended.
Furthermore, there was ‘no merit’ in the Revenue’s argument that the CGP share was inserted in order avoid tax. CGP was incorporated in the Cayman Islands in 1998 and was in the Hutchison group from 1998.
‘The [2007] transaction ... was of divestment and, therefore, the transaction of sale was structured at an appropriate tier, so that the buyer really acquired the same degree of control as was hitherto exercised by HTIL,’ he said, adding that the Court was ‘not inclined’ to accept the Revenue’s argument that the situs of the CGP share was in India, where the underlying assets were situated.
Mauritius and the Cayman Islands
Mauritius, an island nation off Africa’s east coast, has attracted more than 32,000 offshore entities according to the CIA’s World Fact Book. There is no capital gains tax and ‘the Mauritius-India route’ has been widely used by investors to invest in India, PwC Mauritius said in a recent briefing: ‘Mauritius has ranked first among the key FDI contributors in India for many years.’
The Cayman Islands are a British Overseas Territory with a population of about 53,000. Grand Cayman, the largest of the three Cayman Islands, is approximately 22 miles long and four miles wide. A BBC profile updated last month noted that the territory is one of the world's largest financial centres and a ‘well-known tax haven’ that has more registered businesses than it has people: ‘More than 9,000 mutual funds, some 260 banks and 80,000 companies operate through the islands.’
Kapadia explained that ‘when a business gets big enough ‘it does two things’.
‘First, it reconfigures itself into a corporate group by dividing itself into a multitude of commonly owned subsidiaries. Second, it causes various entities in the said group to guarantee each other’s debts.
‘A typical large business corporation consists of sub-incorporates. Such division is legal. It is recognized by company law, laws of taxation, takeover codes etc. On top is a parent or a holding company. The parent is the public face of the business. The parent is the only group member that normally discloses financial results. Below the parent company are the subsidiaries which hold operational assets of the business and which often have their own subordinate entities that can extend layers.
‘If large firms are not divided into subsidiaries, creditors would have to monitor the enterprise in its entirety. Subsidiaries reduce the amount of information that creditors need to gather. Subsidiaries also promote the benefits of specialisation. Subsidiaries permit creditors to lend against only specified divisions of the firm.’
He continued: ‘These are the efficiencies inbuilt in a holding structure .... Subsidiaries are often created for tax or regulatory reasons. They at times come into existence from mergers and acquisitions. As group members, subsidiaries work together to make the same or complementary goods and services and hence they are subject to the same market supply and demand conditions. They are financially inter-linked.
‘One such linkage is the intra-group loans and guarantees. Parent entities own equity stakes in their subsidiaries. Consequently, on many occasions, the parent suffers a loss whenever the rest of the group experiences a downturn. Such grouping is based on the principle of internal correlation.
‘Courts have evolved doctrines like piercing the corporate veil, substance over form etc. enabling taxation of underlying assets in cases of fraud, sham, tax avoidant, etc. However, genuine strategic tax planning is not ruled out.’
Justice KS Radhakrishnan’s concurring judgment began by noting that the point at issue was ‘of considerable public importance, especially on foreign direct investment, which is indispensable for a growing economy like India’.
He observed that in transnational investments ‘the use of a tax neutral and investor-friendly countries to establish [special purpose vehicles] is motivated by the need to create a tax efficient structure to eliminate double taxation wherever possible and also plan their activities attracting no or lesser tax so as to give maximum benefit to the investors’.
Justice Radhakrishnan added: ‘Certain countries are exempted from capital gain, certain countries are partially exempted and, in certain countries, there is nil tax on capital gains. Such factors may go in creating a corporate structure and also restructuring.’
Indian company law and tax law had no control over companies established overseas, he said. Many such companies used ‘offshore financial centres’ situate in Mauritius or the Cayman Islands.
‘Many of these offshore holdings and arrangements are undertaken for sound commercial and legitimate tax planning reasons, without any intent to conceal income or assets from the home country tax jurisdiction and India has always encouraged such arrangements, unless it is fraudulent or fictitious.’
The decision of India’s Supreme Court in favour of Vodafone on 20 January is a ‘landmark decision’ for the foreign investment community and is ‘of even wider significance given what the judges said about tax avoidance,’ according to tax lawyers writing in this week’s issue of Tax Journal.
Nikhil Mehta, a tax barrister at Gray’s Inn Tax Chambers, and Gareth Miles, a tax partner at Slaughter & May, said a key feature of the decision was that ‘legitimate tax planning remains a valid exercise which the courts will respect’.
Tax advisers will regard much of what the judges said as an endorsement of offshore tax planning linked to foreign direct investment.
The judgment handed down on 20 January, which runs to more than 250 pages, is available on the Supreme Court of India’s website.
In February 2007 Hutchison Telecommunications International Limited (HTIL), a Cayman Islands-resident company, sold the entire share capital (a single share) of CGP Investments (Holdings) Limited (CGP), another Cayman Islands-resident company, to the Dutch company Vodafone International Holdings BV (VIHBV). The structure of the Hutchison Telecom group prior to the sale was set out in a chart on page 28 of the judgment.
Sarosh Homi Kapadia, the Chief Justice of India, held that the sale – the ‘offshore transaction’ – was ‘a bona fide structured FDI investment into India which fell outside India’s territorial tax jurisdiction, hence not taxable’. The transaction evidenced ‘participative investment’ and not a sham or ‘tax avoidant pre-ordained transaction’.
Chief Justice SH Kapadia
The Indian Revenue’s claim that it had the right to tax the gain had come as a ‘huge shock’ to tax advisers, said Baker Tilly partner Kevin Phillips. The Supreme Court’s decision would come as a relief to the Vodafone group and ‘a host of other large multinationals’ that had entered into similar deals, Phillips said.
The Times of India quoted Vodafone lawyer Harish Salve as saying, after the verdict was announced: ‘All this talk about uncertainty for foreign investment ... I hope for one area, this judgment clears the air.’
However, The Economic Times said the ruling was ‘a setback not only for India's fight against tax havens but also for taxation in general’. The Supreme Court had ruled that Indian tax authorities had no jurisdiction ‘as the deal was executed through sale of a holding company registered in the Cayman Islands’. India needed to ‘rewrite its tax laws’, the paper said, to ‘enable it to deal with commercial practice in a globalising world’.
‘If every ABC Ltd operating in India is henceforth not to be owned through a holding company registered in some tax haven or the other, so as to permit acquisition by XYZ Ltd through its holding company registered in another tax haven without paying any capital gains tax, the language of tax law will have to make it clear that what counts is whether value accrues to the company changing ownership because of its economic activity in India,’ it argued.
As Mehta and Miles note in their Tax Journal article, new legislation contained in the Indian Direct Taxes Code Bill is likely to reverse some of the impact of the Supreme Court’s decision for transactions implemented after the Bill is enacted.
Chief Justice Kapadia explained in the leading judgment that the Indian Revenue sought to tax capital gains arising from the sale on the basis that CGP, whilst not tax resident in India, held underlying Indian assets. If there was such a liability, VIHBV would be liable for withholding tax.
Indian income tax law was founded on the ‘separate entity’ principle – treating a company as a separate person, he said. It was ‘fairly well accepted’ that a subsidiary and its parent company were ‘totally distinct taxpayers’.
He observed that it was a common practice for foreign investors to ‘invest in Indian companies through an interposed foreign holding or operating company, such as a Cayman Islands or Mauritius based company’.
In doing so, he said, ‘foreign investors are able to avoid the lengthy approval and registration processes required for a direct transfer of an equity interest in a foreign invested Indian company’.
Every strategic foreign direct investment in India should be seen ‘in a holistic manner’, he said. In assessing whether there was tax avoidance, the Revenue should keep in mind ‘the concept of participation in investment, the duration of time during which the holding structure exists; the period of business operations in India; the generation of taxable revenues in India; the timing of the exit; [and] the continuity of business on such exit’.
The onus would be on the Revenue to identify the scheme and its dominant purpose.
The Hutchison structure had been in place since 1994, Kapadia noted, and the 2007 sale agreement indicated ‘continuity’ of the telecom business on the exit of the vendor. Thus it could not be said that the structure was ‘created or used as a sham or tax avoidant’.
Kapadia held that HTIL occupied only a ‘persuasive’ position over the downstream companies. The entire investment in the telecom business was sold to VIHBV through the investment vehicle CGP, and there was no extinguishment of rights in India as the Revenue had contended.
Furthermore, there was ‘no merit’ in the Revenue’s argument that the CGP share was inserted in order avoid tax. CGP was incorporated in the Cayman Islands in 1998 and was in the Hutchison group from 1998.
‘The [2007] transaction ... was of divestment and, therefore, the transaction of sale was structured at an appropriate tier, so that the buyer really acquired the same degree of control as was hitherto exercised by HTIL,’ he said, adding that the Court was ‘not inclined’ to accept the Revenue’s argument that the situs of the CGP share was in India, where the underlying assets were situated.
Mauritius and the Cayman Islands
Mauritius, an island nation off Africa’s east coast, has attracted more than 32,000 offshore entities according to the CIA’s World Fact Book. There is no capital gains tax and ‘the Mauritius-India route’ has been widely used by investors to invest in India, PwC Mauritius said in a recent briefing: ‘Mauritius has ranked first among the key FDI contributors in India for many years.’
The Cayman Islands are a British Overseas Territory with a population of about 53,000. Grand Cayman, the largest of the three Cayman Islands, is approximately 22 miles long and four miles wide. A BBC profile updated last month noted that the territory is one of the world's largest financial centres and a ‘well-known tax haven’ that has more registered businesses than it has people: ‘More than 9,000 mutual funds, some 260 banks and 80,000 companies operate through the islands.’
Kapadia explained that ‘when a business gets big enough ‘it does two things’.
‘First, it reconfigures itself into a corporate group by dividing itself into a multitude of commonly owned subsidiaries. Second, it causes various entities in the said group to guarantee each other’s debts.
‘A typical large business corporation consists of sub-incorporates. Such division is legal. It is recognized by company law, laws of taxation, takeover codes etc. On top is a parent or a holding company. The parent is the public face of the business. The parent is the only group member that normally discloses financial results. Below the parent company are the subsidiaries which hold operational assets of the business and which often have their own subordinate entities that can extend layers.
‘If large firms are not divided into subsidiaries, creditors would have to monitor the enterprise in its entirety. Subsidiaries reduce the amount of information that creditors need to gather. Subsidiaries also promote the benefits of specialisation. Subsidiaries permit creditors to lend against only specified divisions of the firm.’
He continued: ‘These are the efficiencies inbuilt in a holding structure .... Subsidiaries are often created for tax or regulatory reasons. They at times come into existence from mergers and acquisitions. As group members, subsidiaries work together to make the same or complementary goods and services and hence they are subject to the same market supply and demand conditions. They are financially inter-linked.
‘One such linkage is the intra-group loans and guarantees. Parent entities own equity stakes in their subsidiaries. Consequently, on many occasions, the parent suffers a loss whenever the rest of the group experiences a downturn. Such grouping is based on the principle of internal correlation.
‘Courts have evolved doctrines like piercing the corporate veil, substance over form etc. enabling taxation of underlying assets in cases of fraud, sham, tax avoidant, etc. However, genuine strategic tax planning is not ruled out.’
Justice KS Radhakrishnan’s concurring judgment began by noting that the point at issue was ‘of considerable public importance, especially on foreign direct investment, which is indispensable for a growing economy like India’.
He observed that in transnational investments ‘the use of a tax neutral and investor-friendly countries to establish [special purpose vehicles] is motivated by the need to create a tax efficient structure to eliminate double taxation wherever possible and also plan their activities attracting no or lesser tax so as to give maximum benefit to the investors’.
Justice Radhakrishnan added: ‘Certain countries are exempted from capital gain, certain countries are partially exempted and, in certain countries, there is nil tax on capital gains. Such factors may go in creating a corporate structure and also restructuring.’
Indian company law and tax law had no control over companies established overseas, he said. Many such companies used ‘offshore financial centres’ situate in Mauritius or the Cayman Islands.
‘Many of these offshore holdings and arrangements are undertaken for sound commercial and legitimate tax planning reasons, without any intent to conceal income or assets from the home country tax jurisdiction and India has always encouraged such arrangements, unless it is fraudulent or fictitious.’
