The Supreme Court (SC) of India has this afternoon (January 21), pronounced its decision on the much awaited and anticipated ‘Vodafone Case’.

This case concerns the taxability, under the Indian tax laws, of gains arising to a foreign company from transfer of shares of a foreign holding company that indirectly held shares in an Indian operating company.

In one of India’s biggest tax controversies, the Tax Authority had demanded approximately US$2.5 billion in capital gains tax from Vodafone on the 2007 indirect transfer transaction.

The SC in a historic judgment has set aside the decision of the Bombay High Court (HC), which had held the transaction to be taxable in India and that Vodafone International BV was liable to withhold tax on the payment.

The SC has ruled that the transaction is not taxable in India, and it has made the following observations/ comments while pronouncing its ruling:

Presently, there are no look-through provisions in the Indian domestic tax law to tax the transaction.

There is no extinguishment of property rights in India through the transfer of shares between two foreign entities of shares in another foreign entity.

Similarly, provisions which treat a person as an agent/representative of a foreign entity for the purpose of levy and recovery of tax due from such a foreign entity is not applicable in the absence of a nexus.

There is no conflict between the earlier decisions of the SC in Azadi Bachao Andolan, and Mc Dowell. The SC in the case of Azadi (263 ITR 706), had held that an act which is otherwise valid in law cannot be held as sham, merely on the basis of some underlying motive supposedly resulting in some tax advantage. The SC in the case of Mc Dowells (154 ITR 148), held that sanction cannot be accorded to a “colourable” device.

The duration of the holding structure, timing of exit and continuity of business, are important factors while evaluating as to whether the transaction as a whole is a sham. Considering the factual matrix in the present scenario, the SC held that the transaction is not a sham.

Withholding tax provisions in the Indian domestic tax law cannot apply to offshore transactions

The Tax Authority has also been directed to refund the entire amount (US$ 0.5 billion) deposited by Vodafone as part payment towards the demand in early 2011 along with interest

Tax policy certainty crucial for national economic interest.

The decision of the SC is expected to be a milestone development in the taxation of international transactions and on the judicial approach to tax avoidance.

This case is, perhaps, the first in the world where the issue of taxation on indirect transfer of shares is being litigated before a country’s highest judicial forum.

The principles emanating from this ruling could therefore, have ramifications beyond India. It could also be of relevance in shaping India’s tax policy on international taxation and tax avoidance in the future.

The SC’s observation on the need for tax policy certainty is welcome. (Source – T Magazine)