Vodafone case likely to have a direct impact

The Vodafone case is epochal as some well settled tax positions got seemingly unsettled until Supreme Court's ruling. Vipul R Jhaveri writes.

india Updated: Feb 26, 2012 20:16 IST
Vipul R Jhaveri
Vipul R Jhaveri
Hindustan Times

The Vodafone case is epochal as some well settled tax positions got seemingly unsettled until Supreme Court's ruling. As far as foreign direct investments (FDI) into India is concerned, the authorities challenged a whole set of positions including controlling interest to be separable and distinct capital asset from shares of company, treating such asset in India, expanding the scope of taxation to include transfer of controlling interest through indirect transfer of shares of a foreign company, challenging legitimacy of holding company structures etc.

The sheer magnitude of tax demand in Vodafone's case and other similar transactions besides the potential impact on other FDI projects into India attracted the attention of tax payers and revenue authorities alike, globally.

While several countries such as China, South Korea and Indonesia introduced provisions to enable taxation of such indirect transfers of investments made in these countries, Vodafone became a test case in India, the successful outcome of which could enable revenue authorities to raise a tax demand of up to Rs 20,000 crore.

The SC's emphatic rejection of revenue authorities plea on all counts has taken the revenue authorities by surprise, besides rendering its revenue targets for the year unachievable. While review petition clearly is an effort to salvage the situation, speculation is rife on continued applicability of the ruling beyond the current year. Budget 2012 will indicate the government's thinking in the matter and maturity with which it seeks to balance its budget.

An easy option may be a series of amendments to plug "loop holes" that exist in its view. If the government is to stand by its conviction, it is likely that provisions of section 9(1)(i) will be amended to expand the scope to include transfer of capital asset causing indirect transfer of interest in Indian investments as proposed in the Direct Taxes Code (DTC).

Consequential amendments may also be carried out to expand the meaning of capital asset to include controlling interest, options rights under a contract. Likewise, General Anti Avoidance Provisions (GAAR) are also likely to be introduced empowering the revenue authorities to disregard whole or part of the transaction or a structure with a view to overcoming the "look at" approach propagated by the court. The GAAR is also likely to shift the onus of proof to the taxpayer to prove a transaction or structure to be not a colourable device or sham. The provisions relating to withholding tax obligation may also be tightened to cover transactions between two non-residents entailing indirect transfer of capital asset situated in India.

A harder but perhaps more pragmatic alternative may be to incorporate limited amendments primarily to prevent abuse and relieve legitimate planning and structures giving due regard to guidelines laid down by the Supreme Court. It is pertinent to note that even in China not all indirect transfers are liable to tax. Safeguards and guidelines are provided to exclude legitimate transactions and structures bearing in mind the economic realities and mode of doing cross-border business. It is important for the government to align its economic objectives with tax policy rather than an over-arching emphasis on transaction-based taxation, which may not necessarily meet revenue-raising objectives. A cost benefit analysis of both the alternatives is advisable to be undertaken by the government instead of any knee-jerk reaction before amending the law, as it can have an adverse effect on inbound FDI.

(Vipul R Jhaveri is partner, Deloitte Haskins & Sells. The views expressed are personal)

First Published: Feb 26, 2012 20:14 IST