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Saturday, 21 January 2012 10:08
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Vodafone wins tax case, DTC to ensure taxes in future

Justice KS Radhakrishnan summed it up well when, while delivering a separate but concurring judgment on the taxman’s R11,000 crore demand on Vodafone, he said that imposing capital gains taxes on Vodafone’s $11.1bn purchase of Hutch’s stake in its Indian telecom operations was tantamount to imposing capital punishment on capital investment in the country—indeed, if taxes had to be paid, they should have been paid by Hutch, not Vodafone. Friday’s ruling, delivered by a Bench headed by Chief Justice SH Kapadia, comes as a major shot in the arm for foreign investors who are battling similar demands from the taxman—these include the likes of AT&T, SABMiller and E*Trade. In each case, the taxman argues that while the sales may have taken place overseas and between foreigners, the underlying assets (Hutch’s telecom network in India) were in India and were therefore taxable.

Though it is not clear how the taxman will react to Friday’s judgment—retrospective amendments to tax laws to get firms to pay taxes are not unknown!—it does seem likely the government will try and hurry through some of the provisions of the Direct Taxes Code (DTC) that seek to deal with precisely the loopholes that helped Vodafone win the case. As the Bench pointed out, Indian tax law does not have a ‘look through’ provision that allows the taxman to strip a transaction and reconstitute it—in the absence of this, the taxman has to ‘look at’ the facts of the case, and in this case, since Hutch’s Cayman Island structure is an old one, it was clearly not established to avoid paying taxes. The DTC in its original form had tried to get over this, including even double-tax avoidance treaties like with Mauritius, by bringing in General Anti Avoidance Rules that allowed the taxman to overrule existing treaties. This, however, was watered down (the DTC is with Parliament’s Standing Committee), but Section 5(6) of the draft DTC provides for taxing Vodafone-type deals provided the Indian assets are more than 50% of the deal being structured—a 67% stake sale in Vodafone’s case would, under DTC, mean 67% of the capital gains would have to accrue to the Indian taxman. It remains to be seen, however, whether the taxman’s new powers to reconstitute deals under the DTC (when it comes into force) will be used selectively and with care or whether they will be used as a blunt instrument to get firms to cough up more taxes across the board—witness how the government arm-twisted Cairn to agree to ONGC’s demands in the Cairn-Vedanta deal or how the ITC tax victory was undone by an ordinance. If DTC is used as an instrument of oppression, Friday’s judgment will provide a short-lived relief to beleaguered investors, another reason to be cautious while investing in India.



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