Vodafone ruling will boost foreign investor confidence

January 23, 2012

(The views expressed in this column are the authors’ own and do not represent those of Reuters)

Amidst dwindling Indian governance on a variety of fronts, the Supreme Court has always been the differentiator. The court-monitored investigations into the 2G scam come to mind, which as most would agree, would prove the inflection point for India’s polity and governance.

On January 20, the Supreme Court delivered a thumping boost to its image as the saviour (of last resort) of the “rule of law” in this country in the high-profile Vodafone tax case.

The case involved the sale of shares in a Cayman Island company by the Hutchinson Group to Vodafone. All the constituent parties were outside India, except that the Cayman Company (whose shares were transferred) held, through a maze of holding companies outside India, a controlling stake in the Indian telecom operating company — now known as Vodafone India.

Indian tax authorities alleged that the transaction amounted to an “Indirect Transfer” of shares/assets in India, and hence should be subjected to tax in India. It was also alleged that the main purpose of acquiring the shares of the Cayman Company by Vodafone was to acquire the controlling stake in the Indian telecom company. On the other hand, it was argued the case involved transfer of shares of a foreign company by one non-resident to another non-resident, and hence should not fall within the ambit of India taxation — a generally well-accepted tax principle, now upheld by the Supreme Court in Vodafone’s case.

The tax authorities’ interpretation created uncertainty around M&A deals involving Indian targets. On similar lines as Vodafone, tax authorities initiated proceedings in other transactions involving “indirect transfer” of shares of Indian companies, prominent among them being Tata-AT&T, GE-Genpact, Sanofi, SABMiller, to name a few. It had a ripple effect on such transactions during the last two years, with tax uncertainty either leading to a negotiation breakdown or buyers insisting on escrow arrangements to cover any potential tax risks.

The Supreme Court ruling should clear the air on such transactions and provide a much needed boost to M&A deals involving Indian entities.

Also, the court’s observations as to respecting legitimate tax planning should reaffirm the beneficial tax treatment for investing through favourable treaty jurisdictions like Mauritius — another area of a constant flip-flop by the Indian tax administration.

It would be relevant to note that the government has expressed its intention to amend the law and bring such transactions into the tax net either by specific provisions or in the form of general anti-abuse provisions.

One would not mind that. But it remains a challenge how such a provision can be really implemented. For the time being, one only hopes the government does not undo the good work of the Supreme Court by introducing a “retrospective” amendment.

More importantly, the court has made a statement beyond merely clearing the uncertainty around taxability of M&A deals.  In that way, it will survive any law change. In the Vodafone case, tax authorities sought to interpret a law, as old and well-established since 1961, in a different way. Undoubtedly, one cannot ignore the good intentions to bring to tax profits earned from Indian investments.

By making the right choice, the Supreme Court ruling establishes India’s commitment and respect to certainty and stability in its fiscal system. From a macro perspective, the ruling shall allow foreign investors to redeem their confidence in India’s respect for the “rule of law” — often the distinguishing factor compared to its faster-growing BRIC peers. The Indian judiciary has again put India on the top.

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