ISSUE VII : The Vodafone case: Opening a pandora’s box


On December 3, 2008 the High Court of Mumbai pronounced the highly anticipated judgment of Vodafone International Holdings B.V. vs. Union of India. In this case, the Income Tax department issued a show-cause notice to the UK based Vodafone for not paying capital gains tax, by way of advance tax, on acquiring majority stake in Hutchinson Essar. The argument put forward was that Vodafone should have deducted tax at source while making payment to the Hong Kong based Hutchinson Telecom International Ltd (“HTIL”). Vodafone has sought a stay on the order so as to challenge in the Supreme Court. The High Court of Mumbai allowed the application and stayed the order for 8 weeks, giving Vodafone the time required to appeal in the Supreme Court. On January 23, 2008, Vodafone presented the appeal before the Supreme Court who sent the matter back to the tax authority directing them to deal with the question of their jurisdiction to tax such transactions. At the same time, the Supreme Court also allowed Vodafone to approach the Mumbai High Court if it felt aggrieved by the decision of the tax authority.

Pursuant to this order, if the tax authorities hold that they have the jurisdiction to tax such transactions, the implication will be that where the underlying asset in a transaction between two or more non-resident entities is located in India, such transaction shall be liable to tax under the Indian Income Tax laws. Consequently, this shall have a potential impact on transactions involving investment as well as mergers and acquisitions in India. Subsequent to the High Court judgment there has been a noticeable increase in the issuance of similar show-cause notices to several other companies engaging in similar transactions.

This bulletin focuses on an analysis of the issues discussed in the judgment pronounced by the Mumbai High Court and its implications on cross-border transactions. Issues

1. Brief facts and position of the parties

Vodafone UK bought a 52% stake in an Indian company in 2007. The tax department served a notice to Vodafone about the alleged tax liability, estimated to be $2bn which Vodafone claimed to be lacking in any basis. Vodafone engaged in a court battle on the taxability of capital gains on the transaction at the Mumbai High Court. The court admitted a writ petition that challenged the jurisdiction of the Indian tax authorities to issue the notice for recovery of the tax.

The tax authorities contended that Vodafone owes capital gains tax on the purchase as the assets of HTIL were based in India. The Indian parliament passed an amendment that allows the government to book companies that do not withhold taxes in a transaction. Vodafone’s position was that the transaction took place between offshore entities owned by itself and HTIL and was outside India’s jurisdiction. It had, in fact, challenged the constitutionality of the retrospective amendment of the changed tax law.

Since the deal was offshore, neither party thought it was taxable in India. But the tax department claimed that capital gains tax applied and that Vodafone should have deducted the tax while paying HTIL. Vodafone’s position has been that the deal was not taxable in India since:

  • the funds were paid outside India for the purchase of shares in an offshore company;
    • the tax liability should be borne by HTIL;
    • Vodafone was not liable to withhold tax as the withholding rule in India applied only to Indian residents that the recent amendment to the Income Tax Act (“Act”) of imposing a retrospective interest penalty for withholding lapses was unconstitutional.

In contrast, the tax authority’s main argument was focused on proving that even though the deal was offshore, it was taxable as the underlying asset was in India and so it pointed out that (a) the capital asset – the joint-venture – is situated in India and was central to the valuation of the offshore shares; (b) through the sale of offshore shares, HTIL had sold Vodafone valuable rights in the Indian asset including tag along rights, management rights and the right to do business in India; and (c) that the offshore transaction had resulted in Vodafone having operational control over that Indian asset. The tax department has posited that the withholding tax liability always existed and the amendment was just a clarification.

2. Chargeability of the transaction in India

2.1 The most important question that arose in this case was whether a transaction between two non- resident entities could be taxed in India.

The question as to whether the sum paid to a non-resident or a foreign company pursuant to a transaction is chargeable to tax is determined by section 5(2) of the Act.1 Further, income deemed to accrue or arise in India includes all income accruing or arising in India, whether directly or indirectly (a) through or from any business connection in India; or (b) through or from any property in India; or (c) through or from any asset or source of income in India; or (d) through the transfer of a capital asset situated in India.2

In the present case Vodafone admitted that they acquired a controlling interest of CGP Investments (Holdings) Limited (“CGP”) located in the Cayman Islands, directly and Vodafone Essar Limited (“VEL”) in India, indirectly, as a consequence of the transaction.

Controlling rights in a company are acquired along with the acquisition of majority shares in a company. In this transaction, there was not just a transfer of controlling interest but also a transfer of interest in the telecom license jointly held with the Essar Group, use of brand and goodwill, non-compete rights given by HTIL, right to enter into telecom business in India, control premium, etc. The shares of eight Indian companies controlled by HTIL that were being operated in joint-venture with Essar and others were transferred to Vodafone when HTIL decided to sell its stock in the Indian entity. As a consequence, Vodafone also became the successor in interest to HTIL in a license agreement with the Department of Telecommunication.

The fact that such an acquisition was indirect in case of VEL has no bearing as section 9 of the Act clearly uses the words “directly or indirectly.” Therefore, according to the High Court of Mumbai, the transaction was within the definition of “income accruing in India.”

Consequently, the income accrued in India is chargeable to tax under section 5(2) of the Act. Therefore, as per the provisions of section 195,3 Vodafone was under a statutory obligation to deduct income tax at source.

2.1 Another important question was whether section 195 of the Act had extra territorial operation. Vodafone argued that since section 195 had no extra territorial application, it did not apply to cross-border transactions between two non-resident entities. Consequently, there was no obligation to withhold tax.

For section 195 to apply, one must distinguish whether the company or person sought to be taxed for paying a certain sum to another entity has some nexus or interest in India. On signing the agreement HTIL acquired an interest in India, and, therefore a clear nexus to income arising or accruing in India.

The High Court pointed out that under the Indian Income Tax laws, income tax is levied on a twin basis: (a) on resident basis; and (b) on the source of income which accrues or arises in India or is deemed to accrue or arise in India. In this case income did arise in India and was chargeable to tax under section 195. Therefore, Vodafone was under an obligation to deduct tax under section 195.

3. Validity of the show-cause notice

3.1 Another issue was regarding the applicability of section 201 of the Act Vodafone alleged that since section 201, which deems a person4 (company) an assessee in default is not applicable to them, the show- cause notice issued by the Income-Tax authorities lacked jurisdiction.

Section 201 of the Act provides the circumstances where a person may be deemed an assessee in default; where such person (a) does not deduct, or does not pay, or (b) after so deducting fails to pay, the whole or any part of the tax, payable as per the provisions of the Act. By virtue of this section the payer may be deemed an assessee in default on account of failure to deduct TDS wherever required under the Act.

Prior to the 2008 amendment, the applicability of the section was restricted to persons referred to in sections 194 and 200 of the Act. Subsequent to the 2008 amendment, the scope of the section was enlarged to include any person.5 Thus, the failure on the part of Vodafone to deduct tax at source would fall within the purview of section 201 making it an assessee in default.

Vodafone in their petition tried to restrict the applicability of section 201 as per its pre-amendment interpretation. However, while referring to case law, the Court held that Vodafone was unable to demonstrate the show-cause notice to be totally non-est in the eyes of law for an absolute want of jurisdiction of the tax authorities to even investigate into the facts, by issuing a show-cause notice.

3.2 Vodafone also tried to read the conditions precedent in section 191 of the Act into section 201. According to them, post the 2008 amendment, section 191 includes two conditions which must be fulfilled in order to hold the payer liable to tax. These are (a) the payer must have failed to deduct tax and (b) simultaneously the assessee must also have failed to pay the same. In their opinion, it was only in a situation where both these conditions were fulfilled that the payer became liable to be taxed.

This argument was considered unacceptable by the respondent, who argued that sections 191 and 201 were independent of each other and so was the liability of the deductor and the deductee. Even if such an interpretation of the sections was accepted, the condition precedent would still stand as fulfilled on the failure of the deductee to pay tax within the period prescribed under the Act.

3.3 Finally, the constitutional validity of the 2008 amendment was questioned. The Court reaffirmed that the Union has plenary powers to amend legislation with prospective as well as retrospective effect. This includes income tax legislation. Vodafone contended that a legislation that was harsh and placed substantial burden on the assessee must be held unconstitutional and violative of Article 14 of the Constitution; however, the Court did not agree.

4. Impact on mergers and acquisitions

It is apparent from the above that income tax in India is assessed based on (a) domicile of a “person” (company) and (b) source of income i.e., whether it accrues or arises in India or may be deemed to accrue or arise in India.

The judgment clearly implies that in the Vodafone case income did accrue in India, and in the course of the transaction there was not just a transfer of shares but also a transfer of capital assets. As soon as there is a transfer of capital assets and a consequent interest arises in India, the transaction becomes taxable.

Thus, where there is a merger between two non-resident entities and as a consequence of the transaction, majority stake or controlling interest in a company located in India, whether a wholly owned subsidiary or a group company, is transferred to the new company, then such a transaction will come within the purview of the tax laws. While carrying out such transactions the payer company shall have to withhold tax, make contractual provisions to this effect with the payee company, or be deemed an assessee in default.

Further, pursuant to the order passed by the Supreme Court and pending the decision of the tax authority, the High Court’s judgment is likely to impact acquisitions, joint-ventures and other cross-border transactions. Where a non-resident company acquires another non-resident company, and the target company has an underlying asset in India, regardless of the fact that the transaction may take place overseas the acquirer shall be bound to withhold tax. Failure to do so shall deem the acquirer an assessee in default.

If the tax department affirm their jurisdiction to tax Vodafone, such transactions will become more expensive due to the additional tax burden placed by the tax authorities. The key words in all such cases will be “income accruing or arising or deemed to be accruing or arising in India”.6 Where that test is met, the payer will be liable to pay tax under the tax laws.


The Vodafone decision is expected to have a wide impact on structuring and layering in bound investment in India. Given the current judicial position, it seems that eventually companies will have to pay for the value of acquiring controlling interest in India. It is noteworthy that the Supreme Court did not substantively disturb the ruling of the High Court of Mumbai. Now it remains to be seen whether, in light of the agreement, the Tax authority upholds their jurisdiction to tax the transaction.

Prima facie, pending the decision of the tax authority, the ruling of the High Court of Mumbai – as is

– will undoubtedly impact cross-border mergers and acquisitions activity in India which will require thoughtful structuring so as to be tax-efficient for the parties involved.

1 As per section 5(2) the total income of a person who is a non-resident includes all income from whatever source, which is received or is deemed to be received in India in such year by or on behalf of such person, or accrues or arises or is deemed to accrue or arise to him in India during such year.
2 Section 9(1) (i) of the Act.
3 Section 195 applies to all payments that represent a sum chargeable to tax.
4 Person includes principal officer of a company, who is required to deduct any sum in accordance with the provisions of the Act or who is referred to in sub-section (1A) of section 192.
5 Ibid.


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