On January 20, 2012, the Supreme Court of India (the “Supreme Court”) delivered a landmark judgment in Vodafone International B.V. v. Union of India & Anr. ruling that the transfer of shares of a company incorporated outside India from a seller resident outside India to a buyer resident outside India is not taxable by the Indian tax authorities even if such transfer indirectly transfers an asset in India. The outcome brings to closure a fairly contentious chapter for Vodafone Group (“Vodafone”), in which the Indian tax authorities sought to recover approximately US$2.5 billion in taxes in connection with Vodafone’s indirect purchase in 2007 of a controlling stake in Hutchinson Essar Limited, one of India’s largest telecommunications services providers, from The Hutchinson Group, a Hong Kong company. The Supreme Court judgment provides clarity to international investors in structuring a variety of cross-border transactions involving India in a tax efficient manner. The following are the key points that emerge from the Supreme Court judgment for international investors looking to engage in cross-border transactions involving India:
1. Section 9(1)(i) of the Indian Income Tax Act, 1961 which, among other things, provides for taxation of income arising from transfer of capital assets in India, does not apply to the extent such transfer occurs indirectly pursuant to a transfer of shares of a company incorporated outside India.
2. International investors may structure their investments into India through holding companies in jurisdictions such as Mauritius for both tax and commercial reasons. If a holding company was created without any commercial or business substance only to avoid tax, then the tax authorities may ignore such a holding company. Structuring transactions to achieve tax efficiency is permissible provided that the structure used is not a sham or a colorable tax avoidance device.
3. Whether a structure represents a genuine tax planning on the one hand or a sham or a colorable device to avoid tax on the other has to be determined at the threshold by looking at the transaction as a whole in the context to which it properly belongs and not by dissecting the individual parts and looking at them in isolation. The burden is on the tax authorities to ascertain the dominant purpose of a transaction and to establish that a given transaction is a sham or a colorable device designed to avoid tax.
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