A Loophole in Indian Tax System

Updated: Jan 21

Indian telecom industry saw a boom due to technological advancement from 2007. Competition increased with many players coming in. Revenues of telecoms rose with increase in subscriber base. Taxmen in India were cautiously watching every transaction happening in these companies. In 2007, Vodafone International Holdings BV forayed into the Indian telecom market by buying stake in Hutchison Essar Ltd (an Indian subsidiary of Hutchison Telecommunications International) indirectly.

History of transactions.

An illustration of transactions happened

In 1998, Hutchison Telecommunications International made an offshore investment  in Cayman Island (Mauritius) called CGP Investment Holdings. Through this entity, Hutchison Telecommunications International made an investment in Hutchison Essar Limited by buying 67% of shares in it. Vodafone later, bought shares of CGP Investments Holdings instead of Hutchison Essar Limited which helped it in becoming a major stakeholder in Hutchison Essar Limited indirectly.

Taxmen’s game.

As per Income Tax Act, when a party sells a property, the seller has to pay Capital Gains Tax to the government and the buyer has to deduct TDS (Tax Deducted at Source). Income Tax department issued a show cause notice u/s 201 to Vodafone, imposing penalty u/s 271C on non deduction of TDS u/s 195 for amount paid to Hutchison.

Section 195 of Income Tax Act then said, when a non-resident buys a property directly related to India then he is liable for deducting TDS on such payment made.

Vodafone filed a writ petition in December 2008, challenging the Income Tax Department for issuing such notice. It supported itself by saying that there is no sign that transaction happened in India and also the transaction was between two foreign companies. However, the Honorable High Court of Bombay rejected their petition with cost and also asked them to pay the amount within a period of 3 weeks.

Vodafone paid the money as directed and had filed an SLP (special leave petition) before Supreme Court against such rejection. The Apex Court of India in Jan 2012, ruled in favour of Vodafone by saying it acted ‘within the four corners of law’ and ordered the Income Tax Department to return the money which was paid earlier by the company with an interest on 4%.

Apex court also advised Indian taxmen to “look at” the transaction instead of “looking through” it to attribute motives to the deal. What the Indian government saw however was over 20,000 crore in unpaid taxes, interest and penalty slipping out of its hands.

It decided to strike fear into the heart of companies by coming up with the General Anti-Avoidance Rule (GAAR). Then President Shri. Pranab Mukherjee clarified that any transaction happening in or outside India whether directly or indirectly, is required to pay tax in India. The amendment passed was retrospective in nature. Which means that the government could dig up past deals, all the way back to 1962.

After such amendment, the income tax department demanded the company to pay the tax. Even today, the case is pending before International Arbitration.

Why is this case very important to know ?

Cases like these have stirred up global debate about global companies evading taxes in the name of tax planning. A similar case like this has happened recently where Tiger global sold 17% of its stake in Flipkart to Walmart’s Luxembourg entity FIT Holdings- a transaction that was valued at over 14,500 crore through funds based out of Mauritius.

These methods adopted by global giants are reducing the declared profits and shifting their profits to lower tax locations. Also, this may end up destroying moral hazard in the industry. If global giants get away without paying tax, wouldn’t domestic corporations do the same?


(Opinion expressed by the author is his personal. The Generalist Insights take no responsibility of the opinion expressed.)