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Modi Govt muddles up Vodafone retrospective tax case

JUNE 16, 2017

By Naresh Minocha, Consulting Editor

"RETROSPECTIVE tax is a matter of past. That chapter will not be opened again. We are ensuring that neither this government nor the future governments can open this chapter" stated Prime Minister Narendra Modi during January 2016.

What Mr. Modi did not disclose is that Government reserved the right to complicate and lengthen the retrospective taxation cases initiated by the UPA Government.

The NDA Government perhaps knows that it is would ultimately be unable to get even a single pie through due process of law. This is because international arbitrators are unlikely to rationalize retrospective taxation, which is akin to back-stabbing businesses.

Hence muddling up retrospective taxation, for which the blame, in case, lies with the UPA.

This right to mess-up and drag the cases is being exercised with great zeal in the case of Vodafone Group Plc (VGP).

Capital gain tax (CGT) is paid by an entity that sells equity shares/property at a price higher (premium) than the purchase price. Modi Government wants to collect the same CGT from both buyer (VGP) and seller of shares (Hutchison Telecommunications International Limited (HTIL). It is thus redefining taxation!

Simultaneously, it is dragging and complicating the two-front arbitration started by VGP for settlement of CGT of Rs.112.79 billion.

After addition of interest and penalty, this amount snowballed to whopping Rs 374 billion (HK USD 42.3 billion) as on 24th November 2016 when income tax department (ITD) for the first time served a draft assessment order on HTIL. The disputed CGT would perhaps now stand at about Rs 400 billion.

Last month, HTIL affiliate, CK Hutchison Capital Securities (17) Limited (CKHCS17), shed light on this case in a disclosure to prospective subscribers of its USD 1billion debt notes issue.

In the prospectus dated 9th May 2017, CKHCS17 stated: "HTIL has received an assessment order from the ITA dated January 25, 2017 (AO). The AO imposes tax on the alleged gains (Alleged CGT) in respect of the Transaction on HTIL. Furthermore, the ITA has imposed interest and also initiated penalty proceedings".

It continues: "HTIL believes that no assessment for the Alleged CGT can be validly imposed, and it has obtained legal advice that the AO cannot create any liability for taxes, interest, penalties or otherwise that is legally enforceable".

Cayman Islands-registered CKHCS17 is a subsidiary of CK Hutchison Holdings Limited (CKHH), which is also registered in the same tax haven. CKHH was created in 2015 following restructuring of two holding companies & their subsidiaries of Hongkong-based Li Ka-shing group: Cheung Kong (Holdings) Limited and Hutchison Whampoa Limited (HWL). HITL, which was earlier owned by HWL, is now subsidiary of CKHH.

According to CKHH, "The Acquisition took place nine years ago when HTIL was a listed company. Subsequent to the Acquisition, HTIL was privatised and ceased business operations. Neither HTIL nor its subsidiaries have any presence in India ".

CGT has its origin HTIL's decision to sell its entire controlling stake of 66.99% in Hutchison Essar Limited (HEL) (now Vodafone India Limited) to VGP. This stake was held through overseas companies. On 8 May, 2007, HTIL sold its entire interest in Cayman Island-based CGP Investments (Holdings) Limited to VGP's dutch subsidiary named Vodafone International Holdings B.V. (VIHBV) for a total cash consideration (before costs, expenses and interests) of approximately USD 11.1 billion.

HTIL Group realized a pre-tax gain of approximately HKUSD 69,343 million (USUSD 8,890 million). It must be said to ITD's credit that it wanted to levy CGT on this capital gain in 2007.

Foreign Investment Promotion Board (FIPB) overlooked ITD's submissions and cleared the Voda-Hutch deal in April 2007. It is not clear whether Finance Minister Arun Jaitely has ordered probe into the reasons why FIPB granted approval without addressing ITD's concern.

According to an official announcement issued on 9th May 2007, "On the recommendation of the FIPB Meeting held on 27th April, 2007, Finance Minister, Shri P. Chidambaram has approved the proposal of M/s. Vodafone International Holdings B.V. to take note of the transaction by which Vodofone is acquiring or has acquired effective shareholding of 51.96% in M/s. Hutchison Essar Limited".

HTIL claimed that the deal was not taxable as was purely an overseas transaction.

ITD later asked VGP to cough up CGT for its failure to deduct CGT from the transaction. The former considered latter as an agent/representative of HTIL.

After ITD lost this case against VGP in Supreme Court in January 2012, UPA Government brought in retrospective taxation by amending Income Tax Act, 1961 through Finance Act, 2012.

Why is it that the Government took so long to serve CGT notice on HTIL under this amendment? Knowing well that it can't collect any tax from a company that has no presence in India, Modi Govt perhaps believes that serving of the AO on HTIL might prod VGP to turn heat on HTIL.

Under the "supplemental deed" between HTIL and VIHBV in 2007, the former had created a USD 352-million "retention fund" for the latter. VIHBV can draw from this fund to meet "specified" liabilities arising from acquisition of Indian operations. The balance left in this retention fund would be returned to HTIL after 10 years from the date of transaction.

As the transaction is nearing 10 years, ITD's action against HTIL might prod VGP to tap this fund or mutually settle CGT liability under corporate secrecy. As put by CKHCS17, "If, as a consequence of the Retrospective Provisions, Vodafone Netherlands is required to pay tax in India, this could lead to a dispute between Vodafone Netherlands and HTIL".

Another consideration for this belated action against HTIL might be that it would not like to be blamed in future, if it loses CGT case against VGP.

In its annual report for 2017 released on June 02, 2017, VGP has given an update on its two parallel arbitration cases that it has initiated against the Government.

As regards arbitration initiated in 2012 under Netherlands-India Bilateral Investment Treaty (‘Dutch BIT'), VGP says: "In June 2016, the tribunal was fully constituted with Sir Franklin Berman KCMG QC appointed as presiding arbitrator. The Indian Government has raised objections to the application of the treaty to VIHBV's claims and to the jurisdiction of the tribunal under the Dutch BIT. The tribunal is considering these jurisdictional objections and has indicated it will determine shortly whether to decide the Indian Government's objections to jurisdiction as a preliminary question".

Meanwhile, on 12th February 2016, VIHBV received ITD notice on outstanding tax demand of Rs 221 billion (which included interest accruing since the date of the original demand). The Notice cautioned the company the Government can enforce the tax demand by seizing VIHBV's indirectly held assets in India.

As for 2 nd parallel arbitration, VGP and Vodafone Consolidated Holdings Limited (VCHL) had served a trigger notice on Government during June 2015 under the United Kingdom-India Bilateral Investment Treaty (‘UK BIT') contesting retrospective CGT.

VGP claims: "Although relating to the same underlying facts as the claim under the Dutch BIT, the claim brought by Vodafone Group Plc and Vodafone Consolidated Holdings Limited is a separate and distinct claim under a different treaty."

On 24 January 2017, VGGP and VCHL served a Notice of Arbitration on the Government formally commencing the arbitration. Modi Government has failed to appoint a second arbitrator as required under the UK BIT. It has objected to Vodafone's request that the President of the International Court of Justice appoint the 2nd arbitrator to the tribunal.

As put by VGP, "The Indian Government has indicated that it considers the arbitration under the UK BIT to be an abuse of process but this is strongly denied by Vodafone ".

In April 2016, Government has dragged VIHBV to Bombay High Court, contending that against VIHBV be treated as an agent of HTIL in respect of its alleged CGT. VIHBV is liable to pay penalties of up to 100% of the assessed withholding tax for the alleged failure to have withheld such taxes.

VGP is baffled at fresh litigation as the taxation dispute was settled by the Supreme Court in its favour in 2012.

VGP says: "The hearing has since been periodically listed and then adjourned or not reached hearing. VIHBV and Vodafone Group Plc will continue to defend vigorously any allegation that VIHBV or VIL is liable to pay tax in connection with the transaction with HTIL and will continue to exercise all rights to seek redress including pursuant to the Dutch BIT and the UK BIT ".

The prospects of ITD opening another legal front against VGP are strong. The former has no option but to oppose in the High Court(s) where the schemes for merger of VGP's wholly owned subsidiary Vodafone India Limited (VIL) and Idea Cellular Limited (Idea) would be filed in the coming months.

In March this year, VGP and Idea of Aditya Birla Group had announced the proposed merger, which is currently awaiting approval from Competition Commission of India.

In April 2014, Central Board of Direct Taxes had formalized the strategy for opposing any corporate merger scheme that is designed to "defraud revenue".

This update on Vodafone case raises basic question: Is the Modi Government scared of timely settlement of retrospective taxation cases initiated by its predecessor?