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The breakdown of the conciliation talks between Vodafone and the Indian government alludes to yet another opportunity for India to introspect on the aspersion cast on its image as a preferred investment destination among developing economies.
Foreign investors, India Inc and various stakeholders have been closely following the course of this 7-year-old dispute between the British telecom company Vodafone and the Indian tax department. The controversy arose upon Vodafones acquisition in 2007 of Hutchisons indirect interest in India, i.e. Hutchison Essar (held by way of a chain of downstream subsidiaries in British Virgin islands, Cayman islands and Mauritius). The Indian tax authorities asserted that since the transfer involved underlying Indian interests, Vodafone should have withheld/deducted taxes on the payment to Hutchison. Vodafone, of course, challenged this on the ground of lack of territorial nexus since there was no direct transfer of shares/interest in Hutchison Essar in India.
Vodafone went through an arduous and long drawn litigation and, finally, in January 2012, the Supreme Court of India favoured Vodafone and held that India had no jurisdiction to tax the transaction and Vodafone had no withholding tax obligation. The jubilance from this decision, however, was short lived. The Finance Act 2012 unfolded retrospective amendments to the income tax law provisions to nullify the verdict in the Vodafone case and tax the transfer of shares of a foreign company having substantial underlying interest in Indiapopularly known as indirect transfer of shares. These amendments have been positioned as clarifications to certain terms in the domestic tax law and, hence, have been made effective retrospectively.
Post these amendments, in June 2013, the Indian government and Vodafone decided to resolve the dispute through a conciliation process. However, based on the latest updates, it is expected that the Indian government will withdraw from the process in light of Vodafones demand to also include its transfer pricing disputes under the conciliation talks. This would mean that the Indian tax department will resume their tax demand of R20,000 crore (including interest and penalty) from Vodafone. The tax payout may impact Vodafones further investment plans in India, ongoing spectrum auction payments, etc.
The retrospective taxation of indirect transfers has significantly expanded the scope of taxation of non-residents in India in cases of cross-border transactions with an underlying Indian connection. Also, the wordings and scope of the relevant provisions are fraught with ambiguity and scope for wide interpretation. These developments have evoked fear in the