In a huge relief to Vodafone and a major boost to foreign investor confidence in India, the Supreme Court on Friday held in a landmark verdict that the telecom giant is not liable to be taxed on its $11.2-billion acquisition of Hutchison’s Indian telecom assets.

The Income Tax (I-T) Department had raised a demand of $2.6 billion (Rs 11,297 crore) on the 2007 Vodafone-Hutch deal.

The apex court directed the I-T Department to return to Vodafone Rs 2,500 crore (which was deposited by the company as directed by the apex court) with 4 per cent interest within two months from Friday. The Bench headed by the Chief Justice of India, Mr S H Kapadia, also asked the Supreme Court Registry to give back to Vodafone the bank guarantee of Rs 8,500 crore within four weeks.

The “Offshore Transaction herein is a bona fide structured Foreign Direct Investment into India which fell outside India’s territorial tax jurisdiction, hence not taxable,” the court said.

It said the Offshore Transaction between Hutchison Telecommunications International Ltd (a Cayman Islands company) and Vodafone International Holdings (a company incorporated in Netherlands) was “not a sham or tax avoidant preordained transaction” but only evidences participative investment.

Also noting that the subject matter of the transaction was the transfer of the CGP (a company incorporated in Cayman Islands), the court said, “Consequently, the Indian Tax Authority had no territorial tax jurisdiction to tax the said Offshore Transaction.”

Significantly, the judgement by the Chief Justice and Justice Mr Swatanter Kumar observed, “FDI flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law.”

“Certainty and stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner,” it said, adding, “Investors should know where they stand. It also helps the tax administration in enforcing the provisions of the taxing laws.”

The judgement further said it is for the Government to incorporate specific provisions in treaties and in laws so as to avoid conflicting views.

Pointing out that “Hutchison is not a fly by night operator’’ as their structure was in place in India from 1994-(February) 2007, the court also highlighted that, “We find that from 2002-03 to 2010-11 the Group has contributed Rs 20,242 crore towards direct and indirect taxes on its business operations in India.”

In this case, there is no transfer of capital assets situated in India, the court noted, adding that the “sale of CGP share was a genuine business transaction, not a fraudulent or dubious method to avoid capital gains tax.”

“Revenue (Department) cannot tax a subject without a statute to support…every tax payer is entitled to arrange his affairs so that his taxes shall be as low as possible and he is not bound to choose that pattern which will replenish the treasury,” the court observed.

Mr Justice K.S. Radhakrishnan, who concurred with the other two judges on the Bench (the Chief Justice and Mr Justice Mr Kumar), in a separate judgement said the tax demand (on the deal) amounted to ‘capital punishment on capital investment’. He also said since the deal was between two companies incorporated overseas – who have no income or fiscal assets in India -- and since their transaction was carried out offshore, it has “no nexus with the underlying assets in India.”

The I-T Department had claimed that Vodafone failed to deduct tax at source while acquiring the controlling stake.

Earlier, the Bombay High Court had said the I-T Department has the jurisdiction to claim the tax on Vodafone’s acquisition of Hutchison’s mobile business in India as the underlying assets were in the country. Vodafone had moved the Supreme Court against this order denying any tax liability as the deal was between two foreign entities and was done offshore.

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