Lifting of corporate veil vs de facto ownership

The ‘Vodafone controversy' has opened the Pandora's box wherein the revenue authorities have attempted to lift the corporate veil to determine if there is any avoidance of tax.

The High Court has attempted to lift the corporate veil to look into the real nature of transaction to ascertain vital facts and to ascertain whether the buyer enjoys the power by way of interest and capital gains in the assets of the company and whether transfer of shares includes indirect transfer of assets and interest in the company.

Vodafone International Holdings BV (Vodafone) a Netherland entity purchased 100 per cent holding in CGP Holdings limited (CGP), a Cayman Island company from Hutchinson Telecommunication International (HTIL). CGP investments had a fully-owned subsidiary in Mauritius. CGP directly/indirectly controlled 67 per cent of Hutchinson Essar Limited (HEL), a joint venture company of the Hutchinson group (foreign investor) and the Essar group (Indian partner). HEL had obtained telecom licenses to provide cellular telephony in different circles in India from November 1994.

The revenue authorities held that by virtue of holding of shares in the foreign entity, the transaction per-se involved a transfer of capital asset situated in India which gave rise to income chargeable to tax in India i.e. the revenue authorities lifted the corporate veil and held that transfer of shares from CGP to Vodafone resulted in an indirect sale of shares in HEL and therefore the transaction ought to be subject to tax in India. Prior to the Vodafone case, the capital gain was deemed to accrue or arise in the country where the site of shares is situated. However, the Vodafone case has raised the vital controversy in respect of applicability of Section 9(1) (i) of the Income-tax Act (ITA) to the indirect transfer of shares in India i.e. (i) whether transaction of transfer of shares of a non-resident company which has indirect control in the Indian company can be brought to tax in India;(ii) whether the transfer of shares between two non-residents, can be brought within the ambit of capital gains taxation in India; (iii) whether transfer of shares of the company results in the transfer of all underlying rights including the right in the assets of the company. In Vodafone's case, the revenue authorities held that sale and purchase agreement indicated that the contracting parties were conscious of the composite nature of the transaction and various rights and obligations emanating from such agreement and therefore what was transferred was the ‘bundle of rights' embedded in the share transfer agreement.

TAXING CAPITAL GAINS

Further, the revenue authorities disregarded the legal character of the transaction in pursuit of substance and held that the transfer of shares from CGP to Vodafone resulted in indirect sale of shares in HEL. The revenue authorities, by lifting the corporate veil, attempted to tax capital gains arising on transfer of shares of a foreign company of an Indian subsidiary, on the basis that such transfer involves an indirect change in controlling interest in an Indian subsidiary.

The concept of lifting of corporate veil is increasingly applied by the revenue authorities across the world. The ITA, as it stands today, does not have explicit provisions for ‘looking through' the transactions.

However, the proposed Direct Taxes Code (DTC) has General Anti Avoidance Rules provisions embedded in it wherein the transactions involving indirect transfer of controlling stake would specifically be covered under the proposed DTC.

While the intention of the legislature to tax such transactions post DTC is clear, the implications under the existing income tax law become critical for the transaction which already concluded. In the present scenario, on perusal of various judicial decisions, it can be inferred that the revenue authorities have been tempted to look through the transaction by lifting the corporate veil and therefore the concept of de-facto ownership assumes significant importance. De facto ownership means ‘in practice but not necessarily ordained by law' or ‘in practice or actuality, but not officially established.' In the ordinarily language, it means finding the ultimate beneficiaries of the transaction.

As a tax payer, therefore, the questions which often arise are that is it necessary to lift the corporate veil and disregard the distinct and independent corporate status of the company? What is the sanctity of the corporate structure if in each case the corporate veil ought to be lifted? Whether the legal character of the transaction can be disregarded in pursuit of substance? Whether such a microscopic view is justified? With the Vodafone's decision pending before the Supreme Court the controversy seems to increase with the passage of time.