Vodafone tax verdict, a paradigm shift

It is said that the name of one of the Cayman Islands-registered entities in the Vodafone saga, CGP, expands as Capital Gains Protected. Irrespective of the truth or otherwise of this, Vodafone is trying to use the India-Netherlands Bilateral Investment Treaty (BIT) to its advantage.

The decision of the International Arbitration Council in favour of White Industries Australia Ltd and against Coal India, holding the Government of India liable for not protecting the interests of the investor, should provide confidence to Vodafone. Though the Government of India is of the opinion that the BIT would not apply to taxation transactions, the Arbitration Council may have other views; the lengthy legal proceedings in the White Industries case began with invoking of a bank guarantee by Coal India — a contractual act.

The introduction of taxation laws with retrospective effect is being viewed in similar vein. The collateral impact of the decision of the Supreme Court of India in the Vodafone case is already being felt in income-tax forums across the country, as the logic and rationale of the decision is being used extensively — though the impact on the taxpayer is another matter.

Linde-ONGC Deal

Linde AG from Germany along with Samsung Engineering Company Ltd of Korea won a contract from ONGC Petro Additions Ltd for carrying on the work of all activities and services required for the design, engineering, procurement, construction, installation, commissioning and handing over of the plant on a lump-sum turnkey basis for the dual feed cracker and associated units of Dahej Petrochemical Complex. The contract was divisible into three stages: supply of design and engineering of equipment and materials; fabrication and supply of materials and supervision of installation; and testing and commissioning of the equipment at the site in India. The first two stages were done outside India while the third was done in India. The consortium was of the opinion that the transaction could be broken up into these three stages.

As the site for the first two stages was outside India, no permanent establishment could be said to have been established in India, and consequently it was only the third stage that was taxable in India. This question was posed before the Authority for Advance Rulings (AAR). As a preamble to its judgement, the AAR quoted from the Vodafone decision of the Supreme Court and stated that Section 9(1)(i) of the Income-Tax Act is not a look-through provision, and that the Revenue Department must look at the transaction to understand its import. This indicates that a dissecting approach from the angle of taxation should not be resorted to, and the approach must be to understand the nature and the object of the contract on looking at the transaction. Applying the “look-at” test and interpreting the terms of the contract as a whole, the AAR was satisfied that the contract in this case is one and indivisible, and is not open to attempts to split up each component of the contract for the purpose of taxation.

Roxar ruling

In another contract involving ONGC, Roxar from Bahrain won a contract from them for services for supply, installation and commissioning of 36 manometer gauges and asked the AAR if this was an offshore supply contract. Using its own decision in Linde as a base, the AAR went on to rule that decisions and rulings relied on by the counsel of the applicant have now to be considered in the context of the pronouncement of the Supreme Court in Vodafone International Holdings BV Netherlands vs the Union of India . Not surprisingly, it was ruled that the transaction was taxable in India.

While Vodafone may have won at the apex court, the collateral effects of the decision seem to be going against other taxpayers involved in international transactions. In following the rationale of the Vodafone decision, the apex court seems to have nullified its decision in Ishikawajima-Harima, where it dissected a composite contract into two parts and held one of the parts as not amenable to taxation in India. Dissecting a composite contract into two parts was permitted in other taxation laws, such as service tax.

With this new approach of the taxation authorities, entities would now have to change their strategy by not entering into composite contracts. They would probably break up a composite contract into their various constituents and treat them as separate in individual tax jurisdictions. It would again be left to the Tax Department to ferret this out and prove Aristotle's maxim that the whole is greater than the sum of its parts.

(The author is a Bangalore-based chartered accountant)

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