Vodafone Loses Tax Appeal in India

The Bombay High Court has dismissed Vodafone's appeal of a ruling by the Indian tax department that it can seek taxes on Vodafone's US$11.2-billion acquisition three years ago of a majority stake in Hutchison Essar, The Wall Street Journal reports. Tax authorities claim that Vodafone should pay capital gains taxes on the acquisition even though the U.K. company was the buyer. Although Hong Kong's Hutchison Telecommunications International Ltd (HTIL) profited from the sale, tax authorities said that Vodafone was supposed to deduct the taxes and transfer the funds to the Indian government at the time of purchase. Vodafone argues that the transaction was between two foreign companies so Indian tax authorities do not have jurisdiction and, if they do, they should pursue HTIL.

However, Vodafone can still argue to the tax department why the company does not have to withhold the taxes, Bombay High Court Judge D.Y. Chandrachud has said, adding that tax authorities cannot issue a final order on Vodafone's tax liability for the next eight weeks. A lawyer for Vodafone said the company would appeal the decision in India's Supreme Court, the country's highest tribunal. "We will be evaluating this long and detailed order with our advisers," Vodafone tax executive Desmond Webb was quoted as saying, adding “We continue to believe strongly that this transaction is not taxable."

Outlook and Implications

• Case Background: The Vodafone case dates back to May 2007, when the company bought a 67% stake in Hutchison Essar, a joint venture between HTIL and Indian conglomerate Essar Group. The deal was conducted offshore, with Vodafone's Dutch subsidiary purchasing a company in the Cayman Islands controlled by Hong Kong's HTIL. India's tax department has claimed that the Cayman Islands firm was just a shell for Hutchison Essar so it owes capital gains taxes, which Vodafone should have withheld. Nevertheless, Vodafone found some hope in the latest decision by the Bombay High Court. The company's initial reading was that the court accepted that the transaction was between two foreign entities, according to a Vodafone spokesperson, but that taxes may still be due by some Indian companies.
• Bad News for Vodafone: The rejection to its appeal adds more pressure to Vodafone in India. Despite the strong subscriber growth still witnessed in the country as a whole, Vodafone’s Indian venture is facing increasing competition and declining margins. The group in May had taken a US$3.4-billion impairment charge on the value of the 2007 investment in Hutchison Essar. The group’s Indian unit recently won 3G spectrum for an unreasonably high, US$2.8-billion fee to the Indian federal government, bringing more financial burden to the group (see India: 20 May 2010: India Ends 3G Auction; Raises US$14.6 Bil. for Government and World - United Kingdom: 28 May 2010: Vodafone Reports Flat EBITDA for 2009 Financial Year, Hit by Indian Licence Costs).
• Caution for Potential Foreign Investors: The latest court decision and the results of Vodafone’s possible further appeal could depress foreign companies’ interests in investing in India. Vodafone’s case will inevitably bring concern to any potential foreign investors that they might face similar tax treatments. Indian tax authorities are reportedly looking at other big international deals. U.K. brewer SABMiller is embroiled in a tax dispute with India over the 2006 acquisition of Foster's Group's Indian beer business. Although the deal was between two overseas entities, Indian authorities claimed that the Foster's India brand and other Indian assets were transferred, so some taxes should be paid in India.