Project report

Taxation ---- Taxation of Merger and

Acquisition

Presented by

VISHAL VED

XMBA Batch NO - 16 (XMBA 16) VP110316XA20

Contents At a Glance

 Introduction

 Types of Mergers

 Legal Procedures for Merger

 Legal Procedures for Amalgamations and Take-overs

 Motives behind M & A

 Advantages of M & A

 Recent Mergers And Acquisitions

 Income Tax Act , 1961 as Amended by Finance Act 2005

 Swap transaction

 Taxation of Cross Borders M & A

 Proposed tax treatment under Direct Tax Code

 FDI in Telecom Sector in India

 Vodafone-Essar: The case Study –

 CONCLUSION

 Bibliography
Introduction
 Mergers or amalgamation, result in the combination
of two or more companies into one, wherein the
merging entities lose their identities.
 No fresh investment is made through this process.
However, an exchange of shares takes place between
the entities involved in such a process.
 Generally, the company that survives is the buyer
which retains its identity and the seller company
is extinguished.
 The Indian economy has been growing with a rapid
pace and has been emerging at the top, be it IT,
R&D, pharmaceutical, infrastructure, energy,
consumer retail, telecom, financial services,
media, and hospitality etc.

 It is second fastest growing economy in the world

with GDP touching 9.3 % a year in 3006-2007. This
growth momentum was supported by the double-digit
growth of the services sector at 10.6% and
industry at 9.7% in the first quarter of 2006-07.

 Investors, big companies, industrial houses view

Indian market in a growing and proliferating
phase, whereby returns on capital and the
shareholder returns are high. Both the inbound and
outbound mergers and acquisitions have increased
dramatically.

 In the first two months of 2007, corporate India

witnessed deals worth close to $40 billion.
 One of the first overseas acquisitions by an
Indian company in 2007 was Mahindra & Mahindra’s
takeover of 90 percent stake in Schoneweiss, a
family-owned German company with over 140 years of
experience in forging business.
  What hit the headlines was Tata’s takeover of
Corus for slightly over $10 billion.
 On the heels of that deal, Hutchison Whampoa of
Hong Kong sold their controlling stake in
Hutchison-Essar to Vodafone for a whopping $11.1
billion.
 Bangalore based MTR’s packaged food division found
a buyer in Orkala, a Norwegian company for $100
million. Service companies have also joined the
M&A game.
 The taxation practice of Mumbai-based RSM Ambit
was acquired by PricewaterhouseCoopers.

 There are many other bids in the pipeline. On an

average, in the last four years corporate earnings
of companies in India have been increasing by 20-
25 percent, contributing to enhanced profitability
and healthy balance sheets. For such companies,
Mergers & Acquisitions are an effective strategy
to expand their businesses and acquire global
footprint.

Definitions:

Mergers, acquisitions and takeovers have been a part

of the business world for centuries. In today's
dynamic economic environment, companies are often
faced with decisions concerning these actions - after
all, the job of management is to maximize shareholder
value.

Through mergers and acquisitions, a company can (at

least in theory) develop a competitive advantage and
ultimately increase shareholder value.
The said terms to a layman may seem alike but in
legal/ corporate terminology, they can be
distinguished from each other:

# Merger:
 A full joining together of two previously separate
corporations.
 A true merger in the legal sense occurs when both
businesses dissolve and fold their assets and
liabilities into a newly created third entity. This
entails the creation of a new corporation.

# Acquisition:
 Taking possession of another business. Also called
a takeover or buyout.
 It may be share purchase (the buyer buys the
shares of the target company from the shareholders
of the target company. The buyer will take on the
company with all its assets and liabilities. ) or
asset purchase (buyer buys the assets of the
target company from the target company)


In simple terms, A merger involves the mutual
decision of two companies to combine and become
one entity; it can be seen as a decision made by
two "equals", whereas an acquisition or takeover
on the other hand, is characterized the purchase
of a smaller company by a much larger one.
 This combination of "unequals" can produce the
same benefits as a merger, but it does not
necessarily have to be a mutual decision.
  A typical merger, in other words, involves two
relatively equal companies, which combine to
become one legal entity with the goal of producing
a company that is worth more than the sum of its
parts.
 In a merger of two corporations, the shareholders
usually have their shares in the old company
exchanged for an equal number of shares in the
merged entity.
 In an acquisition, the acquiring firm usually
offers a cash price per share to the target firm’s
shareholders or the acquiring firm's share's to
the shareholders of the target firm according to a
specified conversion ratio. Either way, the
purchasing company essentially finances the
purchase of the target company, buying it outright
for its shareholders

# Joint Venture:
 Two or more businesses joining together under a
contractual agreement to conduct a specific
business enterprise with both parties sharing
profits and losses.
 The venture is for one specific project only,
rather than for a continuing business relationship
as in a strategic alliance.

# Strategic Alliance:
 A partnership with another business in which you
combine efforts in a business effort involving
anything from getting a better price for goods by
buying in bulk together to seeking business
together with each of you providing part of the
product.
  The basic idea behind alliances is to minimize
risk while maximizing your leverage.

# Partnership:
 A business in which two or more individuals who
carry on a continuing business for profit as co-
owners.
 Legally, a partnership is regarded as a group of
individuals rather than as a single entity,
although each of the partners file their share of
the profits on their individual tax returns.
 Many mergers are in truth acquisitions. One
business actually buys another and incorporates it
into its own business model.
 Because of this misuse of the term merger, many
statistics on mergers are presented for the
combined mergers and acquisitions (M&A) that are
occurring. This gives a broader and more accurate
view of the merger market.

Types of Mergers:

From the perception of business organizations, there

is a whole host of different mergers.

However, from an economist point of view i.e. based

on the relationship between the two merging companies,
mergers are classified into following:

# Horizontal merger-
 Two companies that are in direct competition and
share the same product lines and markets i.e. it
results in the consolidation of firms that are
direct rivals. E.g. Exxon and Mobil, Ford and
 Volvo, Volkswagen and Rolls Royce and
Lamborghini

# Vertical merger-
 A customer and company or a supplier and company
i.e. merger of firms that have actual or
potential buyer-seller relationship eg. Ford-
Bendix, Time Warner-TBS.

# Conglomerate merger-
 Generally a merger between companies which do
not have any common business areas or no common
relationship of any kind. Consolidated firma may
sell related products or share marketing and
distribution channels or production processes.
Such kind of merger may be broadly classified
into following:

# Product-extension merger –
Conglomerate mergers which involves companies selling
different but related products in the same market or
sell non-competing products and use same marketing
channels of production process. E.g. Phillip Morris-
Kraft, Pepsico- Pizza Hut, Proctor and Gamble and
Clorox

# Market-extension merger –
Conglomerate mergers wherein companies that sell the
same products in different markets/ geographic
markets. E.g. Morrison supermarkets and Safeway, Time
Warner-TCI.

# Pure Conglomerate merger-

Two companies which merge have no obvious relationship
of any kind. E.g. BankCorp of America- Hughes
Electronics.

Conclusions:
 On a general analysis, it can be concluded that
Horizontal mergers eliminate sellers and hence
reshape the market structure i.e. they have
direct impact on seller concentration whereas
vertical and conglomerate mergers do not affect
market structures e.g. the seller concentration
directly. They do not have anticompetitive
consequences.
 The circumstances and reasons for every merger
are different and these circumstances impact the
way the deal is dealt, approached, managed and
executed.
 However, the success of mergers depends on how
well the deal-makers can integrate two companies
while maintaining day-to-day operations.
 Each deal has its own flips which are influenced
by various extraneous factors such as human
capital component and the leadership.
 Much of it depends on the company’s leadership
and the ability to retain people who are key to
company’s on going success. It is important,
that both the parties should be clear in their
mind as to the motive of such acquisition i.e.
there should be census- ad- idiom.
 Profits, intellectual property, costumer base
are peripheral or central to the acquiring
company, the motive will determine the risk
profile of such M&A.
  Generally before the onset of any deal, due
diligence is conducted so as to gauze the risks
involved, the quantum of assets and liabilities
that are acquired etc.

Legal Procedures for Merger,

Amalgamations and Take-overs :

The basis law related to mergers is codified in
the Indian Companies Act, 1956 which works in
tandem with various regulatory policies. The
general law relating to mergers, amalgamations and
reconstruction is embodied in sections 391 to 396
of the Companies Act, 1956 which jointly deal with
the compromise and arrangement with creditors and
members of a company needed for a merger.
 Section 391 gives the Tribunal the power to
sanction a compromise or arrangement between a
company and its creditors/ members subject to
certain conditions.
 Section 392 gives the power to the Tribunal to
enforce and/ or supervise such compromises or
arrangements with creditors and members.
 Section 393 provides for the availability of the
information required by the creditors and members
of the concerned company when acceding to such an
arrangement.
 Section 394 makes provisions for facilitating
reconstruction and amalgamation of companies, by
making an appropriate application to the Tribunal.
 Section 395 gives power and duty to acquire the
shares of shareholders dissenting from the scheme
or contract approved by the majority.
 And Section 396 deals with the power of the
central government to provide for an amalgamation
of companies in the national interest.
 In any scheme of amalgamation, both the
amalgamating company or companies and the
amalgamated company should comply with the
requirements specified in sections 391 to 394 and
submit details of all the formalities for
consideration of the Tribunal.
 It is not enough if one of the companies alone
fulfils the necessary formalities.
 Sections 394, 394A of the Companies Act deal with
the procedures and the requirements to be followed
in order to effect amalgamations of companies
coupled with the provisions relating to the powers
of the Tribunal and the central government in the
matter of bringing about amalgamations of
companies.

After the application is filed, the Tribunal would
pass orders with regard to the fixation of the
dates of the hearing, and the provision of a copy
of the application to the Registrar of Companies
and the Regional Director of the Company Law Board
in accordance with section 394A and to the
Official Liquidator for the report confirming that
the affairs of the company have not been conducted
in a manner prejudicial to the interest of the
shareholders or the public.
 Before sanctioning the scheme of amalgamation, the
Tribunal has also to give notice of every
application made to it under section 391 to 394 to
the central government and the Tribunal should
take into consideration the representations, if
any, made to it by the government before passing
any order granting or rejecting the scheme of
amalgamation.
 Thus the central government is provided with an
opportunity to have a say in the matter of
amalgamations of companies before the scheme of
amalgamation is approved or rejected by the
Tribunal.
 The powers and functions of the Central government
in this regard are exercised by the Company Law
Board through its Regional Directors.
 While hearing the petitions of the companies in
connection with the scheme of amalgamation, the
Tribunal would give the petitioner company an
opportunity to meet all the objections which may
be raised by shareholders, creditors, the
government and others. It is, therefore, necessary
for the company to keep itself ready to face the
various arguments and challenges.
 Thus by the order of the Tribunal, the properties
or liabilities of the amalgamating company get
transferred to the amalgamated company.
 Under section 394, the Tribunal has been
specifically empowered to make specific provisions
in its order sanctioning an amalgamation for the
transfer to the amalgamated company of the whole
or any parts of the properties, liabilities, etc.
of the amalgamated company.
 The rights and liabilities of the employees of the
amalgamating company would stand transferred to
the amalgamated company only in those cases where
the Tribunal specifically directs so in its order.
 The assets and liabilities of the amalgamating
company automatically get vested in the
amalgamated company by virtue of the order of the
Tribunal granting a scheme of amalgamation.
 The Tribunal also make provisions for the means of
payment to the shareholders of the transferor
companies, continuation by or against the
 transferee company of any legal proceedings
pending by or against any transferor company, the
dissolution (without winding up) of any transferor
company, the provision to be made for any person
who dissents from the compromise or arrangement,
and any other incidental consequential and
supplementary matters to secure the amalgamation
process if it is necessary.
 The order of the Tribunal granting sanction to the
scheme of amalgamation must be submitted by every
company to which the order applies (i.e., the
amalgamating company and the amalgamated company)
to the Registrar of Companies for registration
within thirty days.

Motives behind M & A

These motives are considered to add shareholder value:

# Economies of Scale:
 This generally refers to a method in which the
average cost per unit is decreased through
increased production, since fixed costs are shared
over an increased number of goods.
 In a layman’s language, more the products, more is
the bargaining power. This is possible only when
the company’s merge/ combine/ acquired, as the
same can often obliterate duplicate departments or
operation, thereby lowering the cost of the
company relative to theoretically the same revenue
stream, thus increasing profit.
 It also provides varied pool of resources of both
the combining companies along with a larger share
in the market, wherein the resources can be
 exercised.

# Increased revenue /Increased Market

Share:
 This motive assumes that the company will be
absorbing the major competitor and thus increase
its power (by capturing increased market share) to
set prices.

# Cross selling:
 For example, a bank buying a stock broker could
then sell its banking products to the stock
brokers customers, while the broker can sign up
the bank’ customers for brokerage account. Or, a
manufacturer can acquire and sell complimentary
products.

# Corporate Synergy:
 Better use of complimentary resources. It may take
the form of revenue enhancement (to generate more
revenue than its two predecessor standalone
companies would be able to generate) and cost
savings (to reduce or eliminate expenses
associated with running a business).

# Taxes :
 A profitable can buy a loss maker to use the
target’s tax right off i.e. wherein a sick company
is bought by giants.

# Geographical or other diversification:

 This is designed to smooth the earning results of
a company, which over the long term smoothens the
stock price of the company giving conservative
 investors more confidence in investing in the
company. However, this does not always deliver
value to shareholders.

# Resource transfer:
 Resources are unevenly distributed across firms
and interaction of target and acquiring firm
resources can create value through either
overcoming information asymmetry or by combining
scarce resources. Eg: Laying of employees,
reducing taxes etc.

# Improved market reach and industry

visibility –
 Companies buy companies to reach new markets and
grow revenues and earnings. A merge may expand two
companies' marketing and distribution, giving them
new sales opportunities. A merger can also improve
a company's standing in the investment community:
bigger firms often have an easier time raising
capital than smaller ones.

Advantages of M&A’s:

The general advantage behind mergers and
acquisition is that it provides a productive
 platform for the companies to grow, though much of
it depends on the way the deal is implemented.
 It is a way to increase market penetration in a
particular area with the help of an established
base.

Few Benefits of M&A’s are:

# Accessing new markets

# Maintaining growth momentum
# Acquiring visibility and international
brands
# Buying cutting edge technology rather than
importing it
# Taking on global competition
# Improving operating margins and
efficiencies
# Developing new product mixes

 Conclusion
In real terms, the rationale behind mergers and
acquisitions is that the two companies are more
valuable, profitable than individual companies and
that the shareholder value is also over and above
that of the sum of the two companies.
  Despite negative studies and resistance from the
economists, M&A’s continue to be an important tool
behind growth of a company.
 Reason being, the expansion is not limited by
internal resources, no drain on working capital -
can use exchange of stocks, is attractive as tax
benefit and above all can consolidate industry -
increase firm's market power.
 With the FDI policies becoming more liberalized,
Mergers, Acquisitions and alliance talks are
heating up in India and are growing with an ever
increasing cadence.
 They are no more limited to one particular type of
business. The list of past and anticipated mergers
covers every size and variety of business --
mergers are on the increase over the whole
marketplace, providing platforms for the small
companies being acquired by bigger ones.
 The basic reason behind mergers and acquisitions
is that organizations merge and form a single
entity to achieve economies of scale, widen their
reach, acquire strategic skills, and gain
competitive advantage.

In simple terminology, mergers are considered as an

important tool by companies for purpose of expanding
their operation and increasing their profits, which in
façade depends on the kind of companies being merged.

Indian markets have witnessed burgeoning trend in

mergers which may be due to business consolidation by
large industrial houses, consolidation of business by
multinationals operating in India, increasing
competition against imports and acquisition
activities.
 Therefore, it is ripe time for business houses and
corporates to watch the Indian market, and grab this
opportunity of M&A’s.

Issues related to Mergers and Acquisitions.

 Direct Tax implications

 Sales tax implications

 Foreign Direct investments

 Method of valuation

 Anti Trust Act

 Financing of Mergers and Aquisitions

 Role of Investment Bankers

 Accounting of Mergers.

Recent Mergers and Acquisitions

HORIZONTAL MERGER As Ford announced the sale of the

two British iconic cars to Tata Motors Ltd for 2.3
billion.

Ford acquired Jaguar for $2.5 bn in 1989 and Land

Rover for $2.75 bn in 2000 but put them on the
market last year after posting losses of $12.6 bn in
2006 - the heaviest in its 103-year history.

The Hutch and Vodafone merger Hutchison Essor Indian

Company Vodafone(Briton) A Foreign company
HTIL( Whampoa group of Li-Ka Shing. Hong Kong A
foreign company 67% Takes over Asim Ghosh-12%
A.Singh and other companies (Minority) Essor group
Income Tax Act , 1961 as Amended by Finance Act
2005

Provisions relating to carry forward and set off

of accumulated loss and unabsorbed depreciation
allowance in amalgamation or demerger, etc.

Section 72A.
(1) Where there has been an amalgamation of a company
owning an industrial undertaking or a ship or a hotel
with another company or an amalgamation of a banking
company referred to in clause (c) of section 5 of the
Banking Regulation Act, 1949 (10 of 1949) with a
specified bank, then, notwithstanding anything
contained in any other provision of this Act, the
accumulated loss and the unabsorbed depreciation of
the amalgamating company shall be deemed to be the
loss or, as the case may be, allowance for
depreciation of the amalgamated company for the
previous year in which the amalgamation was effected,
and other provisions of this Act relating to set off
and carry forward of loss and allowance for
depreciation shall apply accordingly.

(2) Notwithstanding anything contained in sub-section

(1), the accumulated loss shall not be set off or
carried forward and the unabsorbed depreciation shall
not be allowed in the assessment of the amalgamated
company unless

(a) the amalgamating company (i) has been engaged in

the business, in which the accumulated loss occurred
or depreciation remains unabsorbed, for three or more
years; (ii) has held continuously as on the date of
the amalgamation at least three-fourths of the book
value of fixed assets held by it two years prior to
the date of amalgamation; (b) the amalgamated company
(i) holds continuously for a minimum period of five
years from the date of amalgamation at least three-
fourths of the book value of fixed assets of the
amalgamating company acquired in a scheme of
amalgamation; (ii) continues the business of the
amalgamating company for a minimum period of five
years from the date of amalgamation; (iii) fulfils
such other conditions as may be prescribed to ensure
the revival of the business of the amalgamating
company or to ensure that the amalgamation is for
genuine business purpose.

(3) In a case where any of the conditions laid down in

sub-section (2) are not complied with, the set off of
loss or allowance of depreciation made in any previous
year in the hands of the amalgamated company shall be
deemed to be the income of the amalgamated company
chargeable to tax for the year in which such
conditions are not complied with.

(4) Notwithstanding anything contained in any other

provisions of this Act, in the case of a demerger, the
accumulated loss and the allowance for unabsorbed
depreciation of the demerged company shall (a) where
such loss or unabsorbed depreciation is directly
relatable to the undertakings transferred to the
resulting company, be allowed to be carried forward
and set off in the hands of the resulting company; (b)
where such loss or unabsorbed depreciation is not
directly relatable to the undertakings transferred to
the resulting company, be apportioned between the
demerged company and the resulting company in the same
proportion in which the assets of the undertakings
have been retained by the demerged company and
transferred to the resulting company, and be allowed
to be carried forward and set off in the hands of the
demerged company or the resulting company, as the case
may be.

(5) The Central Government may, for the purposes of

this Act, by notification in the Official Gazette,
specify such conditions as it considers necessary to
ensure that the demerger is for genuine business
purposes.

(6) Where there has been reorganization of business,

whereby, a firm is succeeded by a company fulfilling
the conditions laid down in clause (xiii) of section
47 or a proprietary concern is succeeded by a company
fulfilling the conditions laid down in clause (xiv) of
section 47, then, notwithstanding anything contained
in any other provision of this Act, the accumulated
loss and the unabsorbed depreciation of the
predecessor firm or the proprietary concern, as the
case may be, shall be deemed to be the loss or
allowance for depreciation of the successor company
for the purpose of previous year in which business re-
organization was effected and other provisions of this
Act relating to set off and carry forward of loss and
allowance for depreciation shall apply accordingly :

Provided that if any of the conditions laid down in

the proviso to clause (xiii) or the proviso to clause
(xiv) to section 47 are not complied with, the set off
of loss or allowance of depreciation made in any
previous year in the hands of the successor company,
shall be deemed to be the income of the company
chargeable to tax in the year in which such conditions
are not complied with.

(7) For the purposes of this section, (a) accumulated

loss means so much of the loss of the predecessor firm
or the proprietary concern or the amalgamating company
or the demerged company, as the case may be, under the
head Profits and gains of business or profession (not
being a loss sustained in a speculation business)
which such predecessor firm or the proprietary concern
or amalgamating company or demerged company, would
have been entitled to carry forward and set off under
the provisions of section 72 if the re-organization of
business or amalgamation or demerger had not taken
place;

Explanation 97[(aa) industrial undertaking means any

undertaking which is engaged in (i) the manufacture or
processing of goods; or (ii) the manufacture of
computer software; or (iii) the business of generation
or distribution of electricity or any other form of
power; or 98[(iiia) the business of providing
telecommunication services, whether basic or cellular,
including radio paging, domestic satellite service,
network of trunking, broadband network and internet
services; or (iv) mining; or (v) the construction of
ships, aircrafts or rail systems;
(b) unabsorbed depreciation means so much of the
allowance for depreciation of the predecessor firm or
the proprietary concern or the amalgamating company or
the demerged company, as the case may be, which
remains to be allowed and which would have been
allowed to the predecessor firm or the proprietary
concern or amalgamating company or demerged company,
as the case may be, under the provisions of this Act,
if the reorganization of business or amalgamation or
demerger had not taken place;
99[(c) specified bank means the State Bank of India
constituted under the State Bank of India Act, 1955
(23 of 1955) or a subsidiary bank as defined in the
State Bank of India (Subsidiary Banks) Act, 1959 (38
of 1959) or a corresponding new bank constituted under
section 3 of the Banking Companies (Acquisition and
Transfer of Undertakings) Act, 1970 (5 of 1970) or
under section 3 of the Banking Companies (Acquisition
and Transfer of Undertakings) Act, 1980 (40 of 1980).]
Provisions relating to carry forward and set-off of
accumulated loss and unabsorbed depreciation allowance
in scheme of amalgamation of banking company in
certain cases.
72AA. Notwithstanding anything contained in sub-
clauses (i) to (iii) of clause (1B) of section 2 or
section 72A, where there has been an amalgamation of a
banking company with any other banking institution
under a scheme sanctioned and brought into force by
the Central Government under sub-section (7) of
section 45 of the Banking Regulation Act, 1949 (10 of
1949)1a, the accumulated loss and the unabsorbed
depreciation of such banking company shall be deemed
to be the loss or, as the case may be, allowance for
depreciation of such banking institution for the
previous year in which the scheme of amalgamation was
brought into force and other provisions of this Act
relating to set-off and carry forward of loss and
allowance for depreciation shall apply accordingly.

Explanation For the purposes of this section, (i)

accumulated loss means so much of the loss of the
amalgamating banking company under the head Profits
and gains of business or profession (not being a loss
sustained in a speculation business) which such
amalgamating banking company, would have been entitled
to carry forward and set-off under the provisions of
section 72 if the amalgamation had not taken place;
(ii) banking company shall have the same meaning
assigned to it in clause (c) of section 5 of the
Banking Regulation Act, 1949 (10 of 1949) 1a;
(iii) banking institution shall have the same meaning
assigned to it in sub-section (15) of section 45 of
the Banking Regulation Act, 1949 (10 of 1949) 1a;
(iv) unabsorbed depreciation means so much of the
allowance for depreciation of the amalgamating banking
company which remains to be allowed and which would
have been allowed to such banking company if
amalgamation had not taken place
Cross-border mergers and acquisitions: Tax and
regulatory issues
Indian companies are increasingly becoming involved in
cross border mergers and acquisitions with an
Intention to enhance shareholder value. Several tax
and regulatory issues need to be considered when such
Deals are contemplated.

Swap transaction
When Indian residents holding the entire share capital
of an Indian Company intends to transfer their
Shareholding in the Indian Company to the Foreign say
unlisted Company in exchange for shares of the Foreign
Company thereby making the Indian Company a 100 %
subsidiary of the Foreign Company. This Exchange is
generally termed as share swap transaction.

What are the Tax implications

The transfer of shares in the Indian Company in

exchange of shares of the Foreign Company would imply
Capital gains for the shareholders of the Indian
Company. For the purpose of computing the capital
gains, The consideration received by the shareholders
of the Indian Company would have to be reduced from
the cost of acquisition of the shares in the Indian
Company.
The consideration received computed based on the value
of shares in the Foreign Company and not on the Value
of the shares in the Indian Company given up.
Then the question is, what is the value of shares of
an unlisted Foreign Company. The Income Tax Act 1961
does not provide for any valuation norms for shares of
unlisted companies and the capital gains arising as a
result of such a swap. In case the Foreign Company was
a listed company, the market value of Foreign Company
shares Received could be taken as the consideration
for the transfer and used to compute capital gains.
In the past, legislations like the Gift Tax and Wealth
Tax provided for valuation of shares in unlisted
companies on the basis of Net Asset Value (NAV).It is
a debatable issue whether NAV method is the
appropriate method or not in computing the sale
consideration for capital gains purposes.
One aspect that needs to be considered when the Indian
Company has unabsorbed business losses is, Section 79
of the Act. Section 79 of the Act restricts an Indian
company from carrying forward and setting off its
business losses against future profits in case of
change of more than 51% shareholding of such an Indian
company. Since more than 51% shareholding of the
Indian Company would change, it will not be allowed to
carry forward its prior year's business losses for set
off against profits of future years.

Taxation of Cross Borders Mergers & Acquisitions:

 Any mergers and acquisitions activity is intricate

in its dimensions and would be affected by a
 plethora of laws and regulations depending on the
stakeholders involved. Deal structuring from
 a tax perspective is one of the critical factors
for any business restructuring proposition, such
 that the transaction is tax neutral or results in
minimizing the tax implications. Such acquisitions
 may be routed through direct investments or
through an International Holding Company (IHC).

 An IHC would be advantageous in case the

promoter/company wishes to keep the cash flows
 generated from overseas operations outside India
for future growth needs. In case of direct
investments, the entire surplus amount would have
to be repatriated to India and the same would be
subject to tax in India, thereby reducing the
disposable income in the hands of the
promoter/company.

 Income generated overseas could be repatriated to

the Indian Company in the form of interest,
royalties, service or management fees, dividends,
capital gains. Such income when repatriated to the
Indian Company by the IHC or to the IHC by the
target company would attract double taxation.
Double taxation is a situation in which two or
more taxes are paid for the same
income/transaction which arises because of the
overlap between different countries tax laws and
 jurisdictions.

 The liability is then mitigated or off settled by

tax treaties between the two countries. An ideal
location for an IHC would be one with low/nil
withholding tax on receipts, on income streams and
on subsequent re-distribution as passive income.
 Some of the jurisdictions preferred for
repatriating back to India include Mauritius,
Cyprus, Singapore and Netherlands, which have
relatively better tax treaties with India.

 Mergers and acquisitions play a major role in the

globalization process. Tax laws should better
accommodate cross border merger and acquisitions.
In an endeavor to geographically expand the
utilization of their competitive advantages,
merger and acquisitions allow the firms to do so
in a fast, effective and perhaps in an inexpensive
manner.

 Many countries have some tax rules that grant

certain benefits to merger and acquisitions
transactions, usually allowing some deferral of
the tax otherwise imposed on the owners of some of
the participating parties upon the transaction. On
the other hand, once mergers and acquisitions
transactions cross borders, countries are much
less enthusiastic to provide tax benefits to the
involved parties, understanding that, in some
cases, relief of current taxation practically
means exemption since such countries may
completely lose jurisdiction to tax the
transaction.

 Cross-border merger and acquisitions, although

presenting many of the same issues as domestic
deals, are usually more complex and rife with
surprises and other pitfalls, more so when the
number of geographies involved in the transaction
increases.
 The sheer range of concerns has expanded as the
speed and volume of international deals have
increased. Domestic merger and acquisitions are,
generally and on average, socially desirable
transactions. In many countries, they enjoy tax
(deferral) preferences, but only to the extent to
which they use stock to compensate target
corporations or their shareholders.

 The legal framework for business consolidations in

India consists of numerous statutory provisions
for tax concessions and tax neutrality for certain
kinds of reorganizations and consolidations. With
India rapidly globalising, and the economy growing
and showing positive results, a sound tax policy
is essential in this regard. Tax is an important
business cost to be considered while taking any
business decision, particularly when competing
with other global players.

 The new direct tax code that the Government is

planning to introduce, to replace the current
Income-tax Act, 1961, is expected to emphasize on
transparency and taxpayer friendliness.

 Any mergers and acquisitions activity is intricate

in its dimensions and would be affected by a
plethora of laws and regulations’ depending on the
stakeholders involved. Progressive deregulation in
sectors such as banking, insurance, power,
aviation, housing and policy rationalization in
others like broadcasting, telecommunications and
media, coupled with the government’s decision to
exit non strategic areas through divestment/
disinvestment has further triggered M&A activities
in India.
 Further considering competition in the world
market and pressure on the top line and bottom
line, Indian Companies are increasingly looking at
mergers and acquisitions as instruments for
momentous growth and a critical tool of business
strategy. Deal structuring from a tax perspective
is one of the critical factors for any business
restructuring proposition, such that the
transaction is tax neutral or minimizing tax
implications.

 Such acquisitions may be routed through direct

investments or through an International Holding

 Company (IHC). An IHC would be advantageous in

case the promoter/company wishes to keep the cash
flows generated from overseas operations outside
India for future growth needs.

 In case of direct investments, the entire surplus

amount would have to be repatriated to India and
the same would be subject to tax in India, thereby
reducing the disposable income in the hands of the
promoter/company.

 Income generated overseas, could be repatriated to

the Indian Company in the form of interest,
royalties, service or management fees, dividends,
capital gains. Such income when repatriated to the
Indian Company by the IHC or to the IHC by the
target company would attract double taxation.
Double taxation is a situation in which two or
more taxes are paid for the same
income/transaction which arises because of the
overlap between different countries tax laws and
jurisdictions. The liability is then mitigated or
 off settled by tax treaties between the two
countries.

 An ideal location for an IHC would be one with

low/nil withholding tax on receipts, on income
streams and on subsequent re-distribution as
passive income. Some of the jurisdictions
preferred for repatriating back to India include
Mauritius, Cyprus, Singapore and Netherlands,
which have relatively better tax treaties with
India.

 The paper discusses about the taxation issues in

cross border mergers & acquisitions in India. It
discusses about structuring the transactions. It
also discusses about the taxation issues in sales
of shares and sale of assets.

 It also studies about the various laws governing

the cross border mergers & acquisitions. The paper
takes Vodafone–Hutch deal as a special case to
study the taxation issues in cross border mergers
and acquisitions. The paper proposes to showcase
what lies at the heart of this Vodafone–Hutch
deal, the effect of taxation on such transactions,
the way forward of the deal, options for the
parties involved, impact on future cross border
M&A, concept of tax haven, possible tax planning
in such cases, tax treaty shopping – how far legal
and ethical and the present tax law in India is in
this regard.

II. Historical Background

Given the role that mergers and acquisitions play in

globalization process, the Indian business environment
has indeed altered radically with the changes in the
economic policy and with the
introduction of new institutional mechanisms. The
industrial policy changes in 1991 ushered in
an era of liberal trade and transactions in industrial
and financial sectors of the economy. In the last two
decades, India witnessed substantial rise in mergers
and acquisitions activity in almost
all sectors of the economy. Indian industries
underwent structural changes in the post
liberalization period wherein mergers and acquisitions
were accepted as vital means of corporate
restructuring and redirecting capital towards
efficient management. In a way, restructuring of
business became an integral part of the new economic
paradigm. Restructuring and reorganization became
important as the controls and restrictions gave way to
competition and free trade. Restructuring usually
involves major organizational changes such as shift in
corporate strategies to meet increased competition and
rapidly changing market conditions.

Regulatory Framework: The relevant laws that are to be

implicated in a cross border mergers
and acquisitions in India are as under:

Companies Act, 1956: Cross border M&A, both the

amalgamating company or companies and
the amalgamated (i.e. survivor) company are required
to comply with the requirements specified in Section
391-394 of the Companies Act, which, inter alia,
require the approval of a High court and of the
Central government. Section 394 and 394A of the Act
set forth the powers of the High Court and provide for
the court to give notice to the Central Government in
connection with amalgamation of companies.
Foreign Exchange Laws: The Foreign Direct Investment
Policy of India needs to be followed when any foreign
company acquires an Indian company. FDI is completely
prohibited in certain sectors such as gambling and
betting, lottery business, atomic energy, retail
trading and agricultural or plantation activities. The
Foreign Investment policy of Government of India
along with the press notes and clarificatory circulars
issued by the department of investment
policy and promotion, Foreign Exchange Management Act,
1999 (FEMA) and regulations made there under,
including circulars and notifications issued by the
RBI from time to time, the Securities and Exchange
Board of India Act, 1992 and regulations made there
under (SEBI laws).

Income Tax Act, 1961: A number of important issues

arise in structuring a cross-border merger
and acquisitions deal to ensure that tax liabilities
and cost will be minimized for the acquiring
company. The first step is to explore leveraging local
country operations for cash management
and repatriation advantages. Moreover, the companies
should be looking at the availability of asset-basis
set up structures for tax purposes and keeping a keen
eye on valuable tax attributes in merger and
acquisitions targets, including net operating losses,
foreign tax credits and tax holidays. As per the
provisions of the Income Tax Act, capital gains tax
would be levied on such transactions when capital
assets are transferred. From the definition of
transfer, it is clear that if merger, amalgamation,
demerger or any sort of restructuring results in
transfer of capital asset, it would lead to a taxable
event. As far as merger and acquisitions are
concerned, the provisions of Indian Income Tax Act,
1961 with respect to amalgamation (section 2(1B)),
demerger (section 2(19AA)), securities transaction tax
(STT), capital gains, slump sale, set off and carry
forward of losses, etc. need to be examined
intricately to establish legitimate safeguards.
Tax structure is important factor in mergers and
acquisitions. Tax laws determine the desired tax
treatment of the transaction whether it is taxable or
tax free. An ideal tax structure should be
such that it minimizes the tax leakage, such as tax
withholding relating to cross border mergers
and acquisitions.

Proposed tax treatment under Direct Tax Code: It is to

be noted that recently, the Finance Minister has
released the new Direct Tax Code which seeks to bring
about a structural change in the tax system currently
governed by the Income- tax Act, 1961. Summarized
below are the key proposed provisions that are likely
to have an impact on the mergers and acquisitions in
India:
Currently, the definition of ‘amalgamation’ covers
only amalgamation between companies. It is now
proposed to include, subject to fulfilment of certain
conditions, even amalgamationamongst co-operative
societies and amalgamation of sole proprietary concern
and unincorporated bodies (firm, association of
persons and body of individuals) into a company
in this definition.

For amalgamation of companies to be tax neutral, in

addition to existing conditions the Code
proposes that amalgamation should be in accordance
with the provisions of the Companies
Act, 1956.
In case of demerger, resulting company can issue only
equity shares (as against both equity and preference
shares as per existing provisions) as consideration to
the shareholders of demerged company, for the demerger
to qualify as tax neutral demerger.
Irrespective of sectors (for instance manufacturing or
service), the benefit of carry forward and set off of
losses of predecessor in the hands of successor
Company is proposed to be available to all the
companies. As per existing provisions in view of
definition of “industrial undertaking” certain
companies were not able to utilize the benefit of
losses as a result of amalgamation. Further, the Code
provides for indefinite carry forward of business
losses as against restrictive limit of 8 years under
existing provisions.
Profit from the slump sale of any undertaking is
proposed to be taxed as a business income as
against capital gains income.
Code seeks to eliminate the distinction between long
term and short term capital asset.
Introduction of General Anti Avoidance Rule (‘GAAR’)
which empowers the Commissioner of Income-tax (‘CIT’)
to declare an arrangement as impermissible if the same
has been entered into with the objective of obtaining
tax benefit and which lacks commercial
substance.

Taxation of Mergers & Acquisitions: A Comparative

Study there have been many recent developments in the
competition and taxation laws of various countries.
The tax is a deciding factor for any cross border
reorganization and so all the countries should try to
have a favourable tax environment.

United States: The two primary relevant federal

securities laws in US that has to be complied,
are the Securities Act of 1933 (the “Securities Act”)
and the Securities Exchange Act of 1934
(the “Exchange Act”), including the rules and
regulations promulgated by the Securities and
Exchange Commission (the “SEC”).
Internal Revenue Code of 1986, as amended (Code), is
provided by the federal government, this
code provides for tax laws in US. Section 267 of their
internal revenue code (IRC) exempt US
corporate entity in some cases relating to taxation
aspect as far as mergers and acquisitions are
concerned.

Singapore: Income is taxed in Singapore in accordance

with the provisions of the Income Tax Act (Chapter
134) and the Economic Expansion Incentives (Relief
from Income Tax) Act (Chapter 86). Singapore has also
signed a Comprehensive Economic Cooperation Agreement
(“CECA”) with India.

United Kingdom: Finance Act 2009 and Corporation Tax

Act 2009 which are likely to have a considerable
impact on U.K. acquisition structuring. The existing
Treasury consent regime (whereby certain transactions
involving a foreign body corporate may be unlawful
without prior consent) is replaced with a reporting
requirement for large transactions from 1 July 2009.
Minor changes have been made to the U.K. controlled
foreign company (CFC) rules from 1 July 2009
over a two-year transitional period.

European Union: European competition law is governed

primarily by Articles 85 and 86 of the Treaty
Establishing the European Community. Article 85 is
designed primarily to achieve the same goal as the
Sherman Act in U.S. legislation insofar as it
prohibits all agreements and concerted practices that
affect trade among E.U. members and which have as
their main objective the prevention, restriction or
distortion of competition. Article 86 is designed to
meet the policy objectives of the Clayton Act in that
it prohibits the abuse of a dominant market position
through unfair trading conditions, pricing, limiting
production, tying and dumping.

So, India has followed the footsteps of the developed

economy by tax reforms and other regulatory
developments. US, UK and Singapore seems to have a
friendly environment for mergers and acquisitions by
Indian companies.

III. Literature Review

As per the “Cross-border Transactions - an India Tax
and Regulatory Update”, issued on January 1, 2009 by
Deloitte, India has always been perceived as a
difficult jurisdiction to do business with. In spite
of India having substantially opened the doors for
foreign investment and there being no lack of local
entrepreneurial talent, the country still ranks low in
terms of being a preferred business destination.

The “Taxation of Cross-Border Mergers and

Acquisitions”, issued by KPMG, discusses Limited
Liability Partnership Act and tax attributes of
various assets and share purchases. It highlights
withholding taxes in various countries, deal
structures and various tax liability structures under
acquisition or merger by various modes. It compared
tax liability under asset purchases, demerger,
amalgamation, various corporate laws covering transfer
taxes, IT laws and other accounting principles.

In Vodafone International Holdings BV v. Union of

India [(2008) 175 Taxmann 399 (Bom.
HC)], December 3, 2008, Hutchison Essar Ltd. (“Hutch
India”), a company incorporated in
India, was a joint venture of the Hong Kong-based
Hutchison Telecommunications International
Ltd (“Hutch Hong Kong”) and the India-based Essar
Group. Hutch India was in the business of
providing telecommunication service in India. Hutch
Hong Kong held 67% of the shares of Hutch India
through CGP Investments Holdings Ltd (“the Cayman
Islands SPV”), an SPV registered in Cayman Islands,
and some other shareholders. As a result of this
sale, capital gains, estimated at $ 2 billion, accrued
to the Cayman Islands SPV. Considered from the point
of view of jurisdictions, it is clear that the sale
transaction took place between the Dutch SPV
(owned by a UK group) and the Cayman Islands SPV
(owned by a Hong Kong company). The ultimate effect
however was the transfer of controlling shares of an
Indian company.

FDI in Telecom Sector in India

In Basic, Cellular Mobile, Paging and Value Added

Service, and Global Mobile Personal Communications by
Satellite, Composite FDI permitted is 74% (49% under
automatic route) subject to grant of license from
Department of Telecommunications subject to security
and license conditions.

 FDI up to 74% (49% under automatic route) is also

permitted for Radio Paging Service and Internet
Service Providers (ISP's)

 FDI up to 100% permitted in respect Infrastructure

Providers providing dark fibre (IP Category
I); Electronic Mail; and Voice Mail

This is subject to the conditions that such companies

would divest 26% of their equity in favour of
Indian public in 5 years, if these companies were
listed in other parts of the world. In telecom
manufacturing sector 100% FDI is permitted under
automatic route. The Government has modified
method of calculation of Direct and Indirect Foreign
Investment in sector with caps and have also
issued guidelines on downstream investment by Indian
Companies. Inflow of FDI into India’s
telecom sector during April 2000 to February 2010 was
about Rs. 405,460 million. Also, more than
8 per cent of the approved FDI in the country is
related to the telecom sector.

Vodafone-Essar: The case Study –

IV. Vodafone Hutch case

The acquisition of Hutchison Essar by Vodafone at an

enterprise value of $19.3 billion which comes to
around $794 per share was one of the biggest cross
border deals in the booming Indian telecom market at
that time. Vodafone won the 67% block on sale by
Hutch-Essar leaving behind Reliance Communication and
a consortium led by Hindujas as well. It paid around
10.9 billion dollars for the acquisition.
Profile of Co-parties

Owners: Vodafone: 67% Essar: 33%

Vodafone Profile: Vodafone Group plc is a global

telecommunications company headquartered
in Newbury, United Kingdom.

It is the world's largest mobile telecommunications

company measured by revenues and the world's second-
largest measured by subscribers, with around 332
million proportionate subscribers as at 30 September
2010. It operates networks in over 30 countries and
has partner networks in over 40 additional countries.
It owns 45% of Verizon Wireless, the largest mobile
telecommunications company in the United States
measured by subscribers.

Its primary listing is on the London Stock Exchange

and it is a constituent of the FTSE 100 Index. It had
a market capitalisation of approximately £92 billion
as of November 2010, making it the third largest
company on the London Stock Exchange. It has a
secondary listing on NASDAQ.

Essar Profile: The Essar Group is a multinational

conglomerate corporation in the sectors of
Steel, Energy, Power, Communications, Shipping Ports &
Logistics as well as Construction headquartered at
Mumbai, India. The Group's annual revenues were over
USD 15 billion in financial year 2008-2009.
Essar began as a construction company in 1969 and
diversified into manufacturing, services and
retail. Essar is managed by Shashi Ruia, Chairman –
Essar Group and Ravi Ruia, Vice Chairman Essar Group.
Hutch Profile: Hutchison Whampoa Limited of Hong Kong
is a Fortune 500 company and one of the largest
companies listed on the Hong Kong Stock Exchange. HWL
is an international corporation with a diverse array
of holdings which includes the world's biggest port
and telecommunication operations in 14 countries and
run under the brand. Its business also includes
retail, property development and infrastructure. It
belongs to the Cheung Kong Group

Vodafone-Essar: The case Study –

Essentially the Vodafone Hutch deal involved transfer

of shares of a non-resident Cayman Islands based
entity between two non-residents (Hutch and Vodafone).
Apparently the transaction had no link with India and
therefore the related parties to the transaction
indeed assumed and claimed that no tax on this deal is
payable in India. But the Indian tax
authorities thought otherwise. The Indian tax
authorities issued notice to Vodafone under
section 201 of the Indian Income Tax Act 1961 so as to
show cause as to why it should not be
treated as an “assessee in default” since it
(Vodafone) had failed to discharge its withholding
tax obligation with respect to tax on gains made by
Hutch on the sale of shares to Vodafone.
In addition, the Indian tax authorities decided to
treat Vodafone as an agent of Hutch under
section 163 of the Income Tax Act 1961 to recover the
tax dues. On Vodafone’s challenge to
the notice, the Bombay High Court on December 3, 2008,
approved the Indian tax authorities
jurisdiction to initiate investigation so as to
determine whether the over $11 billion
Hutchison-Vodafone transaction was liable for capital
gains tax in India. Finally on January
20, 2012, the Supreme Court ruled in favour of
Vodafone. The Supreme Court disagreed with
the conclusions arrived at by the Bombay High Court
that the sale of CGP share by HTIL to
Vodafone would amount to transfer of a capital asset
within the meaning of Section 2(14) of
the Indian Income Tax Act and the rights and
entitlements flow from FWAs, SHAs, Term
Sheet, loan assignments, brand license etc. form
integral part of CGP share attracting capital
gains tax. Consequently, the demand of nearly
Rs.12,000 crores by way of capital gains tax,
would amount to imposing capital punishment for
capital investment since it lacks authority
of law and, therefore, stands quashed.

Hutchison International, a non-resident seller and

parent company
based in Hong Kong sold its stake in the foreign
investment company CGP Investments
Holdings Ltd., registered in the Cayman Islands
(which, in turn, held shares of Hutchison-Essar
- Indian operating company, through another Mauritius
entity) to Vodafone, a Dutch nonresident buyer.
Vodafone Essar is owned by Vodafone 52%, Essar Group
33%, and other Indian nationals, 15%. On February 11,
2007, Vodafone agreed to acquire the controlling
interest of 67% held by Li Ka Shing Holdings in Hutch-
Essar for US$11.1 billion, pipping Reliance12
Communications, Hinduja Group, and Essar Group, which
is the owner of the remaining 33%.
The whole company was valued at USD 18.8 billion. The
transaction closed on May 8, 2007.
The total is Vodafone Essar subscription is
106,347,368 subscribers i.e., 23.94% of the
total 444,295,711 subscribers.
Individual Investors: Individual large stake holders
Analjit Singh and Asim Ghosh sold their
stakes to Vodafone in December 2009. Asim Ghosh, the
former managing director of Vodafone Essar, had 4.68
per cent stake in the company held through investment
firm AG Mercantile, and sold a part of it for about Rs
3.3 billion. Analjit Singh, who had a share of 7.58
per cent through three companies, sold a part of his
stake for over Rs 5 billion. After the sale, the
stakes held by Ghosh and Singh in Vodafone Essar will
come down to 2.39 per cent and 3.87 per cent
respectively.
Vodafone Hutch deal –Time Line

The time line for the Vodafone and Hutch deal is as

follow:
2007/05/29 - Court sends notice to Vodafone and Hutch
2007/05/05 - Vodafone-Hutch deal gets Finance
Minister's nod
2007/04/04 - Vodafone-Hutch deal: Decision likely at
next FIPB meeting
2007/03/19 - FIPB to take up Vodafone proposal on
Tuesday
2007/03/16 - Hutchison offers $415 m to Essar as
`sign-on bonus'
2007/03/16 - Vodafone's Hutch deal in order: Kamal
Nath
2007/03/15 - Essar, Vodafone reach agreement on
jointly managing Hutch
2007/02/18 - What Vodafone will collect from the Hutch
call
2007/02/15 - `Roses for Essar, telephony for masses'
2007/02/15 - Vodafone pledges $2-b investments13
2007/02/12 - Hutch: Vodafone top bidder with $19-b
offer
2007/02/11 - Hindujas to partner Qatar Telecom, Altimo
for Hutch
2007/02/10 - Hutch bidding goes to the wire
2007/01/11 - Vodafone offer in a few weeks
2007/01/09 - Vodafone starts due diligence of Hutch
2007/01/06 - Hutchison, Essar differ over right of
refusal
2007/01/03 - Essar gets fund pledge worth $24 b for
Hutch-Essar buy
2006/12/29 - Reliance Comm in race for Hutch-Essar
2006/12/23 - Vodafone joins race for Hutchison Essar
stake
2006/12/21 - Vodafone may join race for Hutch

Taxation issue in Vodafone – Hutch deal: The Indian

Revenue authorities issued show cause
notice to Vodafone arguing that they had failed to
discharge withholding tax obligation with
respect to tax on gains made by Hutch on sale of
shares to Vodafone. Vodafone filed a writ
petition in the Mumbai High Court challenging the
jurisdiction of the Revenue department.
The revenue department issued show-cause to Vodafone
asking for an explanation as to why Vodafone Essar
(which was formerly Hutchison Essar) should not be
treated as an agent (representative assessee) of
Hutchison International and asked Vodafone Essar to
pay $ 1.7 billion as capital gains tax.

Indian Income Tax department view: The whole

controversy in the case of Vodafone is about the
taxability of transfer of share capital of the Indian
entity. Generally, the transfer of shares of a non-
resident company to another non-resident is not
subject to tax in India.

But the revenue department is of the view that this

transfer represents transfer of beneficial interest of
the shares of the Indian company and, hence, it will
be subject to tax.
The revenue authorities are of the view that as the
valuation for the transfer includes the valuation of
the Indian entity also and as Vodafone has also
approached the Foreign Investment Promotion Board
(FIPB) for its approval for the deal, Vodafone
has a business connection in India and, therefore, the
transaction is subject to capital gains tax in India.

Vodafone view: On the contrary, Vodafone’s argument is

that there is no sale of shares of the Indian company
and what it had acquired is a company incorporated in
Cayman Islands which, in turn, holds the Indian
entity. Hence, the transaction is not
subject to tax in India.

Vodafone argued that the deal was not taxable in India

as the funds were paid outside India for
the purchase of shares in an offshore company that the
tax liability should be borne by Hutch; that Vodafone
was not liable to withhold tax as the withholding rule
in India applied only to Indian residence that the
recent amendment to the IT act of imposing a
retrospective interest penalty for withholding lapses
was unconstitutional.

Now the taxman’s argument was focused on proving that

even though the Vodafone-Hutch deal was offshore, it
was taxable as the underlying asset was in India and
so it pointed out that the capital asset; that is the
Hutch-Essar or now Vodafone-Essar joint venture is
situated here and was central to the valuation of the
offshore shares; that through the sale of offshore
shares, Hutch had sold Vodafone valuable rights - in
that the Indian asset including tag along rights,
management rights and the right to do business in
India and that the offshore transaction had
resulted in Vodafone having operational control over
that Indian asset. The Department also argued that the
withholding tax liability always existed and the
amendment was just a clarification.

Key questions before the High Court:

  Whether the show cause notice issued by the
Revenue authorities was without Jurisdiction as
Vodafone could not be said to be liable under
section 201 of the Income tax Act 1961 for not
withholding tax?

  Whether the provisions relating withholding tax

obligation under section 195 of the Acts have
extra territorial application and a non resident
without presence in India has an obligation to
comply with it?

  Whether the transaction per se resulted in

income chargeable to tax in India?

Vodafone’s Petition and Arguments:

Vodafone’s argument is that there is no sale of
shares of the Indian company and what it had
acquired is a company incorporated in Cayman Islands
which in turn holds the Indian entity. Hence, the
transaction is not subject to tax in India.

The petitions and arguments of Vodafone are as

under:

It was not in default (under section 201) for not

withholding tax as the law applied to
situations where tax had been withheld and not
deposited. Hence, to impose an obligation
 where no withholding had been made was
unconstitutional. Giving a contextual
interpretation, “person” liable to withhold tax
could not include a non resident having no
presence (in India), since such an interpretation
would amount to treating unequal’s as equal by
imposing onerous compliance obligations as
applicable to residents or nonresidents having a
presence in India. The transfer was with respect to
ownership of shares in a foreign company and no
capital asset in India. Further, change in
controlling interest in Indian companies was only
incidental to change in foreign shareholding.

Vodafone also challenged the constitutional validity

of retrospective amendments to
sections 191 and 201 of the Act, motivated to impose
an obligation on payer to withhold
tax.

The transfer of the shares of CGP which was a

capital asset situated outside India could not
result in any income chargeable to tax in India. A
share in a company represents a bundle of
rights and its transfer results in a transfer of all
the underlying rights. However, what were
transferred were only a share and not the individual
rights.

When there is no look-through provisions under the

Income Tax Act, 1961 ("the Act"), such a
provision cannot be read into the statute and the
corporate veil cannot be lifted unless a tax fraud
is perpetrated. The Supreme Court ("SC") in the case
of Azadi Bachao Andolan (2003) 263 ITR
706 has held that there was no tax consequence in
India when the shares of one of the16
intermediate holding company in Mauritius were
transferred. Similarly, there should not be a
tax consequence, even when an upstream holding company
transfers its shares.

Analysis of the issue: HC ruling in Vodafone Case: The

HC held that the series of transactions
in question has a ‘significant nexus' with India.
Since the essence of it was change in controlling
interest in HEL, it constituted a source of income in
India. It held that the price paid by
Vodafone factored in, as part of the consideration,
diverse rights and entitlements being
transferred as part of the composite transaction. Many
of these entitlements were not relatable
to the transfer of the CGP share. It held that
intrinsic to the transaction were transfer of other
rights and entitlements. Such rights and entitlements
constitute ‘capital assets' as per the
provisions of the Act.

The apportionment of consideration paid by Vodafone

for a bundle of entitlements stated above
lies within the jurisdiction of the Indian Revenue.
The Indian Revenue Authorities sought to
apportion income resulting to HTIL between what has
accrued or arisen or what is deemed to
have accrue or arise as a result of a nexus with India
and that which lies outside.

Subsequent to the HC ruling, the Revenue has raised a

tax demand of Rs. 112,180 million on Vodafone for
failure to withhold taxes. Meanwhile, the appeal filed
by Vodafone before the Supreme Court was heard in
November 2010.

Analysis of decision: This is a landmark ruling which

throws light on principles of taxation of
cross-border transfers. The High Court's observation
on the ‘principle of proportionality' that a
portion of the income would be chargeable to tax is a
significant one. The Court has also observed that the
other rights and entitlements, passed on as a part of
the deal are separate assets and can be regarded as
‘capital assets', within the meaning of the Act. These
observations seemto indicate that transactions
involving a simpler transfer of shares of a company
outside India, which has companies in its fold in
India, would not be chargeable to tax in India.

However, if certain other rights and entitlements in

India are transferred along with the transfer of
shares, there would be an incidence of tax in India.
This decision could certainly embolden the Revenue
authorities to investigate offshore transactions,
which have a connection with India or cases where
limited interest exists in India and the demand raised
by the Revenue authorities is a clear indication of
things to come.

The Dutch government, on behalf of Vodafone, has

approached the Indian government for settling a three-
year-old dispute involving a tax claim of over Rs
11,000 crore. Netherlands has written to India asking
it to consider an alternate dispute resolution that
will run parallel to the ongoing court process through
what is termed as a Mutual Agreement Procedure (MAP).

India would examine the request and take a decision in

accordance with the provisions of the India-
Netherlands double tax avoidance agreement (DTAA). MAP
is an alternate process of dispute resolution, and is
an option available to a taxpayer in addition to and
concurrent with the appellate process. However, under
MAP, once the proceedings are initiated, it is
possible to obtain a stay on the tax demand provided
one gives a bank guarantee.

This opens up the possibility of a settlement on the

lines of what Vodafone clinched in the UK earlier this
year, when it agreed to pay £1.25 billion in taxes to
settle a decade-long dispute dating back to 2000
regarding its Luxembourg subsidiary.

Supreme Court of India Decision

The Supreme Court today ruled in favour of Vodafone in
the $2 billion tax case saying capital
gains tax is not applicable to the telecom major. The
apex court also said the Rs 2,500 crore
which Vodafone has already paid should be returned to
Vodafone with interest. The decision will be a big
boost for cross-border mergers and acquisitions here.
The Income tax department’s contention, if upheld,
would have rendered standard transaction structures
too risky forcing foreign companies to weigh
potentially new litigation and insurance costs. Nearly
five years after the Indian taxman issued the first
notice to Vodafone international on September 2007 for
failure to withhold tax on payments made to Hutchison
Telecom, Chief Justice of India SH
Kapadia and Justice KS Radhakrishnan pronounced their
judgement.

The SC has ruled that the transaction is not taxable

in India, and it has made the following observations/
comments while pronouncing its ruling:

 Presently, there are no look-through provisions in

the Indian domestic tax law to tax
the transaction.

 There is no extinguishment of property rights in

India through the transfer of shares
between two foreign entities of shares in another
foreign entity.

 Similarly, provisions which treat a person as an

agent/representative of a foreignentity for the
purpose of levy and recovery of tax due from such a
foreign entity is notapplicable in the absence of a
nexus.
 There is no conflict between the earlier decisions
of the SC in Azadi Bachao Andolan, and Mc Dowell. The
SC in the case of Azadi (263 ITR 706), had held that
an act which is otherwise valid in law cannot be held
as sham, merely on the basis of some underlying motive
supposedly resulting in some tax advantage. The SC in
the case of Mc Dowells (154 ITR 148), held that
sanction cannot be accorded to a “colourable”
device.

 The duration of the holding structure, timing of

exit and continuity of business, are important factors
while evaluating as to whether the transaction as a
whole is a sham. Considering the factual matrix in the
present scenario, the SC held that the transactionis
not a sham.

 Withholding tax provisions in the Indian domestic

tax law cannot apply to offshore transactions

 The Tax Authority has also been directed to refund

the entire amount (US$ 0.5 billion) deposited by
Vodafone as part payment towards the demand in early
2011 along with interest

 Tax policy certainty crucial for national economic

interest.

The decision of the SC is expected to be a milestone

development in the taxation of international
transactions and on the judicial approach to tax
avoidance. This case is, perhaps, the first in the
world where the issue of taxation on indirect transfer
of shares is being litigated before a country’s
highest judicial forum. The principles emanating from
this ruling could therefore, have ramifications beyond
India. It could also be of relevance in shaping
India’s tax policy on international taxation and tax
avoidance in the future.

V. Summary & Concluding remarks

Indian tax laws are complex and possibly are in the
process of getting more complicated by the
day in terms of regular annual amendments and judicial
decisions which continuously revise the
judicial interpretations in the light of changing
business environment. The growing importance19
of the Indian economy and the increasing demands for
resources has given the government the
confidence to tax offshore deals wherever possible. In
the case of transactions involving large
capital sums, it would be advisable for the concerned
parties to approach the Authority for Advance Rulings
(AAR) which would freeze the tax treatment for a
particular transaction in the case of a non resident.
This would avoid the kind of pitfalls that Vodafone
finds itself in.

This would also have a major impact on deals with a

country with which India does not have a
Double Taxation Avoidance Agreement (DTAA). The major
legal battles such as the Vodafone dispute which
essentially determine the fate of a large chunk of
Foreign Direct Investments into India and is in this
context much awaited. The challenge lies in balancing
the interest of the investors and the revenue
authorities. The new direct tax code that the
Government is planning to introduce so as to replace
the current Income-tax Act, 1961 (‘the IT Act’), is
expected to emphasize on transparency and taxpayer-
friendliness.

At present, the dispute resolution mechanism in India

moves slowly. Assessment proceedings continue for more
than two years from the date of filing of the tax
return. Thereafter, the two appellate levels take
approximately two to seven years to dispose of an
appeal. If the dispute still continues, on a question
of law, the matter gets referred to the High Court and
the Supreme Court which generally takes very long.
This is worrying the Indian corporate sector as it
takes a lot of management time and effort. There is a
need to expedite the litigation procedure. There
should be a limitation period on disposal of appeals
as well.

Amendments brought about by the Finance Act, 2008

would have a major impact on transfer of shares
overseas, especially in a case where the seller of the
shares is a resident (as per tax laws)
of a country with which India does not have a Double
Taxation Avoidance Agreement (DTAA).

The amendment also brings the investors from countries

like the US and UK within the tax net
in India, since India’s DTAA with such countries
provide for taxation of capital gains in
accordance with the domestic tax laws of India. In
this way, there is an urgent need to speed up
the system and bring more clarity in rules and
amendments.
Biblograph

 K.R. Girish and Himanshu Patel, KPMG, “Deals:

India wants more taxes from cross-border

 M&A”, February 19, 2008, International Tax Review.

 Government widens scope of anti-abuse provisions

in I-T Act” by Abhineet Kumar & Sidhartha,
March 4, 2010, Mumbai.

 India issues advance ruling on capital gains tax

implications of an intra group share transfer”
by Ernst &Young.

 Taxation of Cross Border Mergers and Acquisitions,

2010 Edition, KPMG United States
available on

http://kpmg.com/Global/en/IssuesAndInsights/Article
sPublications/Documents/TaxMA-2010/MA_Cross-
Border_2010_India.pdf

 Cross-border mergers and acquisitions - Addressing

the taxation issues from an Indian
perspective, Gaurav Goel.

 Economic Times, Times of India, Mint web pages for

various news and updates Cross Border Business
Reorganization: Indian Law Implications, Aniket
Singhania & Vaibhav Shukla.
 Corporate Mergers & Acquisitions, Gurminder Kaur,
2005.