Friday, December 5, 2008

Bombay High Court decision in Vodafone: An initial analysis

This post mentioned that Vodafone had lost its case in the Bombay High Court. In the present post I will only highlight a few important conclusions of the Court (in Vodafone International Holdings v. Union of India and Asst. Director of Income Tax, Writ Petition No. 2550/2007) along with a few initial comments:

[Para 157]

Revenue has made out a strong prima facie case that the transaction entered upon by the Petitioner amounts to transfer of a capital asset and not merely a transfer simplicitor of controlling interest ipso facto in a corporate entity, especially in the light of the fact that the interest in Telecom License is jointly held with the Essar Group complied with the use of Brand & Goodwill and non-complete rights given by HTIL. There is a right to enter into Telecom Business in India, with a control premium.

[Para 159]

The Petitioner themselves have not disputed that the transaction involves transfer of controlling interest. If any transaction involves a transfer of controlling interest in a company or a group of companies, such a transfer has to be viewed both from the point of view of transferor and transferee. It is inconceivable as to how HTIL can transfer its controlling interest in HEL without extinguishing its rights in the shares of the Indian group and without which, a transferee cannot acquire a controlling interest.

[Para 160]

…the purpose of transfer of its interest in HEL was to enable the Petitioner to acquire controlling interest in HEL…

  • The Court seems to be advocating looking at the substance of the transaction over the form. A detailed discussion of McDowell and Azadi Bachao Andolan on this point would have explained the rationale of the Court better.

[Para 161]

Shares in themselves may be an asset but in some cases like the present one, shares may be merely a mode or a vehicle to transfer some other asset(s). In the instant case, the subject matter of transfer as contracted between the parties is not actually the shares of a Cayman Island Company, but the assets (as stated supra) situated in India. The choice of the Petitioner in selecting a particular mode of transfer of these right enumerated above will not alter or determine the nature or character of the asset.

  • The terminology of “mode or vehicle” seems to be taking Indian tax law back to the pre-Azadi days.

[Para 162]

Prima facie, apart from the acquisition of controlling interest, the Petitioner has acquired other interests and intangible rights. The Petitioner accordingly became a successor in interest in the joint venture between HTIL and the Essar group and became a co-licensee with the Essar group to operate mobile telephony in India.

[Para 163]

It is an admitted fact that VEL (earlier HEL), a subsidiary of the Petitioner in which the Petitioner has acquired 67% interest, was a group company of HTIL and now a group company of the Petitioner. Any profit or gain which arose from the transfer of a group company in India has to be regarded as a profit and gains of the entity or the company which actually controls its, particularly when on facts, the flow of income or gain can be established to such controlling company (HTIL). In the present case, by reason of the transfer, the income accrued not to CGP, but to HTIL and was treated as profits of HTIL and accordingly was distributed to the share holders of HTIL in Hong Kong…

  • This comes suspiciously close to lifting the corporate veil between entities of the same group. This result seems to be out of accordance with the common law position on group companies. See Adams v. Cape Industries, [1991] 1 All ER 929.

[Para 168]

The very purpose of entering into agreements between the two foreigners is to acquire the controlling interest which one foreign company held in the Indian company, by other foreign company. This being the dominant purpose of the transaction, the transaction would certainly be subject to municipal laws of India, including the Indian Income Tax Act

  • Again, substance prevails over form.

[Para 169]

Petitioner has willfully failed to produce the primary/original agreement dated 11th February, 2007…

[Para 170]

…Petitioner has not been able to demonstrate the show cause notice to be totally non-est in the eyes of law for absolute want of jurisdiction of the authority to even investigate into the facts…

[Para 177]

In the present case, the Petitioner has been requested to only show cause as to why it should not be treated as an assessee in default. The Petitioner was requested to produce certain documents for proper adjudication in the matter. One of the crucial documents required by the second Respondent was the primary agreement entered upon between the Petitioner and HTIL. The said agreement has not been produced by the Petitioner either before second Respondent or even before us. Without the said agreement and other relevant documents, it will be impossible for us to find out the true nature of the transaction. Inspite of repeated demands by the Respondents, the same have not been produced, leaves us with no option but to draw an adverse inference against the Petitioner, since it clearly amounts to withholding of the best evidence, even assuming that the onus of proof does not lie on the Petitioner…

[Para 180]

When the Petitioner has challenged the constitutional validity of the Amendment to Sections 191 and 201 of the I.T.Act by the Finance Act, 2008, then the same must be in context of certain facts pleaded and proved by evidence in the form of documents on record and not in vaccum or in the abstract. The present Petition totally lacks particulars as to the nature of agreement dated 11th February, 2007 and all other agreements preceding or following the same entered into by HTIL and/or the Petitioner.

  • This factor of non-production of the original agreement appears to have played a great role in the decision. In oral arguments, Mr. Parasaran, the ASG appearing for the Revenue, had stressed on this aspect a lot. However, it would perhaps have been better if the Court rested its decision on the ground that the authorities were entitled to fully look into the facts, instead of passing observations on the merits of the case.

An initial opinion:

I am still unconvinced that Vodafone deserved to lose on merits. Perhaps, the Court could have limited itself to deciding on grounds of maintainability. A writ petition against a show-cause can be sustained only if the notice is totally non-est. The Court could have simply stopped at saying that there was not enough material for it to come to that conclusion. Instead, the detailed discussion of the merits may render the decision legally untenable.

In an initial post on the arguments in the case, I said “While there appears to be some merit in the argument that the petition for quashing the show-cause notice is premature, it appears that the Court is unlikely to accept this plea either, particularly since detailed hearings were heard on the merits.” Perhaps, this factor – that the merits were argued in depth – induced the Court to express its opinion on the merits as such. My initial view however, is that those opinions on the merits may not be correct in law. A more detailed post explaining this will follow in a few days.

(Update: The judgment is now available on ITAT online here)

(Note: The detailed post is now available here)


Niraj said...

This is a good initial summary of the case. One factor to be highlighted is that the arguments in the Court did not deal considerably with the interplay between McDowell and Azadi. The Court had directed the arguments elsewhere. Mr Chagla in fact even managed to get Mr. Parasaran to concede that the Department was not alleging evasion. Despite that the Court has proceeded mainly on avoidance-type lines. The concession made in Court was not that in law controlling interest was transferred, but that in economic substance perhaps that was the case. Undoubtedly, the SC appeal will see detailed arguments on substance-versus-form again. The ghost of Fisher and Westminster is not really exorcised in India after this judgment, is it!?

dhruv said...

Dear Mr. Naniwadekar and Mr. Niraj:

Do you not think that it is good that our court takes a proactive role in bringing more money to tax? It is essential that companies do not escape paying tax in India. Why money in an Indian business should escape the Indian tax law? ? it is good that the court does not allow the strict word of the law to circumvent social policy. Also, what does Mr. Niraj mean by the ghost of Fisher?

Anonymous said...

Hi Mr. Mihir,

I remember you arguing in the finals of the Palkhivala tax moot last year on a problem which was based on facts similar to the Vodafone dispute, I remember you were arguing for the IT Department (i am a student and was in the audience). Have you changed your views since then, for you and your teammate seemed to arguing strongly on the merits for the Department.

On another note; I do not understand why Vodafone conceded that there was transfer of a controlling interest?

Anand said...

Very nice initial comments; I look forward to your further views. As someone present in the Courtroom, I must say that there were some signs that the Court would side with the Department. Although I think Mr. Chagla was excellent, Mr. Parasaran was arguing on the facts quite a bit. For instance, he harped on the FIPB approval quite a bit - and as you point out on that fact that the original agreement was not brought on the record be Vodafone. I agree with you though that the Court should either have limited itself to maintainability - or at least, it should have got it right on the merits!

It is a huge judgment, it was nice to read your summary and comments on the key passages. I look forward to more details.



Mihir Naniwadekar said...

No I have not changed my views since then. I believed even then that the case should have been decided against the Department.

"On another note; I do not understand why Vodafone conceded that there was transfer of a controlling interest?"

As Mr. Niraj pointed out, the concession was more to the effect that the economic substance of the transaction was transfer of the controlling interest in India. There was no point denying this - in fact, I believe that there are press releases and other statements from Vodafone that "we have acquired a controlling interest..."

The point is that this concession was at best one of economic substance. The issue still was whether the legal form could be ignored to look at the economic substance.

Mihir Naniwadekar said...


Thank you for your comments. It should be interesting to see what attitude the SC will take. I am pretty certain that the appeal will be admitted at the very least...

"Do you not think that it is good that our court takes a proactive role in bringing more money to tax?"

No I do not. The point is not to tax, but to legitimately tax.

"It is essential that companies do not escape paying tax in India."

Two points -
First, if by 'escape' you mean 'legally avoid', I do not agree with you. It is open to all entities to plan their activities so as to reduce their tax burden, as long as that planning does not break any law. There is legally (and even morally, for that matter) nothing wrong in such planning.
Secondly, please note that there is no 'escaping' as such. For something to 'escape' from a liability, it must first be within the scope of the liability!

"it is good that the court does not allow the strict word of the law to circumvent social policy"

Why exactly is it good to circumvent the law for an alleged social 'benefit'? Is that a matter for the Court? Also, there are strong policy reasons as well to justify the view opposite to you. Azadi Bachao mentions this aspect.

"Also, what does Mr. Niraj mean by the ghost of Fisher?"

He is referring to a specific passage in Azadi Bachao Andolan where the Court traced the development of English law on the distinction between evasion and avoidance.

In case you have any more doubts, I will clarify them after my other post on this judgment.

Thank you for your comment.

Niraj said...


"Do you not think that it is good that our court takes a proactive role in bringing more money to tax?"

Ah, perhaps we could just abolish the system of appeals? Whatever the AO decides is final? Then we will have lots and lots of tax!!! Problem is of course that we will have no businesses left...


Hello! Except for the fact that a great sum of money rides on the outcome of this case, I wonder if this case presents any novel issue of law that is not already settled or applied by Indian courts? Certainly, the authority of the Revenue to issue a show-cause notice cannot be disputed except in a Writ seeking a Prohibition upon the ground of there being no jurisdiction upon the Revenue to do so. The problem really is, jurisdiction in matters of Revenue are inextricably tied to the substance of the transaction and Courts do not enter into the substance of a transaction except to determine the controversy before them. Vodafone here, originally alleged a failure to disclose jurisdiction on the part of the Revenue and the burden was simply upon them to establish that the issue of jurisdiction was determinable without regard to the merits or substance of the transaction. If they failed to so distinguish between the two before the Court and readily offered to argue upon the merits, they have, by default, conferred authority upon the Court to expand their complaint to encompass an examination of the merits of matter with a view to adjudicate upon the issue of jurisdiction satisfactorily.

How can Vodafone refuse to be bound by the Order passed in their case under these circumstances? The only refuge for them would be to demonstrate, with reference to their petition, submissions and arguments, that the Court entering into the merits of the matter was unforeseen and Vodafone took reasonable steps to dissuade the Court from examining the merits of the case. I wonder if a mere refusal to produce the Agreement discharges this burden for them.

Mihir Naniwadekar said...

@K.V. Dhananjay

Thank you for your comment. I agree with your point about the maintainability and the merits being somewhat tangled together. I am unaware as to why Vodafone decided to adopt the strategy of challenging the show-cause notice, instead of waiting for the assessment and then to file an appeal before the CIT(A), tribunal etc.

I do however think that on merits, the Court came to the wrong conclusion. Particularly, I do not think that the Court was justified in effectively lifting the veil over the intermediary companies. The Court mentions that the substance of the transaction is admittedly transfer of controlling interest in India. However, that was 'admitted' to be only the economic substance. The issue which needs to be determined is, whether in view of Azadi Bachao Andolan, is the Court entitled to look at the substance of the transaction ignoring the legal form? Azadi appears to be in conflict with McDowell and is a smaller decision. Nonetheless, it is difficult to say that Azadi is per incuriam as it specifically refers to MDowell. Unfortunately, there is no clear explanation in the decision as to why the Court decided to adopt a "substance-over-form" view.

But I agree with your point that Vodafone in a sense 'brought it upon itself' by challenging the show-cause. I look forward to inputs as to why they might have decided to adopt this strategy.

Niraj said...

In order for Vodafone to win its case, it needed to win on merits. If the Court was going to quash the notice, an examination of merits was essential. However, as the Court rejected on maintainability, it is hard to justify the remarks on the merits.

As to significance, economically there is a lot of money at stake. Not just in this particular case but several others. Legally, it has the potential of re-opening the substance versus form debate. This aspect my well be argued at length in an appeal; and it remains to see whether the SC will once again endorse Azadi. The problem with the Bombay decision is not just that it endorses substance over form; but also that is does so without providing any clear explanation. It attaches too much eight to the alleged 'admission' that the transfer was of controlling interest in India. To my mind, the admission was one of economic substance and not of legal form.

Kodur_Sathya said...

Well i want to know why the agreements were not produced? When the matter is taken to the SC, would they still refrain in doing so?. In such a case,What could happen?

Anand said...


I am not aware for certain as to why the original agreement was not produced. Also, I do not know whether the SC will let them produce the agreement in appeal, as it was not produced in the original petition.

I will hazard a guess as to why the agreement was not produced. I think the point of the petitioner was that the facts as disclosed in the show cause notice sent to them by the Department did not show even prima facie that the Department had jurisdiction. They were effectively saying, "Look, they have sent us the show cause notice. The show cause notice is based on the facts highlighted in that notice. Even assuming all their facts are true, we cannot be taxed..."

Kodur_Sathya said...

well According to me, The facts have to be presented on either side. The department and the Vodafone.

So at the first instance, What stopped the vodafone in producing an agreement even after the request of HC.

In a judgement, it seems that even highcourt got covinced that without seeing the agreement, they couldnot form an opinion.

Now when the matter is going to SC, I am also not sure whether sc would undertake this appeal?

They may even refer the case to the lower HC and ask the vodafone to present the agreement with HC . As SC would not entertain looking at the basic documents.

Hrishikesh said...

I agree with Mr. Kodur Sathya. However, I strongly believe that the Court should not have expressed the opinion on the merits of the case. If the Court was saying that it did not know the nature of the transaction, then it could just have said "Petition is not maintainable as the facts are not clear. Revenue is entitled to investigate into the facts. Petition is premature"

Why go on and pass holdings on law about the chargeability of the transaction?


With reference to the standing of a person to ask an appropriate Court of Law to review the constitutionality of a Statute, Courts in India have largely employed the conventions evolved in jurisdictions with a 'written constitution'.

In view of the fact that the instant petition was filed pursuant to Article 226 of the Constitution and that Constitutional provisions were invoked to advance the claim of the petitioners, the accepted practice in Constitutional Courts is fully relevant to the instant proceeding. The accepted practice, as formulated in a leading American case of Ashwander v Tennessee Valley Authority (297 US 288) has by repeated usage become widely accepted in Constitutional Courts in our country. It says:

“The Court developed, for its own governance in the cases confessedly within its jurisdiction, a series of rules under which it has avoided passing upon a large part of all the constitutional questions pressed upon it for decision. They are

1. The Court will not pass upon the constitutionality of legislation in a friendly, nonadversary, proceeding, declining because to decide such questions is
‘legitimate only in the last resort, and as a necessity in the determination of real, earnest and vital controversy between individuals. It never was the thought that, by means of a friendly suit, a party beaten in the legislature could transfer to the courts an inquiry as to the constitutionality of the legislative act’. (Chicago & Grand Trunk Ry. v. Wellman , Compare Lord v. Veazie , Atherton Mills v. Johnston.)

2. The Court will not anticipate a question of constitutional law in advance of the necessity of deciding it. (Liverpool, N.Y. & P. S.S. Co. v. Emigration Commissioners , Abrams v. Van Schaick ; Wilshire Oil Co. v. United States.) ‘It is not the habit of the Court to decide questions of a constitutional nature unless absolutely necessary to a decision of the case.(Burton v. United States.)

3. The Court will not ‘formulate a rule of constitutional law broader than is required by the precise facts to which it is to be applied. (Liverpool, N.Y. & P. S.S. Co. v. Emigration Commissioners, supra; compare Hammond v. Schapp Bus Line.)

4. The Court will not pass upon a constitutional question, although properly presented by the record, if there is also present some other ground upon which the case may be disposed of. This rule has found most varied application. Thus, if a case can be decided on either of two grounds, one involving a constitutional question, the other a question of statutory construction or general law, the Court will decide only the latter. (Siler v. Louisville & Nashville R. Co ., Light v. United States.)

Appeals from the highest court of a state challenging its decision of a question under the Federal Constitution are frequently dismissed because the judgment can be sustained on an independent state ground. (Berea College v. Kentucky.)

5. The Court will not pass upon the validity of a statute upon complaint of one who fails to show that he is injured by its operation. (Tyler v. The Judges , Hendrick v. Maryland.)

6. The Court will not pass upon the constitutionality of a statute at the instance of one who has availed himself of its benefits. (Great Falls Mfg. Co. v. Attorney General , Wall v. Parrot Silver & Copper Co . St. Louis Malleable Casting Co. v. Prendergast Construction Co.)

7. When the validity of an act of the Congress is drawn in question, and even if a serious doubt of constitutionality is raised, it is a cardinal principle that this Court will first ascertain whether a construction of the statute is fairly possible by which the question may be avoided.”

In the Constitution Bench decision of our Supreme Court in Bashernath Vs. Commissioner of Income Tax , a dissenting judgment of Justice S.K.Das said:

“…In view of my finding that the necessary foundation on facts for sustaining the plea of waiver has not been laid in this case, it becomes unnecessary to decide, in the abstract, the further question if a right guaranteed by any of the provisions in Part III of the Constitution can be waived at all. I am of the view that this Court should indeed be rigorous in avoiding to pronounce on constitutional issues where a reasonable alternative exists; for we have consistently followed the two principles

(a) that ‘the Court will not anticipate a question of constitutional law in advance of the necessity of deciding it’ (Weaver on Constitutional Law, p. 69) and

(b) ‘the Court will not formulate a rule of constitutional law broader than is required by the precise facts to which it is to be applied’ (ibid. p. 69).”

Eminent Author H.M.Seervai in his treatise ‘Constitutional Law of India’ refers to the above principle thus:

“It may be added that Basher Nath’s Case discussed the question of fundamental rights contrary to the wise and well settled rule that a court will not pronounce on a constitutional question unless it is absolutely necessary to do so. Strictly speaking, no constitutional question arose at all if it was held, as in fact it was held by S.K. Das J., that there was no waiver of fundamental rights at all. The observations of Subba Rao J. are, therefore, not only per incuriam, but obiter.
S.K.Das J adverted to this rule and regretted a departure from it by his brother judges ; for the rule, see 11 American jurisprudence , Rottschacfer, ‘Constitutional Law’ , Cooley, ‘Constitutional Law’ , the rule was reiterated by Gajendragadkar J. in Bihar v R.B.H.R.M. Jute Mills .”

The Order and Judgment in this case cites, at pertinent part, that:

69. Mr.Mohan Parasaran, the learned Additional Solicitor General submitted that the reliefs sought in the above Petition are two fold:

(ii) Challenge to the Constitutional validity of Amendment to Section 191 and Section 201 of the Income Tax Act made by the Finance Act,2008.

71. The learned Additional Solicitor General also submitted that the Constitutional validity of the provisions of the I.T.Act cannot be determined in the absence of the said agreement and merely on hypothetical considerations.

147. The arguments that section 201 of the Act is a procedural provision and, therefore, the amendments made thereto can have retrospective effect is totally misconceived. Section 201 of the Act empowers the Assessing Officer to treat a person as an assessee in default thereby visiting such person with severe penal consequences viz., an obligation to pay over the tax of another, a liability for interest, liability to penalty under section 221 of the Act and a further liability to penalty under section 271C of the Act. Such a provision imposing penalty/quasi-punishment cannot be enacted with retrospective effect, and the same is unconstitutional.

148. It is therefore submitted by Mr. Chagla that this Court may be pleased to quash the impugned notice and make the rule absolute with costs.

169. We are also clearly of the view that the Petitioner has wilfully failed to produce the primary/original agreement dated 11th February, 2007 and other prior and subsequent agreements/documents entered into between the Petitioner and HTIL. In the absence of all relevant agreements and documents, it will be impossible to appreciate the true nature of the transaction. We agree with Mr.Parasaran, that in the absence of the said agreement and other relevant documents, constitutional validity of Income Tax provisions cannot be gone into.

180. When the Petitioner has challenged the constitutional validity of the Amendment to Sections 191 and 201 of the I.T. Act by the Finance Act,2008, then the same must be in context of certain facts pleaded and proved by evidence in the form of documents on record and not in vaccum or in the abstract. The present Petition totally lacks particulars as to the nature of agreement dated 11th February, 2007 and all other agreements preceding or following the same entered into by HTIL and/or the Petitioner. The essential facts supported by the necessary documents as proof of such facts, have been conveniently kept away from this Court.

Vodafone, therefore, apparently failed to establish a factual basis to prove that they are entitled to challenge the constitutionality of those two provisions of the Income Tax Act.

They probably should examine whether any other petition challenging such constitutional validity should first be resolved and explore if they could buy more time on appeal before the Supreme Court on that basis. The Supreme Court generally defers resolution of a case on such grounds.

Mihir Naniwadekar said...

@K.V. Dhananjay

Thank you very much for your detailed comment; I am sure it will be very useful to all readers.

Kodur_Sathya said...

Now, it good to know that, SC asked to handle at the IT tax level and comply with same.
This is the best way to resolve things.