[2012] 17 taxmann.com 206 (Article)
VODAFONE ANALYSED
Section 9(1)(i) of the Income-tax Act, 1961 (hereinafter referred to as "the Act") reads as under:
"9. Income deemed to accrue or arise in India. —(1)The following incomes shall be deemed to accrue or arise in India :
(i) all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.
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The Supreme Court dealt with the interpretation of the provisions of section 9(1)(i) in Vodafone International Holdings B.V. v. Union of India [2012] 17 taxmann.com 202(SC). The facts of the case involved a holding company incorporated offshore (transferor foreign company) controlling an Indian subsidiary company through a maze of 100% subsidiaries incorporated in various foreign countries which are investment companies. The transferor of foreign company sought to divest control over Indian subsidiary by transferring shares in an upstream foreign subsidiary company to another foreign company (transferee foreign company) through an offshore transaction (i.e. sale outside India) and the transferee foreign company stepping into the shoes of the transferor foreign company.
The issue was whether the transaction could be termed an indirect transfer of a capital asset situate in India and whether section 9(1)(i) would be attracted in such a case and consequently whether the capital gains arising from such transactions could be taxed in India. Can the revenue tax the capital gains arising from the sale of the shares of the upstream foreign subsidiary on the basis that the upstream foreign subsidiary whilst not a tax resident in India holds underlying Indian assets? In deciding this issue, the Supreme Court was called upon to decide and decided various issues as under:
A. INTERPRETATION OF SECTION 9(1)(i)
(a) Whether the word "indirectly" used in section 9(1)(i) would cover "indirect transfers" of capital assets[See (C) below] situate in India?
(b) Does section 9(1)(i) contain "look through"1 provisions?
(c) Where is the share of foreign subsidiary situate? - Situs of the shares?
The answers to (a) and (b) above are in the negative.
The legislature has not used the words "indirect transfer" in Section 9(1)(i). If the word indirect is read into section 9(1)(i), it would render the express statutory requirement of the 4th sub-clause in section 9(1)(i) nugatory. This is because Section 9(1)(i) applies to transfers of a capital asset situate in India. This is one of the elements in section 9(1)(i) and if indirect transfer of a capital asset is read into Section 9(1)(i) then the words capital asset situate in India would be rendered nugatory. Similarly, the words underlying asset do not find place in section 9(1)(i). Further, "transfer" should be of an asset in respect of which it is possible to compute a capital gain in accordance with the provisions of the Act. Thus, the words directly or indirectly in section 9(1)(i) go with the income and not with the transfer of a capital asset (property). The Direct Tax Code (DTC) Bill, 2010 proposes to tax income from transfer of shares of a foreign company by a non-resident, where at any time during 12 months preceding the transfer, the fair market value of the assets in India, owned directly or indirectly, by the company, represents at least 50% of the fair market value of all assets owned by the company. Thus, the DTC Bill, 2010 proposes taxation of offshore share transactions. This proposal indicates in a way that indirect transfers are not covered by the existing section 9(1)(i) of the Act. In fact, the DTC Bill, expressly stated that income accruing even from indirect transfer of a capital asset situate in India would be deemed to accrue in India. These proposals, therefore, show that in the existing section 9(1)(i) the word indirect cannot be read on the basis of purposive construction. The question of providing "look through" in the statute or in the treaty is a matter of policy. It is to be expressly provided for in the statute or in the treaty. Similarly, limitation of benefits has to be expressly provided for in the treaty. Such clauses cannot be read into the section by interpretation. For the foregoing reasons, section 9(1)(i) is not a "look through" provision. [S.H. Kapadia, CJI]
Section 64 of Act says that in computing the total income of an individual, there shall be included all such income as arises directly or indirectly to the son's wife, of such individual, from assets transferred directly or indirectly on and after 1.6.73 to the son's wife by such individual otherwise than for adequate consideration. Similar expression like "from asset transferred directly or indirectly", are found section 64(7) and (8) as well. On a comparison of section 64 and Section 9(1)(i) what is discernible is that the Legislature has not chosen to extend section 9(1)(i) to "indirect transfers". Wherever "indirect transfers" are intended to be covered, the Legislature has expressly provided so. The words "either directly or indirectly", textually or contextually, cannot be construed to govern the words that follow, but must govern the words that precede them, namely the words "all income accruing or arising". The words "directly or indirectly" occurring in Section 9, therefore, relate to the relationship and connection between a non-resident assessee and the income and these words cannot and do not govern the relationship between the transaction that gave rise to income and the territory that seeks to tax the income. In other words, when an assessee is sought to be taxed in relation to an income, it must be on the basis that it arises to that assessee directly or it may arise to the assessee indirectly. In other words, for imposing tax, it must be shown that there is specific nexus between earning of the income and the territory which seeks to lay tax on that income. Reference may also be made to the judgment of the Supreme Court in Ishikawajma-Harima Heavy Industries Ltd. v. Director of Income Tax, Mumbai [2007] 3 SCC 481 and CIT v. R.D. Aggarwal (1965) 1 SCR 660.
Section 9 has no "look through provision" and such a provision cannot be brought through construction or interpretation of a word 'through' in Section 9. In any view, "look through provision" will not shift the situs of an asset from one country to another. Shifting of situs can be done only by express legislation. Section 9 has no inbuilt "look through mechanism". [Per K.S. Radhakrishnan J. in concurring judgment]
Under the Indian Companies Act, 1956, the situs of the shares would be where the company is incorporated and where its shares can be transferred. In the present case, it has been asserted by appellants that the transfer of the CGP share (upstream foreign subsidiary share ) was recorded in the Cayman Islands, where the register of members of the CGP is maintained. This assertion has neither been rebutted in the impugned order of the Department dated 31-05-2010 nor traversed in the pleadings filed by the Revenue nor controverted . In the circumstances, the arguments of the Revenue that the situs of the CGP share was situated in the place (India) where the underlying assets stood situated cannot be accepted. [S.H. Kapadia, CJI]
In any view, "look through provision" will not shift the situs of an asset from one country to another. Shifting of situs can be done only by express legislation [K.S. Radhakrishnan, J]
B. NATURE OF A SHARE-WHETHER SHARE SALE CAN BE EQUATED WITH ASSETS SALE OR SLUMP SALE
Whether like the "corporate veil" there is any "share veil2"? Whether share in a company can be X-rayed (like piercing corporate veil to see the actual persons behind the company) and "share veil be lifted"3 to see the "underlying assets" of the company in whom shares are held? Can it be contended that sale of shares is in effect a sale of underlying assets represented by the share?
The present case concerns an offshore transaction involving a structured investment. This case concerns "a share sale" and not an asset sale. It concerns sale of an entire investment. A "sale" may take various forms. Accordingly, tax consequences will vary. The tax consequences of a share sale would be different from the tax consequences of an asset sale. A slump sale would involve tax consequences which could be different from the tax consequences of sale of assets on itemized basis. "Control" is a mixed question of law and fact. Ownership of shares may, in certain situations, result in the assumption of an interest which has the character of a controlling interest in the management of the company. A controlling interest is an incident of ownership of shares in a company, something which flows out of the holding of shares. A controlling interest is, therefore, not an identifiable or distinct capital asset independent of the holding of shares. The control of a company resides in the voting power of its shareholders and shares represent an interest of a shareholder which is made up of various rights contained in the contract embedded in the Articles of Association. The right of a shareholder may assume the character of a controlling interest where the extent of the shareholding enables the shareholder to control the management. Shares, and the rights which emanate from them, flow together and cannot be dissected. In the felicitous phrase of Lord MacMillan in IRC v. Crossman [1936] 1 All ER 762, shares in a company consist of a "congeries of rights and liabilities" which are a creature of the Companies Acts and the Memorandum and Articles of Association of the company. Thus, control and management is a facet of the holding of shares. Applying the above principles governing shares and the rights of the shareholders to the facts of this case, we find that this case concerns a straightforward share sale. [S.H. Kapadia, CJI]
Shares of any member in a company is a movable property and can be transferred in the manner provided by the Articles of Association of the company. Stocks and shares are specifically included in the definition of the Sale of Goods Act, 1930. A share represents a bundle of rights like right to (1) elect directors, (2) vote on resolution of the company, (3) enjoy the profits of the company if and when dividend is declared or distributed, (4) share in the surplus, if any, on liquidation.
Share is a right to a specified amount of the share capital of a company carrying out certain rights and liabilities, in other words, shares are bundles of intangible rights against the company. Shares are to be regarded as situate in the country in which it is incorporated and register is kept. Shares are transferable like any other movable property under the Companies Act and the Transfer of Property Act. Restriction of Transfer of Shares is valid, if contained in the Articles of Association of the company. Shares are, therefore, presumed to be freely transferable and restrictions on their transfer are to be construed strictly. Transfer of shares may result in a host of consequences.
Voting rights vest in persons who names appear in the Register of Members. Right to vote cannot be decoupled from the share and an agreement to exercise voting rights in a desired manner, does not take away the right of vote, in fact, it is the shareholders' right. Voting rights cannot be denied by a company by its articles or otherwise to holders of shares below a minimum number such as only shareholders holding five or more shares are entitled to vote and so on, subject to certain limitations. Rights and obligations flowing from voting rights have been the subject matter of several decisions of the Supreme Court. In Chiranjit Lal Chowdhuri v. Union of India (1950) 1 SCR 869 at 909 : AIR 1951 SC 41, with regard to exercise of the right to vote, the Supreme Court held that the right to vote for the election of directors, the right to pass resolutions and the right to present a petition for winding up are personal rights flowing from the ownership of the share and cannot be themselves and apart from the share be acquired or disposed of or taken possession of. In Dwarkadas Shrinivas of Bombay v. Sholapur Spinning & Weaving Company (1954) SCR 674 at 726 : AIR 1954 SC 119, the Supreme Court noticed the principle laid down in Chiranjit Lal Chowdhuri (supra).
Voting arrangements in shareholders Agreements (SHAs) or pooling agreements are not "property". Contracts that provide for voting in favour of or against a resolution or acting in support of another shareholder create only "contractual obligations". A contract that creates contractual rights thereby, the owner of the share (and the owner of the right to vote) agrees to vote in a particular manner does not decouple the right to vote from the share and assign it to another. A contract that is entered into to provide voting in favour of or against the resolution or acting in support of another shareholder, creates contractual obligation. Entering into any such contract constitutes an assertion (and not an assignment) of the right to vote for the reason that by entering into the contract: (a) the owner of the share asserts that he has a right to vote; (b) he agrees that he is free to vote as per his will; and (c) he contractually agrees that he will vote in a particular manner. Once the owner of a share agrees to vote in a particular manner, that itself would not determine as a property.
Shares represent congeries of rights and controlling interest is an incident of holding majority shares. Control of a company vests in the voting powers of its shareholders. Shareholders holding a controlling interest can determine the nature of the business, its management, enter into contract, borrow money, buy, sell or merge the company. Shares in a company may be subject to premiums or discounts depending upon whether they represent controlling or minority interest. Control, of course, confers value but the question as to whether one will pay a premium for controlling interest depends upon whether the potential buyer believes one can enhance the value of the company.
The House of Lords in IRC v. V.T. Bibby & Sons (1946) 14 ITR (Supp.) 7 at 9-10, after examining the meaning of the expressions "control" and "interest", held that controlling interest did not depend upon the extent to which they had the power of controlling votes. Principle that emerges is that where shares in large numbers are transferred, which result in shifting of "controlling interest", it cannot be considered as two separate transactions namely transfer of shares and transfer of controlling interest. Controlling interest forms an inalienable part of the share itself and the same cannot be traded separately unless otherwise provided by the Statute. Of course, the Indian Company Law does not explicitly throw light on whether control or controlling interest is a part of or inextricably linked with a share of a company or otherwise, so also the Income Tax Act. In the impugned judgment, the High Court has taken the stand that controlling interest and shares are distinct assets. Control is an interest arising from holding a particular number of shares and the same cannot be separately acquired or transferred. Each share represents a vote in the management of the company and such a vote can be utilized to control the company. Controlling interest, therefore, is not an identifiable or distinct capital asset independent of holding of shares and the nature of the transaction has to be ascertained from the terms of the contract and the surrounding circumstances. Controlling interest is inherently contractual right and not property right and cannot be considered as transfer of property and hence a capital asset unless the Statute stipulates otherwise. Acquisition of shares may carry the acquisition of controlling interest, which is purely a commercial concept and tax is levied on the transaction, not on its effect. [K.S. Radhakrishnan, J]
C. "CAPITAL ASSET"
What is the real extent of control which a holding company has over a subsidiary? Whether the holding company possesses a legal right to appoint directors on board of subsidiary and whether this is a "property right"? What is the true scope of the expression "capital asset" as defined in section 2(14) of the Act and whether this includes such right of holding company to direct its downstream subsidiary to vote?
A legal right is an enforceable right. Enforceable by a legal process. The question is what is the nature of the "control" that a parent company has over its subsidiary. It is not suggested that a parent company never has control over the subsidiary. For example, in a proper case of "lifting of corporate veil", it would be proper to say that the parent company and the subsidiary form one entity. But barring such cases, the legal position of any company incorporated abroad is that its powers, functions and responsibilities are governed by the law of its incorporation. No multinational company can operate in a foreign jurisdiction save by operating independently as a "good local citizen". A company is a separate legal persona and the fact that all its shares are owned by one person or by the parent company has nothing to do with its separate legal existence. If the owned company is wound up, the liquidator, and not its parent company, would get hold of the assets of the subsidiary. In none of the authorities have the assets of the subsidiary been held to be those of the parent unless it is acting as an agent. Thus, even though a subsidiary may normally comply with the request of a parent company it is not just a puppet of the parent company. The difference is between having power or having a persuasive position. Though it may be advantageous for parent and subsidiary companies to work as a group, each subsidiary will look to see whether there are separate commercial interests which should be guarded. When there is a parent company with subsidiaries, is it or is it not the law that the parent company has the "power" over the subsidiary. It depends on the facts of each case. For instance, take the case of a one-man company, where only one man is the shareholder perhaps holding 99% of the shares, his wife holding 1%. In those circumstances, his control over the company may be so complete that it is his alter ego. But, in case of multinationals it is important to realise that their subsidiaries have a great deal of autonomy in the country concerned except where subsidiaries are created or used as a sham. Of course, in many cases the courts do lift up a corner of the veil but that does not mean that they alter the legal position between the companies. The directors of the subsidiary under their Articles are the managers of the companies. If new directors are appointed even at the request of the parent company and even if such directors were removable by the parent company, such directors of the subsidiary will owe their duty to their companies (subsidiaries). They are not to be dictated by the parent company if it is not in the interests of those companies (subsidiaries). The fact that the parent company exercises shareholder's influence on its subsidiaries cannot obliterate the decision-making power or authority of its (subsidiary's) directors. They cannot be reduced to be puppets. The decisive criteria is whether the parent company's management has such steering interference with the subsidiary's core activities that subsidiary can no longer be regarded to perform those activities on the authority of its own executive directors.
As regards the right to direct a downstream subsidiary as to the manner in which it should vote is concerned, the legal position is well settled, namely, that even though a subsidiary may normally comply with the request of a parent company, it is not just a puppet of the parent company. The difference is between having the power and having a persuasive position. A great deal depends on the facts of each case. Further, as stated above, a company is a separate legal persona, and the fact that all the shares are owned by one person or a company has nothing to do with the existence of a separate company. Therefore, though it may be advantageous for a parent and subsidiary companies to work as a group, each subsidiary has to protect its own separate commercial interests. On the facts and circumstances of this case, the right , if at all it is a right, to direct a downstream subsidiary as to the manner in which it should vote would fall in the category of a persuasive position/influence rather than having a power over the subsidiary.
Applying the test of enforceability, influence/ persuasion cannot be construed as a right in the legal sense. One more aspect needs to be highlighted. The concept of "de facto" control, which existed in the Hutchison structure, conveys a state of being in control without any legal right to such state. This aspect is important while construing the words "capital asset" under the income tax law. As stated earlier, enforceability is an important aspect of a legal right. Applying these tests, on the facts of this case the group holding company in this case had no legal right to direct its downstream companies in the matter of voting, nomination of directors and management rights.[S.H. Kapadia, CJI]
Whether a transaction such as above could be said to be "transfer" within the meaning of section 2(47) of the Act of capital asset being controlling interest in Indian subsidiary (which is a capital asset situate in India) by extinguishment of right to control ?
On transfer of shares of a foreign company to a non-resident off-shore, there is no transfer of shares of the Indian Company, though held by the foreign company, in such a case it cannot be contended that the transfer of shares of the foreign holding company, results in an extinguishment of the foreign company control of the Indian company and it also does not constitute an extinguishment and transfer of an asset situate in India. Transfer of the foreign holding company's share off-shore, cannot result in an extinguishment of the holding company right of control of the Indian company nor can it be stated that the same constitutes extinguishment and transfer of an asset/ management and control of property situated in India.
D. LIFTING THE CORPORATE VEIL
Whether and to what extent Revenue was entitled to lift corporate veil between holding company and subsidiary in matters of taxation/apply substance over form concept?
The approach of both the corporate and tax laws, particularly in the matter of corporate taxation, generally is founded on the abovementioned separate entity principle i.e., treat a company as a separate person. The Indian Income-tax Act, 1961, in the matter of corporate taxation, is founded on the principle of the independence of companies and other entities subject to income-tax. Companies and other entities are viewed as economic entities with legal independence vis-a-vis their shareholders/participants. It is fairly well accepted that a subsidiary and its parent are totally distinct tax payers. Consequently, the entities subject to income-tax are taxed on profits derived by them on standalone basis, irrespective of their actual degree of economic independence and regardless of whether profits are reserved or distributed to the shareholders/participants. Furthermore, shareholders/participants, that are subject to (personal or corporate) income-tax, are generally taxed on profits derived in consideration of their shareholding /participations, such as capital gains. Now-a-days, it is fairly well settled that for tax treaty purposes a subsidiary and its parent are also totally separate and distinct tax payers.
It is generally accepted that the group parent company is involved in giving principal guidance to group companies by providing general policy guidelines to group subsidiaries. However, the fact that a parent company exercises shareholder's influence on its subsidiaries does not generally imply that the subsidiaries are to be deemed residents of the State in which the parent company resides. Further, if a company is a parent company, that company's executive director(s) should lead the group and the company's shareholder's influence will generally be employed to that end. This obviously implies a restriction on the autonomy of the subsidiary's executive directors. Such a restriction, which is the inevitable consequences of any group structure, is generally accepted, both in corporate and tax laws. However, where the subsidiary's executive directors' competences are transferred to other persons/bodies or where the subsidiary's executive directors' decision making has become fully subordinate to the Holding Company with the consequence that the subsidiary's executive directors are no more than puppets then the turning point in respect of the subsidiary's place of residence comes about. Similarly, if an actual controlling Non-Resident Enterprise (NRE) makes an indirect transfer through "abuse of organisation form/legal form and without reasonable business purpose" which results in tax avoidance or avoidance of withholding tax, then the Revenue may disregard the form of the arrangement or the impugned action through use of Non-Resident Holding Company, re-characterize the equity transfer according to its economic substance and impose the tax on the actual controlling Non-Resident Enterprise. Thus, whether a transaction is used principally as a colourable device for the distribution of earnings, profits and gains, is determined by a review of all the facts and circumstances surrounding the transaction. It is in the above cases that the principle of lifting the corporate veil or the doctrine of substance over form or the concept of beneficial ownership or the concept of alter ego arises. There are many circumstances, apart from the one given above, where separate existence of different companies, that are part of the same group, will be totally or partly ignored as a device or a conduit (in the pejorative sense).
E. SUBSTANCE v. FORM
Whether Westminster principle has been given discarded in UK by subsequent decisions in Ramsay case and Dawson case and whether the Revenue could invoke the rule in Ramsay/Dawson case in the instant case
In The Commissioners of Inland Revenue v. His Grace the Duke of Westminster 1935 All E.R. 259 laid down the following principle known as the Westminster principle: "given that a document or transaction is genuine, the court cannot go behind it to some supposed underlying substance". The said principle has been reiterated in subsequent English Courts Judgments as "the cardinal principle". Ramsay was a case of sale-lease back transaction in which gain was sought to be counteracted, so as to avoid tax, by establishing an allowable loss. The method chosen was to buy from a company a readymade scheme, whose object was to create a neutral situation. The decreasing asset was to be sold so as to create an artificial loss and the increasing asset was to yield a gain which would be exempt from tax. The Crown challenged the whole scheme saying that it was an artificial scheme and, therefore, fiscally ineffective. It was held that Westminster did not compel the court to look at a document or a transaction, isolated from the context to which it properly belonged. It is the task of the Court to ascertain the legal nature of the transaction and while doing so it has to look at the entire transaction as a whole and not to adopt a dissecting approach. In the present case, the Revenue has adopted a dissecting approach at the Department level. Ramsay did not discard Westminster but read it in the proper context by which "device" which was colourable in nature had to be ignored as fiscal nullity. Thus, Ramsay lays down the principle of statutory interpretation rather than an over-arching anti-avoidance doctrine imposed upon tax laws.
Furniss (Inspector of Taxes) v. Dawson [1984] 1 All E.R. 530 dealt with the case of interpositioning of a company to evade tax. On facts, it was held that the inserted step had no business purpose, except deferment of tax although it had a business effect. Dawson went beyond Ramsay. It reconstructed the transaction not on some fancied principle that anything done to defer the tax be ignored but on the premise that the inserted transaction did not constitute "disposal" under the relevant Finance Act. Thus, Dawson is an extension of Ramsay principle. After Dawson, which empowered the Revenue to restructure the transaction in certain circumstances, the Revenue started rejecting every case of strategic investment/tax planning undertaken years before the event saying that the insertion of the entity was effected with the sole intention of tax avoidance. In Craven (Inspector of Taxes) v. White (Stephen) [1988] 3 All. E.R. 495 it was held that the Revenue cannot start with the question as to whether the transaction was a tax deferment/saving device but that the Revenue should apply the look at test to ascertain its true legal nature. It observed that genuine strategic planning had not been abandoned.
Ramsay (supra) enunciated the look at test. According to that test, the task of the Revenue is to ascertain the legal nature of the transaction and, while doing so, it has to look at the entire transaction holistically and not to adopt a dissecting approach. One more aspect needs to be reiterated. There is a conceptual difference between preordained transaction which is created for tax avoidance purposes, on the one hand, and a transaction which evidences investment to participate in India. In order to find out whether a given transaction evidences a preordained transaction in the sense indicated above or investment to participate, one has to take into account the factors enumerated hereinabove, namely, duration of time during which the holding structure existed, the period of business operations in India, generation of taxable revenue in India during the period of business operations in India, the timing of the exit, the continuity of business on such exit, etc. In the present case, the group structure was in place since 1994. It operated during the period 1994 to 11.02.2007. It has paid income tax ranging from Rs. 3 crore to Rs. 250 crore per annum during the period 2002-03 to 2006- 07. Even after 11.02.2007, taxes are being paid by the transferee foreign company ranging from Rs. 394 crore to Rs. 962 crore per annum during the period 2007-08 to 2010-11 (these figures are apart from indirect taxes which also run in crores). Thus, applying the above tests, it cannot be said that the structure was created or used as a sham or tax avoidant. It cannot be said that the transferor/transferee foreign companies (both reputed MNCs) were "fly by night" operators/short time investors. In a case like the present one, where the structure has existed for a considerable length of time generating taxable revenues right from 1994 and where the court is satisfied that the transaction satisfies all the parameters of "participation in investment" then in such a case the court need not go into the questions such as de facto control v. legal control, legal rights v. practical rights, etc.
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1. The expression "look through" or "looking through" is used informally in tax contexts to indicate that separate legal form of an entity is disregarded and the tax consequences impacting directly on owners/participants-See IBFD International Tax Glossary
2. This expression is not used in the judgment but used for clarity.
3. This expression is not used in the judgment but used for clarity.