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Friday, 20 January 2012

Phoney tax cases

A well respected City tax adviser once explained to me how tax litigation works with big companies.  The tax payer and the tax authorities square up to each other and state their positions.  Each party takes advice and the advice given to both parties by their respective advisers will be broadly similar, although the adviser naturally talks up his sides chances of success.  Just a tad.

But then each party takes a view of their chances of winning and, particularly in the case of the tax authorities, they will go to court to push the envelope or to make a point.  The trouble is nobody has told the judge what the answer should be. The case starts in the lower courts and works its way up as bumbling fools miss the points or eager young 50 year olds try to make a name for themselves by over-interpreting judgements from the higher courts, but eventually after many years the case rises to a level of court of sufficient competence to come to the correct conclusion - although in some cases the parties run out of courts.

It seems the UK is not alone in this system, with the Indian courts following a similar approach because India’s supreme court has found in favour of Vodafone in dispute with the Indian tax authorities over a capital gains $2.9bn tax bill plus $1.5 billion of interest and penalties.

The idiocy of the Indians' position takes a little explaining.

Vodafone spent $10.9bn to acquire Hutchison Essar, an Indian telecoms company, in 2007 from its Hong Kong based parent, Hutchinson Whampoa.  Only it didn't acquire the shares directly.  A Dutch resident subsidiary of Vodafone Group plc acquired Hutchison Telecommunications International Ltd’s  stake in Hutchison Essar Ltd, which it owned through a Cayman Island company.

The capital gain thus arose in the Cayman Island subsidiary of Hutchison.  Now Indian law says that when an Indian seller realises a capital gain, the purchaser may be liable for the tax on the capital gain (on the basis that the purchaser who is liable may have done a runner offshore but the acquirer of the Indian assets has something that they can get there hands on.

The gist of the Vodafone argument was that since the sale and purchase took place between entities outside India there was no Indian tax payer realising a gain.  Looking at the Indian companies in isolation, nothing happened.  The transaction took place at a higher level.

Vodafone's further argument was that it was not their liability but Hutchison, which makes perfect sense to me even if it didn't seem that way to the Indian income tax department.

Fortunately for good sense, the Indian Supreme Court passed the judgement in favour of Vodafone, saying that the Indian Income tax department had "no jurisdiction" to levy tax on overseas transaction between companies incorporated outside India

The irony is that the decision makes it more likely that Vodafone will now proceed with an IPO of part of its Indian business, which the Vodafone CEO has said would happen only if the appeal was successful. Which should generate some more capital gains.

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