The last week in India saw the new Union budget 2011-13 being presented in the parliament. The much awaited verdict of the Supreme Court of India (SC) in the case of Vodafone International Holdings B.V. (Vodafone) also came out along with the verdict on the controversial 2G spectrum case, however the SC decision in the Vodafone case is proposed to be nullified by the provisions in the new Union budget. The past few months in India have also seen some fundamental changes in the tax and capital markets regimes. We set out below a summary of the Union budget, the judgments and the changes:
Highlights of the Indian Budget 2012-13
The Indian Finance Minister presented the Budget of the Government of India for the financial year 2012-13 along with the Finance Bill 2012 on 16 March 2012. As expected, the main areas of the Budget were the infrastructure, power and the agricultural sectors, with a focus on maintaining the momentum for growth. To broaden the tax base, the Finance Minister has introduced an 'Alternate Minimum Tax' on partnerships, sole proprietorships and association of persons, tax deduction at source on immovable property transactions between residents, General Anti-Avoidance Rules, taxation on laundered money, taxation of foreign assets not brought into India, transfer pricing on specified domestic transactions and taxation of services based on a negative list.
- Income tax: retrospective amendments are proposed by way of clarification, applicable from 1 April 1962, such that the SC decision in the Vodafone case (see below), which ruled that the transfer of shares of a foreign company outside India does not attract taxation in India, is nullified. This clarification would in effect bring about far reaching and significant changes with respect of taxation of international transactions involving underlying assets in India. 'Shares' or 'interests' in a company registered or incorporated outside India are deemed to be situated in India if the 'shares' or 'interest' derive their value directly or indirectly substantially from assets located in India. The definitions of 'property' and 'transfer' include disposing of or parting with any rights in or in relation to an Indian company. Such rights include rights of management or control. The characterisation of such transfer of rights as being effected or dependent upon or flowing from transfers of shares of a foreign company shall be immaterial.
- The cascading effect of 'Dividend Distribution Tax' (DDT) in a multi tier structure is proposed to be removed. If the subsidiary has paid DDT on dividends paid to its holding company, then the holding company would be exempt from DDT when paying a dividend to its parent company in the same year to the extent that the dividend is paid out of the dividend received from its subsidiary which has paid the DDT.
- Alternate Minimum Tax (AMT) on tax payers other than companies. Where regular income tax payable by sole proprietorships, partnership firms and associations of persons is less than the AMT, their 'Adjusted Total Income' will be regarded as taxable income and will be taxed at the rate of 18.5%.
- The threshold limit for the applicability of a tax audit in the case of a 'business' is proposed to be increased from INR 6 million to INR 10 million.
- The concession tax rate at 15% on a dividend received by an Indian company from a specified foreign company in which it owns at least 26% is extended for one more year. Accordingly, such dividend received by an Indian company from such specified foreign company in the financial year 2012-13 will also be taxed at the concessionary rate of 15%.
- The Bill rationalises the tax regime applicable to the Venture Capital industry by removing the currently applicable sectoral restrictions.
- Comprehensive 'General Anti Avoidance Rules' (GAAR) are proposed to be introduced from financial year 2012-3. To tackle aggressive tax planning/ sophisticated tax structures, GAAR will codify the 'substance over form' principle for tax purposes. GAAR will apply to both Indian residents as well as non-residents. GAAR would apply only to those cases of 'impermissible avoidance arrangements' where the main purpose or one of the main purposes of entering into an 'arrangement' is to obtain a 'tax benefit' and such arrangements satisfies at lease one of the following four tests: (a) it creates rights and obligations that are normally not created between two parties dealing on an arm's length basis; (b) it abuses or misuses the provisions of the Indian Tax Act; (c) it lacks 'commercial substance' or is deemed to lack commercial substance (as defined in the Bill); and (d) it is carried out in a manner which is normally not employed for bona fide purposes. An 'Approving Panel' will have the final authority to determine whether the application of GAAR is warranted in a case or not.
- Incentives have been proposed for the infrastructure, pharmaceuticals and agricultural sectors.
The wording of the Bill indicates that though the Finance Minister has tried to take some very positive steps by extending some tax benefits to boost the development of infrastructure and the venture capital sector in India and further provide some relief for holding company structures, there are some other worrying and far reaching amendments and new provisions. The introduction of the general anti avoidance rules without heeding to the suggestions of the Parliamentary Standing Committee in its report on the Direct Tax Code Bill, some measures to mop up unaccounted money, retrospective clarifications on the source rule of income and retrospective clarification on characterisation of income from software are significant causes of concern. Nevertheless, the status quo in the tax rates is a major relief.
The Supreme Court Judgment on Vodafone International Holdings B.V.
Please note that the SC decision in this case will be nullified upon the passing of the Indian Finance Bill 2012 as detailed above.
- Hutchinson Group, Hong Kong (Hutch) held about a 67% stake in Hutchinson Essar Limited (HEL), an Indian telecom company, through a chain of various intermediary companies including offshore Cayman Islands companies and British Virgin Islands companies.
- Vodafone purchased Hutch's 67% stake in HEL in an offshore deal involving the sale of a Cayman Islands holding company (CGP) of HEL. The consideration was paid to another Cayman Islands company (HTIL) that was the sole beneficial owner of the single one share of CIHL.
- The Indian Tax Authority (ITA) claimed that Vodafone should be treated as a defaulter for not deducting Indian withholding tax while making payments for the purchase of CGP. According to the ITA, this offshore transaction was an artificial tax avoidance scheme that effectively resulted in a transfer of an Indian asset (HEL, an Indian company) and hence, liable to capital gains tax in India.
- Vodafone challenged this decision and the case eventually reached the SC.
The SC Judgement
The SC held that this offshore transaction involving an indirect transfer of interests in an Indian company (HEL) was outside the jurisdiction of the ITA and hence, not taxable in India under the Indian Income Tax Act. Accordingly, there was no need for Vodafone to deduct any withholding tax in India while making payments towards the consideration to HTIL. While ruling in the favour of Vodafone, the SC dealt with and laid down various important principles in the context of cross border taxation and international holding structures. A summary of the key propositions and observations of the SC is given below:
- The SC came to the conclusion that the Hutch offshore structure was bona fide and a long term structure for various business purposes and was not designed for tax evasion.
- Every strategic Foreign Direct Investment (FDI) coming into India, as an investment destination, should be seen in a holistic manner and it should be seen whether the structure was preordained for 'tax avoidance' or it was for the investment to participate in India.
- To find out whether a given transaction evidences a pre-ordained transaction or investment to participate, one has to take into account various factors such as: duration of time for which the holding structure existed; the period of business operations in India; generation of taxable revenues in India during the period of business operations in India; the timing of the exit; and the continuity of business on such exit.
- The SC used a 'timing test' to examine the genuineness of a structure i.e. timing of incorporation of the entities in the structure from where the ultimate exit takes place. Structures created for genuine business reasons are those which are generally created or acquired at the time when the investment was made, at the time where further investments are being made, or at the time of restructuring or consolidation.
- The SC held that sale of the CGP share, for exiting from the Indian telecommunication business, cannot be considered as a pre-ordained transaction, with no commercial purpose other than to avoid tax in India. It was a genuine business transaction and not a fraudulent method to avoid capital gains tax in India.
- A charge of capital gains tax arises on a transfer of a capital asset situated in India. Accordingly, a charge of capital gains tax would fail in the absence of any of the three necessary elements: transfer, existence of a capital asset and situation of such asset in India.
- The SC held that 'controlling interest' in a company is an incident of ownership of shares, something which flows out of the holding of shares. It is not an identifiable or distinct capital asset independent of the holding of shares. Thus 'controlling interest' is not a separate asset itself to attract tax in India.
The Supreme Court Judgment on the 2G Spectrum Case
- India has 22 telecommunications zones and 281 zonal licenses are granted in the market.
- When operators are given licenses from public bodies, a spectrum is provided with the license and there is no allowance for public officials to auction the spectrums.
- After 10 January 2008, over 100 second generation (2G) Unified Access Service Licenses (UASL) were granted to private companies at 2001 prices and on a first-come-first-serve basis.
- Investigations revealed that several public policies were breached and public officials received bribes from companies in order to obtain 2G licenses. The case went before the Supreme Court of India (SC).
The SC Judgement
The Supreme Court of India passed a landmark verdict cancelling UASL granted to private companies after 10 January 2008 and also the subsequent allocation of spectrum to these licensees. Key decisions made by the SC are set out below:
- The Supreme Court considered what the process of distribution
of natural resources which are national assets should be, and
whether spectrum would fall under the meaning of natural resource
It was observed that natural resources, although not defined anywhere, are understood as elements having intrinsic utility to mankind. Natural resources belong to the people but the State legally owns them on behalf of its people. It is the people who are designated as owners of a country's natural resources. The State is deemed to have proprietary interest in natural resources and must act as a guardian and trustee of the same. Spectrum has been internationally accepted as a scarce, finite and renewable natural resource which is susceptible to degradation in case of inefficient utilisation. The Supreme Court held that the State is the legal owner of natural resources (which includes spectrum) as a trustee of the people and although it is empowered to distribute the same, the process of distribution must be guided by the constitutional principles including the doctrine of equality and larger public good.
- The SC observed that it is aware that it should not interfere with the State's fiscal policies. However, where it is clearly demonstrated that the policy framed by the State or its agency and its implementation is contrary to public interest or violates the Constitution, it is the duty of the courts to exercise their jurisdiction in the larger public interest. Therefore, the court held that the exercise undertaken by the public officials was wholly arbitrary, capricious and contrary to public interest as well as violating the doctrine of equality.
- A public authority must adopt a transparent and fair method for making selections so that all eligible persons get a fair opportunity to compete. In the Supreme Court's view, a duly publicized auction conducted fairly and impartially is perhaps the best method for discharging this burden and methods like first-come-first served when used for alienation of natural resources are likely to be misused.
- The 2G licenses granted to private companies on or after 10 January 2008 and subsequent allocation of the spectrum were declared illegal and have been quashed. The direction will become operative after four months.
- The Telecom Regulatory Authority of India (TRAI) to make fresh recommendations for the grant of licences and allocation of spectrum in the 2G band in 22 service areas by auction. The central government will then consider the TRAI recommendation and take an appropriate decision within the next month and fresh licenses should be granted by auction.
- Three private companies have been directed to pay INR 50 million while four others have been directed to pay INR 5 million as penalty.
This decision will have far reaching effects. For example, the granting of government's licences to exploit natural resources such as minerals may also fall within the scope of this decision.
The Institutional Placement Programme
The Securities Exchange Board of India (SEBI) has introduced an
Institutional Placement Programme (IPP), through the SEBI (Issue of
Capital and Disclosure Requirements) (Amendment) Regulations,
The provisions with respect to IPP apply to issues of fresh shares and / or offers for sale of shares by a listed issuer for the purpose of achieving the minimum public shareholding in terms of Rule 19(2)(b) and Rule 19A of the Securities Contract (Regulation) Rules, 1957 (SCRR).
IPP is a further public offer of eligible securities by a listed issuer, promoter / promoter group of a listed issuer (Eligible Seller), in which the offer, allocation and allotment of such securities is made only to qualified institutional buyers (QIBs). The Amendment defines 'eligible securities' as 'equity shares of the same class listed and traded in the stock exchange(s)'. An IPP has to be managed by one or more merchant bankers registered with SEBI.
Few of the key provisions of the Amendment are discussed below:
Conditions for the IPP - A special resolution approving the IPP has to be passed by the shareholders in terms of section 81(1A) of the Companies Act, 1956;
Offer Document - The IPP has to be made on the basis of an offer document, which should contain all material information including the disclosures as specified in Schedule XVIII of the SEBI (SEBI ICDR Regulations).
Pricing and allocation / allotment - The Eligible Seller has to announce a floor price or price band at least one day prior to the opening of the IPP. The minimum number of allottees for each offer made under the IPP cannot be less than ten and no single allottee shall be allotted more than 25% of the offer size. No allocation / allotment can be made, either directly or indirectly, to any QIB who is a promoter or any person related to the promoters of the issuer.
Restrictions - The promoter or promoter group who are offering their eligible securities should not have purchased and / or sold the eligible securities of the issuer company in the 12 weeks preceding the offer.
Restriction on offer size - The aggregate of all tranches of the IPP made by the Eligible Seller should not result in increase in public shareholding by more than 10% or such lesser percentage as is required to reach the minimum public shareholding requirements in terms of Rules 19(2)(b) and 19A of the SCRR.
Lock In - The eligible securities allotted under the IPP cannot be sold by the allottee for a period of 1 year from the date of allotment, except on the floor of the recognized stock exchange(s).
Offer for sale of shares by Promoters through the Stock Exchange Mechanism
Further, SEBI in exercise of powers conferred under section 11(1) of the Securities and Exchange Board of India Act, 1992 (SEBI Act), has introduced provisions in relation to sales of shares held by promoters of listed companies through the stock exchanges, in its circular dated 1 February 2012 (Circular).
The Circular facilitates promoters to dilute / offload their holding in listed companies in a transparent manner and allows offers for sale of shares by promoters of such companies through a separate window provided by the stock exchange(s) (OFS).
The Bombay Stock Exchange and the National Stock Exchange (Stock Exchanges) are the only stock exchanges eligible to provide OFS.
Pricing – The sellers have an option to choose the price at which the shares are allotted to the successful bidders by one of the following methods: (a) Single Clearing Price (proportionate basis methodology); or (b) Multiple Clearing Prices (price priority methodology)
Restriction on offer size – The size of the offer is required to be at least 1% of the paid-up capital of the company and subject to a minimum of INR 25 million. However, in respect of companies where 1% of the capital at the closing price on the last trading day of the last completed quarter is less than INR 25 million, the dilution should be at least 10% of the paid-up capital or such lesser percentage as to achieve the minimal public shareholding in a single tranche.
Announcement/Notice of OFS – The seller is required to announce its intention to sell shares on the Stock Exchanges at least one day prior to the opening of the OFS along with the stipulated information.
Allocation – A minimum of 25% of the shares offered shall be reserved for mutual funds and insurance companies, subject to the allocation methodology adopted by the seller.
Withdrawal/Cancellation of offer – The OFS can be withdrawn by a seller any time prior to its proposed opening. Cancellation of the OFS is permitted during the bidding period.
We are very grateful to Khaitan & Co, the leading Indian law firm with offices in Mumbai, New Delhi, Kolkata and Bangalore, for allowing us to use their newsletters to prepare this briefing note.
You can contact Khaitan & Co at email@example.com for further information or specific advice on the issues covered by this briefing note.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 03/04/2012.