India: Retrospective Capital Gains Tax On Indirect Transfers: The Ghost Of The Vodafone Case Revisits Cairn (Uk)

  • The Delhi Bench of the Income Tax Appellate Tribunal upholds capital gains tax demand of Approx. INR 10,247 Crore (Approx. USD 1.565 Billion) on a transfer of shares of a Jersey company in 2006, which derived value from assets in India due to retrospective operation of indirect transfer law introduced in 2012.
  • Ambulatory approach / dynamic interpretation of tax treaties has been laid down.
  • Interest of Approx. INR 18,000 Crore (Approx. USD 2.75 Billion) claimed may not be levied in a case where the tax liability could not have been foreseen and the seller can't be at fault for non-deduction by the buyer.

BACKGROUND

Explanations 4 and 5 to Section 9(1)(i) of the Income-tax Act, 1961 ("Indirect Transfer Provisions") were introduced by way of the Finance Act, 2012 pursuant to the landmark ruling of the Supreme Court in Vodafone International Holdings BV v. Union of India1 (the "Vodafone case") in which the Court held that transfer of shares of a Cayman Islands company would not be subject to capital gains tax in India, since the shares of the Cayman Islands company were not located in India. The Indirect Transfer Provisions were enacted with retrospective effect from 01/04/1962 and were styled as a clarification.

Over the past few months, the Central Board of Direct Taxes ("CBDT") has taken a number of steps to ease concerns relating to this issue. In June, 2016 CBDT amended the Income-tax Rules, 1962 to provide for computation and fair market value and reporting requirements in relation to the Indirect Transfer Provisions.2 However, the Indirect Transfer Provisions continue to be applied in a harsh manner, which provides cause for grave concern and uncertainty.

FACTS

Cairn India Holdings Limited ("CIHL") was incorporated in Jersey in August, 2006 as a wholly owned subsidiary of Cairn UK Holdings Limited ("CUHL" / "Taxpayer"), a holding company incorporated in the United Kingdom in June, 2006. Under a share exchange agreement between CUHL and CIHL, the former transferred shares constituting the entire issued share capital of nine subsidiaries of the Cairn group, held directly and indirectly by CUHL, that were engaged in the oil and gas sector in India ("Subsidiaries"). Thereafter, Cairn India Limited ("CIL") was incorporated in India in August, 2006 as a wholly owned subsidiary of CUHL. By way of a subscription and share purchase agreement and a share purchase deed, shares constituting the entire issued share capital of CIHL were transferred to CIL ("Transaction"), the consideration for which was partly in cash and partly in the form of shares of CIL. CIL then divested 30.5% of its shareholding by way of an Initial Public Offering ("IPO"). As a result of divesting Approx. 30% of its stake in the Subsidiaries and part of IPO proceeds, CUHL received Approx. INR 6101 Crore (Approx. USD 931 Million).

In January, 2014, many years after the transaction was completed as per the existing law, the Assessing Officer ("AO") initiated reassessment proceedings under Sections 147 and 148 of the Income-tax Act, 1961 ("ITA") which provide for reassessment proceedings in cases where income has escaped assessment. The AO issued the draft assessment order in March, 2015, to which CUHL filed its objections before the Dispute Resolution Panel ("DRP") under Section 144C of the ITA. The DRP issued its directions in December, 2015 and the AO drafted the final assessment order in January, 2016, determining the income of the Taxpayer arising from the Transaction at Approx. INR 24,500 Crore (Approx. USD 3.742 Billion) as short-term capital gains chargeable to tax at a 40% rate, subject to chargeability of surcharge and cess as applicable. As per the order, the taxpayer is also required to pay interest under Sections 234A and 234B of the ITA which provide for levy of interest in case of defaults in payment of taxes by a taxpayer, and penalty proceedings under the ITA were also initiated against the Taxpayer.

Aggrieved by such order, the Taxpayer preferred an appeal before the Income Tax Appellate Tribunal, Delhi bench ("ITAT").

ARGUMENTS ADVANCED

The Taxpayer made the following contentions:

  • The Indirect Transfer Provisions are bad in law and ultra vires the Right to Equality enshrined in the Constitution of India, and the Taxpayer should be assessed as per Section 9 of the ITA as it stood before the enactment of the Indirect Transfer Provisions by way of the Finance Act, 2012.
  • Since the Double Tax Avoidance Agreement between India and United Kingdom ("Tax Treaty") was entered into in 1994, the Taxpayer should be taxed as per domestic law provisions as they existed in 1994.
  • The tax department has erred in interpreting Section 9 of the ITA as it stood before the enactment of the Indirect Transfer Provisions.
  • The facts in the case pertain to an internal reorganisation of the Cairn group without involving any sale or transfer to a third party, did not result in any change in the controlling interest and no tax may be levied on an internal reorganisation which does not result in any increase in wealth of the group.
  • Since the capital gains tax liability on account of the Transaction only arose pursuant to the enactment of the Indirect Transfer Provisions by way of the Finance Act, 2012, no interest should be levied in that regard and the penalty proceedings initiated should be dismissed.

The tax department put forth the following submissions:

  • The Indirect Transfer Provisions were only introduced as clarifications for the removal of doubts and the income of the Taxpayer in question was always and is taxable in India.
  • Under the Tax Treaty, capital gains is to be taxed in accordance with the domestic laws of each country as per Article 14 therein.
  • CUHL being a non-resident, any income accruing or arising to it, whether directly or indirectly, through the transfer of a capital asset situated in India shall be deemed to accrue or arise in India. Since CIHL shares derive substantial value from assets in India, they were situated in India.
  • There is no concept of group taxation in India, each assessee is taxed separately and the Transaction was a clear case of sale which resulted in capital gains.
  • The tax department also distinguished the impugned case from the Vodafone case on the ground that in the latter, it was a transfer of a foreign share between two non-residents while in the former, it was as transfer from a non-resident to a resident and hence the latter could not be applied.

RULING

The ITAT at the outset dismissed the Taxpayer's argument regarding the legal validity of the retrospective amendments brought in by the Indirect Transfer Provisions, taking the view that the ITAT is not the appropriate forum to rule on the constitutional validity of the Indirect Transfer Provisions.

On the Taxpayer's contention thst a 'static' approach ought to be employed in interpreting the Tax Treaty so as to tax assessees as per domestic law as it existed in 1994, the ITAT perused the ruling of the Delhi High Court in the case of DIT v. New Skies Satellite BV3 which was relied on by the Taxpayer. The ITAT observed that acts of Parliament may neither supply or alter the boundaries of a tax treaty, nor supply any redundancy to any part of the tax treaty. The ITAT then drew an analogy and opined that similarly, the provisions of a tax treaty cannot limit the boundaries of domestic tax laws. It therefore endorsed the ambulatory approach / dynamic interpretation of tax treaties whereby the tax treaty will be interpreted in light of current law as it exists.

The ITAT also took the view that the facts in the case at hand did not involve a simple internal reorganisation, since the entire series of transactions culminated in the IPO by way of which the Taxpayer received considerable gains. On perusing the financial statements of the Taxpayer the Court also observed that the Taxpayer had not paid any tax on the capital gains even in UK. Based on this and the view that tax treaties are intended to provide relief from double taxation, the ITAT held that the gains are chargeable to tax in India owing to the Indirect Transfer Provisions.

The ITAT did afford the taxpayer a lone breath of relief by ruling that the Taxpayer could not have previously visualized its tax liability in 2006 at the time of the Transaction and relied on various judicial pronouncements to ultimately hold that the Taxpayer cannot be burdened with the levy of interest as contended by the tax department.

However, moving to the last issue on the penalty proceedings under the ITA, the ITAT observed that the issue was premature and went on to dismiss that ground of the appeal.

In conclusion, the appeal of the Taxpayer was partly allowed, as regards the issue of payment of interest.

ANALYSIS

The primary contention of the tax department which formed the bedrock for all other contentions raised by them, was that the income in question was always, and is taxable in India, since the shares of CIHL which were transferred by the Taxpayer derive their value substantially from assets situated in India, thus reemphasizing that the Indirect Transfer Provisions were mere clarifications. It is pertinent to note even though the ITAT favoured the tax department on all issues but one, while adjudging the issue on levy of interest on the tax payable, it observed that the tax liability of the Taxpayer has "arisen because of retrospective amendment made by the Finance Act, 2012", tacitly lending credence to the view that the Indirect Transfer Provisions brought forth a new levy which had not existed previously.

While the ITAT did not provide much detailed reasoning on the issue of static v. ambulatory approach in interpretation of tax treaties, the ruling in this regard is in consonance with the approach followed by most countries today and also with the Model Tax Convention on Income and on Capital, 2014 prepared by the Organisation of Economic Co-operation and Development.

The ruling of the ITAT that interest may not be levied in the case is most certainly a welcome move which should provide some amount of comfort to other taxpayers who may be in a position similar to that of the Taxpayer and at a risk of shouldering an unforeseen tax burden. Moreover, it is hoped that CBDT may soon allay concerns surrounding issues regarding the retrograde positioning on retrospectivity, including liability of residents to deduct withholding taxes while making certain payments to non-residents, and payment of interest / penalties by the concerned non-resident.

The ITAT did not touch upon the issue of the legal validity of the retrospective amendments and appropriately so. However, considering the quantum of tax liability in the case at hand, it is likely that the matter will be appealed before higher courts which possess the jurisdiction to adjudge the issue. Accordingly, it is pertinent to note that while the power of the Parliament to enact retrospective law is undisputed, the Supreme Court has in the past, while examining the effect of a retrospective imposition of tax, ruled that if any unforeseen financial burden were imposed on a taxpayer it would violate Article 19(1)(g)4 (the Freedom to practice trade and profession) of the Constitution of India, and that if a clarification which seeks to overturn a judicial decision results in an unreasonable new levy of tax by substantially changing a law, then it would be unconstitutional.5 Hence, various Constitutional rights and freedoms including the Right to Equality and the principles of natural justice may also be in play, should the matter go to a higher court, and the decision(s) of the concerned court(s) will have tremendous ramifications which may transcend the subject of taxation.

In the short term, this is a blow to India's image of a place that is serious about improving the ease of doing business and a quick final resolution of this issue does not seem likely in the near future.

Footnotes



1 (2012) 6 SCC 613

2 Please refer to our Tax Hotline on this for a more detailed analysis (available at http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/draft-rules-on-capital-gains-on-indirect-transfer-of-assets-issued-challenging-times-for-global-ma.html?no_cache=1&cHash=4e116033e0e7f88164a1a47b00077a9a).

3 ITA. No. 473&474/2012

4 Ujagar Prints v. Union of India, (1989) 3 SCC 488

5 National Agricultural Co-operative Marketing Federation of India v. Union of India, (2003) 5 SCC 23

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.