All About India: Vodafone and More
The most important thing that happened in January was the Indian Supreme Court’s ruling in Vodafone. The transaction in Vodafone was one that India’s tax department deemed taxable, but it was also deemed to be as confusing as possible in order to avoid taxation. Vodafone Group bought Indian mobile operator Hutchison Essar from Hong Kong-based Hutchison Telecommunications International Ltd. (HTIL) — a Li Ka Shing company, in an $11.1 billion transaction that gave Vodafone a two-thirds stake in Hutchison Essar. Vodafone International Holdings BV, registered in the Netherlands, acquired the entire share capital of CGP Investments (Holdings) Ltd., a Cayman Islands company from HTIL, giving it control over Hutchison India, which was owned by CGP, and thereby gained virtually 100 percent control over Hutchison Essar. HTIL made a huge capital gain goes without saying.
August 2007, six months after that acquisition, the tax department levied an INR 11,000 crore tax on Hutch. But Hutch was smart. It took the money and ran as fast as it possibly could. By the time the tax department came knocking, Hutch had legally removed all presence of itself from India.
A month later, in September 2007, the tax department hit on Vodafone, stating that it should have known better and deducted and withheld the tax before paying Hutch for its share of the company.
Three months of legal battles ensued, resulting in the decision of the Bombay High Court in favor of the tax department. Two months later, the Supreme Court, to whom Vodafone appealed, assessed an INR 2,500 crore ‘‘deposit,’’ along with a bank guarantee of INR 8,500 crore. Regardless of whether you like big business, this isn’t exactly business-friendly and portends dire implications if you buy a company and are held responsible for paying in advance and in full taxes that are clearly not yours, especially if you did not think those taxes were valid in the first place.
Vodafone fought and won.
The Supreme Court ruled that the sale was between two offshore entities and that the business did not, in essence, change hands in India.
The Court also ordered the tax department to re-fund that INR 2,500 crore deposit within two months, with 4-percent interest. This definitely sets a better tone for businesses interested in entering the Indian market. Fear not, though — the Finance Department has a vested interest in its tax department collecting as much as it possibly can. The Times of India reported on January 21 that the Ministry of Finance had immediately set up a committee of high-ranking officials to assess the impact of the Supreme Court decision. The MOF has not ruled out amending the Income Tax Act to ensure that the tax department can levy capital gains tax on transactions between foreign entities for owner-ship of Indian business operations.
The government is in a big quandary because it was counting on far more than just the Vodafone revenue: BirlaTata AT&T and VedantaSesa Goa are two pend-ing cases involving offshore changes of ownership and substantial amounts of Indian operating assets. Let’s be realistic: Things happen at a far slower pace in India, so how quickly can you expect an amendment to the ITA to ensure that the government can levy capital gains tax on transactions involving foreign country change of ownership of India operations?
There’s always the argument, ‘‘Wait until the DTC bill,’’ the direct tax code legislative measure that would change India from a common law tax system to a constitutional-law-based system. Under the proposed DTC bill, income would be treated as accruing in India if an entity has operations and assets in India, no matter who owns it. Change of ownership brings with it a capital gains tax.
Of course, it’s not likely that a DTC bill will be adopted during my lifetime and I intend to live a long life. Every speaker at events in India I’ve attended during the past year has spoken publicly in favor of the DTC. When I spoke to them privately, however, they expressed their doubts.
The revenue department, according to the January 21 Times of India, hopes to implement the DTC on April 1, the start of the next fiscal year. This must be an April Fool’s joke. The standing committee chair, Yashwant Sinha, hasn’t even submitted committee recommendations yet. I doubt there will be any recommendations over the next fiscal year.
Further, according to the January 19 Economic Times, India’s income tax laws currently do not specify that ‘‘locals’’ have to disclose their foreign assets even though there currently is a tax (although not enforced) on worldwide income. The DTC, as it stands, has a provision that seeks to mandate that taxpayers disclose these assets, similar in nature to the IRS’s new Form 8938. Once the DTC comes into effect, the Indian Revenue Service said, taxpayers will have to ‘‘come clean’’ on their offshore accounts and assets. I wonder if there are any elected members of the Lok Sabha, the Indian legislature, who do not have offshore accounts or assets. Maybe there will eventually be a DTC. But there will never be an Indian Form 8938.
What’s going on with other taxes? On January 21 The Times of India reported that the Bombay High Court, under pressure from the central government, ruled 2 to 1 to uphold a service tax on the construction of flats and ‘‘other properties.’’ That phrase, ‘‘other properties,’’ is worth discussing later. The challenge to the constitutionality of the law was made by the Maharashtra Chamber of Housing Industry. It is bound to go to higher tribunals if for no other reason than the financial impact: Builders state that the buyer of a INR 1 crore flat will now have to pay INR 2.5 lakh more as service tax. Of course, if the legitimacy of this tax is validated through the Indian judicial system, it will present all sorts of nightmares for the Indian government.
Meanwhile, in anticipation of the delivery of the annual budget, the states issued to Finance Minister Pranab Mukherjee a demand that they be allowed to increase taxes on professionals, raising the current maximum of INR 2,500 per year by four times as much. It isn’t that much, but it does drive home the point that the states will never willingly give up their control of non-direct taxes to a national goods and services tax. I don’t care if Maharashtra state, Mumbai, is the overwhelming contributor to a GST — there are more than 20 states out there that will not budge on the matter.
Zones and Treaties
Before the economic recession started worsening in India, there was a war going on between the country’s Ministry of Finance and its Ministry of Commerce. Commerce sponsored private special economic zones (SEZs) in India. There were hundreds of them. I don’t think that they increased business, because the economic incentives of going into a zone meant that a firm uprooted its location in one part of Delhi to move its already established enterprise to another section of Delhi. No new business was created and no true innovation occurred — just a move to another part of the city for the purpose of paying far lower taxes.
Well, the recession put a damper on those SEZs, and their economic justification was called into question. In response, the government has offered a national manufacturing policy to create seven mega zones to encourage manufacturing, offering such benefits as tax concessions and instantaneous approval for locating within zones that will be set up on industrial waste areas and landfills or otherwise infertile land that has been acquired by the government. It is a lofty idea, but I doubt if anything will come of it. How are you going to create 100 million more jobs without having a de-tailed plan in place? At least seven national investment and manufacturing zones are proposed to be set up in the north and west. A survey has been commissioned to create zones similar to those that supposedly have been set up in the south. These would be greenfield integrated industrial townships in areas of at least 5,000 hectares. I bring this up because this is a new program announced by the government. I doubt if I will write about it again, as I don’t think that anything will ever come of it.
M.C. Joshi, chair of the Central Board of Direct Taxes, recently went to Macao to facilitate a double tax avoidance agreement including exchange of tax-related and banking information and to prevent tax evasion. Macao deserves its reputation not just as a gambling paradise but also as a true haven for money laundering from shady banks. I do not know if there is any trade, per se, between Macao and India. Macao appears to be just another jurisdiction taking pride in signing yet another international agreement that is virtually worthless.
On the other hand, India’s new treaty with Taiwan is a good treaty and fits in well as a possible alternative to doing business between India and China through a Hong Kong entity. Yet the best alternative still appears to be doing business between India and anywhere else using a Mauritius entity. In mid-November, India’s Authority for Advance Rulings decided that the capital gains tax exemption under the India-Mauritius tax treaty cannot be denied to Mauritius companies. This is a political decision. Most of the elected legislators in the Lok Sabha own Mauritius corporations doing business in India.
I think that there will soon be some changes to the cozy thing going on between India and Mauritius. Let’s face it: The India-Mauritius tax treaty has been heavily abused. If for no other reason than protecting what they already have, the legislators will likely regulate as much as they can get away with before demonstrating that they can offer a more level playing field for other jurisdictions. So what and where are these jurisdictions? Outlook Business (New Delhi) recently featured ‘‘Tax Haven Hot Spots,’’ reviewing offshore jurisdictions as the choice of holding company for India related business.
The extent of the ‘‘Mauritius problem,’’ as the Indian government perceives it, lies simply in the amount of money (in billions of U.S. dollars) that comprises both inward and outward foreign direct investment in India. From April 2010 through March 2011, $5.6 billion poured into India through Mauritius corporations. The rest of the world contributed $9.3 billion. It is similar for money leaving India (although to what extent this is ‘‘round tripping,’’ I don’t know). During this same period, $5 billion left for Mauritius, while the rest of the world experienced $8.7 billion going their way.
The Indian government has a problem: It is facing a large deficit concurrently with outstanding debt of $306 billion. Collecting taxes would obviously alleviate this problem, because the government loses up to $800 million a year in revenue it is locked out of because of Mauritius. Now I am definitely not one to dispute that there is a whole lot of money lost because of the DTAA with Mauritius, but I think it is only half as much as the Indian government says it is. Still, this is nothing to sneeze at.
Basically, there are five tax haven jurisdictions that are truly advantageous for Indian business: Mauritius, Singapore, the Netherlands, Cyprus, and the United Arab Emirates. Mauritius and the Netherlands are on a downward trend vis-à-vis the future, while things for Singapore and Cyprus are looking up. Singapore, in particular does offer major league banking.
What is the downside for Singapore? How about a 17 percent corporation tax rate for a holding company, compared with Mauritius’s 3 percent rate along with no transfer pricing rules? Publicly held corporations will likely accept the higher tax rate and transfer pricing audits in exchange for a better image, not to mention ease and accessibility to the best international banks that Singapore has to offer. This is one area where Mauritius cannot compete. On the other hand, nothing compares to Mauritius if you don’t need the image or the banking!
Yes, Mauritius will be King of the Hill for some time, but at some stage it will be held accountable, because there is simply too big a drain on tax revenues.
