Vodafone: Key Points

The Supreme Court’s judgment today in Vodafone is of enormous importance to a number of branches of Indian law. The majority judgment has been delivered by the Chief Justice and Swatanter Kumar J. A concurring judgment delivered by K.S. Radhakrishnan J. in some respects goes even further. A copy of the judgment is available on the Supreme Court’s website. A detailed analysis of the judgment will follow. This post reproduces key extracts from the two judgments with brief comments, on some of the issues before the Court.
1.      Azadi Bachao Andolan and McDowell
Both judgments hold that Azadi Bachao Andolan is good law. The Chief Justice holds that there is no conflict between Azadi and McDowell because the observations of Reddy J. are confined to cases in which a colourable device is used. Radhakrishnan J. appears to have gone even further and has expressly said that the “ghost” of the Duke of Westminster has not been exorcised. We will analyse this in detail in the coming days.
[para 64] The  words  “this  aspect” [ed: referring to the majority’s observation that they “on this aspect” agree with Reddy J.’s judgment] express  the  majority’s  agreement  with  the  judgment  of Reddy, J. only in relation to tax evasion through the use of colourable devices and by resorting to dubious methods and subterfuges. Thus, it cannot be said that all tax planning is illegal/illegitimate/impermissible.  Moreover,  Reddy,  J. himself  says  that  he  agrees  with  the  majority.  In  the judgment  of  Reddy,  J.  there  are  repeated  references  to schemes  and  devices  in  contradistinction  to  “legitimate avoidance  of  tax  liability”  (paras  7-10,  17  &  18).    In  our view,  although  Chinnappa  Reddy,  J.  makes  a  number  of observations  regarding  the  need  to  depart  from  the “Westminster” and tax avoidance – these are clearly only in the  context  of  artificial  and  colourable  devices.  Reading McDowell, in the manner indicated hereinabove, in cases of treaty  shopping  and/or  tax  avoidance,  there  is  no  conflict between  McDowell  and    Azadi  Bachao  or    between  McDowell and Mathuram Agrawal.
[paras 110, 112] Justice Reddy has, the above quoted portion shows, entirely agreed  with  Justice  Mishra  and  has  stated  that  he  is  only supplementing  what  Justice  Mishra  has  spoken  on  tax avoidance. Justice Reddy has also opined that the ghost of Westminster (in the words  of  Lord  Roskill)  has  been  exorcised  in  England.    In our  view,  what  transpired  in  England  is  not  the  ratio  of McDowell and cannot be and remains merely an opinion or view. 112.   Justice Reddy, we have already indicated, himself has stated  that  he  is  entirely  agreeing  with  Justice  Mishra  and has  only  supplemented  what  Justice  Mishra  has  stated  on Tax  Avoidance,  therefore,  we  have  go  by  what  Justice Mishra has spoken on tax avoidance
2.      Corporate Veil
Both the Chief Justice and Radhakrishnan J. hold that the existence of a holding-subsidiary relationship is no reason to suppose that the two entities are not separate in law. The Chief Justice sets out circumstances in which the Revenue may appeal to India’s “judicial anti-avoidance rule”. Justice Radhakrishnan cites with approval Adams v Cape Industries.
[paras 67, 68] 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
In the application of  a  judicial  anti-avoidance  rule,  the  Revenue  may  invoke the  “substance  over  form”  principle  or  “piercing  the corporate  veil”  test  only  after  it  is  able  to  establish  on  the basis  of  the  facts  and  circumstances  surrounding  the transaction that the impugned transaction is a sham or tax avoidant…the  concept  of  participation  in  investment,  the  duration  of time  during  which  the  Holding  Structure  exists;  the  period of  business  operations  in  India;  the  generation  of  taxable revenues  in  India;  the  timing  of  the  exit;  the  continuity  of business  on  such  exit.    In  short,  the  onus  will  be  on  the Revenue  to  identify  the  scheme  and  its  dominant  purpose. The corporate business purpose of a transaction is evidence of the fact that the impugned transaction is not undertaken as a colourable or  artificial  device.    The  stronger  the evidence  of  a  device,  the  stronger  the  corporate  business purpose must exist to overcome the evidence of a device

[paras 58, 61] Legal relationship between a holding company and WOS is  that  they  are  two  distinct  legal  persons  and  the  holding company  does  not  own  the  assets  of  the  subsidiary  and,  in law,  the  management  of  the  business  of  the  subsidiary  also vests in its Board of Directors
3.      Shareholders’ Agreements and Rangaraj
Justice Radhakrishnan has expressed the view that Rangaraj v Gopalakrishnan, which we have discussed on several occasions, may have been wrongly decided because shareholders have the freedom to contract unless there are specific restrictions in legislation.
[paras 63, 64]  The  nature  of  SHA  was  considered  by  a  two  Judges Bench  of  this  Court  in  V.  B.  Rangaraj  v.  V.  B. Gopalakrishnan and Ors. (1992)  1  SCC  160 …    This  Court  has  taken  the  view  that provisions  of  the  Shareholders’  Agreement  imposing restrictions  even  when  consistent  with  Company  legislation, are  to  be  authorized  only  when  they  are  incorporated  in  the Articles  of  Association,  a  view  we  do  not  subscribe
64.  Shareholders  can  enter  into  any  agreement  in  the  best interest  of  the  company,  but  the  only  thing  is  that  the provisions in the SHA shall not go contrary to the Articles of Association.    The  essential  purpose  of  the  SHA  is  to  make provisions  for  proper  and  effective  internal  management  of the  company
4.      Controlling Interest and Extinguishment
Both the Chief Justice and Justice KS Radhakrishnan have held (on this aspect affirming the legal conclusion of the Bombay High Court in the impugned judgment) that “controlling interest” is not a distinct capital asset.
[para 88]  As  a  general  rule,  in  a  case  where  a transaction  involves  transfer  of  shares  lock,  stock  and barrel,  such  a  transaction  cannot  be  broken  up  into separate  individual  components,  assets  or  rights  such  as right  to  vote,  right  to  participate  in  company  meetings, management  rights,  controlling  rights,  control  premium, brand  licences  and  so  on  as  shares  constitute  a  bundle  of rights
[para 144] Further, the High Court failed to note  on  transfer  of  CGP  share,  there  was  only  transfer  of certain  off-shore  loan  transactions  which  is  unconnected with underlying controlling interest in the Indian Operating Companies. The  other  rights,  interests  and  entitlements continue  to  remain  with  Indian  Operating  Companies  and there is nothing to show they stood transferred in law
5.      Section 9
[para 71] Hence, it is not necessary that  income  falling  in  one  category  under  any  one  of  the sub-clauses  [ed: of section 9] should  also  satisfy  the  requirements  of  the other sub-clauses to bring it within the expression “income deemed to accrue or arise in India” in Section 9(1)(i)… The  said  sub-clause  consists  of three  elements,  namely,  transfer,  existence  of  a  capital asset,  and  situation  of  such  asset  in  India.  All three elements should exist in order to make the last sub-clause applicable [emphasis added].
[paras 171-174] Section  9, therefore,  covers  only  income  arising  from  a  transfer  of  a capital  asset  situated  in  India  and  it  does  not  purport  to cover  income  arising  from  the  indirect  transfer  of  capital asset in India. 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
6.      Situs of the CGP Share
Although both the Chief Justice and Justice K.S. Radhakrishnan hold that the situs of the CGP share is the place of incorporation/register of shares, they appear to have adopted different approaches: the Chief Justice applies the Indian Companies Act, while Justice KS Radhakrishnan applies the well-known conflict of laws rules on situs of shares. This will be discussed in more detail in a subsequent post.
[para 82] Be  that  as  it  may,  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  VIH  that  the  transfer  of  the  CGP  share  was recorded  in  the  Cayman  Islands,  where  the  register  of members  of  the  CGP  is  maintained.
[para 127] Situs of shares situates at the  place  where  the  company  is  incorporated  and/  or  the place  where  the  share  can  be  dealt  with  by  way  of  transfer.  CGP  share  is  registered  in  Cayman  Island  and  materials placed  before  us  would  indicate  that  Cayman  Island  law, unlike  other  laws  does  not  recognise  the  multiplicity  of registers

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V. Niranjan

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