Merger and Acquisition agreements entered into outside India - applicability of TDS under section 195 - Treatment of Assessee in Default (AID)

In a landmark judgment, [Reported in Vodafone International Holdings B.V., Versus Union of India and others -2008 -TMI - 31744 - HIGH COURT OF BOMBAY] honorable high court of Mumbai has decided the taxability of a transaction which was felt by the assessee as non-taxable in India.

In the present case, appellant contended that:

1. The Income tax is a tax on the income payable by the recipient. Income tax of the recipient is payable by the payer only in certain limited circumstances, including when the legislature deems the payer to be an "assessee in default" (AID)

2. On the issue section 201, appellant submitted that:

i. The provision for deduction and withholding are under the Chapter 'COLLECTION AND RECOVERY OF TAX'. That Chapter does not contain charging provisions but only provides for a convenient machinery for the recovery of tax.

ii. Section 191 provides that even where there is failure to deduct tax in accordance with the provisions of that Chapter, "income-tax shall be payable by the assessee direct". In other words, the liability to pay tax is that of the assessee and not of any other person. The Explanation, however, is the counter-part of Section 201: for the removal of doubts it declares that in the special cases of Sections 194 and 200, the defaulting persons shall be deemed to be AID as referred to in Section 201. (NB: Prior to its amendment in 2002 Section 201 did not define "such person". The words "referred to in section 200" were inserted after "such person". A consequent amendment was made in 2003 by the addition of the Explanation to Section 191).

iii. Failure to deduct or to withhold tax is visited with the penal consequences as provided in Section 271C, and by virtue of Section 273B no penalty shall be imposed if it is proved that "there was reasonable cause for the said failure".

iv. Therefore, by reason of failure to deduct or withhold tax other than under Section 194, the payer is liable to be penalized under Section 271C but he does not become liable for the tax. That liability is and remains that of the payee who is the assessee, a position that is clarified by Section 191.

v. A person who fails to deduct or withhold tax and who is not the assessee can be made liable for the tax only by a legal fiction, a legal fiction that deems the payer to be an assessee in default when he is not. Such a legal fiction must be construed strictly and be applied to only such persons as are specifically mentioned and no others.

vi. Section 201 creates the legal fiction that deems the person who has failed to deduct tax under Section 194 and the person who has deducted tax but failed to pay to the credit of the Central Government as required under Section 200 alone to be AID. That these are the only cases in which the legal fiction is applicable is clarified by the Explanation to Section 191.

vii. All other persons failing to deduct tax, including those mentioned in Section 195, may be liable to be penalized but are not AID.

3. On the issue of extra territorial jurisdiction of section 195, appellant submitted that:

a.  Although the Indian Parliament is competent to enact legislation which may have extra-territorial operation (Article 245 of the Constitution), such legislation, if it were to operate extra territorially, must require clear and cogent language to that effect.

b.  Where a non-resident has no presence in or nexus with India Parliament's competence to legislate in respect of such person has been doubted. 

After Hearing the Argument in Detail and Referring various Apex Courts Decisions, Honorable High Court has delivered a detailed judgment (more that 75 pages) to holding that:

1 Even if the burden of proof does not lie on a party the Court may draw an adverse inference if he withholds important documents in his possession which can throw light on the facts at issue.

2  When the Petitioner has challenged the constitutional validity of the Amendment to Sections 191 and 201 of the I.T.Act by the Finance Act,2008, then the same must be in context of certain facts pleaded and proved by evidence in the form of documents on record and not in vaccum or in the abstract.

Nature of Transaction:

Shares in themselves may be an asset but in some cases like the present one, shares may be merely a mode or a vehicle to transfer some other asset(s). In the instant case, the subject matter of transfer as contracted between the parties is not actually the shares of a Cayman Island Company, but the assets (as stated supra) situated in India. The choice of the Petitioner in selecting a particular mode of transfer of these right enumerated above will not alter or determine the nature or character of the asset.

Prima facie, apart from the acquisition of  controlling interest, the Petitioner has acquired other interests and intangibles rights. The Petitioner accordingly became a successor in interest in the joint venture between HTIL and the Essar group and became a co-licensee with the Essar group to operate mobile telephony in India. The joint venture by itself confers an enduring benefit to the Petitioner. Prima facie, the Petitioner has not only become the successor in interest in that Joint Venture to HTIL, but also has acquired a beneficial interest in the license granted by the Department of Telecommunications in India to its group companies, now known as Vodafone Essar Limited.

It is an admitted fact that VEL (earlier HEL), a subsidiary of the Petitioner in which the Petitioner has acquired 67% interest, was a group company of HTIL and now a group company of the Petitioner. Any profit or gain which arose from the transfer of a group company in India has to be regarded as a profit and gains of the entity or the company which actually controls its, particularly when on facts, the flow of income or gain can be established to such controlling company (HTIL). In the present case, by reason of the transfer, the income accrued not to CGP, but to HTIL and was treated as profits of HTIL and accordingly was distributed to the share holders of HTIL in Hong Kong at the rate of Hong Kong $ 6.15 per share. Therefore, the recipient of the sale consideration was none other  than HTIL and this was a consequence of divestment of its Indian interests in Hutchinson Essar Group, liable for capital gains.

Finally Honorable HC held that:

A perusal of the show cause notice, the chronological list of dates and events, clearly reveals that the present case involves investigation into voluminous facts and perusal of numerous lengthy and complicated agreements. Based on the above, the question of chargeability of the transaction to tax and also the question of duty to deduct tax at source, can be determined. In the present case, the show cause notice, cannot be termed extraneous or irrelevant or erroneous on its face or not based on any material at all.

(For full text of judgment - visit Vodafone International Holdings B.V., Versus Union of India and others [2008 -TMI - 31744 - HIGH COURT OF BOMBAY]