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  • Writer's pictureIRALR


This blog has been authored by Manya Manchanda a 2017-2022 student at Vivekananda Institute of Professional Studies, GGSIP University


India’s Telecommunication sector is one of the fastest growing and promising industries as India has a subscriber base of over 1.2 bn. In the Telecommunication sector, 100% FDI is allowed, upto 49% is allowed through the automatic route and beyond 49% under the government route. In today’s scenario, several jurisdictions compete for scant capital. A significant factor that foreign investors look for is regulatory assurance on tax, foreign exchange feasibility and protection of investments made by the corporations. Foreign investments in India are affected by the legal environment and taxation policies followed by India. The key to boosting foreign investment in India is tax certainty and constancy. The Vodafone tax case is probably the most debated tax controversy in India that has gathered spotlight from investors all over.

Factual Analysis of the case

In February 2007, Hutchinson Telecommunications International Limited (HTIL), a Hong Kong-based entity sold its stake in a Caymanian-based entity named CGP Investments (Holdings) Limited to Vodafone International Holdings BV (VIHBV), a Netherlands-based entity, which indirectly held shares of Hutchinson Essar Limited (HEL), an Indian company.

In other words, HTIL, a telecommunication giant was providing mobile and internet services in several countries including India through buffers like CGP Investments Limited. CGP Investments owned shares in Mauritius-based entities which in turn held a stake in certain Indian companies and eventually held a 67 % stake in Hutchison Essar Limited (HEL), which is a joint venture between Hutch and Essar and a dominant player in the Indian telecom industry.

Ultimately, HTIL who was managing its Indian operations through a web of companies based in Mauritius and the Cayman Islands decided to put up its stake for sale. HTIL accepted Vodafone’s offer of purchase. This acquisition gave Vodafone command over CGP and its subsidiaries including Hutchison Essar Limited (HEL). Further, Hutchison Essar became Vodafone Essar Ltd (VEL). This transaction was for a consideration of USD 11.1 billion paid to HTIL, who earned capital gains on the sale of such shares.

Question of Law involved

Thus, a crucial question of law that was involved is whether capital gains earned by Hutchinson Telecommunications International Ltd (HTIL) on the sale of an Indian telecom network to Vodafone by the means of an offshore share transfer arrangement, was taxable in India or not. Secondly, whether Vodafone International Holdings [SP1] BV had any consequent obligation to withhold taxes in India on the consideration paid to Hutchison Telecommunications International Limited.

In March 2007, the Joint Director of Income Tax (International Taxation) issued a notice under section 133(6) [SP2] of the Income Tax Act, 1961 to HEL to inquire about the sale of stake of HTIL in HEL, together with the Shareholders agreements and details of the transaction for the acquisition of the share capital of CGP. Further, Income Tax Department issued a show-cause notice to VEL u/s 163(1) [SP3] of the Income Tax Act, 1961 to justify why it should not be treated as a representative assesses of Vodafone International Holdings (VIHBV).

Tax Department’s Contentions

In September 2007, the Indian Income Tax Department gave a show-cause notice to Vodafone Co. to clarify why the tax was not accumulated on instalments made to HTIL in connection to the transfer. The Income Tax Department argued that the said transaction of transfer of shares in CGP Investments had the impact of indirect transfer of assets located in India.

The Income Tax Departments issued another notice u/s. 201(1) and 201(1A) [SP4] of the Income Tax Act, 1961 to VIHBV to defend themselves as to why it should not be treated as an assessee in default for failure to withhold tax. Thus, the IT Department’s viewpoint towards taxation of international transactions adds an additional element of threat that may substantially to alter the decision of whether to invest or not in India.

Further into the bargain, VIHBV filed a writ petition in the Bombay High Court challenging its liability to pay tax and the jurisdiction of the Income Tax Authority of India to tax a transaction between HTIL and VIH that did not involve the transfer of a capital asset situated in India.

On August 4, 2010, the Bombay High Court admitted the writ petition and a division bench, comprising of Justice Chandrachud and Justice Devodhar heard both parties. Vodafone chiefly argued that the transaction only concerned one share of CGP Investments in the Cayman Islands, which was a capital asset situated outside India, and that therefore no income had accrued or arisen or deemed to have accrued or arisen in India. In response, the IT department argued that the subject matter of the transaction on a true construction of the sale and purchase agreement and other relevant documents qualify as a composite transaction involving a transfer of rights in VEL by HTIL resulting in accrual or deemed accrual of income for HTIL from a source of income in India i.e. a capital asset situated in India that would therefore be taxed in India per se. The court ruled in favour of the Income Tax authorities and directed Vodafone to clear the tax demanded. The decision by the court as well as the IT department’s approach generates enormous ambiguity about which offshore transactions may fall within the Indian tax liability.

Following this decision, Vodafone appealed the decision in the Supreme Court of India. The Supreme Court unambiguously decided the matter in favour of Vodafone and held that even though the concealed subject matter of the transfer was the Indian telecommunication business, the Indian tax laws did not have provisions by which such extra-territorial share transfer agreements could be brought to be taxed in India.

Amendments made to the Income Tax Act to tax indirect transfer of assets

Disappointed by the judgment, side-stepping the effect of the Apex Court, the Government resorted to retrospective legislation that certainly created an unpredictable and unstable business environment. The Central Government amended the Income Tax Act 1961, retrospectively. This amendment allowed tax authorities to retrospectively tax transactions, including that of Vodafone’s stake in HEL. Subsequently, tax authorities claimed 200 billion rupees in respect of taxes on capital gains, including interest and certain penalties from Vodafone. Vodafone decided not to challenge such retrospective amendments and thus this demand led to Vodafone invoking the Netherlands-India Bilateral Investment Treaty (BIT) with the aim to bring the dispute to adjudication via an international tribunal in 2014 under the India-Netherlands Bilateral Investment Promotion & Protection Agreement (BIPA).

They argued that the imposition of tax through retrospective amendment, even after the final judgement by the Supreme Court, lead to a violation of fair and equitable treatment (FET) as promised under the India-Netherlands BIT. The India-Netherlands BIT under Article 4.1 lays down that “the investors shall at all times be accorded fair and equitable treatment, which includes an obligation to ensure a stable and predictable regulatory environment”.

The Investment Treaty Dispute

In 2017, Vodafone in furtherance of the existing India-Netherlands BIPA commenced a second arbitration under India-UK BIPA. The reason for the initiation of these proceedings by Vodafone was that India questioned the jurisdictional objection in the arbitration under the earlier India-Netherlands BIPA. The Indian government moved to the Delhi High Court seeking an injunction against Vodafone to refrain it from initiating a second arbitration under the India-UK BIT. India argued that this amounted to the abuse of process, leading to parallel proceedings and would result in inconsistent awards.

Primarily on August 22, 2017, the Delhi High Court allowed an ex-parte interim order restraining arbitration under India-UK BIT. Since Vodafone made an offer to consolidate the arbitrations under the India-UK BIT and the India-Netherlands BIT.However, Vodafone made an offer to consolidate the arbitrations under the India-UK BIT and the India-Netherlands BIT. Thus, on May 7, 2018, the Delhi High Court in its final judgment dismissed the plea of the Indian government seeking an anti-arbitration injunction against Vodafone.

The Award by the Arbitral Tribunal

This case before the Permanent Court of Arbitration at The Hague was concluded in September 2020, the arbitral tribunal comprised of L.Y. Fortier, R. Oreamuno Blanco and F. Berman, in which the Court affirmed that the Indian Tax Department breached Article 4(1)by imposing tax liability along with interest and penalties on Vodafone. Additionally, the Indian government was asked to pay about Rs 40 crore as partial compensation for the legal costs incurred and to refund the tax which has been collected so far.

This award contradicts India’s usual position that tax disputes do not come under the domain of investment treaties. The New Bilateral Investment Treaties entered into by India have to an extent excluded measures concerning taxation or enforcement of taxation obligations from their scope, for example, 2018 India-Belarus BIT and the 2020 India-Brazil BIT. It is possible that India will intensely negotiate on the integration of such exclusions in all Bilateral Investment Treaties.

Changing dimensions of BIT Treaty

Thus, India has revised its BIT model and has a step towards the future of investment treaties. A specific exclusion is carved out for that “any law or measure regarding taxation, including measures taken to enforce taxation obligations.” Also, a detailed explanation has also been included to inter alia affirm that (i) what constitutes tax-measure is the sole prerogative of the host State, and (ii) such measures are non-justiciable.

Several clauses of the model BIT are noticeable as India’s learnings from the Vodafone arbitration. To compute a few- (a) the revised model also carries an obligation to treaty jurisdictional challenge as a preliminary issue and dismiss frivolous claims (b) the tribunal’s obligation to accord a high level of deference that international law accords to States with regard to their development and implementation of domestic policies (c) ability of the contracting States to jointly clarify the scope of BIT provisions (d) widely framed exceptions and denial of benefit clauses, etc.

The Criticisms of the Arbitral Award

The Vodafone award has also received certain criticisms relating to the scope of treatment that extends to legislative measures. In an exclusion clause in the Netherlands BIPA treaty specially carves out the effect of “domestic legislation or arrangements…relating wholly or mainly to taxation,” which led the Government to argue that the international arbitration tribunal could not consider the effect of legislative actions while the assessing claim of treaty violation.

Questions have been raised about the scope of international treaties over domestic taxation. Owing to examples wherein Parliament has retrospectively amended the tax laws of the country against the taxpayers, with complete judicial authority on the validity of such amendments and thus, enforced the revival of tax demands under the Constitutional mandate.

Vodafone has initiated another change in India’s policy landscape with other countries. Its tax dispute has been influential not just in India but across the globe. The result of enforcement and subsequent proceedings that arose out of the Permanent Court of Arbitration’s award is bound to trigger an ardent review by other countries on their scope of investment treaties. Moving forward in future, it may become a global standard that tax is excluded from the scope of investment treaties internationally.

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