Vodafone+Ratan Melting–A possible lethal combination

 

The Vodafone controversy has still not come to rest. The implications, repercussions and consequences of the Bombay High Court (BHC) order in the case of Vodafone are still being studied by international tax experts. This order by BHC, if upheld by the Supreme Court of India would be path-breaking in international tax jurisprudence to say the least!

 

An interesting dimension that may gain monstrous proportion and may be deliberated upon is what happens if we analyze the Vodafone order with some other recent rulings and weapon the tax authorities may gain in their armory.

 

One such analysis is being discussed hereunder. One of the judgments that may be referred by tax authorities along with the Vodafone order is by Supreme Court of India in Ratan Melting & Wire Industries case (Commissioner of Central Excise v. M/s Ratan Melting & Wire Industries).

 

With Vodafone controversy gaining so much discussion, neither the facts nor ruling of Vodafone controversy need be discussed here. In the Ratan Melting case, 5-Judge bench of the Apex Court have held that Circulars and instructions issued by the Central Board of Excise and Customs (CBEC) are no doubt binding in law on the authorities under the respective statutes (which grants power to CBEC), but when the Supreme Court or High Court declares the law on the question arising for consideration, it would not be appropriate for the Court to direct that the circular should be given effect to and not the view expressed in a decision of the Supreme Court or the High Court. So far as the clarifications/circulars issued by the Central Government/State Government are concerned, they represent merely their understanding of the statutory provisions. They are not binding upon the Courts. It is for the Court to declare what the particular provision of statute lays down and it is not for the executive. In other words, a circular which is contrary to the statutory provisions has really no existence in law.

 

CBEC is an executive authority under the indirect tax legislations similar to Central Board of Direct Taxes (CBDT) under the income tax laws having certain powers to direct/instruct the lower revenue authorities.

 

After Ratan Melting, it is clear that circulars of the CBEC or CBDT cannot prevail over the law laid down by the Courts. On the help of this argument, tax authorities basing there claim on Vodafone order may claim that an important circular on which much of the international tax structuring is based is not applicable in certain circumstances. The circular referred here is circular 789 dated April 13, 2000 (Circular).

 

The Circular has inter alia clarified that wherever a certificate of residence is issued by the Mauritius Authorities, such Certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the Indo-Mauritius Double Taxation Avoidance Convention (IMTT).

 

The said clarification has been issued in the light of the provisions of IMTT and seeks to clarify as to when a person may be considered as resident of Mauritius to claim benefit of IMTT. The Circular has been applied in other cases also to claim treaty benefit based upon the tax residency certificate only.

 

The Supreme Court in the landmark judgment in Indian international tax issues, that the Circular is in accordance with the law in the context of IMTT. Under the IMTT, capital gains derived by a resident in the Mauritius from the alienation of any property other than (amongst others) immovable property and moveable property forming part of business of permanent establishment is taxable only in Mauritius. This provision inter alia provides benefit in case of sale of shares of Indian companies to Mauritius entity. Such benefit of IMTT is available to an entity which is treated as a taxable unit under the taxation laws in force in Mauritius. The Circular is important in specifying the principles on which residential status in Mauritius may be proved.

 

The Circular pertains to IMTT. Regarding, other treaty countries, tax authorities may argue that Circular is not applicable or in any event Azadi Bachao Andolan judgment is not applicable, so Circular does not hold good anymore in view of the Vodafone order. It may be noted that Ratan Melting being a 5-Judge bench order has overriding effect over the 2-Judge bench order in Azadi Bachao Andolan case, to the extent of any inconsistency.

 

Tax authorities might also claim that in case of shell companies, effective control and management is situated elsewhere then the treaty country so shell company is not a resident of that treaty country. This would in particular impact transactions routed through Cyprus as it would be difficult for tax authorities to challenge the Circular in the context of IMTT due to Azadi Bachao Andolan case upholding its validity in the context of IMTT. Based on the Vodafone order, tax authorities may claim that tax on transfer of business/economic interest may be taxable in India, accordingly, treaty benefit may be denied on the presumption that asset is in India or atleast Indian authorities gains ground to investigate into the claim of the foreign companies about their actual residency in the treaty country, instead of just being shell investment company. Initiation of such investigations would throw open a Pandora box!

 

However, other than Mauritius and Cyprus, another jurisdiction with similar benefits regarding capital gains is Singapore. But in case of Singapore there is a limitation of benefit (LOB) clause, which in essence is a measure against treaty shopping, as it require substantive presence in Singapore to claim treaty benefit. Once substantive presence is required and is established then it would not be possible for the Indian tax authorities to claim that there is a ploy to evade taxes and that would also prove the residential status in Singapore. LOB clause restricts the benefits of tax treaty to qualified residents of the Contracting States.

 

Tax authorities may again agitate the whole issue citing Vodafone order and Ratan Melting judgment to claim that the aforesaid Circular is not applicable any more or atleast in case of countries other than Mauritius. Merits of this proposition of tax authorities would be most probably decided by Apex Court; still, as may be gathered from the whole discussion, tax authorities may, given their extra-ordinary zeal to find innovative ways to gather tax may somehow put an arguable case. Though Vodafone order as such may not be applicable to treaty countries as in that case transaction under consideration had been done in a tax haven with which India has no treaty, but due to Ratan Melting judgment, tax authorities may develop a lethal weapon to attack tax structuring done through treaty countries, as discussed above.

 

But tax authorities should be aware that any over indulgence on Vodafone matter would adversely impact foreign investment in India, especially if it against well established Indian tax jurisprudence and international tax principles.