Vodafone loses $2bn India tax challenge

Vodafone has lost a landmark legal battle against the Indian tax authorities in a case that lawyers warn will have implications for future cross-border deals in the country.

The Mumbai High Court ruled on Wednesday that the UK telecoms group must pay capital gains tax into the Indian coffers for its $11bn acquisition of a controlling stake in Hutchison Essar, a domestic mobile phone operator, completed three years ago. The UK mobile operator could face a total tax bill of more than $2bn.

It is the first time an Indian court has ruled that the country’s tax department can charge a foreign company over a transaction that occurred outside India.

The decision, which follows a complex three-year long legal dispute, has been closely watched by foreign companies because it will set a precedent for other international merger and acquisition deals in India.

Vodafone bought a 67 per cent stake in Hutchison Essar, now known as Vodafone Essar, from Hutchison of Hong Kong in 2007. The transaction was made via a Dutch company controlled by Vodafone that paid $11bn to a Cayman Islands entity run by Hutchison Whampoa, the seller, for another Cayman Islands group that indirectly held a controlling stake in the India-based mobile operator.

“As it stands, today’s verdict is a landmark decision because there are several other similar offshore transactions waiting to be executed, which have been in the limbo for some time, and this decision at least lends some level of clarity about M&A tax policy in India,” said Mukesh Butani, a partner at BMR Advisors law firm.

Vodafone is expected to appeal against the verdict to India’s highest judicial body, the Supreme Court in New Delhi, as it argues the transaction should not be taxable in India because it took place overseas.

Des Webb, global tax executive at Vodafone, said it would take the Indian tax department “eight weeks before they pass any order or demand for tax”.

“We need to consider our options. We have to look at the judgment in detail, we will be discussing it with our advisers . . . but we are seriously considering to make an appeal to the Supreme Court,” he said.

“We continue to believe strongly that this transaction is not taxable in India and will continue to defend our ­position.”

However, the court ruled that the deal should have been subject to Indian capital gains tax because the operating assets of Hutchison Essar were in India.

“The Indian tax authority’s order can’t be held to lack jurisdiction,” one of the judges said.

Other foreign companies have monitored the case closely because of the similarity of Hutchison’s sale to several other deals, including the sale of a stake in Genpact India, an outsourcing company, by General Electric in 2004.

“My clients are very concerned about the outcome of this legal battle, as it will determine whether they want to invest or not in India,” said one person advising foreign companies operating in India.