[Economy] Vodafone Essar Case: Capital Gains Tax Meaning, Reasons, Timeline, Implications, explained

[Economy] Vodafone Essar Case: Capital Gains Tax Meaning, Reasons, Timeline, Implications, explained

Before venturing into Vodafone Essar Court Case, Let’s start with the basics
Some information may be technically incorrect / outdated. This article is for illustration and understanding purpose only and not for writing the actual answers in your exam.

  1. Two type of taxes.
  2. What is capital gains tax?
  3. Who pays the Capital Gains Tax?
  4. Players in the Vodafone Case
  5. Timeline of Events
  6. December 2006, Hong Kong
  7. February  2007, London
  8. March 2007, Mumbai
  9. Sept 2010: Vodafone losses in Bombay HC
  10. Aug-Oct 2011: SC hearing
  11. January 2012: Landmark Judgment of Supreme court
  12. March 2012: Review Petition by Government
  13. Budget 2012: Retrospective Amendment in Income Tax Act
  14. Epilogue

Two type of taxes.

Indirect tax

is paid by rich and poor alike, on the purchase of goods and services. Sale tax, excise duty, custom duty, entertainment tax and examples of indirect tax.

Direct tax

Is paid by middle class and rich men on their income and property. Income tax, corporate tax, Wealth tax, capital gains tax, are examples of direct tax.
Direct taxes collected by the income tax department.

What is capital gains tax?

First, What is capital?

  • Capital is something that generates income for you. It can be a building, it can be a rickshaw, it can be a truck, it can be printing press machinery.
  • When you sell these capital assets, and IF you make profit (gain), then you have to pay tax. This tax is known as capital gains tax.

There are two types of capital gains tax.

  • Short-term capital gains tax, if you owned that asset for less than 36 months, before selling it.
  • Long-term capital gains tax, if you owned that asset for more than 36 months before selling it.

Do Shares of a company also come under Capital Gains tax?

Yes Shares of a company also come under Capital Gains Tax. And there is different ‘time-frame’ for them.

  • Short-term capital gains tax, if you owned those shares for less than 12 months, before selling it.
  • Long-term capital gains tax, if you owned those shares for more than 12 months before selling it.

Who pays the Capital Gains Tax?

Who is to pay CGT? The seller or the buyer?

  • Suppose I own a shopping mall building worth Rs.1 crore and
  • I sell it to you for Rs.2 crores, and thus I made the profit (Gains) of Rs. 1 crore and I have to pay Rs.10 lakh to the government as capital gains tax. Now the convention is that I (the seller) don’t actually pay Rs.10 lakh by myself
  • Instead of that, you just give me only Rs.1 crore 90 lakhs. And keep aside 10 lakh rupees.
  • Then, you (the buyer) will pay the 10 lakh rupee to the Government on my behalf. (Thus you purchased the mall for Rs.2 crore).
  • This is the concept of Tax Deduction @Source (TDS)

So in the case of Vodafone: indeed Hutchison was the seller so he has to pay the Capital gains tax but he doesn’t ‘actually’ pay it. It is for the Vodafone (buyer) to deduct that tax money from his payment and give the tax to Indian Government. That’s why IT Department harasses Vodafone and not the Hutch.
Now coming to the Vodafone Essar case

Players in the Vodafone Case

Players in the Vodafone Case

Vodafone UK based Telecom company.
Hutch Hong-Kong based company.
Hutchison Essar Ltd. (HEL) India based company
CGP Investments Holdings Ltd Cayman Island based company, has 67% stakes in Hutch-Essar India. CGP itself is owned by Hutch, Hong Kong.
Income Tax dept. India based *insert whatever word you want*
Innocent Bystanders You and I, because we’ve to prepare such topics for competitive exams.

Timeline of Events

December 2006: Hong Kong

Hutchison Telecommunication International Ltd (HTIL) Boss: My Indian arm “Hutchison Essar Limited (HEL)” is not making good money. I want to quit from India.
(To his Secretary ) as you know, I own CGP Investments Holdings Ltd, located in Cayman. And CGP holds 67% in HEL (India). So, just make an announcement that I want to sell CGP and start talking with prospective buyers.
Secretary: but why all this complex procedure?
HTIL boss: oh come on man, don’t you know that Cayman Island is a Tax Haven. They don’t have Capital Gains Tax! Better we sell via Cayman route and we’ll save a truckload of ca$h in tax.

February  2007, London

Vodafone (UK) Boss: (To his Netherland subsidiary manager) Take these suitcase full of 11 billion US Dollars, go to Cayman Island, buy that CGP holdings Ltd. From HTIL (Hong Kong) and give me “miss call” when the deal is finished.

March 2007, Mumbai

Income Tax Commissioner’s Office.
Minister (on Phone): Mast bakraa haath mein aayaa hai (मस्त बकरा हाथ मे आया है!). Send a notice to Vodaphone, ask them to pay Rs. 12000 crores under capital gains tax because they purchased an Indian Company HEL (Hutch Essar Ltd) for 11 billion dollars!
IT Commissioner: Sir, may I humbly point it out that It is a common practice among multinational companies (MNCs) to establish such SPV (Special purpose vehicles/ flimsy companies) in Tax havens of Mauritius / Cayman Island.
And then those flimsy companies (SPV) such as CEG Ltd., buy shares of an Indian company (HEL).
When the MNC wishes to sell or acquire an Indian company, they don’t directly come and buy in India, they simply purchase or sell the shares of these flimsy companies in Cayman’s Island because the transfer of shares of an SPV outside India, is not taxable in India. And Cayman Island itself has very negligible tax rates. It is a win win situation for them.
And This is not the first case, there have been truckload of merger and acquisitions like this, in past and we’ve never sent any notice to any such company because this matter is outside my Jurisdiction, sir.
Minister: Betaa, don’t give me this “GYAN” (ज्ञान), get me some “CASH” ! I’ve to give Rs.71,000 crores in debt-waiver scheme to farmers in 2008 to win the General elections.

  • We are already giving billions of rupees in subsidies on diesel, LPG, Kerosene, Fertilizers.
  • We’ve to pay crores of rupees to Government employees under 6th Pay Commission.
  • We’re running Development schemes like MNREGA (Rs.40,000 crores a year), and in future we are thinking of starting Food security Act (2 lakh crores a year). Where is the money to pay for all this?
  • I’ve to give crores to that loss-making Air India.
  • I’ve to pay Rs.28000 crores Common Wealth games arrangement.
  • All these things requires huge huge huge cash, man. Money doesn’t fall from sky. We cannot tax the aam-aadmi beyond a level and
  • We couldn’t get decent money from sale of 2G spectrum, or coal mines auction
  • Reliance isn’t paying much from KG Basin gas exploration.
  • Don’t you understand? We’ve to find new ‘sources’ of income. Vodafone is a good “bakraa”. Let’s rip him apart.
  • Then we use it to create bogus Developmental schemes, siphon off the money and use it to fight election. This shall help us get absolute majority in Bihar and Uttar Pradesh because Public of UP and Bihar is so Gullible they will vote for anyone who tells them ki “hum aap ke liye Delhi se paisa bhejte hai!(हम आपके लिए दिल्ली से पैसा भेजते है!)

IT Commissioner: as you wish. I’ve sent the notice to HEL (India).
Minister: Mogembo khush hua. (मोगेम्बो खुश हुआ)
HEL(India) Boss: (To IT Commissioner) Why the hell are you sending notice to me? I am not a party to any of this! Don’t you see I’m getting ‘sold’ here. Ask the buyer Vodafone of UK or the seller Hutch of Hongkong about your Capital gains tax!

In the mean time

Vodafone International boss: (To HEL Boss): I’ve purchased majority shares of your company. You shall take my name like an obedient wife. From this day on, you shall be known as VEL (Vodafone Essar Limited) and not HEL (Hutchison Essar limited).
HEL boss: as you wish my lord. Mr. HEL transforms into Mr.VEL.
IT Commissioner: caught you now! Mr.VEL, you’re the Indian agent of Vodafone, now you pay the capital gains tax or I’ll start your ragging worst than that in B.J.Medical College, Ahmedabad.
Vodafone files appeals in Bombay highcourt and supreme-court, stay orders here and there, sometimes victory sometimes defeat
Fast-forward to

Sept 2010

Bombay HC: Yes IT Department is right. Mr. Vodafone you’ve to pay the Capital Gains Tax.
Mr.Vodafone: I’ll go to supreme court.
Leftist Media: Shame shame. You’re going to Supreme Court!! We are going to report this as in such a tone as if you’re the main culprit here and doing something immoral.
Mr.Vodafone: When the kinds of Shibu Soren, Sanjay Dutt and Vikas Yadav can goto Supreme court, why can’t I? Saving tax is a legal activity. I’ve done nothing wrong. I’m the innocent bystander here. You don’t have the guts to cover blackmoney issue until Anna Hazare and Baba Ramdev raised it, but just because I’m a rich MNC company I must be the bad guy, right? All you mediawalla want, is money to keep your mouth shut.

Aug-Oct 2011

Location: Supreme Court, Delhi
IT Commissioner: Your Honor, this Mr.Vodafone here, has purchased ownership of an Indian mobile company called HEL (Hutch Essar Limited) for USD 11 billion and now he is not giving me Rs.12,000 crores as Capital Gains tax.
Mr.Vodafone: Get your facts right Commissioner Gordon. Please see this diagram again.
Players in the Vodafone Case
Long thing cut short, I purchased a Cayman Island company from Hutch Hongkong. Now this Cayman Island company happens to have 67% shares of Hutch Essar ltd (HEL, India), and thus I only have “Shares” of HEL. I did not purchase any assets like trucks, buildings or mobile towers from the HEL (India) itself. So where is the capital and where are the gains?
IT commissioner: No that is incorrect. Capital Gains tax applies!! Because You gained Assets of an Indian company.

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