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

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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Some information may be technically incorrect / outdated.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

VodafoneUK based Telecom company.
HutchHong-Kong based company.
Hutchison Essar Ltd. (HEL)India based company
CGP Investments Holdings LtdCayman 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 BystandersYou 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.

Gurmeet (from court viewers): This is utter nonsense. If today you buy 10% of the shares of a particular company, let us say Jet Airways, does this mean that you automatically own 10% of all of Jet Airways’ assets? Does this mean that 10% of the entire fleet of aircraft now belongs to you? By buying out a company that holds 67% of HEL, it doesn’t mean that Vodafone now owns 67% of the assets of HEL. Those assets continue to belong to HEL, which is a separate legal entity based in India. Read the Company law, Damnit. Because there has been no transfer of assets, there has been no capital gain.

Judge: order, order.
Mr. Vodafone: Yes your honor, there is a difference between the sale of shares in a company and the sale of assets of that company. It is an elementary principle of company law that ownership of shares in a company does not mean ownership of the assets of the company. Thus, an individual who owns 45 per cent share capital does not own 45 of that company’s assets. The assets belong to that company which is a separate legal entity. So I have not received any ‘capital asset’ from the Indian company. I cannot be taxed for capital gains!

IT commissioner: ya But still, you purchased the shares of a company.  According to Indian law, capital gains tax applies to sell of shares!

Mr.Vodafone: Agreed that a person has to pay Capital gains tax on the sell of shares according to Indian Income tax act. But This share-purchase took place in Cayman’s island, between two Non-Indian companies. They don’t have any capital gains tax there. So how come you hold me responsible for paying Capital Gains Tax in India? You don’t have any jurisdiction over this matter! And If this is your logic, why didn’t you arrest Sunny Leone when she came to participate in Big Boss season #5? She is a porn actress, and watching porn is illegal in India (except for Karnataka MLAs). But you cannot arrest Sunny Leone in India, because you don’t have jurisdiction over her activities in America. It is completely legal to shoot porn in California State of USA. So why this Kolaveri Di with me?

T.V. SIVAKUMARAN (from Court audience): Let me give another simpler illustration. ICICI Bank shares are listed in the US Stock exchange. As a US citizen, I own some shares. If I sell them and make a profit, should I be made liable to pay Capital Gains Tax in India, U.K. and other countries, where ICICI Bank holds Assets?

Judge: order, order.
IT Commissioner: umm…well….ahhh… oh yes, you and Hutchison International, have intentionally conspired to make this deal in Cayman’s Island. Because it is a tax haven. Because Cayman island doesn’t have capital gains tax. You guys are very smart, you intentionally create such flimsy companies in Tax havens, and then make merger and acquisitions to avoid as much tax as possible. You’re not the only culprit; plenty of Indian companies are doing the same thing. [But since you’re a big ‘bakraa’ worth Rs.12000 crores we’ve special interest in you]

Mr. Vodafone: of course. Why not? It is a completely legal activity to save tax through legal means. What’s wrong in that? Blame it to your outdated laws and tax-treaties. If a drunk rich brat kills 15 people in drunk driving, he still gets out of jail on bail, thanks to your outdated laws So who is to blame? The drunkard or the Government?

Yes we save taxes by running the show through tax havens in Mauritius and Caymand island, but you cannot ignore the enormous employment generated because of me. See how many people got jobs in Vodafone outlets and the substantial increase in excise duty, sales tax and other duties. Not to mention all those people who got jobs, they also pay income tax, they go out purchase homes, automobiles, perfumes and skin whitening creams and what about that indirect employment generated in those industries?

You cry about the puny 12000 crores in capital gains, what about the million dollar happiness in the lives of all those people benefitted directly or indirectly because of my entrepreneurship?.

January 2012

Landmark Judgment of Supreme court

Saare sabuto aur gawaaho ko madde nazar rakhte hue, ye adalat iss natije par pahuchi hai ki (सारे सबूतों और गवाहों को मद्देनजर रखते हुए, ये अदालत इस नतीजे पर पहुची है की)

  • Indian authorities do not have jurisdiction on an overseas transaction.
  • Certainly and stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner
  • This offshore transaction evidences participative investment in India and not a sham.
  • The demand of nearly 12,000 crore by way of capital gains tax, in my view, would amount to imposing capital punishment for capital investment since it lacks authority of law and therefore stands squashed.

Location: Finance minister’s Office, Delhi

There is pindrop silence in the office. Babus are not even playing that “Solitaire/Hearts” card-game in their Windows 98 computers.
Some of them are busy in toilet, actually leaking information about ‘possible future-moves of their minister’ to their journalist friends in TimesNow, via SMS from their Antique Nokia-1100 mobile phones.
Minister (entering the Office) : Itnaa Sannaataa kyo hai bhai? (इतना सन्नाटा क्यों है भाई?)
IT Commissioner: Because We have suffered a humiliating defeat in Supreme court, in that Vodafone case.
Minister: You mean as humiliating as Team India’s defeat in Austrialian test-matches?
IT Commissioner: Well, not *that* humiliating, but still very humiliating.
Minister: I cannot let this matter go. Rs. 12000 crores is not a small amount! I’ve Gujarat Assembly elections ahead, I need the ca$h! Gang up the best tax-lawyers, study the judgement and File a review petition in Supreme Court again!

March 2012

Supreme court rejects the review petition.
Those Best Tax-lawyers demand lakhs of rupees as consultation fees from Government of India.
IT Commissioner (to self): Khaayaa piyaa kucchh nahi, glass fodaa…. (खाया पिया कुछ नहि, ग्लास फोड़ा..)

Budget 2012

Minister (announcing in Parliament): I propose an amendments in the Income Tax Act with retrospective effect from 1962 so that all persons, whether residents or non-residents, having business connection in India, will have to deduct tax at source and pay it to the government

even if the deal is executed on a foreign soil!
With this ‘move’, I’m trying to get around the court’s decision which said that
the government cannot tax a deal between two foreign entities, even if the transaction includes an Indian asset.
Our party has ‘history’ of trying to outsmart judiciary, whether it was Shah Bano case or 42nd Constitutional amendment or….
Random MP: (putting his i-pad aside) What does this “retrospective effect” mean?
Peon: Retrospective effect means if Government passes such law in 2012, still the past deals between companies made in 2007 can be taxed. Only Civil laws can be made with retrospective effect. But criminal laws cannot be made with retrospective effect.
Random MP: Elaborate
Peon: Criminal law cannot be made with retrospective effect, meaning if in 2012, Government passes a law that mobile phone thieves will get life time imprisonment, then only those thieves who’re caught in 2012, after the commencement of that law, will be jailed for lifetime.
But, If a thief stole the mobile phone in 2007, he cannot be given lifetime imprisonment, he has to be tried under the punishment provision that were in effect during that time. On same logic, people are still languishing in jail under TADA and POTA cases, even though those acts are scrapped now.
Random MP:That means I must hurry and do as much corruption as I can, before that Lokpal thing comes in effect, Whaat an idea Sir-ji.

Outside Parliament

Salman to Media: Right now we only know that it is a unanimous judgement that has gone against the revenue authorities… We have to examine. We obviously need revenue for the government’s important programmes.

Epigue

Anand: Just like the Govt insists on tax revenue, even when the supreme court dismissed their case,
we citizens need to insist that the revenue is spent wisely by the Govt on the welfare of its citizens.
The extra tax revenue that the govt would have got from Vodafone would not benefit any citizen.
Instead 90% of the money would find their way into the pockets of our politicians,
while the rest is frittered away as salaries for a burgeoning bureaucracy.

Demo Question for CSAT

Which of the following statements are true?

  • Capital Gains tax is a type of Indirect tax
  • There are three types of Capital Gains tax in India: Short term, Medium term and Long term.
  • Central Excise Department looks after collection of Capital Gains Tax
  • Direct Tax Code 2010, has no provisions about Capital Gains Tax.
[Economy] Vodafone Essar Case: Capital Gains Tax Meaning, Reasons, Timeline, Implications, explained




So far 195 Comments posted

  1. Sasikumar

    As simple as it can… Hats off to you Mrunal Ji… Decided to follow your website for my preparation…

  2. Shivam Shukla

    one can clearly see the research done and the hard work put in for this article, which is explained beautifully

  3. vipul

    In india capital gain tax applicable for shares of companies also. so is there any boundary line for volume of shares or if we mango people will by some share in low volume then also CGT is payable by us ??

  4. kapyS

    Mrunal bhai, one questio. In the latest Nokia-Microsoft deal case why are the It dept asking Nokia 21000 cr rather than microsoft as tax is deducted at source?

  5. yogender

    Thanx a tone mrunal sir…………plz explain why did govt asking tax from nokia(nikia-microsoft deal)rather to ask microsoft bcz=tax has deducted at source……….

  6. Prakhar

    Awesome explanation sir! The whole picture is quite clear now. U hv made all this very easy to understand with simple and witty language.
    best part ws.. Why this Kolaveri Di with me! I really burst out laughing that tym. Peon explaining the MP was also very funny
    Great work done!

  7. AAKASH

    Hey, KapYs,

    Your answer to this question is that Nokia has not sold its Chennai plant yet to Microsoft. Leaving that plant, every asset of Nokia is with microsoft. And the royalty demand is basically from the products of that particular plant. Nokia goes intelligent here,…

  8. Lusy

    Lovely article…really cleared a lot of concept…but pls explain that nokia-microsoft deal…actually didnt undersood by above answer by aakash…pls…

  9. mounika

    Thank you very much mrunal….. simplifying and captivating….like peeling the banana and feeding,we are all very grateful to you…such complicated issues became so easy….

  10. suhel

    Bhai mrunal mazaa aagya…what an explanation…right from the top drawer.You just get into each & every corner of the case.

    “””””SHEER BRILLIANCE “””””

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