The issue relates to transfer of shares of CGP, a Cayman Islands company, by the Hutchison Group to the Vodafone Group. CGP through intermediate companies and contractual arrangements held a controlling stake in Hutchison Essar Limited, an Indian company. Hutchison Essar Limited, now known as Vodafone Essar Limited, is a major player in the telecoms sector in India.

The Tax Authorities in India contended that the transaction relating to transfer of shares in CGP amounted to transfer of a capital asset situated in India. The Indian Tax Authorities asserted jurisdiction in respect of this transaction and held that Vodafone ought to have withheld taxes from the consideration payable. As Vodafone had failed to do so, Vodafone was liable to pay approximately USD 2 billion in taxes.

Vodafone challenged the order of the Indian Tax Authorities before the Bombay High Court. Vodafone contended that the Indian Tax Authorities had no jurisdiction to impose taxes over the CGP transaction, which was an offshore transaction between two non-resident entities. However, the Bombay High Court held in favour of the Indian Tax Authorities.

Supreme Court Decision

Vodafone challenged the decision of the High Court before the Supreme Court. The Supreme Court set aside the decision of the High Court and held that the transaction was not subject to tax in India.

The Court held that the situs of the shares of CGP was in the Cayman Islands and there was nothing to indicate that they were assets in India. One of the key issues to be determined by the Supreme Court was whether it would be possible to look through the Non-Indian holding structure to the Indian assets.

The Supreme Court held that the Indian Tax Authorities should not be allowed to pierce the corporate veil fleetingly, unless it can be shown that the transaction is a sham transaction whose purpose is to avoid tax. A transaction could be a sham transaction if it had no business purpose or if it lacked continuity. The current transaction was a legitimate business transaction. The holding structure existed for a considerable period of time, the business operations in India were carried on for a considerable period of time, there was continuity of business on exit and so there were very good reasons to conclude that this was a bona fide foreign direct investment into India.

The Supreme Court decision is a relief to investors making bona fide investments into India that are made through tax efficient jurisdictions. The Supreme Court noted, "FDI [Foreign Direct Investment] flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law. Certainty 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." However, it remains to be seen whether the Indian government will pass any legislation to reduce the effect of this judgment and enable the Indian Tax Authorities to tax certain offshore transactions.