Vodafone's $2 Billion Indian Tax Battle Rumbles On

­India's Income Tax department has issued a notice to Vodafone asking it to explain why the company feels that the Tax Department does not have the necessary jurisdiction to proceed with its tax liability claim against it. The tax liability relates to the US$11.2 billion purchase of Hutchison Essar in 2007.

The notice was 531 pages in length, along with a 1901 page supplement. Vodafone has until 16th November to respond.

The Indian government has argued that although the transaction took place via subsidiaries in Mauritius, as the bulk of the assets were within India, then taxes should be paid to the Indian government. In addition, under Indian law, it is the buyer of assets who pays taxes, not the seller.

Vodafone International Holdings BV, a company registered in the Netherlands, acquired the entire share capital of CGP Investments (Holdings) Ltd, a Cayman Islands based company from Hutchison International (HTIL). CGP, itself, owns 52 per cent stakes in Hutchison India.

Vodafone Essar has argued that Vodafone Holdings , CGP Investments as well as HTIL are foreign companies and as the transaction was structured through Mauritius, capital gains cannot have been accumulated within India. Also India and Mauritius have a double taxation avoidance treaty, so it would not be possible for India to apply capital gains tax on transactions that are already taxed within Mauritius.

Last December, the Bombay High Court dismissed Vodafone's argument that it shouldn't be held liable, but Vodafone appealed has that decision.

In June this year, Hutchison Telecom International accepted that it might have to make some payments in regards to the ongoing tax dispute. In an SEC filing, Hutchison said that it had received legal advice and believes that the sale is not taxable in India, and therefore, no Indian tax is payable by the firm. For that reason, the company has not set aside any liabilities in its accounts for a possible tax bill.

However, Hutchison also said that there can be no assurance what the final outcome will be, and if it eventually has to make any such payments or suffer any Indian tax on this sale, it may have a material adverse effect on the company's financial position and results of operations.

The tax liability is around US$2 billion, although there is a potential US$4 billion impact if the company loses the appeal - as the government is entitled to demand to levy a penalty which can result in a doubling of the outstanding tax demand.

As part of the transaction with Hutchison Telecom, Vodafone was able to set aside US$352 million of the payment against any further liabilities, but that is dwarfed by the potential tax bill.

Posted to the site on 1st November 2009