Case Note:
S.H. Kapadia, C.J.I. and Swatanter Kumar, J. Direct Taxation - Capital gains - Revenue had
sought to tax the capital gains arising from the sale of the share capital of CGP on the
basis that CGP, whilst not a tax resident in India, holds the underlying Indian assets -
Whether the decision rendered in Union of India v. Azadi Bachao Andolan needs to be
overruled insofar as it departs from McDowell and Co. Ltd. v. CTO principle for the (a) Para
46 of McDowell judgment has been missed which reads as, "on this aspect Chinnappa
Reddy, J. Has proposed a separate opinion with which we agree" (i.e. Westminster
principle is dead) and (b) That, Azadi Bachao failed to read paras 41-45 and 46 of
McDowell in entirety. Held, the majority judgment in McDowell held that "tax planning
may be legitimate provided it is within the framework of law" (para 45). In the latter part
of para 45, it held that "colourable device cannot be a part of tax planning and it is wrong
to encourage the belief that it is honourable to avoid payment of tax by resorting to
dubious methods". It is the obligation of every citizen to pay the taxes without resorting
to subterfuges. The above observations should be read with para 46 where the majority
holds "on this aspect one of us, Chinnappa Reddy, J. has proposed a separate opinion with
which we agree". The words "this aspect" express the majority's agreement with the
judgment of Reddy, J. only in relation to tax evasion through the use of colourable devices
and by resorting to dubious methods and subterfuges. Thus, it cannot be said that all tax
planning is illegal/illegitimate/impermissible. Moreover, Reddy, J. himself stated that he
agrees with the majority. In the judgment of Reddy, J. there were repeated references to
schemes and devices in contradistinction to "legitimate avoidance of tax liability" (paras
7-10, 17 & 18). Although Chinnappa Reddy, J. made a number of observations regarding
the need to depart from the "Westminster" and tax avoidance, these were clearly only in
the context of artificial and colourable devices. It was held that while reading McDowell,
in cases of treaty shopping and/or tax avoidance, there was no conflict between McDowell
and Azadi Bachao or between McDowell and Mathuram Agrawal. Direct Taxation -
Determination of conclusive effect of a relationship between Holding Company andSubsidiary Company. Held, it was held as generally accepted that the group parent
company is involved in giving principal guidance to group companies by providing general
policy guidelines to group subsidiaries. However, the fact that a parent company exercises
shareholder's influence on its subsidiaries does not generally imply that the subsidiaries
are to be deemed residents of the State in which the parent company resides. Further, if
a company is a parent company, that company's executive director(s) should lead the
group and the company's shareholder's influence will generally be employed to that end.
This obviously implies a restriction on the autonomy of the subsidiary's executive
directors. Such a restriction, which is the inevitable consequences of any group structure,
is generally accepted, both in corporate and tax laws. However, where the subsidiary's
executive directors' competences are transferred to other persons/bodies or where the
subsidiary's executive directors' decision making has become fully subordinate to the
Holding Company with the consequence that the subsidiary's executive directors are no
more than puppets then the turning point in respect of the subsidiary's place of residence
comes about. Similarly, if an actual controlling Non-Resident Enterprise (NRE) makes an
indirect transfer through "abuse of organisation form/legal form and without reasonable
business purpose" which results in tax avoidance or avoidance of withholding tax, then
the Revenue may disregard the form of the arrangement or the impugned action through
use of Non-Resident Holding Company, recharacterise the equity transfer according to its
economic substance and impose the tax on the actual controlling Non-Resident Enterprise.
Thus, whether a transaction is used principally as a colourable device for the distribution
of earnings, profits and gains, is determined by a review of all the facts and circumstances
surrounding the transaction. It is in the above cases that the principle of lifting the
corporate veil or the doctrine of substance over form or the concept of beneficial
ownership or the concept of alter ego arises. There are many circumstances, apart from
the one given above, where separate existence of different companies, that are part of
the same group, will be totally or partly ignored as a device or a conduit (in the pejorative
sense). The common law jurisdictions do invariably impose taxation against a corporation
based on the legal principle that the corporation is "a person" that is separate from its
members. It is the decision of the House of Lords in Salomon v. Salomon that opened the
door to the formation of a corporate group. If a "one man" corporation could be
incorporated, then it would follow that one corporation could be a subsidiary of another.
This legal principle is the basis of Holding Structures. It is a common practice in
international law, which is the basis of international taxation, for foreign investors to
invest in Indian companies through an interposed foreign holding or operating company,
such as Cayman Islands or Mauritius based company for both tax and business purposes.
In doing so, foreign investors are able to avoid the lengthy approval and registration
processes required for a direct transfer (i.e. without a foreign holding or operating
company) of an equity interest in a foreign invested Indian company. However, taxation
of such Holding Structures very often gives rise to issues such as double taxation, tax
deferrals and tax avoidance. In this case, we are concerned with the concept of GAAR. In
this case, we are not concerned with treaty shopping but with the anti-avoidance rules.
The concept of GAAR is not new to India since India already has a judicial anti-avoidance
rule, like some other jurisdictions. Lack of clarity and absence of appropriate provisions
in the statute and/or in the treaty regarding the circumstances in which judicial antiavoidance rules would apply has generated litigation in India. Holding Structures are
recognized in corporate as well as tax laws. Special Purpose Vehicles (SPVs) and Holding
Companies have a place in legal structures in India, be it in company law, takeover code
under SEBI or even under the income tax law. When it comes to taxation of a Holding
Structure, at the threshold, the burden is on the Revenue to allege and establish abuse,
in the sense of tax avoidance in the creation and/or use of such structure(s). In the
application of a judicial anti-avoidance rule, the Revenue may invoke the "substance over
form" principle or "piercing the corporate veil" test only after it is able to establish on the
basis of the facts and circumstances surrounding the transaction that the impugned
transaction is a sham or tax avoidant. To give an example, if a structure is used for circular
trading or round tripping or to pay bribes then such transactions, though having a legal
form, should be discarded by applying the test of fiscal nullity. Similarly, in a case where
the Revenue finds that in a Holding Structure an entity which has no commercial/business
substance has been interposed only to avoid tax then in such cases applying the test of
fiscal nullity it would be open to the Revenue to discard such interpositioning of that
entity. However, this has to be done at the threshold. In this connection, we may reiterate
the "look at" principle enunciated in Ramsay in which it was held that the Revenue or the
Court must look at a document or a transaction in a context to which it properly belongsto. It is the task of the Revenue/Court to ascertain the legal nature of the transaction and
while doing so it has to look at the entire transaction as a whole and not to adopt a
dissecting approach. The Revenue cannot start with the question as to whether the
impugned transaction is a tax deferment/saving device but that it should apply the "look
at" test to ascertain its true legal nature (Craven v. White which further observed that
genuine strategic tax planning has not been abandoned by any decision of the English
Courts till date). Applying the above tests, every strategic foreign direct investment
coming to India, as an investment destination, should be seen in a holistic manner. While
doing so, the Revenue/Courts should keep in mind the following factors: the concept of
participation in investment, the duration of time during which the Holding Structure
exists; the period of business operations in India; the generation of taxable revenues in
India; the timing of the exit; the continuity of business on such exit. The onus will be on
the Revenue to identify the scheme and its dominant purpose. The corporate business
purpose of a transaction is evidence of the fact that the impugned transaction is not
undertaken as a colourable or artificial device. The stronger the evidence of a device, the
stronger the corporate business purpose must exist to overcome the evidence of a device.
Direct Taxation - Whether the approach of the High Court (acquisition of CGP share with
"other rights and entitlements") was correct? Held, it was stated that the subject matter
of the transaction has to be viewed from a commercial and realistic perspective. The
present case concerns an offshore transaction involving a structured investment. This
case concerns "a share sale" and not an asset sale. It concerns sale of an entire
investment. A "sale" may take various forms. Accordingly, tax consequences will vary.
The tax consequences of a share sale would be different from the tax consequences of an
asset sale. A slump sale would involve tax consequences which could be different from
the tax consequences of sale of assets on itemised basis. "Control" is a mixed question of
law and fact. Ownership of shares may, in certain situations, result in the assumption of
an interest which has the character of a controlling interest in the management of the
company. A controlling interest is an incident of ownership of shares in a company,
something which flows out of the holding of shares. A controlling interest is, therefore,
not an identifiable or distinct capital asset independent of the holding of shares. The
control of a company resides in the voting power of its shareholders and shares represent
an interest of a shareholder which is made up of various rights contained in the contract
embedded in the Articles of Association. The right of a shareholder may assume the
character of a controlling interest where the extent of the shareholding enables the
shareholder to control the management. Shares, and the rights which emanate from them,
flow together and cannot be dissected. In the felicitous phrase of Lord MacMillan in IRC
v. Crossman, shares in a company consist of a "congeries of rights and liabilities" which
is a creature of the Companies Acts and the Memorandum and Articles of Association of
the company. Thus, control and management is a facet of the holding of shares. Applying
the above principles governing shares and the rights of the shareholders to the facts of
this case, this case concerns a straightforward share sale. VIH acquired Upstream shares
with the intention that the congeries of rights, flowing from the CGP share, would give
VIH an indirect control over the three genres of companies. If one looks at the chart
indicating the Ownership Structure, one finds that the acquisition of the CGP share gave
VIH an indirect control over the tier I Mauritius companies which owned shares in HEL
totalling to 42.34 per cent; CGP India (Ms), which in turn held shares in TII and Omega
and which on a pro rata basis (the FDI principle), totalled up to 9.62 per cent in HEL and
an indirect control over Hutchison Tele Services (India) Holdings Ltd. (Ms), which in turn
owned shares in GSPL, which held call and put options. Although the High Court has
analysed the transactional documents in detail, it has missed out this aspect of the case.
It has failed to notice that till date options have remained un-encashed with GSPL.
Therefore, even if it be assumed that the options under the Framework Agreements 2006
could be considered to be property rights, there has been no transfer or assignment of
options by GSPL till today. Even if it be assumed that the High Court was right in holding
that the options constituted capital assets even then Section 9(1)(i) was not applicable
as these options have not been transferred till date. Call and put options were not
transferred vide SPA dated 11th February, 2007 or under any other document whatsoever.
Moreover, if, on principle, the High Court accepts that the transfer of the CGP share did
not lead to the transfer of a capital asset in India, even if it resulted in a transfer of indirect
control over 42.34 per cent (52 per cent) of shares in HEL, then surely the transfer of
indirect control over GSPL which held options (contractual rights), would not make the
transfer of the CGP share taxable in India. Acquisition of the CGP share which gave VIH
an indirect control over three genres of companies evidences a straightforward share saleand not an asset sale. There is another fallacy in the impugned judgment. On examination
of the impugned judgment, we find a serious error committed by the High Court in
appreciating the case of VIH before FIPB. On 19th March, 2007, FIPB sought a clarification
from VIH of the circumstances in which VIH agreed to pay US$ 11.08 bn for acquiring 67
per cent of HEL when actual acquisition was of 51.96 per cent. In its response dated 19th
March, 2007, VIH stated that it had agreed to acquire from HTIL for US$ 11.08 bn, interest
in HEL which included a 52 per cent equity shareholding. According to VIH, the price also
included a control premium, use of Hutch brand in India, a non-compete agreement, loan
obligations and an entitlement to acquire, subject to the Indian FDI rules, a further 15 per
cent indirect interest in HEL. According to the said letter, the above elements together
equated to 67 per cent of the economic value of HEL. This sentence has been misconstrued
by the High Court to say that the above elements equated to 67 per cent of the equity
capital (See para 124). 67 per cent of the economic value of HEL is not 67 per cent of the
equity capital. If VIH would have acquired 67 per cent of the equity capital, as held by the
High Court, the entire investment would have had breached the FDI norms which had
imposed a sectoral cap of 74 per cent . In this connection, it may further be stated that
Essar had 33 per cent stakes in HEL out of which 22 per cent was held by Essar Mauritius.
Thus, VIH did not acquire 67 per cent of the equity capital of HEL, as held by the High
Court. This problem has arisen also because of the reason that this case deals with share
sale and not asset sale. This case does not involve sale of assets on itemised basis. The
High Court ought to have applied the look at test in which the entire Hutchison structure,
as it existed, ought to have been looked at holistically. This case concerns investment into
India by a holding company (parent company), HTIL through a maze of subsidiaries. When
one applies the "nature and character of the transaction test", confusion arises if a
dissecting approach of examining each individual asset is adopted. As stated, CGP was
treated in the Hutchison structure as an investment vehicle. As a general rule, in a case
where a transaction involves transfer of shares lock, stock and barrel, such a transaction
cannot be broken up into separate individual components, assets or rights such as right
to vote, right to participate in company meetings, management rights, controlling rights,
control premium, brand licences and so on as shares constitute a bundle of rights. Further,
the High Court failed to examine the nature of the following items, namely, noncompete
agreement, control premium, call and put options, consultancy support, customer base,
brand licences etc. On facts, the High Court, in the present case, ought to have examined
the entire transaction holistically. VIH has rightly contended that the transaction in
question should be looked at as an entire package. The items mentioned hereinabove,
like, control premium, non-compete agreement, consultancy support, customer base,
brand licences, operating licences etc. were all an integral part of the Holding Subsidiary
Structure which existed for almost 13 years, generating huge revenues, as indicated
above. Merely because at the time of exit capital gains tax becomes not payable or exigible
to tax would not make the entire "share sale" (investment) a sham or a tax avoidant. The
High Court failed to appreciate that the payment of US$ 11.08 bn was for purchase of the
entire investment made by HTIL in India. The payment was for the entire package. The
parties to the transaction have not agreed upon a separate price for the CGP share and
for what the High Court calls as "other rights and entitlements" (including options, right
to non-compete, control premium, customer base etc.). Thus, it was not open to the
Revenue to split the payment and consider a part of such payments for each of the above
items. The essential character of the transaction as an alienation cannot be altered by the
form of the consideration, the payment of the consideration in installments or on the basis
that the payment is related to a contingency ("options", in this case), particularly when
the transaction does not contemplate such a split up. Where the parties have agreed for
a lump sum consideration without placing separate values for each of the above items
which go to make up the entire investment in participation, merely because certain values
are indicated in the correspondence with FIPB which had raised the query, would not
mean that the parties had agreed for the price payable for each of the above items. The
transaction remained a contract of outright sale of the entire investment for a lump sum
consideration (see: Commentary on Model Tax Convention on Income and Capital dated
28th January, 2003 as also the judgment of this Court in the case of CIT (Central), Calcutta
v. Mugneeram Bangur and Company (Land Deptt.). Thus, it is necessary to "look at" the
entire Ownership Structure set up by Hutchison as a single consolidated bargain and
interpret the transactional documents, while examining the Offshore Transaction of the
nature involved in this case, in that light. Direct Taxation - Whether Section 9 of the
Income Tax Act, 1961 is a "look through" provision as submitted on behalf of the
Revenue? Held, Section 9(1)(i) gathers in one place various types of income and directs that income falling under each of the sub clauses shall be deemed to accrue or arise in
India. Broadly there are four items of income. The income dealt with in each sub clause is
distinct and independent of the other and the requirements to bring income within each
sub-clause, are separately noted. Hence, it is not necessary that income falling in one
category under any one of the sub-clauses should also satisfy the requirements of the
other sub-clauses to bring it within the expression "income deemed to accrue or arise in
India" in Section 9(1)(i). In this case, the concerned provision is last sub-clause of Section
9(1)(i) which refers to income arising from "transfer of a capital asset situate in India".
Thus, charge on capital gains arises on transfer of a capital asset situate in India during
the previous year. The said sub-clause consists of three elements, namely, transfer,
existence of a capital asset, and situation of such asset in India. All three elements should
exist in order to make the last sub-clause applicable. Therefore, if such a transfer does
not exist in the previous year no charge is attracted. Further, Section 45 enacts that such
income shall be deemed to be the income of the previous year in which transfer took place.
Consequently, there is no room for doubt that such transfer should exist during the
previous year in order to attract the said sub clause. The fiction created by Section 9(1)(i)
applies to the assessment of income of non residents. In the case of a resident, it is
immaterial whether the place of accrual of income is within India or outside India, since,
in either event, he is liable to be charged to tax on such income. But, in the case of a nonresident, unless the place of accrual of income is within India, he cannot be subjected to
tax. In other words, if any income accrues or arises to a non resident, directly or indirectly,
outside India is fictionally deemed to accrue or arise in India if such income accrues or
arises as a sequel to the transfer of a capital asset situate in India. Once the factum of
such transfer is established by the Department, then the income of the non-resident
arising or accruing from such transfer is made liable to be taxed by reason of Section
5(2)(b) of the Act. This fiction comes into play only when the income is not charged to tax
on the basis of receipt in India, as receipt of income in India by itself attracts tax whether
the recipient is a resident or non resident. This fiction is brought in by the legislature to
avoid any possible argument on the part of the non-resident vendor that profit accrued or
arose outside India by reason of the contract to sell having been executed outside India.
Thus, income accruing or arising to a non-resident outside India on transfer of a capital
asset situate in India is fictionally deemed to accrue or arise in India, which income is
made liable to be taxed by reason of Section 5(2)(b) of the Act. This is the main purpose
behind enactment of Section 9(1)(i) of the Act. Necessity is to give effect to the language
of the section when it is unambiguous and admits of no doubt regarding its interpretation,
particularly when a legal fiction is embedded in that section. A legal fiction has a limited
scope. A legal fiction cannot be expanded by giving purposive interpretation particularly
if the result of such interpretation is to transform the concept of chargeability which is
also there in Section 9(1)(i), particularly when one reads Section 9(1)(i) with Section
5(2) (b) of the Act. What is contended on behalf of the Revenue is that under Section
9(1)(i) it can "look through" the transfer of shares of a foreign company holding shares
in an Indian company and treat the transfer of shares of the foreign company as
equivalent to the transfer of the shares of the Indian company on the premise that Section
9(1)(i) covers direct and indirect transfers of capital assets. For the above reasons,
Section 9(1)(i) cannot by a process of interpretation be extended to cover indirect
transfers of capital assets/property situate in India. To do so, would amount to changing
the content and ambit of Section 9(1)(i). Section 9(1)(i) cannot be re-written. The
legislature has not used the words indirect transfer in Section 9(1)(i). If the word indirect
is read into Section 9(1)(i), it would render the express statutory requirement of the 4th
sub-clause in Section 9(1)(i) nugatory. This is because Section 9(1)(i) applies to transfers
of a capital asset situate in India. This is one of the elements in the 4th sub-clause of
Section 9(1)(i) and if indirect transfer of a capital asset is read into Section 9(1)(i) then
the words capital asset situate in India would be rendered nugatory. Similarly, the words
underlying asset do not find place in Section 9(1)(i). Further, "transfer" should be of an
asset in respect of which it is possible to compute a capital gain in accordance with the
provisions of the Act. Moreover, even Section 163(1)(c) is wide enough to cover the
income whether received directly or indirectly. Thus, the words directly or indirectly in
Section 9(1)(i) go with the income and not with the transfer of a capital asset (property).
Lastly, it may be mentioned that the Direct Tax Code (DTC) Bill, 2010 proposes to tax
income from transfer of shares of a foreign company by a non-resident, where at any time
during 12 months preceding the transfer, the fair market value of the assets in India,
owned directly or indirectly, by the company, represents at least 50 per cent of the fair
market value of all assets owned by the company. Thus, the DTC Bill, 2010 proposes taxation of offshore share transactions. This proposal indicates in a way that indirect
transfers are not covered by the existing Section 9(1)(i) of the Act. In fact, the DTC Bill,
2009 expressly stated that income accruing even from indirect transfer of a capital asset
situate in India would be deemed to accrue in India. These proposals, therefore, show
that in the existing Section 9(1)(i) the word indirect cannot be read on the basis of
purposive construction. The question of providing "look through" in the statute or in the
treaty is a matter of policy. It is to be expressly provided for in the statute or in the treaty.
Similarly, limitation of benefits has to be expressly provided for in the treaty. Such clauses
cannot be read into the Section by interpretation. For the foregoing reasons, Section
9(1)(i) held to be as not a "look through" provision. Direct Taxation - Issue of Situs of the
CGP Share - Determination thereof. Held, according to the Revenue, under the Companies
Law of Cayman Islands, an exempted company was not entitled to conduct business in
the Cayman Islands. CGP was an "exempted company". According to the Revenue, since
CGP was a mere holding company and since it could not conduct business in Cayman
Islands, the situs of the CGP share existed where the "underlying assets are situated",
that is to say, India. That, since CGP as an exempted company conducts no business either
in the Cayman Islands or elsewhere and since its sole purpose is to hold shares in a
subsidiary company situated outside the Cayman Islands, the situs of the CGP share, in
the present case, existed "where the underlying assets stood situated" (India). No merits
in the arguments were found to be present. Be that as it may, under the Indian Companies
Act, 1956, the situs of the shares would be where the company is incorporated and where
its shares can be transferred. In the present case, it has been asserted by VIH that the
transfer of the CGP share was recorded in the Cayman Islands, where the register of
members of the CGP is maintained. This assertion was neither rebutted in the impugned
order of the Department dated 31st May, 2010 nor traversed in the pleadings filed by the
Revenue nor controverted in the current proceedings. In the circumstances, it the
arguments of the Revenue that the situs of the CGP share was situated in the place (India)
where the underlying assets stood situated held to be not acceptable. K.S. Radhakrishnan,
J. Direct Taxation - Correctness of decision as laid down in the Azadi Bachao case. Held,
Justice Chinnappa Reddy had started his concurring judgment in McDowell by mentioning
that, "While I entirely agree with my brother Ranganath Mishra, J. in the judgment
proposed to be delivered by me, I wish to add a few paragraphs, particularly to
supplement what he has said on the "fashionable" topic of tax avoidance." The quoted
portion showed that he entirely agreed with Justice Mishra and has stated that he is only
supplementing what Justice Mishra has spoken on tax avoidance. Justice Reddy, while
agreeing with Justice Mishra and the other three judges, has opined that in the very
country of its birth, the principle of Westminster has been given a decent burial and in
that country where the phrase "tax avoidance" originated the judicial attitude towards
tax avoidance has changed and the Courts are now concerning themselves not merely
with the genuineness of a transaction, but with the intended effect of it for fiscal purposes.
Justice Reddy also opined that no one can get away with the tax avoidance project with
the mere statement that there is nothing illegal about it. Justice Reddy has also opined
that the ghost of Westminster (in the words of Lord Roskill) has been exercised in
England. What transpired in England is not the ratio of McDowell and cannot be and
remains merely an opinion or view. The confusion had arose (see Paragraph 46 of the
judgment) when Justice Mishra has stated after referring to the concept of tax planning
as, "On this aspect, one of us Chinnappa Reddy, J. Has proposed a separate and detailed
opinion with which we agree." Since, Justice Reddy, himself has stated that he is entirely
agreeing with Justice Mishra and has only supplemented what Justice Mishra has stated
on Tax Avoidance, therefore, one has to go by what Justice Mishra has spoken on tax
avoidance. Justice Reddy has depreciated the practice of setting up of Tax Avoidance
Projects rightly because the same is/was the situation in England and Ramsay and other
judgments had depreciated the Tax Avoidance Schemes. The ratio of the judgment is what
is spoken by Justice Mishra for himself and on behalf of three other judges, on which
Justice Reddy has agreed. Justice Reddy has clearly stated that he is only supplementing
what Justice Mishra has said on Tax avoidance. Justice Reddy has endorsed the view of
Lord Roskill that the ghost of Westminster had been exorcised in England and that one
should not allow its head rear over India. If one scans through the various judgments of
the House of Lords in England, one thing is clear that it has been a cornerstone of law,
that a tax payer is enabled to arrange his affairs so as to reduce the liability of tax and
the fact that the motive for a transaction is to avoid tax does not invalidate it unless a
particular enactment so provides (Westminster Principle). Needless to say if the
arrangement is to be effective, it is essential that the transaction has some economic or commercial substance. Lord Roskill's view is not seen as the correct view so also Justice
Reddy's. A five Judges Bench judgment of this Court in Mathuram Agrawal v. State of
Madhya Pradesh after referring to the judgment in B.C. Kharwar as well as the opinion
expressed by Lord Roskill on Duke of Westminster stated that the subject is not to be
taxed by inference or analogy, but only by the plain words of a statute applicable to the
facts and circumstances of each case. Revenue cannot tax a subject without a statute to
support and in the course we also acknowledge that every tax payer is entitled to arrange
his affairs so that his taxes shall be as low as possible and that he is not bound to choose
that pattern which will replenish the treasury. Revenue's stand that the ratio laid down in
McDowell is contrary to what has been laid down in Azadi Bachao Andolan, accordingly
held to be unsustainable and, therefore, called for no reconsideration by a larger branch.
Direct Taxation - Determination of conclusive effect of a relationship between Holding
Company and Subsidiary Company. Held, the subsidiary companies are the integral part
of corporate structure. Activities of the companies over the years have grown enormously
of its incorporation and outside and their structures have become more complex. Multi
National Companies having large volume of business nationally or internationally will
have to depend upon their subsidiary companies in the national and international level for
better returns for the investors and for the growth of the company. When a holding
company owns all of the voting stock of another company, the company is said to be a
WOS of the parent company. Holding companies and their subsidiaries can create
pyramids, whereby subsidiary owns a controlling interest in another company, thus
becoming its parent company. Legal relationship between a holding company and WOS is
that they are two distinct legal persons and the holding company does not own the assets
of the subsidiary and, in law, the management of the business of the subsidiary also vests
in its Board of Directors. In Bacha F. Guzdar v. CIT, it was held that shareholders' only
rights is to get dividend if and when the company declares it, to participate in the
liquidation proceeds and to vote at the shareholders' meeting. Holding company, if the
subsidiary is a WOS, may appoint or remove any director if it so desires by a resolution in
the General Body Meeting of the subsidiary. Holding companies and subsidiaries can be
considered as single economic entity and consolidated balance sheet is the accounting
relationship between the holding company and subsidiary company, which shows the
status of the entire business enterprises. Shares of stock in the subsidiary company are
held as assets on the books of the parent company and can be issued as collateral for
additional debt financing. Holding company and subsidiary company are, however,
considered as separate legal entities, and subsidiary are allowed decentralised
management. Each subsidiary can reform its own management personnel and holding
company may also provide expert, efficient and competent services for the benefit of the
subsidiaries. The U.S. Supreme Court in United States v. Bestfoods had explained that it
is a general principle of corporate law and legal systems that a parent corporation is not
liable for the acts of its subsidiary, but the Court went on to explain that corporate veil
can be pierced and the parent company can be held liable for the conduct of its subsidiary,
if the corporal form is misused to accomplish certain wrongful purposes, when the parent
company is directly a participant in the wrong complained of. Mere ownership, parental
control, management etc. of a subsidiary is not sufficient to pierce the status of their
relationship and, to hold parent company liable. In Adams v. Cape Industries Plc., the
Court of Appeal emphasized that it is appropriate to pierce the corporate veil where
special circumstances exist indicating that it is mere fao?=ade concealing true facts.
Courts, however, will not allow the separate corporate entities to be used as a means to
carry out fraud or to evade tax. Parent company of a WOS, is not responsible, legally for
the unlawful activities of the subsidiary save in exceptional circumstances, such as a
company is a sham or the agent of the shareholder, the parent company is regarded as a
shareholder. Multi-National Companies, by setting up complex vertical pyramid like
structures, would be able to distance themselves and separate the parent from operating
companies, thereby protecting the multinational companies from legal liabilities. Direct
Taxation - Whether the approach of the High Court (acquisition of CGP share with "other
rights and entitlements") was correct? Held, the High Court has reiterated the common
law principle that the controlling interest is an incident of the ownership of the share of
the company, something which flows out of holding of shares and, therefore, not an
identifiable or distinct capital asset independent of the holding of shares, but at the same
time speaks of change in the controlling interest of VEL, without there being any transfer
of shares of VEL. Further, the High Court failed to note on transfer of CGP share, there
was only transfer of certain off-shore loan transactions which is unconnected with
underlying controlling interest in the Indian Operating Companies. The other rightsinterests and entitlements continue to remain with Indian Operating Companies and there
is nothing to show they stood transferred in law. The High Court has ignored the vital fact
that as far as the put options are concerned there were pre-existing agreements between
the beneficiaries and counter parties and fresh agreements were also on similar lines.
Further, the High Court has ignored the fact that Term Sheet Agreement with Essar had
nothing to do with the transfer of CGP, which was a separate transaction which came
about on account of independent settlement between Essar and Hutch Group, for a
separate consideration, unrelated to the consideration of CGP share. The High Court
committed an error in holding that there were some rights vested in HTIL under SHA dated
5th July, 2003 which is also an agreement, conferring no right to any party and
accordingly none could have been transferred. The High Court had also committed an error
in holding that some rights vested with HTIL under the agreement dated 1st August, 2006,
in fact, that agreement conferred right on Hutichison Telecommunication (India) Ltd.,
which is a Mauritian Company and not HTIL, the vendor of SPA. The High Court has also
ignored the vital fact that FIPB had elaborately examined the nature of call and put option
agreement rights and found no right in presenti has been transferred to Vodafone and
that as and when rights are to be transferred by AG and AS Group Companies, it would
specifically require Government permission since such a sale would attract capital gains,
and may be independently taxable. Direct Taxation - Whether Section 9 of the Income Tax
Act, 1961 is a "look through" provision as submitted on behalf of the Revenue? Held,
Section 9(1)(i) covers only income arising or accruing directly or indirectly or through the
transfer of a capital asset situated in India. Section 9(1)(i) cannot by a process of
"interpretation" or "construction" be extended to cover "indirect transfers" of capital
assets/property situate in India. On transfer of shares of a foreign company to a nonresident off-shore, there is no transfer of shares of the Indian Company, though held by
the foreign company, in such a case it cannot be contended that the transfer of shares of
the foreign holding company, results in an extinguishment of the foreign company control
of the Indian company and it also does not constitute an extinguishment and transfer of
an asset situate in India. Transfer of the foreign holding company's share off-shore,
cannot result in an extinguishment of the holding company right of control of the Indian
company nor can it be stated that the same constitutes extinguishment and transfer of an
asset/ management and control of property situated in India. The Legislature wherever
wanted to tax income which arises indirectly from the assets, the same has been
specifically provided so. For example, reference may be made to Section 64 of the Indian
Income Tax Act, which says that in computing the total income of an individual, there
shall be included all such income as arises directly or indirectly: to the son's wife, of such
individual, from assets transferred directly or indirectly on and after 1st June, 1973 to the
son's wife by such individual otherwise than for adequate consideration. The same was
noticed by this Court in CIT v. Kothari (CM). Similar expression like "from asset
transferred directly or indirectly", is available in Sections 64(7) and (8) as well. On a
comparison of Section 64 and Section 9(1)(i) what is discernible is that the Legislature
has not chosen to extend Section 9(1)(i) to "indirect transfers". Wherever "indirect
transfers" are intended to be covered, the Legislature has expressly provided so. The
words "either directly or indirectly", textually or contextually, cannot be construed to
govern the words that follow, but must govern the words that precede them, namely the
words "all income accruing or arising". The words "directly or indirectly" occurring in
Section 9, therefore, relate to the relationship and connection between a non-resident
assessee and the income and these words cannot and do not govern the relationship
between the transaction that gave rise to income and the territory that seeks to tax the
income. In other words, when an assessee is sought to be taxed in relation to an income,
it must be on the basis that it arises to that assessee directly or it may arise to the
assessee indirectly. In other words, for imposing tax, it must be shown that there is
specific nexus between earning of the income and the territory which seeks to lay tax on
that income. Reference may also be made to the judgment of this Court in IshikawajmaHarima Heavy Industries Ltd. v. Director of Income Tax, Mumbai and CIT v. R.D. Aggarwal.
Section 9 has no "look through provision" and such a provision cannot be brought through
construction or interpretation of a word 'through' in Section 9. In any view, "look through
provision" will not shift the situs of an asset from one country to another. Shifting of situs
can be done only by express legislation. Federal Commission of Taxation v. Lamesa
Holdings BV (LN) gives an insight as to how "look through" provisions are enacted.
Section 9, thus, has no inbuilt "look through mechanism". Direct Taxation - Issue of Situs
of the CGP Share - Determination thereof. Held, situs of shares situates at the place where
the company is incorporated and/ or the place where the share can be dealt with by wayof transfer. CGP share is registered in Cayman Island and materials placed before us
would indicate that Cayman Island law, unlike other laws does not recognise the
multiplicity of registers. Section 184 of the Cayman Island Act provides that the company
may be exempt if it gives to the Registrar, a declaration that "operation of an exempted
company will be conducted mainly outside the Island". Section 193 of the Cayman Island
Act expressly recognises that even exempted companies may, to a limited extent trade
within the Islands. Section 193 permits activities by way of trading which are incidental
of off shore operations also all rights to enter into the contract etc. The facts in this case
as well as the provisions of the Caymen Island Act would clearly indicate that the CGP
(CI) share situates in Caymen Island. The legal principle on which situs of an asset, such
as share of the company is determined, is well settled. Reference may be made to the
judgments in Brassard v. Smith, London and South American Investment Trust v. British
Tobacco Co. (Australia). Erie Beach Co. v. Attorney-General for Ontario, R. v. Williams
[1942] AC 541. Situs of CGP share, therefore, situates in Cayman Islands and on transfer
in Cayman Islands would not shift to India. Direct Taxation - Shareholders' Agreement -
Meaning and scope vis-a-vis the view taken in the case of V. B. Rangaraj v. V. B.
Gopalakrishnan and Ors. Held, Shareholders' Agreement (SHA) is essentially a contract
between some or all other shareholders in a company, the purpose of which is to confer
rights and impose obligations over and above those provided by the Company Law. SHA
is a private contract between the shareholders compared to Articles of Association of the
Company, which is a public document. Being a private document it binds parties thereof
and not the other remaining shareholders in the company. Advantage of SHA is that it
gives greater flexibility, unlike Articles of Association. It also makes provisions for
resolution of any dispute between the shareholders and also how the future capital
contributions have to be made. Provisions of the SHA may also go contrary to the
provisions of the Articles of Association, in that event, naturally provisions of the Articles
of Association would govern and not the provisions made in the SHA. The nature of SHA
was considered by a two Judges Bench of the Apex Court in V. B. Rangaraj v. V. B.
Gopalakrishnan and Ors. In that case, an agreement was entered into between
shareholders of a private company wherein a restriction was imposed on a living member
of the company to transfer his shares only to a member of his own branch of the family,
such restrictions were, however, not envisaged or provided for within the Articles of
Association. This Court has taken the view that provisions of the Shareholders' Agreement
imposing restrictions even when consistent with Company legislation, are to be
authorised only when they are incorporated in the Articles of Association, a view we do
not subscribe. This Court in Gherulal Parekh v. Mahadeo Das Maiya held that freedom of
contract can be restricted by law only in cases where it is for some good for the
community. Companies Act 1956 or the FERA 1973, RBI Regulation or the I.T. Act do not
explicitly or impliedly forbid shareholders of a company to enter into agreements as to
how they should exercise voting rights attached to their shares. Shareholders can enter
into any agreement in the best interest of the company, but the only thing is that the
provisions in the SHA shall not go contrary to the Articles of Association. The essential
purpose of the SHA is to make provisions for proper and effective internal management
of the company. It can visualise the best interest of the company on diverse issues and
can also find different ways not only for the best interest of the shareholders, but also for
the company as a whole. In S. P. Jain v. Kalinga Cables Ltd., the Apex Court held that
agreements between non-members and members of the Company will not bind the
company, but there is nothing unlawful in entering into agreement for transferring of
shares. Of course, the manner in which such agreements are to be enforced in the case of
breach is given in the general law between the company and the shareholders. A breach
of SHA which does not breach the Articles of Association is a valid corporate action but,
as we have already indicated, the parties aggrieved can get remedies under the general
law of the land for any breach of that agreement.,