News From Telecom World

Vodafone tax demand may crimp India M&A deals

Posted on: December 7, 2008

Financial experts say mobile operator’s $2 billion tax bill could deter foreign investors.

Vodafone Group PLC’s tax woes in India could have broader implications for other acquisitions in the country and possibly deter future deals as foreign investors grow wary of changing rules after the event.

India’s demand of a $2 billion tax from Vodafone several months after the British company bought a stake in a local cellphone company is bound to create uncertainty among investors, say experts.

“In general, an over aggressive tax administration will have a negative influence on an investment decision. Any body, which is perceived as creating new rules, makes it difficult (for investors) to assess what the profitability will be,” said Harry L.”Hank” Gutman, director, KPMG, tax governance institute, US.

“In the near term, we will see a deceleration in investments,” V.N. Srinivasa Rao, partner, tax and regulatory services, Ernst & Young, said.

Earlier this week, an Indian court dismissed a challenge from a unit of Vodafone Group, which is contesting demands that it pay capital-gains tax over its acquisition of Hutchison Essar from Hutchison Telecommunications International Ltd. for $11 billion. It first received the tax charge in late 2007, months after the deal was finalized in February the same year.

“We are disappointed that the court was unable to agree with Vodafone that the taxability or not of the transaction could be decided now,” Vodafone said in a statement after the court’s decision. It said it will appeal the decision.

Vodafone International Holdings BV, a Dutch company wholly owned by U.K.-based Vodafone Group, has long challenged Indian tax authorities’ jurisdiction to recover the tax, suggesting the deal between its Dutch unit and Hong Kong’s Hutchison Whampoa Ltd.’s Cayman Islands-registered vehicle isn’t liable to be taxed in India, as it took place on foreign soil.

The Indian income-tax department argues that Vodafone is liable to pay the tax, as the transaction involved the transfer of an Indian asset and Vodafone should have withheld tax on behalf of the Indian government.

“Attempts to expand jurisdiction beyond what is thought to be normal jurisdiction, is very troublesome,” KPMG’s Gutman said.

More cases likely under scrutiny
The ruling in the Vodafone tax case isn’t final as Vodafone has eight weeks to appeal. Experts predict it will take at least two years for the final word to beheard.If the Supreme Court upholds the High Court decision, then the tax department has to screen the financial details of the deal, and then arrive at a final tax liability. This will again be followed by a process of appeals and counter appeals.

“Vodafone, based on advice received, continues to believe that the transaction is not subject to tax in India and is confident of a positive outcome ultimately,” Vodafone has said.

Still, experts point out that companies will be wary that an M&A deal – which has received all necessary approvals – may come under financial scrutiny even at a later date with retrospective effect.

“It would definitely affect M&A deals – not only in telecom but also in other sectors,” Neha Gupta, senior research analyst at research firm Gartner Inc., said.

“If the Bombay High Court’s move comes through, those deals where there is offshore transfer of ownership of shares would now start attracting tax,” she added.

T.P. Ostwal, partner at Mumbai-based chartered accountancy firm TP Ostwal & Associates said that many cases such as Vedanta Resources’s $981 million buy of Sesa Goa Ltd. from Japan’s Mitsui & Co. Ltd. in 2007, private equity firms’ General Atlantic Partners and Oak Hill Capital Partners 60% buy into U.S.-listed but India-based Genpact from U.S.’s General Electric in 2004 could come under the scanner.

In fact, Business Standard daily Friday quoted Prakash Chandra, director general of international tax, Central Board of Direct Taxes, as saying:”This was a test case. There may be other similar cases that may have escaped scrutiny.”

He added that the tax body will now be issuing notices on over a dozen cases.

The final ruling, if it goes against Vodafone, would also mean that indirect controlling interest is also a capital asset, whose ownership transfers will attract tax liability in India, say legal experts.

This implies that all global deals, wherein the seller has any Indian unit, could also attract the attention of India tax authorities, a New Delhi based legal expert, who declined to be named, said.

“It will be an aspect that people will be worried about. It is a problem,” said Anand Prasad, partner at New Delhi-based legal firm, Trilegal.

Another fallout would be possible higher valuations for any deal, factoring in the tax implications, say experts.

“(Foreign) companies will be more cautious on what value they pay for. Companies will take that (taxation) into account when forging a deal. It will impact valuations,” Girish Trivedi, deputy director, telecom practice, Frost & Sullivan, South Asia and Middle East, said.

Ernst & Young’s Rao said that the perception of the Indian tax environment “is that it’s not good, or not easy. A case like this amplifies the negativity of the perception.”

Source: Total Telecom

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