Capital gains tax on sale of offshore companies
Capital gains tax on sale of offshore companies
In one of my dreams, I was Bill Gates. I owned cars,
diamond mines, plantations in France and dozens of profitable foreign and
Philippine companies. Of course, all of my assets were indirectly held through
several layers of offshore companies in tax haven countries. As remnants of my
consciousness surfaced, I tried to do as much tax planning as I could, even in
my dreams. I was content, sipping coconut juice, lounging in my private island,
dreaming that should I one day decide to sell one of my offshore companies, I
would not be subject to tax in the Philippines.
Such island paradise dreams, however, were disturbed
by the decision of the Indian High Court in the Vodafone Case. On September 8,
2010, the High Court in Mumbai affirmed that
India's tax department has jurisdiction over offshore transactions, which would
make Vodafone liable to pay capital gains tax on its
acquisition of shares outside of India. Estimates on the liability pegged it at
about USD2.6 billion. I shudder to think of how this could affect us: will it
hit the Philippines like a tax tsunami or will it be dispersed and flow
discreetly into the Indian Ocean?
Of recent memory, there is probably no other case in
tax litigations around the world that is as highly watched and anticipated as
the Vodafone one. International forums
on taxation have been abuzz with developments on this case from the moment the
Indian tax authority demanded payment of capital gains taxes from seemingly cut
and dried transactions originally thought to be beyond Indian tax jurisdiction.
The case started in 2007, when Vodafone entered the
Indian telecoms market by paying USD11 billion in exchange for 67% ownership in
Hutchison Essar, India’s third biggest telecoms company by subscribers.
Under the Hutchison Essar sale, a Dutch company
controlled by Vodafone paid the USD11 billion to a Cayman Island entity owned
by Hutchison, for another tax haven company that indirectly held a controlling
stake in the India-based mobile operator. Theoretically, the situs of the sale
of shares is so far removed from India, that no matter how far the long arm of
the Indian law stretches, it will not be able to reach it.
Vodafone’s acquisition was structured as sale of
shares, which took place outside of India between foreign companies. Just like
in the Philippines, such a transaction would have been treated as exempt from
taxation in India prior to the case. In fact, as an implied acknowledgement
that a loophole exists, the Indian government, during the pendency of the case,
proposed a new direct tax code and introduced for the first time rules and
regulations specifically addressing such transactions. This time, the Indian
government proposed to have capital gains tax imposed on acquisitions made
overseas if the acquired firm holds 50% assets in an Indian firm.
Despite the lack of existing laws, India’s tax
department argued that even though the Hutchison Essar sale was offshore, the
deal should be subject to capital gains tax in India because the assets sold
are based in India. Thus, an asset whose value is created in India by the
existence of Indian customers and operating assets based in India should, when
sold, give rise to a capital gain chargeable in India. It insisted that
Vodafone should have withheld the capital gains tax on the deal on the
government’s behalf. Indian officials argued that Vodafone, as the buyer, was
responsible for remitting the money to the government.
Of course, in the face of such a huge tax liability,
Vodafone will once more appeal the case to the Indian Supreme Court, as it
believes the transaction should not be taxable in India because it took place
offshore. The appeal will likely generate another thousand pages of briefs and
position papers that this case has already spawned.
Tax experts all over the world tremble at the
repercussion of the outcome on tax principles relating to the extraterritorial
jurisdiction of a local tax authority. The outcome of the case may allow Indian
tax authorities to examine offshore transfers of shares having an impact, no
matter how remote, on Indian businesses. The question, of course, is if the tax
authorities in other jurisdictions, such as the Philippines, have any
inclination to adopt the same rules and interpretations. More importantly, how
fast will they react to these new developments?
Some tax pundits are apprehensive that the Indian tax
authority’s USD2 billion victory may come at the price of foreign investments
shying away from India. Perhaps this is
not cause for alarm for the Indian government since foreign investors have been
continually knocking on its doors begging to be let in. Other not so lucky
jurisdictions are, however, cautioned against adopting the same hard stance as
the one taken by the Indian authorities.
Regardless of the outcome of the case, investors -- whether
in India or in the Philippines -- should clearly be careful in structuring
future M&A transactions. If a
structure that is assumed to be well thought-out and scrutinized, due to the
sheer size, could fall prey to the inquisitive and far reaching efforts of the
Indian tax authorities to collect more taxes, it is safe to assume that similar
structures inside and outside of India are also at risk.
Surely, there are ways to address the loopholes in the
Vodafone case. For example, if the offshore companies had been in treaty
countries instead of just tax havens, perhaps the issue on capital gains
brought by the tax authorities would never have prospered. In this case, the
exemption offered by the treaty may insulate the transaction from the prying
hands of the tax authorities. In such a case, will this then result in a round
of renegotiations of treaties to address certain cases of capital gains tax
exemption? Will this errant court decision one day be the rule in taxation of
The issue in this case is one that may be applicable
in the Philippines as well. Will this new development prompt the tax
authorities to draft new regulations for taxing offshore sales of companies
with underlying Philippine assets? Is there even a way for Philippine tax
authorities to keep track of offshore sales in the first place? The sheer size
of the transaction and the massive amount of media exposure alerted the tax
authorities to the Vodafone deal. Other
deals that are not as substantial simply fall below the radar and may not be as
publicized. How then will the tax authorities be able to implement the
regulations if one is indeed drafted? How long will it take before deal makers
and structure designers devise new plans to respond to new regulations?
Admittedly, the recent financial crisis has put
pressure not just on businesses but also on governments to increase revenue
generation. One should not strive to kill the goose that lays the golden
egg. However, taxes due must always be
paid as part of good corporate citizenship. A subtle balance, therefore, on tax
planning and tax collection must be reached.
As dawn emerged, accompanied by the shrilling sound of
my alarm clock, I woke up from my dream and realized I am not Bill Gates; nor
do I own layers of multinational companies.
But perhaps I can buy coconut juice for lunch and make at least one part
of my dream come true.