News analysis: Tax fear in India

A tax row involving UK mobile phone giant Vodafone and India’s revenue service might seem irrelevant to real estate funds operating in the country, but it actually has important implications

Vodafone, the UK mobile phone giant, is not having a great time in India, and its experience to date has unpredictable implications for real estate funds too.

In 2007, the company took a controlling 67 percent stake in Indian phone company Hutchison Essar for $10.9 billion but in a long running dispute, India’s tax service just this week said under its Income Tax Act, it has jurisdiction to levy a capital gains tax on the transfer of shares.

Vodafone argues it should not have to pay because the transfer of shares was from a Cayman Islands-registered company owned by Hutchison and as such it isn’t liable for tax by dint of its taking place on foreign soil. However, India's tax department says Vodafone should have withheld a reported $2 billion on behalf of the government because it involved the transfer of an Indian asset.
Abhishek Goenka of tax advisor, Taxand India, said that though India’s revenue service had not made a tax demand yet, it is expected sometime soon.

Though not obviously of relevance to private equity real estate funds, what happens to Vodafone is of concern to foreign funds when they come to investing in India using offshore companies. This is because foreign firms tend to use offshore structures when the haven in question has a tax treaty with India that should lead to a capital gains tax being zero.  

Vodafone’s experiences to date suggest that instead of sitting by and watching tax revenue being lost, India intends to challenge such structures to ensure revenue is not lost.

Unfortunately, Vodafone’s fight is not the only tax issue that should be of concern to private equity real estate funds engaged in India.

Later this month, the country is expected to publish a revised Draft Direct Taxes Code, part of which would affect foreign companies establishing entities in Mauritius, the most popular tax haven for investors into India. This is because the new Direct Taxes Code attempts to supercede a Mauritius-India tax treaty that investors have been relying on.

Accountancy firm Deloitte said last year that Mauritius accounted for 44 percent of direct foreign investments in India between April 2000 and April 2009, which shows just how important Mauritius is.

The firm explained: “The reasons for using Mauritius are simple: India has a tax treaty with Mauritius providing that gains on any transfer of shares in an Indian company by the Mauritius holding company shall not be taxable in India but in Mauritius as per the domestic tax laws in Mauritius. Domestic tax laws in Mauritius do not tax capital gains. Therefore, any transaction on account of the transfer of shares in an Indian company by a Mauritius holding company is a tax free transaction both in India and Mauritius.”
It added: “The debatable option has been whether India can change its domestic law to unilaterally nullify the effect of the treaty. The new draft Direct Taxes Code Bill appears to be just such an attempt.”

India is an emerging market, of course, and as such exits are few and far between. But the day will come when funds are well into the harvesting part of the cycle. India’s approach to foreign registered companies will really impact then.