Vodafone verdict: SC puts FDI welcome mat back in place

India’s good fortune is that for every institution that fails, there is another to step in and do its jobs.

For the last one year or more, the UPA government has done little to boost investor confidence. It has handled the 2G and CWG scams badly. It has mismanaged the economy. Its ministers have been busy playing games - thanks to the power vacuum caused by an abdicating PM. The policy paralysis has been all-pervasive.

Now, boosting the confidence of the international community in the India story is a Supreme Court verdict in the Vodafone case .

What the government could not do - instill confidence among foreign investors - the court has done by upholding the principle that a deal that happens abroad cannot be taxed in India.

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The judgment has huge implications for foreign direct investment (FDI) in India since it enables serious investors like Vodafone - who are interested in investing hugely in India - to buy shakeholdings held abroad without fear of the taxman.

A BBC report said that the Supreme Court ruling will have (favourable) implications for deals done abroad by GE, SAB Miller, Cadbury, AT&T, Sanofi, and Vedanta.

Vodafone had bought Indian mobile operator Hutch through a $11.2 billion deal in May 2007. Through companies based in Netherlands and Cayman Islands, Vodafone acquired 67 percent in Hutchison-Essar Ltd (HEL) from the Hong Kong-based Hutchison group.

The Indian IT department demanded Rs 11,000 crore in taxes claiming that though the deal happened abroad, the underlying assets were Indian and hence liable to taxes as applicable here.

The taxman won his case in the Bombay High Court, and Vodafone was asked to pay Rs 11,000 crore. When the company appealed to the Supreme Court, it had to deposit Rs 2,500 crore and provide a bank guarantee for the balance Rs 8,500 crore.

Both the money and the bank guarantee will have to be returned as the court has made it clear that “Vodafone has no obligation under section 163 clause 1 (c) of Income Tax Act.”

In its verdict delivered on Friday, a three-judge Supreme Court bench headed by Chief Justice Sarosh H Kapadia said that the income-tax department has “no jurisdiction” to tax an overseas transaction between companies incorporated outside India.

An ecstatic Vodafone management has been singing the judiciary’s praises and promising more investments in India. CEO Vittorio Colao said he welcomed the “Supreme Court’s decision, which underpins our confidence in India. We will continue to grow our Indian business - including making significant investments in rural areas and in 3G network coverage - for the benefit of Indian consumers.”

So even while the official policy is to welcome foreign investment, the taxman’s money chase had threatened to drive investment away. The Supreme Court has restored the welcome mat to its old place.

However, the taxman will get his revenge somewhere else. Since there is a possibility that that judgment will encourage foreign investors - and maybe even Indian firms with bases abroad - to do all their deals outside India, and that too from tax havens, the new direct taxes code that may be implemented from next year will probably make such deals taxable explicitly.

When last heard of, Finance Minister Pranab Mukherjee and Law Minister Salman Khurshid were in confabulations to see what they could do to retain the money slipping away from the exchequer’s grasp in a difficult year for revenues.

A review appeal is unlikely since the Vodafone verdict was unanimous.