Essar may be hit with a $1 billion tax bill on stake sale to Vodafone

The Britain-based Vodafone group has estimated that the Essar group may have to pay $1 billion (Rs 4,500 crore) out of the $5 billion it receives from Vodafone as tax to the Indian authorities, depending on the outcome of various cases in Indian courts.

The British operator, which announced a 16.2% increase in year on year India revenues, however said it did not believe that the transaction would have to be taxed, at least at source, but has sought clarification.

Essar is selling its 33% stake in the Indian unit of Vodafone to the UK-based parent firm for $5 billion, according to the terms of a five-year-old agreement. The British company said that on 30 March 2011 the Essar Group exercised its underwritten put option over 22.0% of Vodafone Essar Limited (‘VEL’) following which, on 31 March 2011, the Group exercised its call option over the remaining 11.0% of VEL owned by the Essar Group — indicating that the transaction is irrevocably done.

Vodafone is separately fighting a case against the Indian Income Tax department after the latter slapped a nearly $2 billion tax notice on the British firm for failing to cut tax at source.

The Britain-based Vodafone Group had paid nearly $11 billion five years ago to Hong Kong based Hutchison Telecom, owned by billionaire Li ka-Shing when it bought a majority control of the Indian company. Later, in 2007, India’s tax department sent a notice to Vodafone Group asking why it paid the entire amount to the Hong Kong firm as it should have paid only around $9 billion, after withholding tax.

This was contested by Vodafone, by pointing out that the transaction was in no way legally connected to India and it involved the sale of shares of a Mauritius-based company by a Hong Kong based company to a Britain-based company.

The case, being heard in the Supreme Court of India, will be up for hearing on July 19, Vodafone said in its latest statement.

The case is being seen as setting a new precedent, as completely foreign transactions have never been taxed by the Indian government, even if they indirectly involved the change in ownership of Indian assets or companies. Vodafone is being extra cautious in the second purchase in the deal — that of 33% from the Essar group, Hutchison’s former India partner.

It maintained that it believes that no tax is made out in this case as well, but said it has erred on the side of caution.

“In light of the uncertainty created by the Indian tax authority’s actions as set out above, [Vodafone] has sought confirmation from the Authority for Advanced Rulings (‘AAR’) in India on whether withholding tax is due in respect of consideration payable on the acquisition of Essar Group’s (‘Essar’) offshore holding in Vodafone Essar A ruling from the AAR is expected by the end of May 2011.

“‪The Group does not believe that there is any legal requirement to withhold tax in respect of these transactions but if, contrary to expectations, the AAR directs tax to be withheld, this amount is anticipated to be approximately an additional US$1.0 billion,” it said.

A tax of $1 billion will be a big hit to the Essar group, which had been calculating returns of $5 billion from the transaction. Essar was also exploring other avenues to monetize its stake in the company, including going to the stock-market, but was successfully resisted in its designs by Vodafone.

On its Indian tax case, it said it “believes that neither it nor any other member of the Group is liable for such withholding tax, or is liable to be made an agent of HTIL; however, the outcome of the proceedings remains uncertain and such proceedings may or may not dispose of the matter in its entirety and there can be no assurance that any outcome will be favourable to VIHBV or the Group.”


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