Vodafone defeats India in landmark $2.9bn tax case
Vodafone and Hutchison conducted their transaction offshore, with Vodafone’s Dutch subsidiary, Vodafone International Holdings BV, acquiring CGP Ltd., a Cayman Islands holding company controlled by Hong Kong-based Hutchison.Essentially, the court ruled that India's government can’t levy a capital gains tax on the assets because the transaction occurred between foreign companies.
We'd make a couple of points here. First - while we won't comment on the legal technicalities as we don't have access to them - this means a transfer of wealth away from Indian taxpayers and towards, among others, Vodafone shareholders and top Vodafone executives (in the form of their stock options and other remuneration.)
Next, corporate executives have been lining up to congratulate the Indian courts (of course.) Aside from the question of whether the law is being upheld fairly or not, their loud claims that this ruling - and the more general trend of tax-cutting for corporations - is positive for India and encourage investment and economic growth in India are open to serious question. (Now this dispute was not really about tax rates - it was about tax loopholes - but the same basic calculus holds.
Even the IMF has recognised that lower corporation taxes and tax holidays may not boost growth. Think about it like this. Governments in oil-rich countries, for instance, levy extremely high tax rates - effective marginal tax rates of 90 percent or more are common enough - because investors know that the oil is there, and if they want it, that is where they have to go. Just because profits are reduced by tax doesn't mean there aren't profits. The oil companies will gnash their teeth and threaten to go to where there are more attractive tax regimes - but at the end of the day ExxonMobil knows that if it disinvests in a fit of pique because of high taxes, Sinopec will fill its shoes (and, probably fill its own boots.)
Now in the case of the Indian telecommunications market, a similar calculation applies. Corporate lobbyists will insist that if tax rates are too high they will go somewhere friendlier. But at the back of their minds they know that the Indian telecommunications market is a goldmine. And if they don't like the tax rate, others will be perfectly hard to put up with it.
It is important here not to take the perspective of the single investor (who may well make a risk and return calculation and opt to invest in another country) but to take the perspective of the country concerned. If one investor leaves, another will take its place. It's not quite as simple as this in the real world, of course - but the basic principle holds.
If India's supreme court had ruled that India should have been able to levy those taxes, the corporations would all have huffed and puffed about the investment climate, but at the end of the day they would still get their foreign investors slavering to be the investors to come in.
Finally, an absolutely fundamental principle of international tax was at stake here. As the International Chamber of Commerce said:
"Today’s judgment should be read as a clear endorsement of the view that countries don’t have jurisdiction to tax international transactions based on the location of underlying assets."This is yet more evidence why the international system for taxing multinational corporations is broken. It needs a complete overhaul.
Broadly, there are two ways to tax multinational corporations. The predominant way, fiercely supported by the OECD and multinational corporations, is to tax them according to the strange legal contortions that their lawyers and accountants twist them into, stuffing profits into tax havens and costs into the high-tax countries. It is a system that uses OECD rules which, as one prominent tax expert recently noted:
“is based on a fundamental misunderstanding of practical economics.”There is an alternative system, which a growing number of U.S. states are using: unitary taxation. Under such a system, you disregard all the corporate shenanigans and tax companies according to the real economic substance of what they do in the real world. Developing countries like India would do well to take a greater interest in this possibilities - and on others.
More on unitary tax on our transfer pricing page.