PROJECT FOR THE SUBJECT

Interpretation of Statutes

CONSIDERATIONS GUIDING THE INTERPRETATIONOF TAX STATUTES

(With Special Reference to VodafoneJudgment)

SUBMITTED BY

Ms. Nagendra Chauhan

Semester – VII

B.A.LL.B. (Hons)

UNDER THE GUIDANCE OF

Mrs. Nidhi Saxena

Asst. Prof., ILNU

Submitted to

INSTITUTE OF LAW

NIRMA UNIVERSITY, AHMEDABAD

ACADEMIC YEAR (2011-12)

D E C L A R A T I O N

I Nagendra Chauhan declare the work entitled “CONSIDERATIONSGUIDING THE INTERPRETATION OF TAX STATUTES (With SpecialReference to Vodafone Judgment)”, being submitted to NirmaUniversity for the project in the subject of IOS is original andwhere the text is taken from the authenticated books, articles orweb articles, appropriate reference is given. It is true in my bestof knowledge.

Date : 9th October 2012 Nagendra Chauhan

Roll No 09 BAL 029

VII Semester

Institute of Law

Nirma University

ContentsD E C L A R A T I O N..............................................2CHAPTER I..........................................................3

INTRODUCTION AND REASERCH METHEDOLOGY :............................4Synopsis:........................................................4

Introduction.....................................................4Research Methodology.............................................6

Aims and objectives:...........................................6Scope and limitations:.........................................6

Hypothesis:....................................................7Statement of Problem:..........................................7

Mode of Writing................................................8Mode of Citation...............................................8

Chapter II.........................................................9CONSIDERATIONS GUIDING THE INTERPRETATION OF TAX STATUTES..........9

I. The classical rule: Strict construction of taxing statutes....9II. Dilutions to the Principle of Strict Construction............11

A shift to purposive construction?............................11Chapter III.......................................................18

Vodafone Saga and its Critical Analysis...........................18Chapter IV........................................................20

Conclusion........................................................20

CHAPTER I

INTRODUCTION AND REASERCH METHEDOLOGY :

Synopsis:

Introduction In this paper, the researcher studies the ancient maxim that

taxing statutes have to be construed strictly with special

reference of Vodafone judgment. Beginning with a discussion of

the classical rule, the researcher moves on to focus on the

various dilutions to the rule of strict construction and

comment on the same. These include a shift to purposive

construction, external aids, machinery provisions, exemptions

and evasions. The purpose is to gather a sense of what could

be driving the judiciary to dilute the rule of strict

construction and the implications of the same.

Tax avoidance through artificial devices — holding companies,

subsidiaries, treaty shopping and selling valuable properties

indirectly by entering into a maze of framework agreements —

has become a very lucrative industry today.

A large part of the income of the ‘Big 5' accountancy and

consultancy firms derives from tax avoidance schemes which

flourish in the name of tax planning. Their legality has

agitated courts in India and abroad for a long time. In 1985,

a 5-judge bench of the Supreme Court in the McDowell case

settled the question decisively, observing:

“In that very country where the phrase ‘tax avoidance'

originated, the judicial attitude towards [it] has changed and

the smile, cynical or even affectionate though it might have

been at one time, has now frozen into a deep frown. The courts

are now concerning themselves not merely with the genuineness

of a transaction, but with [its] intended effect for fiscal

purposes. No one can now get away with a tax avoidance project

with the mere statement that there is nothing illegal about

it. In our view, the proper way to construe a taxing statute,

while considering a device to avoid tax is … to ask … whether

the transaction is a device to avoid tax, and whether the

transaction is such that the judicial process may accord its

approval to it.”

“It is neither fair not desirable to expect the legislature to

… take care of every device and scheme to avoid taxation,” the

ruling added. “It is up to the Court … to determine the nature

of the new and sophisticated legal devices to avoid tax ...

expose [them] for what they really are and refuse to give

judicial benediction.”

‘Legitimate tax planning'

Despite such a clear pronouncement, recent judgments of

smaller Supreme Court benches have gone back to calling

artificial tax avoidance devices “legitimate tax planning”.

Though the Income Tax Act obliges even non-residents to pay

tax on incomes earned in India, many foreign institutional

investors avoided paying taxes citing the Double Taxation

Treaty with Mauritius. This treaty says a company will be

taxed only in the country where it is domiciled. All these

FIIs, though based in other countries and operating

exclusively in India, claimed Mauritian domicile by virtue of

being registered there under the Mauritius Offshore Business

Activities Act (MOBA). Companies registered under MOBA are not

allowed to acquire property, invest or conduct business in

Mauritius.

Yet these ‘Post Box Companies' claimed to be domiciled there

and the I-T department allowed them to get away with claiming

the benefits of the treaty for many years. Given the benign

attitude of the Indian tax authorities and the fact that there

was no capital gains tax and virtually no tax at all on these

companies in Mauritius, most FIIs and most of the foreign

investment in India, by 2000, came to be routed through

Mauritius.

The party finally ended when a proactive tax officer tried to

stop this blatant evasion. Relying on McDowell, he lifted the

corporate veil of MOBA companies to determine their place of

management and actual place of residence. Since this happened

to be in different countries in Europe or North America, the

relevant Double Tax Avoidance treaty became the one between

India and that country. All these treaties provided for

capital gains to be taxed where the gains had accrued. Since

the gains accrued in India, he levied capital gains tax on

these FIIs.

.

Research Methodology

Aims and objectives:

The aim of this project is to look at the Vodafone judgement

passed by the honourable Supreme Court and its consequences.

Thereby analyzing the various concepts in Taxation Law such as

Tax avoidance, Capital Gain etc and the way it has been dealt

to incur the liabilities.

To understand the concept of tax avoidance.

Taxing statutes have to be construed strictly

To analyze that just because the operating company pays

taxes in India, can the investor company be exempted from

Capital gains tax.

To examine the various impacts caused by tax haven

concept.

To determine the impact of the judgment with special

reference to FDI.

Scope and limitations:

In this paper, the researcher studies the ancient maxim that

taxing statutes have to be construed strictly. Beginning with

a discussion of the classical rule, the researcher moves on to

focus on the various dilutions to the rule of strict

construction and comment on the same. These include a shift to

purposive construction, external aids, machinery provisions,

exemptions and evasions. The purpose is to gather a sense of

what could be driving the judiciary to dilute the rule of

strict construction and the implications of the same.

Also, the project limits itself to studying of the Vodafone

judgement by the Honourable Supreme Court. It even observes

the tax laws under Income tax Act 1961.

The researcher’s study was even limited by his understanding

as there could be some basic observations which he might have

failed to put forward in the project due to limited

understanding of the subject.

Hypothesis:

1. Taxing statutes have to be construed strictly.

2. A normal view would be that if one non-resident sells

shares of a foreign company to another non-resident of

India; and the transaction takes place outside India,

there can be no tax on the same.

3. In Vodafone case, clearly a series of tax havens and SPVs

(Special Purpose Vehicle) have been used to avoid Indian

Taxes.

  

Statement of Problem:

Department’s view – in brief: Department’s claim, in essence

was: CGP is a nullity, a sham entity.  Transfer of CGP’s

shares has no substance. The parties to the transfer

themselves laid bare the real transaction – that of sale of

HEL stake. Real transfer is: The transfer of substantial

interest (67% stake) in HEL.  This controlling shareholding

has its situs in India.  Since the transferred asset is

situated in India, the capital gains arising on the same is

liable to tax in India. VIH was therefore required to deduct

tax at source.

 

Honourable Supreme Court has given a ruling that – only the

legal transaction –sale of CGP share - is to be considered. By

selling CGP share, the seller may have transferred its

interests in HEL. However, Indian interest arises due to sale

of CGP share. It does not arise out of the SPA (which recorded

the real facts). All the arguments of the revenue were

rejected.

 

Crux of the matter: Should one simply consider the legal

form of the transaction (i.e., sale of one share in CGP);

or should one consider real form - the entire set of

facts as stated by the parties themselves in the SPA and

various other correspondences? Is the case fit for

considering “Substance over Form”? Is the case fit for

lifting the Corporate Veil?

Mode of Writing

A descriptive and analytical method of writing has been

followed.

Mode of Citation

A uniform mode of Citation has been followed.

Chapter II

CONSIDERATIONS GUIDING THE INTERPRETATION OF TAX STATUTES

I. The classical rule: Strict construction of taxing statutes

The classical rule with regard to the construction of taxing

statutes is that they should be strictly construed. It is a

well-established rule that can be traced to common law in

England and has been imported into the Indian legal system as

well.1

A person should not be taxed unless there are clear words

indicating that purpose. Every statute must be read “according1 G.P. Singh, PRINCIPLES OF STATUTORY INTERPRETATION, 815 (12th edn., 2010).

to the natural construction of its words”.2 In a taxing

statute, it is only what is clearly said that needs to be

looked at. Considerations guiding the interpretation of taxing

statutes cannot include equity or presumptions. Nothing must

be read in or implied. In the interpretation of taxing

statutes, the language of the statute is the only thing that

can be fairly looked at.3 This has been the classical approach

towards the interpretation of tax statutes as followed in

England as well as in India.

The rationale for the strict construction of taxing statutes

lies in the fact that they impose pecuniary burdens.

Therefore, in some sense, they operate as penalties. It is on

the basis of this that clear and unambiguous language is

required in order to make out a charge of tax.4

This rule of strict construction is also known as the Duke of

Westminster principle, being named after its famous exposition

in the case of IRC v. The Duke of Westminster5. In this case, the

respondent i.e. Duke of Westminster, covenanted to pay his

gardener an yearly sum for a period of seven years without

prejudice to the remuneration received by the gardener for his

services. The Duke then sought to deduct such payments in

order to ascertain his total taxable income for surtax. The

Revenue i.e. Appellant however sought to show these payments

2 In re Micklethwait, (1885) 11 Ex 452 (Court of Exchequer Chamber);Tennant v. Smith, [1892] A.C. 150 (House of Lords). 3 Cape Brandy Syndicate v. Inland Revenue Commissioners, [1921] 1 K.B. 64 (King’s Bench Division). 4 P.B. Maxwell, INTERPRETATION OF STATUTES, 256 (12th edn., 1962). 5 The Commissioners of Inland Revenue v. The Duke of Westminster, [1936] A.C. 1 (House of Lords).

as payments of salary or wages and impose tax thereon. In this

case, the court rejected the argument that in the construction

of taxing statutes, it must ignore the legal position and

instead focus on “the substance of the matter”. The court

observed that every person is entitled to arrange his affairs

in such a manner that the burden of tax that falls upon him be

as low as legally permissible. The doctrine of “substance of

the matter” cannot be used to impose a greater liability on

the person. It is the true nature of the legal obligation and

nothing else that is the substance. On this basis, the court

dismissed the appeal.6

As mentioned before, this line of reasoning has found

resonance in India too. The Supreme Court of India has

reiterated the position that it is a maxim of tax law that tax

is not to be imposed on a person unless the words of the

taxing statute are unambiguous.7 The Supreme Court has observed

that the strict letter of the law is to be considered in

determining tax liability and not other things such as the

spirit of the statute or the substance of the law. If the

Court is satisfied that a case falls within the provisions,

then a tax can be imposed. However, if a situation does not

fall within the “four corners of the provisions of the taxing

statute”, no tax can be imposed. Inference, analogy and

probing of legislative intent in order to get to the substance

6 The Commissioners of Inland Revenue v. The Duke of Westminster, [1936] A.C. 1 (House of Lords). 7 Mathuram Agrawal v. The State of Madhya Pradesh, AIR 2000 SC 109 (SupremeCourt of India).

of the matter are not permitted in the interpretation of tax

statutes.8

A taxing statute has three components: the subject of the tax,

the person liable to pay tax and the rate at which tax is to

be paid. In the case of ambiguity regarding any of these three

ingredients in a taxing statute, there is no tax in law.

Unless the legislature does not modify the defect, no tax can

be imposed as per law. This is because taxing statutes need to

be strictly construed.9

Another principle of statutory interpretation that is seen

with respect to taxing statutes is that the courts must favour

the assessee in case there is ambiguity and two or more

reasonable interpretations of the taxing provisions exist.10

Thus, in this section, it has been seen that the judiciary has

stressed on the requirement of clear and unambiguous language

in order to impose a tax upon an individual. This strict rule

of has governed the interpretation of tax statutes. However,

from the latter half of the previous century, several

dilutions to this strict rule have been seen. In the following

sections of this paper, the researcher seeks to discuss these

detours from the straight route laid down by the rule of

strict construction

.

8 A.V. Fernandez v. State of Kerala, AIR 1957 SC 657 (Supreme Court of India). 9 Mathuram Agrawal v. The State of Madhya Pradesh, AIR 2000 SC 109 (SupremeCourt of India). 10 CIT v. Karamchand Premchand Ltd., AIR 1960 SC 1175 (Supreme Court of India).

II. Dilutions to the Principle of Strict Construction

A shift to purposive construction?

As has been noted above, the strict rule of construction has

been subject to some dilution, especially since the latter

half of the previous century.

A good example of this was seen in the decision of the Supreme

Court in CCE v. ACER India Ltd.11. The main question in the case

revolved around whether the value of operational software

could be deducted from the total value of computers supplied

to customers in the calculation of the amount of central

excise payable as duty. In this background, an entire section

of the judgment was directed towards the principles guiding

the interpretation of taxing statutes. The Supreme Court noted

that the imposition of tax is a constitutional function. It

referred to the strict construction that needs to be given to

taxing statutes. It also observed that the doctrine of

“substance of the matter” had been rejected. However, the

court noted several other considerations to be made in the

interpretation of taxing statutes that fall outside the four

corners of the language of the statute.12

In the eyes of the researcher, many of these signify a

departure from the strict rule of interpretation. Some of

these had their basis in previous judgments whereas some11 Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of India). 12 Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of India).

others seemed to be pronounced by the court for the first

time. To begin with, the Court noted that existing market

practice must be a consideration behind the interpretation of

taxing statutes. Similarly, the court also noted that public

policy could be a guiding factor in the interpretation and

application of taxing statutes. 13

The court also noted that the statute must not be interpreted

in such a manner that it leads to the wide scale evasion of

duty. An interpretation based on this dictum can have

significantly different results in practice from those seen

earlier based upon the strict rule of interpretation. While,

in this case, the dictum was motivated by the desire to

prevent consumers of computer products from having to face the

burden of excess duty imposed on the respondent, its

ramifications on other types of cases involving taxation can

be quite telling. The researcher opines that this would go far

in tilting the balance of power in favour of the Revenue.14

Most importantly, the Supreme Court made observations

expressly providing that the rule of strict construction was

not to be always applied in the interpretation of tax

statutes. The Supreme Court noted that the principle of strict

construction may not be adhered to in case the statutory

construction can reasonably have only one meaning. The court

went on to substantiate this by the statement that the

principle of purposive construction will be adhered to in case

13 Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of India). 14 Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of India).

the literal meaning results in absurdity. The Supreme Court

here explicitly provided that purposive construction could be

given precedence over literal meaning in the case of absurdity

and that this maxim is applicable even in the case of taxing

statutes.15 This is reflective of the shift in favour of

purposive construction, at least in some cases, even in the

interpretation of taxing statutes. This is extremely

significant because this allows the courts to go beyond the

four corners of the statute in order to determine “legislative

purpose” in a manner that was not allowed hitherto. This is an

extremely controversial and significant shift which leaves

open a wide range of conclusions open with respect to the

interpretation of tax statutes. It might be argued that it

purposive construction would only come into operation in case

literal construction leads to absurd results. Yet, even this

must be seen to be significant. The following paragraph

illustrates a case where this difference has been seen.

In the case of CWS v. CIT16, the Court delved into provisions of

the Income Tax Act, 1961 revolving around the imposition of

tax on the appellant, which was the assessee company, with

regard to expenditure on the company’s assets used by its

employees either partly or wholly for their own benefit. A

plain reading of the statute would have meant that liability

could not be imposed. However, the court went ahead to uphold

the assessment of the Revenue on the basis of a reading of the

15 Commissioner of Central Excise, Pondicherry v. ACER India Ltd., (2004) 8 SCC 173 (Supreme Court of India). 16 C.W.S. (India) Ltd. v. Commissioner of Income Tax, JT 1994 (3) SC 116 (Supreme Court of India).

statute along with legislative intent to tax. The court

compared the impugned provision with analogous provisions in

previous and successive versions of the Income Tax Act and

concluded that the assessee must be held liable for tax in

accordance with its reading of Parliamentary intention. The

Court stated that non-taxation here would be a result that

would be incongruous, discriminatory and most importantly,

absurd. The court opined that though literal construction was

the general rule in the interpretation of tax statutes, it

could not be adhered to in case the result was incongruous,

discriminatory or absurd. It stated that interpretation of

statutes could not be a mechanical exercise. It held that the

object of all interpretation was to give effect to the object

of the enactment with regard to the language used. In this

manner, the Supreme Court went ahead to affirm the taxation of

the assessee company i.e. the appellant in spite of the fact

that literal interpretation would have led to a contrary

result of non-taxation.17

It is submitted that while such decisions of the Supreme Court

might seem as the right step in order to ensure that the ends

of justice are met in a particular case, they also create a

large enough window of opportunity allowing for some

unnecessary judicial flexibility that could negatively impact

the interpretation of tax statutes when they operate as

precedents. Grandiose declarations embracing purposive

construction and privileging it over strict construction can

lead to unintended consequences. The problem would lie not in17 C.W.S. (India) Ltd. v. Commissioner of Income Tax, JT 1994 (3) SC 116 (Supreme Court of India).

ascertaining the existence of absurdity. Like most cases, the

problem would lie in ascertaining legislative intent and the

purpose of the statute. The researcher feels that the

availability of such interpretive capacity in the hands of the

judiciary could lead to a strengthening of the position of the

Revenue as against the assessee and seriously impact the

interests of the assessee in this manner.

The following sections highlight certain other dilutions to

the rule of strict construction.

a. The usage of external aids

It has been seen that courts have employed certain external

aids in the interpretation of taxing provisions. In doing so,

they have gone beyond the four corners of the language of the

statute and have thereby diluted the rule of strict

construction.

For example, in the case of Nawn Estates v. CIT18, the Supreme

Court was called upon to interpret the term ‘investment’ as

found in the Income Tax Act, 1922. This term had not been

defined by the statute. The Supreme Court considered various

external aids in coming to the conclusion that the appellant

was to be brought within the purview of the tax on the basis

that it was an ‘investment company’. The Court considered the

legislative history of the Income Tax Act 1922, right from its

amendment in 1955. It also considered the legislative history

18 Nawn Estates (P) Ltd. v. C.I.T, West Bengal (1977) 1 SCC 7 (Supreme Courtof Indi a).

of the Income Tax Act, 1961. The Supreme Court also sought to

substantiate its position on the understanding of ‘investment’

in common business parlance. Significantly, the Court even

went on to recognise that English authorities can be useful

guides in the interpretation of analogous provisions,

fundamental concepts and general principles “unaffected by the

specialties of the English Income Tax Statutes”. Again, it is

reiterated that while the Court may have concluded rightly in

the case, the acceptance of such a broad variety of external

aids to construction can lead to some vulnerability of the

rule of strict construction. The researcher is especially

concerned with the idea of usage of analogous English

provisions in the interpretation of Indian counterparts. It

must be understood that taxing environments and policy

considerations in the two countries are different. Therefore,

the researcher opines that importing an English understanding

of specific taxing provisions to the Indian scenario will lead

to more questions than the solutions it provides. Extreme

caution needs to be exercised by the interpreting authority in

this regard.

b. Exemptions

An area of considerable disagreement in the construction of

taxing statutes has been that of exemptions. An exemption is

an exception from the general obligation to pay taxes.19 There

are two opinions on the matter of construction of exemptions

19 A.B. Kafatiya, INTERPRETATION OF STATUTES, 293 (2008).

in case of ambiguity. According to one view, an exemption must

be liberally construed so as to benefit the assessee from then

operation of the duty. The other view is that exemptions tend

to increase the burden on the general burden of taxpayers, and

for this reason, they must be strictly construed against the

assessee.20

There is no presumption with regard to the application of

exemption. The person claiming the exemption has to establish

that he is entitled to it as per the language of the taxing

enactment.21

An example of the liberal interpretation of exemptions was

seen in CCE v. NE Tobacco Company22. The question was whether the

unit or factory established by the respondent in a certain

Export Promotion Industrial Park could be given the status of

a ‘new industrial unit’ so as to avail an exemption. The

Supreme Court held that an exemption notification must be

liberally construed in favour of the respondent. It therefore

dismissed the appeal.23 However, it must be mentioned that

there are various authorities in opposition to this view,

including various other judgments of the Supreme Court.

An illustration is the case of Orissa State Warehousing Corporation v.

CIT24. In this case, the appellant sought to benefit from an20 Singh, supra note 1, at 839 and 840. 21 Commissioner of Income Tax v. Ramakrishna Deo, AIR 1959 SC 239 (Supreme Court of India). 22 Commissioner of Central Excise v. North- Eastern Tobacco Company, AIR 2003 SC 616 (Supreme Court of India). 23 Commissioner of Central Excise v. North- Eastern Tobacco Company, AIR 2003 SC 616 (Supreme Court of India). 24 Orissa State Warehousing Corporation v. Commissioner of Income Tax, AIR 1999 SC 1388 (Supreme Court of India).

exemption on the basis of Section 10(29) of the Income Tax

Act, 1961. The appellant argued that liberal interpretation

must be given to income derived from “letting out of godowns

or warehouses for storage, processing or facilitating the

marketing” so as to include interest derived on fixed

deposits. The Supreme Court observed that exemptions are an

exception to the general rule that a taxing statute must be

construed in favour of the assessee in case of ambiguity. The

Court, dismissing the appeal, held that entitlement for

exemptions should not be read with any wider connotation or

latitude to the taxpayer. This case was an example of the

literal approach to construction of exemptions.25

Therefore, it can be concluded that authorities exist in

support of both liberal as well as literal interpretation of

exemption provisions in statutes.

However, where there is a beneficient object, such as

increased production or incentives to co-operatives, exemption

provisions are to be liberally construed. In the case of CIT v.

Straw Board Manufacturing26, the Supreme Court employed liberal

interpretation to strawboard within the expression ‘paper and

pulp’ so as to enable the respondent to benefit from

concessions for the furtherance of industrial activity.27

25 Orissa State Warehousing Corporation v. Commissioner of Income Tax, AIR 1999 SC 1388 (Supreme Court of India). 26 Commissioner of Income Tax, Amritsar v. Straw Board Manufacturing Co. Ltd., AIR 1989 SC 1490 (Supreme Court of India). 27 Commissioner of Income Tax, Amritsar v. Straw Board Manufacturing Co. Ltd., AIR 1989 SC 1490 (Supreme Court of India).

The researcher opines that the observations of the Supreme

Court in UoI v Wood Papers28provides a part of the solution in

resolving the conflicting methods of interpretation of

exemptions. The Court noted that the applicability of an

exemption needs to be strictly viewed keeping in mind

legislative intent, inequitable burden on taxpayers and

augmentation of revenue. However, once doubt about

applicability is removed, and it is ascertained that the

assessee was meant to be entitled, and then a liberal

construction is appropriate. Therefore, strict and liberal

constructions are to be invoked at different stages of

interpretation of an exemption provision.29

The researcher is in agreement with this reading by the

Supreme Court.

c. Machinery provisions

It has been held by the Supreme Court that a fiscal statute

must be strictly construed only with regard to taxing

provisions such as charging provisions and not to machinery

provisions. A machinery section should be so construed so as

to effectuate liability.30 The researcher agrees with this line

of reasoning. As long as the subject, assessee and the rate of

tax are clear, procedural aspects like the machinery for

28 Union of India v. M/S Wood Papers Ltd., AIR 1991 SC 2049 (Supreme Court of India). 29 Union of India v. M/S Wood Papers Ltd., AIR 1991 SC 2049 (Supreme Court of India). 30 CIT Central, Calcutta v. National Taj Traders, AIR 1980 SC 485 (Supreme Court of India).

enforcement must not allow one to escape the clutches of

taxation.

d. Evasion of tax

A significant departure from the Westminster principle was

seen in the decision of the House of Lords in Ramsay v. IRC31.

In this case, the taxpayer company sought to reduce its

capital gains tax through a series of transactions that would

create artificial capital losses. Each of these losses would

seem “genuine” as per the Westminster principle. But taken on

the whole, the effect was that the company would escape tax

liability. The court held that it could not stand still in the

face of increasingly sophisticated devices of tax avoidance.

It had to view the scheme as a whole and not step by step.

Holding that the court could not apply the Westminster

principle for sham transactions, the appeal was dismissed.32

The above decision significantly formed the backbone of the

decision of the Constitution Bench of the Supreme Court in

McDowell v. CTO33 (“McDowell”). The Supreme Court dramatically

held that the Westminster principle had been buried in England

and that India should also dissociate itself from the

principle. The court stated that intended effect of a

transaction for fiscal purposes had to be considered in

31 W.T. Ramsay v. Inland Revenue Commissioners, [1982] A.C. 300 (House of Lords). 32 W.T. Ramsay v. Inland Revenue Commissioners, [1982] A.C. 300 (House of Lords). 33 McDowell and Co. v. Commercial Tax Officer, AIR 1986 SC 649 (Supreme Court of India).

determining tax liability and that no one could get away with

a tax avoidance project merely by stating that nothing was

illegal about it. The court was motivated by various ill-

effects of tax avoidance such as loss of revenue, piling up of

black money, burden on remaining taxpayers, inequity of advice

available to the Revenue and the skillful avoider. The Court

also observed that tax avoidance was unethical in a welfare

state. The court held that the construction of a scheme of tax

avoidance was neither liberal nor literal. Rather, the

question is whether a transaction is a device to avoid tax and

whether the judiciary can accord approval to it. The Court had

to take stock of new and sophisticated legal devices and

relate it to existing legislation with the help of “emerging”

techniques of interpretation.34

This above case was notably criticized by the Supreme Court

itself in Union of India v. Azadi Bachao Andolan35. The Court here

referred to various authorities to support its proposition

that the Westminster principle was dead. However, it

incorrectly held that the concurring judgment in the McDowell

case was not reflective of the majority. The researcher opines

that it was also wrong in placing reliance on another

Constitution Bench decision of the Supreme Court that came

after McDowell i.e. Mathuram Agrawal v. State of MP36 since this

34 McDowell and Co. v. Commercial Tax Officer, AIR 1986 SC 649 (Supreme Court of India). 35 Union of India v. Azadi Bachao Andolan, AIR 2004 SC 1107 (Supreme Court of India). 36 Mathuram Agrawal v. The State of Madhya Pradesh, AIR 2000 SC 109 (SupremeCourt of India).

latter decision was not pronounced in the context of tax

avoidance schemes.

It is thus the researcher’s opinion that the McDowell case has

indeed succeeded in modifying the Westminster principle at

least in the context of tax avoidance schemes, and has

provided a qualification to the rule of strict construction to

that extent. While this is a theoretical anomaly, it has been

practically necessitated so as to prevent large scale losses

to the revenue through intricately designed schemes. It has

led to the strengthening of the position of the Revenue vis-à-

vis the assessee.

Yet, the researcher argues that this qualification has made

the task of interpretation very complex. It becomes tough to

delineate acceptable tax planning from unacceptable tax

avoidance. Moreover, an inquiry into the motives of either the

legislature or the assessee is always going to be fraught with

danger. The wisdom of this step must be doubted, at least from

the point of view of statutory interpretation.

Chapter III

Vodafone Saga and its Critical Analysis

Department’s view – in brief: Department’s claim, in essence

was: CGP is a nullity, a sham entity.  Transfer of CGP’s

shares has no substance. The parties to the transfer

themselves laid bare the real transaction – that of sale of

HEL stake. Real transfer is: The transfer of substantial

interest (67% stake) in HEL.  This controlling shareholding

has its situs in India.  Since the transferred asset is

situated in India, the capital gains arising on the same is

liable to tax in India. VIH was therefore required to deduct

tax at source.

 

Honourable Supreme Court has given a ruling that – only the

legal transaction –sale of CGP share - is to be considered. By

selling CGP share, the seller may have transferred its

interests in HEL. However, Indian interest arises due to sale

of CGP share. It does not arise out of the SPA (which recorded

the real facts). All the arguments of the revenue were

rejected.

 

Crux of the matter: Should one simply consider the legal

form of the transaction (i.e., sale of one share in CGP);

or should one consider real form - the entire set of

facts as stated by the parties themselves in the SPA and

various other correspondences? Is the case fit for

considering “Substance over Form”? Is the case fit for

lifting the Corporate Veil?

Critical Analysis

Vodafone's argument was that it did not pay directly for an

asset located in India. It paid for acquiring the controlling

interest in a Cayman Islands-based holding company. The

transaction was between two non-resident companies. The

Supreme Court applied several well-established principles of

tax jurisprudence in deciding the case in favour of Vodafone.

The doctrine of form over substance, the source rule, the law

relating to direct and indirect transfers, the concept of

business assets, and the anti-abuse rules were all gone into

in the 276-page judgment. Did the deal amount to questionable

tax planning or tax avoidance device? The Supreme Court gave a

firm ‘no' as the answer to this question. In its opinion, use

of holding companies and the investment structure and also the

use of offshore financial entities can be driven in certain

cases by business and commercial purposes.

The use of such devices will not imply tax avoidance.

Taxpayers are free to arrange their affairs to minimise tax

within the framework of tax laws. There is a distinction

between legitimate tax minimisation and abusive tax avoidance.

The Court upheld the law laid down in the Azadi Bachao case

and also distinguished the Mcdowell ruling.

The Supreme Court has ruled that the case concerned mere sale

of shares simplicity and there was no sale of assets. It was only

by acquiring the shares of CGP that Vodafone got an indirect

control over several kinds of companies in the group structure

of Hutchison. True, sale of shares of a foreign company is not

subject to tax in India. But what about other rights acquired

by Vodafone by virtue of this complex transaction? What about

control premium because of the 67 per cent acquisition?

What about the non-compete agreement? What about the brand

licences, operating licences, customer base, etc.? According

to the Supreme Court, these rights were acquired only as a

consequence of the transfer of shares in CGP. The transaction

cannot be dissected and the payment cannot be split into

compartments. There was no anti-avoidance provision in the

Indian law. The Court made the distinction between the look-to

principle and the look-through principle. In the absence of

anti-avoidance provisions in the law, it is not possible to

invoke the theory of see through.

A major consideration that prevailed with the Supreme Court

was that the complicated structures were put in place long

before acquisition of the relevant shares. It rejected the

Bombay High Court's view that applying the proportionality

theory, a part of the transaction must be brought to tax. It

concluded that the deal should be viewed as a consolidated

transaction based on economic nexus. “Applying the ‘look at'

test in order to ascertain the true nature and character of

the transaction, we hold, that the offshore transaction herein

is a bona fide structured FDI investment into India which fell

outside India's territorial tax jurisdictions, hence not

taxable.” This was not a sham transaction. Nor was it meant to

avoid tax.

Chapter IV

Conclusion

In the eyes of the researcher, the various dilutions to the

rule of strict construction are reflective of judicial

recognition of the fact that the legislature is possibly

missing a few steps in its attempt to grapple with fast paced

economic developments. This is visibly seen in the case of tax

evasions. The rate of growth of the nature and functions of

the Revenue is far outstripped by the growth of the creatures

and activities subject to taxation. The strict rule of

construction was inspired by a need to balance the powers of

the individual against the State and prevent the State from

penalizing the individual unnecessarily. However, economic

developments have shifted the balance against the State and in

favour of companies, who have at their disposal considerable

resources and tax expertise. It is no surprise then that most

of the dilutions, such as purposive construction and evasion

seem to favour the Revenue. The few constructions that favour

the assessee, such as liberal construction of exemptions, also

have underlying economic objectives such as promotion of

industrialization as their basis.

However, the researcher is of the opinion that the judiciary

has invited some trouble on itself by creating dilutions to

the rule of strict construction. It has opened up avenues for

arguments based on legislative intent and “real nature” of

transactions in cases involving taxation. The researcher

believes that the judiciary will resolve this conflict, more

often than not, by favouring the Revenue, in keeping with the

reasons for the creation of dilutions.

The brunt of this change, however, shall be borne by the

weaker of the taxpayers. Neither do they have the wherewithal

to come up with intricate arguments to reduce their tax burden

nor does judicial attitude seem to be in their favour.

In order that the interests of these weaker sections are

protected, the researcher hopes that the dilutions to the rule

of strict construction be viewed with great caution. From a

theoretical point of view too, the researcher is of the

opinion that the dilutions represent a definite compromise and

that they will lead to various problems in statutory

interpretation. While the rule of strict construction still

holds a dominant position in the interpretation of taxing

statutes, there can be no doubt that the departures from the

rule have struck its effectiveness in a manner that the

implications will be substantial.

Literature Review:

Books Referred:

1. A.B. Kafatiya, INTERPRETATION OF STATUTES, 293 (2008).

2. G.P. Singh, Principles of Statutory Interpretation, 815

(12th edn., 2010).

3. P.B. Maxwell, Interpretation of Statutes, 256 (12th edn.,

1962).

Cases referred:

1. In re Micklethwait, (1885) 11 Ex 452 (Court of

Exchequer Chamber); Tennant v. Smith, [1892] A.C. 150

(House of Lords).

2. Cape Brandy Syndicate v. Inland Revenue Commissioners,

[1921] 1 K.B. 64 (King’s Bench Division).

3. The Commissioners of Inland Revenue v. The Duke of

Westminster, [1936] A.C. 1 (House of Lords).

4. Mathuram Agrawal v. The State of Madhya Pradesh, AIR

2000 SC 109 (Supreme Court of India).

5. A.V. Fernandez v. State of Kerala, AIR 1957 SC 657

(Supreme Court of India).

6. Mathuram Agrawal v. The State of Madhya Pradesh, AIR

2000 SC 109 (Supreme Court of India).

7. CIT v. Karamchand Premchand Ltd., AIR 1960 SC 1175

(Supreme Court of India).

8. Commissioner of Central Excise, Pondicherry v. ACER

India Ltd., (2004) 8 SCC 173 (Supreme Court of India).

9. Commissioner of Central Excise, Pondicherry v. ACER

India Ltd., (2004) 8 SCC 173 (Supreme Court of India).

10. Commissioner of Central Excise, Pondicherry v. ACER

India Ltd., (2004) 8 SCC 173 (Supreme Court of India).

11. Commissioner of Central Excise, Pondicherry v. ACER

India Ltd., (2004) 8 SCC 173 (Supreme Court of India).

12. Commissioner of Central Excise, Pondicherry v. ACER

India Ltd., (2004) 8 SCC 173 (Supreme Court of India).

13. C.W.S. (India) Ltd. v. Commissioner of Income Tax, JT

1994 (3) SC 116 (Supreme Court of India).

14. C.W.S. (India) Ltd. v. Commissioner of Income Tax, JT

1994 (3) SC 116 (Supreme Court of India).

15. Nawn Estates (P) Ltd. v. C.I.T, West Bengal (1977) 1

SCC 7 (Supreme Court of Indi a).

16. Commissioner of Income Tax v. Ramakrishna Deo, AIR 1959

SC 239 (Supreme Court of India).

17. Commissioner of Central Excise v. North- Eastern

Tobacco Company, AIR 2003 SC 616 (Supreme Court of

India).

18. Orissa State Warehousing Corporation v. Commissioner of

Income Tax, AIR 1999 SC 1388 (Supreme Court of India).

19. Commissioner of Income Tax, Amritsar v. Straw Board

Manufacturing Co. Ltd., AIR 1989 SC 1490 (Supreme Court

of India).

20. Commissioner of Income Tax, Amritsar v. Straw Board

Manufacturing Co. Ltd., AIR 1989 SC 1490 (Supreme Court

of India).

21. Union of India v. M/S Wood Papers Ltd., AIR 1991 SC

2049 (Supreme Court of India).

22. CIT Central, Calcutta v. National Taj Traders, AIR 1980

SC 485 (Supreme Court of India).

23. W.T. Ramsay v. Inland Revenue Commissioners, [1982]

A.C. 300 (House of Lords).

24. McDowell and Co. v. Commercial Tax Officer, AIR 1986 SC

649 (Supreme Court of India).

25. Union of India v. Azadi Bachao Andolan, AIR 2004 SC

1107 (Supreme Court of India).