Looking through Voda Ruling

Rohan Shah, Managing Partner , ELP
SC's principles on Look at vs Look through

As the Hon’ble Supreme Court (‘SC’), set itself to writing its judgment in the Vodafone case, the tax pandits and professional all over the world were waiting expectantly on how the SC would rule in relation to three abiding  tax controversies:-

 I.  The issue of substance over form

II.  The issue of whether a strict or a purposive interpretation of taxing provisions (particularly       the charging provisions) is the correct on interpretational approach

III. The definition of the line between ‘tax planning’ an ‘tax avoidance’

The SC has in its seminal judgement in the Vodafone case offered clarity and ongoing guidance as to all three of the aforesaid issues.  

‘Look at’, not ‘through’: ‘Investment to participate’ or ‘pre-ordained transactions’

The SC has on its consideration of the ‘look at’ versus the ‘look through’ doctrine held “If government intends to tax such transaction, it must be reflected clearly in the provisions and tax treaties. It is important for the tax administration, as well as the Courts, to ‘look at’ the legal nature of the transaction, in its entirety and holistically."

The SC’s judgement in Vodafone is a ruling that will be closely considered, if not followed, in the development of global tax jurisprudence and policy. It is therefore relevant to reflect on the policy and precedents globally on the issues of ‘form’ vis-a-vis ‘substance’ and ‘tax planning’ vis-a-vis ‘tax avoidance’. Much of the approach globally, especially in OECD countries like Australia, Belgium, Canada, New Zealand and Spain, has been to frame anti-avoidance rules of varying degrees of specificity and intensity. Probably the strongest statutory anti-avoidance rule being paragraph 42 of the German Tax Code under which legal constructions that are inappropriate to achieving the economic result sought by the taxpayer can be disregarded for tax purposes. The United States has probably the greatest contemplation of economic and legal variable in the framing of its anti-avoidance doctrines to cover substance over form, step transaction, business purpose, sham transaction, and economic substance. The French courts have developed the doctrine of ‘abnormal management act’ under which transactions that deviate from what a prudent businessperson would do, can be disregarded for tax purposes.  An alternative anti-avoidance provision in France is L64 of the Tax Code which can be interpreted to cover both simulation and abuse of right. In the Netherlands, the rule of fraus legis (meaning a fraud upon law) is essentially similar to Germany’s paragraph 42 of German Tax Code with the essential difference that fraus legis is a judicially evolved doctrine and is not statutory prescription.

In UK, the law has evolved beyond the initial approach in Inland Revenue Commissioners v. Duke of Westminster, ([1936] A.C. 1, at pp. 19c20), where it was stated “Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax”. More recent judgements have toned down the carte blanche offered under Duke of Westminster (supra). A more purposive interpretation has been seen in more recent judgement like in Bayfine UK vs HMRC ([2011] STC 717).

The SC has drawn the central thought in relation to any anti-avoidance approach and fused that approach with a dose of commercial and common sense, to articulate the distinction between ‘investment transactions for participation’ and ‘pre-ordained transaction for tax evasion’. The SC has cautioned against looking at transactions with undue suspicion, as also, against dissecting a transaction rather than looking at it holistically.  The SC has prescribed the following indices to help distinguish between an investment for participation and a pre-ordained transaction:

1)             The concept of participation in investment;

2)             The duration of time during which the Holding Structure exists;

3)             The period of business operations in India;

4)             The generation of taxable revenues in India; the timing of the exit;

5)             The continuity of business on such exit.

The five indices aforesaid would normally offer a good guidance in relation to the object or purpose of any investment transaction which is being examined to determine its intent.  Some may observe that there could have been a longer and more specific list. The indices set out will also be severely tested in the factual framework of transactional ingenuity. The indices however undeniably provide a robust commercial benchmark to help distinguish between a genuine investment transaction and a transaction actuated only with a intent to tax evasion.  As with any set of indices and benchmarks their abiding relevance will be determined in equal measure by how the tax regulator and the assessee embrace both, the letter and spirit of the Vodafone judgement.

The SC has managed to draw a fine balance between earlier SC decision in Gujarat State Financial vs M/S. Natson Manufacturing Co. (P) (1978 AIR 1765) which held that in a taxing statute the strict legal position as disclosed by the form and not the substance of the transaction is determinative of its taxability, and approach in the McDowell and Co. Ltd. v. CTO [(1985) 3 SCC 230] which led to the almost paranoiac mindset that every investment through a subsidiary or a SPV, which attracted a tax lower than the highest tax applicable, was a scheme of tax avoidance.  The SC, in holding that every transaction which is an investment to participate must be ‘looked at’ rather than ‘looked through’ - even if there are some related tax benefits, has offered definitive guidance  into the future on the entire ‘substance’ versus ‘form’ and ‘tax planning’ vis-a-vis ‘tax avoidance’ debate.

Interpretation of taxing statues - Strict interpretation versus purposive interpretation

The concept of literal interpretation of tax statues is not a new concept in the Indian jurisprudence.  Over a period of time, the Courts in India have evolved two primary principles for interpretation of Tax Statutes:

  • Literal/ strict interpretation of the statues
  • If the interpretation of a fiscal enactment is open to doubt, the construction beneficial or favourable to the assessee must be adopted

In A. V. Fernandes v State of Kerala (AIR 1957 SC 657), the Supreme Court stated the principle that if the revenue satisfies the court that t he case falls strictly within the provisions of the law, the subject can be taxed. If, on the other hand, the case does not fall within the four corners of the provisions of the taxing statute, no tax can be imposed by inference or by analogy or by trying to probe into the intentions of the Legislature and by considering what was the substance of the matter.  Similarly, in Innamuri Gopalam and others v State of A. P. (1964 2 SCR 888), the Supreme Court held that "In construing a statutory provision the first and foremost rule of construction is the literary construction. All that the court has to see at the very outset is what does the provision say. If the provision is unambiguous and if from the provision the legislative intent is clear, the court need not call into aid the other rules of construction of statutes. The other rules of construction are called into aid only when the legislative intent is not clear."

In C.I.T. v Madho Pd. Jatia (SC) (105 ITR 179) the Supreme Court held that If the provisions of a taxing statute are clear and unambiguous, full effect must be given to them irrespective of any consideration of equity. Where, however, the provisions are couched in language which is not free from ambiguity and admits of two interpretations a view which is favourable to the subject should be adopted. In State of Punjab v Jullundar Vegetables Syndicate,( 1966 SCR (2) 457), the Supreme Court observed that unless there is a specific provision for making an assessment, a taxing statute cannot be interpreted to widen its scope against the assessee; but on the contrary has to be so interpreted as to benefit the tax-payer. In the case of CIT vs. N.C.Budharaja & Co. (204 ITR 412), the Supreme Court held that “Liberal interpretation of an incentive provision should not do violence to plain language. The object of an enactment should be gathered from a reasonable interpretation of the language used therein. A liberal interpretation of a taxing provision cannot be adopted on the plea that this would advance the purported object of the Act”

The principle of strict interpretation has been given full play by the SC in its reading of charging provision in the Income Tax Act, 1961. The SC has held that Section 5 and Section 9 cannot be extended to cover indirect transfers of capital assets or property situated in India. The SC has held that the absent a specific taxing provision for indirect transfers such as in the Direct Tax Code (DTC) Bill 2010, Section 9 of cannot be extrapolated.

Global jurisprudence is in some instances leaning towards a more purposive interpretation rather than following the strict interpretation doctrine, as evidenced recently in the UK in Bayfine UK vs HMRC (supra).  

From an Indian perspective, the onus has rightly been left to the Legislature to articulate in its collective wisdom what it intends to tax in clear and unambiguous language.  There are no constraints on the will of Legislature other than those imposed by the Constitution of India. However, in terms of the SC in Vodafone judgement, absent a clear statutory provision to tax, no tax would normally be imposable on the adoption of any so called purposive interpretation of the legislative provisions.


The wisdom of SC in Vodafone judgement will be repeatedly tested on the threshold of commercial complexity and ingenuity. It will also be tested on the threshold of the interpretative ingenuity of tax administrator, whom the SC has invested with the onus of distinguishing between genuine investments of participation and pre-ordained transactions for evasion. 

We will surely reengage with these controversies in the future. The SC has, however, done its best to reduce the scope of future controversies.

This article is written by Rohan Shah & Bharath M., Economic Law Practice.