BUNTY, TERA NETWORK SLOW HAI KYA? – ESSAR TELECOM LEGAL SAGA

Foreign Direct Investment (FDI) into the country through tax-friendly jurisdictions (TFJs) like Mauritius and Singapore has long been entangled in the debate between tax planning and tax avoidance. The significant tax savings on gains realized when investments are exited at multiples of the initial investment have led to a considerable erosion of the domestic tax base, frustrating conscientious tax officers. The fact that jurisdictions like Mauritius have minimal domestic economic activity but thrive as conduits for offshore investments from major economies such as the United States and European nations has exacerbated tensions within India's tax administration. These authorities have often struggled to uncover the veil of such practices, which they view as abuses of investment routing.

Courts have had mixed responses, often undermining the efforts of tax officers who argue that intermediate companies in TFJs are merely conduits and that tax exemptions were never intended to encourage the blatant abuse of channeling investments from third countries.

Courts have accepted tax residency certificates (TRCs) issued by TFJs as proof of residency, benefiting jurisdictions that host these brass plate companies. An industry of accountants, lawyers, and bankers thrives on this system, with thousands of companies often sharing the same incorporation address, requiring no substantial presence beyond a postal address to qualify as residents. Tax experts debate this issue extensively, citing precedents for both sides. The more astute experts know how to present their cases and choose judges sympathetic to the notion that a piece of paper stamped by an authority in Mauritius or similar locales can facilitate tax avoidance worth thousands of crores.

One notable case that has emerged at the Income Tax Appellate Tribunal involves the Essar group of companies, once a major telecom player. Although a news report in Tax Sutra (an online tax news service) provides limited details about the nature of the case, it offers a glimpse into the potential issues at stake.

The report states that the lawyer representing the tax department, senior advocate Mr. N. Venkataraman, has outlined numerous reasons for the case to be heard by a special bench, which typically consists of three judges instead of the usual two. Avoiding overly technical details, the tax department's arguments suggest that the capital gain exemption claimed by the taxpayer, based on its origin in Mauritius, may not be valid due to the lack of substantial presence in Mauritius and the insufficiency of a mere TRC as conclusive evidence. Since the case before the tax tribunal arises from an unfavorable ruling by lower authorities, it is crucial to understand their findings and determine if they are legally and factually sound. These proceedings are confidential, and outsiders cannot access them. However, it is notable that the Essar group, a conglomerate with interests in diverse sectors such as oil, steel, shipping, textiles, power, and telecom, was primarily rooted in India and had a history of defaulting on bank loans. This led to one of their businesses, Essar Steel, being acquired through insolvency proceedings, resulting in a significant debt write-off.

While it is conceivable to grant tax exemptions for investments through TFJs to foreign companies bringing in FDI, it is worth exploring how this issue arose in the case of Essar, essentially an Indian company. To understand this, we need to trace some of its history. In 1995, when the telecom revolution was just beginning, Essar swiftly initiated GSM operations in Delhi under the brand name Essar Cellphones. As a pioneer, Essar quickly capitalized on a significant opportunity in this emerging sector.

Initially, Essar acquired licenses for the telecom circles of Eastern UP, Rajasthan, Haryana, and Punjab. Over time, Essar aggressively expanded its footprint and partnered with Hutchison, forming Hutchison Essar Limited, a joint venture in which Essar held a 33% stake. Hutchison Essar also acquired the telecom business of BPL Mobile in a major acquisition in 2006. While the historical investment details are not immediately traceable, it can be presumed that Essar's entire investment in telecom came from its resources in India, primarily through cross-holdings by other Essar companies. Like many conglomerates in the country, Essar was known for using funds raised in one business to support investments in another through intercorporate investments and loans.

It is challenging to determine where and how the FDI element originated in their case, which could have entitled them to seek tax exemption on capital gains. In 2006, Hutchison decided to exit India, and Vodafone of the U.K. bought Hutchison's stake, valued at approximately US$11.5 billion. This transaction itself became a landmark tax case and led to a highly criticized amendment to the law, expanding the scope of taxation to areas historically excluded from the Indian tax net

So far, the foreign aspect of Essar's investments in its telecom venture is not evident or explicit. However, subsequent events reveal that the entire value of Essar's telecom business in India eventually migrated to two entities located in Mauritius. The details of how this transition occurred could make for a thrilling story, should more information come to light. According to public data, Essar established a presence in Mauritius as early as the 1990s through some acquisitions. Whether this foothold helped offshore other Indian investments is something for tax authorities to investigate, and any speculation without proper data would be inappropriate.

In July 2011, Essar and the Vodafone group announced that Vodafone would acquire Essar's residual stake in their telecom venture, providing a complete exit for Essar. The two Essar entities in Mauritius, Essar Communications (Mauritius) Limited (ECML) and ETHL Communications Holdings Limited (ECHL), sold their direct and indirect shareholdings in Vodafone Essar Limited (VEL), amounting to 33%, to the Vodafone group. The deal was valued at US$5.46 billion, including a net payment of US$3.32 billion for the 22% stake in VEL held by ECML and ECom, after withholding tax of US$0.88 billion.

A payment of US$1.26 billion for the remaining 11% stake in VEL held by ECHL made up the balance. Evidently, the Essar group exited the telecom venture with a significant profit, given that its overall investment seems to have been under US$800 million based on available public information. Naturally, the tax authorities were highly suspicious of the claim for tax exemption by interposing a couple of Mauritius entities in a case where the entire initial investment originated from resources in India.

There is scant evidence in the public domain indicating that the Essar group had resources outside the country during the period from 1995 to 2007 when they made substantial investments in the telecom business. The pressing question arises: how did the shares representing a 33% interest in the Vodafone Essar joint venture (formerly Hutch-Essar) leave the borders of India without detection? The answer may lie in the rulings of the tax department, currently being contested before the tribunal, though this information remains inaccessible at this stage.

One of the questions raised by the Additional Solicitor General (ASG) offers a clue: whether the liquidation of ETIL, termed as voluntary liquidation, was merely a disguise or a tactical maneuver, potentially stemming from a lender's loan agreement to which ETIL was not party, but ostensibly mandated by key personnel of the Essar Group based in India. Speculation suggests that the Mauritius entities gained control of ETIL's shares in the telecom venture by orchestrating its liquidation and asset distribution. This prompts questions about how ECML and ECHL managed to obtain beneficial and legal ownership of ETIL to acquire its shares.

This scenario demands more factual clarity, but it mirrors a phenomenon known as asset externalization, which a few other businesses have also achieved. When value accumulates within an Indian entity, a strategic maneuver involving foreign shareholders at nominal values, while Indian shareholders gradually exit at book values (disregarding true business worth), may appear simplistic but outlines the general scheme that each case may have executed with varying degrees of sophistication. If the tax department failed to intervene during these events, it could render the case a fait accompli. Once value migrates in this manner, overseas entities assume shareholder status and claim entitlement to the full value of the underlying company.

Subsequently, the exit at the overseas level evades the Indian legal framework, particularly when invoking the cover of DTAA protection, as in the current case under the India-Mauritius tax treaty. Therefore, the key issue raised here is not only whether a Tax Residency Certificate (TRC) alone can serve as the definitive basis for accessing treaty exemptions, but also whether cases like the present one genuinely involve little or no actual Foreign Direct Investment (FDI), thereby undermining the legitimacy of tax exemptions.

The extent to which past actions of shareholding migration will influence the appellate court after considerable time has elapsed remains speculative. However, if it is proven that the liquidation leading to share migration was merely a step to ultimately achieve tax-exempt capital gains upon exit, the doctrine of disregarding steps lacking commercial purpose could be invoked. This might potentially invalidate the ownership claim of the Mauritius companies over the shares. In such a scenario, reliance on the treaty and TRC may offer little protection if courts uphold this approach.

Alternatively, if the courts do not adopt this viewpoint, questions may arise about the legitimacy of invoking DTAA cover when entities in Mauritius made minimal or no genuine FDI, acquiring shares through legal maneuvers. Whether TRC alone can ensure tax exemption if the legitimacy of FDI is challenged would be another critical aspect tested in this case.

Once this hurdle is cleared, the Tax Residency Certificate (TRC) could become pivotal in determining the outcome of the case. From a philosophical standpoint, the extent to which the Indian system should bend to accommodate dubious tax claims, under the guise of avoiding discouraging Foreign Direct Investment (FDI), poses a significant policy dilemma.

It seems that courts, in stretching Double Taxation Avoidance Agreements (DTAA) to accommodate every instance of potential abuse to appease the FDI sector, may overstep their mandate. Their role ostensibly involves interpreting laws and assessing facts, rather than speculating on economic implications they may not fully grasp.

In all likelihood, the current case appears destined for protracted litigation, given its surprising journey to the tribunal over more than 13 years. Perhaps, it raises the question whether the present litigating lawyers will ever witness its ultimate resolution.