The Indian government is threatening to seize Vodafone’s assets in the country if it doesn’t pay a disputed USD2.1 billion tax demand.

Both sides have been in dispute over the tax demand ever since Vodafone made its initial investment in the country in 2007.

An attempt by the Indian government to retrospectively change the law after it lost a court case scared away foreign investors and the government has been seen as keener now to seek an amicable settlement and close the issue.

Now it is reported that the Income Tax dept at the government has sent a letter to Vodafone warning that it may seize Vodafone assets if it doesn’t pay the outstanding tax bill.

In the letter, the tax department said that it may seek to recover any overdue amounts, even from overseas companies, “from any assets of the non-resident which are, or may at any time come, within India.”

Background
The Indian government has argued that although the transaction took place via subsidiaries in Mauritius, as the bulk of the assets were within India, then taxes should be paid to the Indian government. In addition, under Indian law, it is the buyer of assets who pays taxes, not the seller.

Vodafone International Holdings BV, a company registered in the Netherlands, acquired the entire share capital of CGP Investments (Holdings) Ltd, a Cayman Islands based company from Hutchison International (HTIL). CGP, itself, owns 52 per cent stakes in Hutchison India.

Vodafone Essar has argued that Vodafone Holdings , CGP Investments as well as HTIL are foreign companies and as the transaction was structured through Mauritius, capital gains cannot have been accumulated within India. Also India and Mauritius have a double taxation avoidance treaty, so it would not be possible for India to apply capital gains tax on transactions that are already taxed within Mauritius.

A High Court ruling was issued in favour of Vodafone, but the government then changed the law to make similar transactions subject to tax, and also retrospectively applied it to past transactions.

The lack of legal clarity and the risk of doing business in a country where tax laws can be retrospectively changed spooked foreign investors.

The current government had been making conciliatory noises about the situation, until this latest development.