Financial Management –II

Mergers and Acquisitions

B V S Kapil 59

M Manivel 69

G Nishanth 79

Swapnil Potdukhe 89

Mozzam Rangwala 99

XIME

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VODAFONE acquires HUTCH

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Table of Contents

Company Profile: Hutchison Essar ..............................................................................................3

Company Profile: Vodafone..........................................................................................................3

Highlights of Acquisition ...............................................................................................................3

Reasons behind Hutchison’s Exit .................................................................................................4

Reasons for Vodafone’s Entry ......................................................................................................4

Valuation of Hutchison Essar by Vodafone ...............................................................................5

Timeline of Acquisition..................................................................................................................6

Capital Gains Tax ..........................................................................................................................7

Sections of Income Tax Act, 1961 .................................................................................................7

Controversy ....................................................................................................................................8

Implications of not paying the Capital Gains Tax ......................................................................8

Arguments by Vodafone and Revenue Department ...................................................................9

Bombay High Court’s verdict ....................................................................................................10

Conclusion ....................................................................................................................................11

References .....................................................................................................................................12

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Company Profile: Hutchison Essar

In 1992, Hutchison Whampoa and its Indian business partner established a company that in 1994

was awarded a license to provide mobile telecommunications services in Mumbai (formerly

Bombay) and launched commercial service as Hutchison Max in November 1995. Around 1995,

the company services were branded Max Touch¸ renamed to Orange in 2000. In December 2006,

Hutchison Essar re-launched the "Hutch" brand nationwide, consolidating its services under a

single identity. By 2007, Hutch had around 24 million customers and had 16 operating circles

across India along with licenses for 6 more circles. Hutch had a market share of over 16% in

India when it was acquired by Vodafone.

Company Profile: Vodafone

Vodafone Group plc is the world's largest mobile telecommunications company measured by

revenues and the world's second-largest measured by subscribers It operates networks in over

30 countries and has partner networks in over 40 additional countries. Group had 289 million

customers till Dec, 2008. The Company's ordinary shares are listed on the London Stock

Exchange and NYSE. The Company had a total market capitalization of approximately £74

billion at 31 December 2008.

Highlights of Acquisition

Acquisition of 67% share by Vodafone in Hutch-Essar previously held by Hutchison Telecom.

Vodafone gets full operational control.

Transaction consideration: US$11.1bn (£5.7bn).

Implied enterprise value: US$18.8bn (£9.6bn).

Partnership agreement with Essar.

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Reasons behind Hutchison’s Exit

According to Hutchison, urban markets in India had become saturated.

Future expansion if any would have had to be only in the rural areas, which would lead to falling

average revenue per user (ARPU) and consequently lower returns on its investments.

HTIL had suffered a loss to the tune of HK$768 million in 2005.

HTIL also wanted to use the money earned through this deal to fund its businesses in Europe,

Vietnam and Indonesia.

The sale of Interests in India would have enabled Hutchison Telecom to become one of Asia’s

best capitalized companies.

Relations between Hutchison telecom and the Essar group of India.

Reasons for Vodafone’s Entry

Indian Telecom sector was one of the fastest growing sector between 2002-07 with a CAGR

(Compounded annual growth rate) of 22%.

None of Vodafone’s global acquisitions at that time, including those of the German business of

Mannesmann, telecom businesses in Japan and Belgium, were performing up to the mark.

Markets, including the US, were maturing and were not growing in a big way.

Stiff competition among almost all major players in the industry, including global telecom

majors like BT, O2 of UK, Verizon from the US, Maxis Telecommunications of Malaysia,

Orascom from Egypt, The Hinduja group, Reliance and Bharti Airtel from India.

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Valuation of Hutchison Essar by Vodafone

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Timeline of Acquisition

December first week: Reliance Communications plans bid for Hutch-Essar.

December third week: Vodafone joins the race, ropes in UBS as advisor.

January first week: Hutch, Ruias differ on right of first refusal; Hindujas say they too will

bid; RCom gets $2 billion commitments from private equity firms.

January second week: Vodafone starts due diligence on Hutch-Essar, followed by the

Ruias; Hindujas place a non-binding bid.

February 9: Final day for submitting bids. Essar group, Reliance Communications, Hindujas

and Vodafone place their final bids.

February 10: Hindujas confirm to have partnered with Qatar Telecom and Russia's Altimo to

form a consortium.

February 11: Vodafone wins the race with a $19.3 billion bid.

Agreement: 11-Feb-2007

Transaction sealed on 08-May-2007

Operations start on 20-Sep-2007. Brand name changed from Hutch to Vodafone on the

same day.

The acquisition took place under Section 47(vii) of Income -Tax Act 1961.

Vodafone pays the entire deal amount in cash.

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Capital Gains Tax

As per Indian Income Tax laws, a capital gain tax is a voluntary tax payable on the sale of assets,

investments, capital accumulation, and productivity.

A Capital Gain can be defined as an any income generated by selling a capital investment.

A capital investment can be anything from business stocks, paintings, and houses to family

businesses and farmhouses.

The 'gain' here, refers essentially to the difference between the price originally paid for the

investment and money received upon selling it.

Sections of Income Tax Act, 1961

Section 9(1)(i)

All income accruing or arising, whether directly or indirectly, through or from any business

connection in India, or through or from any property in India, or through or from any asset or

source of income in India, or through the transfer of a capital asset situated in India” shall be

deemed to accrue or arise in India and taxed accordingly

Section 5(2)

The taxable income of a non-resident includes income "received or deemed to be received in

India" and income that "accrues or arises or deemed to accrue or arise in India". It does not

include income that accrues or arises or is deemed to accrue or arise outside India.

Section 195

Buyer will be responsible for paying the tax after purchasing any capital asset- a share or

debenture of a company in India.

The buyer will have to deduct TDS and failure to do so would leave him liable to pay the tax.

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Controversy

The whole controversy in the case of Vodafone is about the taxability of transfer of share capital

of the Indian entity. Generally, the transfer of shares of a non-resident company to another

non-resident is not subject to tax in India. As a result Vodafone neither deducted the tax at source

nor did it pay after the acquisition.

Implications of not paying the Capital gains Tax

The IT department sent a notice to Vodafone asking them to pay $1.7 Billion as capital gains tax.

It argues that company should have deducted the tax at source while making the payment to

HTIL.

A notice was sent to Vodafone by the IT department under the section 163 of Income- tax Act.

The notice would establish the Indian tax authorities’ jurisdiction over the transaction. Section

163 of the Act defines who all may be considered as agents of non-residents for the purpose of

tax in India. Contending that the erstwhile Hutchison-Essar was an “agent” of non-resident

Hutchison Inter-national; the income tax department had claimed that the Vodafone-Essar deal

involved Indian operations and so was liable to be taxed in the country.

IT department files a case in Bombay High Court. The case was filed for violation of Section 195

of Income Tax Act, 1961

According to the IT department, there was also confusion over the total direct and indirect

foreign holding of Hutchison Essar. This is because, Mr. Analjit Singh and Mr. Asim Ghosh who

owned the remaining 15% of the Vodafone-Hutch deal out of 67%, were financed by HTIL.

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Arguments by Vodafone and Revenue Department

Vodafone

The transfer of shares of a non-resident company to another non-resident is not subject to tax in

India. Also, there was no sale of shares of the Indian company and what it had acquired is a

company incorporated in Cayman Islands which, in turn, holds the Indian entity. Hence, the

transaction is not subject to tax in India.

Revenue Department

Transfer of beneficial interest of the shares of an Indian company and, hence, it will be subject to

tax. It argues that company should have deducted the tax at source while making the payment to

HTIL

In addition, Vodafone had failed to produce its agreement with Hutchinson which alone could

have revealed the true nature of the transaction.

Also, the valuation for the transfer includes the valuation of the Indian entity also and as

Vodafone has also approached the Foreign Investment Promotion Board (FIPB) for its approval

for the deal, Vodafone had a business connection in India.

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Bombay High Court’s Verdict

Justices D Y Chandrachud and J P Devadhar rejected Vodafone’s appeal against a ruling by the

tax department that it had a right to tax the UK firm’s acquisition of a majority stake in

Hutchison Essar in 2007.

Bombay high court said that Vodafone had a tax liability under Section 201(1) and 201(1A) of

the income tax act. It asked Vodafone to pay Rs. 12000 Crores (more than $2.5 billion) to the

revenue department which included the initial tax of around $1.7 billion plus the penalty for

evading tax, plus an interest of 18%.

The judges, however, asked the I-T department not to send a final notice to Vodafone for another

eight weeks. Vodafone was also allowed to negotiate the extent of tax payable with the

department.

But, Vodafone chose to challenge the verdict in The Supreme Court.

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Conclusion

From the detailed analysis of the Bombay High Court order it is apparent that the

transaction between HTIL and Vodafone did give rise to income chargeable to tax in

India under the provisions of sections 5(2) and 9 of the Income tax Act, 1961.

This is a case where the existence of separate corporate entities had not been recognized

by the Vendor, HTIL itself and through the corporate veil, the conclusion with regard to

the real nature of the transaction is inescapable.

Having concluded that the income is chargeable to tax in India, Vodafone was under an

obligation to deduct tax at source at the time of making payment of sale consideration to

HTIL in terms of section 195 of the Act. The facts clearly proved that on the date of

payment i.e. on 8th May, 2007 Vodafone had sufficient nexus and presence in India and

it cannot claim that it was not bound by Indian laws including tax laws and the

withholding tax provisions contained in section 195 of the Act. The provisions of section

195 were clearly attracted and the plea of payment being from one non-resident to

another is not sustainable.

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References

Wikipedia: Vodafone-Essar

Vodafone Main Website

Economic times: 9 Sep, 2010

Business Line: 18 Feb, 2007

CA Club India

Taxguru

Business Standard: Feb 12, 2007

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