After Vodafone, UK-based Vedanta Resources Plc and Aditya Birla group firm Indian Rayon also face a potential tax demand of around Rs 900 crore and Rs 45 crore, respectively, for their failure to deduct taxes on payments to buy Indian assets, said a senior government official.  

The Income Tax department has issued the notices under Section 201 of the Income Tax Act, which deals with "consequences of failure to deduct or pay".

Both Indian Rayon and Vedanta acquired stakes in Indian companies, and the department contends they should have deducted tax while making the payment to the seller. Indian Rayon paid $150 million to acquire 16.45 per cent in Idea Cellular [Get Quote], India's fifth-largest mobile phone company, from US telecom giant AT&T in September 2005, and Vedanta paid $981 million to buy 51 per cent in Sesa Goa [Get Quote] from Japan's Mitsui & Co in April 2007.

The I-T department contends that Indian Rayon and Vedanta ought to have deducted tax since the sellers (AT&T and Mitsui respectively) have earned capital gains from selling their stake. Long-term capital gain tax attracts a rate of 20 per cent.

The I-T department had simultaneously issued notices to Indian Rayon and Sesa Goa--the two Indian firms involved in the transactions--asking them why they should not be treated as an "agent" of AT&T and Mitsui (the foreign firms concerned), respectively.

Under the Income Tax Act (Section 163), a local firm making or receiving payment from foreign companies is considered an "agent" because the responsibility for paying the tax lies with it. This section effectively prevents Indian firms from absolving themselves from deducting or paying tax in deals involving overseas parties.

Vedanta has challenged the notice in Karnataka High Court. However, the department is encouraged after the recent Supreme Court ruling in the Vodafone case, which involveda similar case of failure to deduct taxes while buying out Hong Kong Telecom International's stake in Hutch-Essar (now Vodafone) in 2007.

Vodafone had moved the Bombay High Court after receiving a notice from the I-T department. After this was rejected late last year, the company appealed to the Supreme Court which, in turn, asked the company to first subject itself to the I-T department's scrutiny first. The department is expected to cite the case in Karnataka High Court in the Vedanta case also.

Efforts to contact Vedanta failed as e-mails and telephone calls to them went unanswered.

An Aditya Birla group official acknowledged that the department has sought some additional information on the transaction with AT&T, but no tax demand has been raised so far. The official added that Indian Rayon had secured a no-objection certificate from the I-T department before paying AT&T the money.

A senior I-T official, however, said the department had initiated action after AT&T failed to pay capital gains tax.

The I-T department had also raised a demand of Rs 45 crore on Tata Industries which also bought 16.45 per cent in Idea, which was a three-way joint venture at the time, from AT&T in 2005 for $150 million (both AT&T and Tata have since sold out of Idea, which is now solely owned by the Aditya Birla group).

Tata Industries, however, paid the tax, but has challenged the department's decision in court. Tata Industries also has been served a notice recently under section 163 asking why it should not be treated as an agent of AT&T.