The finance ministry is confident Vodafone doesn't have any basis to go for international arbitration to settle its tax dispute.
However, it fears the telecom company might take legal recourse under domestic laws, which will prevent the government from raising the demand till the case is resolved.
After securing the Cabinet nod on Tuesday to withdraw the conciliation offer, the tax department is planning to serve the company a demand notice that involves tax dues of Rs 7,900 crore (Rs 79 billion) and interest payment of about Rs 8,000 crore (Rs 80 billion).
For defaulting on tax payment, the company will also be asked to pay Rs 7,900 crore (Rs 79 billion).
"The case may go to courts again.
"After the retrospective amendment to the Income Tax Act, the government has a strong case but the penalty and interest may be waived by courts.
"The problem is since the case will now be fought in courts for the next several years, Vodafone will buy more time to clear its dues," a finance ministry official told Business Standard on condition of anonymity.
The tax demand was first raised in 2007.
Taking into account inflation and currency depreciation, Vodafone's actual tax liability would be much less, even if the government won the case, the official said.
If Vodafone chooses to challenge the tax notice, it will have four levels for appeal -- Commissioner of Income Tax (Appeals), Income Tax Appellate Tribunal, the high court and the Supreme Court.
In 2012-13, the government had amended the law to upturn a Supreme Court judgment and tax Vodafone on its acquisition of Hutchison Whampoa's stake in Hutchison Essar.
As the move drew a lot of criticism, the finance
ministry agreed to Vodafone's conciliation proposal.
For this, a Cabinet approval was secured, but the conciliation process couldn't be initiated as Vodafone wanted this to be carried out under the United Nations Commission on International Trade Law, while the government wasn't ready to do it outside the scope of the Indian Arbitration and Conciliation Act.
Also, Vodafone wanted to club its transfer pricing cases with the conciliation case.
The company is fighting a Rs 3,700-crore (Rs 37 billion) transfer pricing dispute with tax authorities for a transaction made in 2008-09.
Last month, the tax department had added about Rs 3,200 crore (Rs 32 billion) to Vodafone's income in a fresh transfer pricing case, pegging its additional tax liability at about Rs 1,000 crore (Rs 10 billion).
In January, Vodafone served India a supplementary notice under a bilateral investment promotion and protection agreement.
Finance ministry officials, however, said tax issues weren't covered under the India-Netherlands investment promotion agreement and, therefore, the company didn't have a strong case.
In a statement earlier this month, Vodafone said at a meeting with Indian government officials, its representatives had suggested international conciliation mechanisms, "but all of these suggested ways were rejected by the Indian government".
It added the company had entered into discussions with the Indian government in good faith and with a desire to achieve a fair outcome, acceptable to both parties. On the Hutchison Essar sale, it said the government was seeking to tax an event twice.
Earlier, the government had agreed during the conciliation proceedings, the assessing officer would keep the tax demand in abeyance.
The withdrawal of conciliation will allow tax authorities to move ahead with a demand notice.
However, it fears the telecom company might take legal recourse under domestic laws, which will prevent the government from raising the demand till the case is resolved.