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Foreign companies are bracing themselves this week for a Mumbai High Court hearing in a case that could determine the future viability of mergers and acquisitions by offshore groups of Indian assets.
In the case, which will begin on Tuesday and last for five days, Indian tax authorities will argue that Vodafone, the UK-based mobile phone group headed by Arun Sarin, is liable for an estimated $2bn in taxes on its $11bn acquisition of local operator, Hutchison Essar, last year.
"Everybody is anxiously waiting for the outcome. It's a very tricky issue centring on whether the government can tax beneficial ownership and the transfer of shares offshore," says Mukesh Butani, tax practice leader at BMR & Associates, a consulting firm.
A ruling against Vodafone, headed by Arun Sarin, would spark concern among foreign companies operating in the country, with the government already eyeing a number of similar cases involving multinationals.
It would also be a blow for Vodafone, which is seeking to expand in fast-growing emerging markets such as India to counter stagnant sales in its core markets.
In the case, Vodafone is contesting government claims that it should have withheld, on behalf of tax authorities, capital gains tax on its acquisition of a controlling stake in Hutchison Essar from Hong Kong conglomerate Hutchison last year.
While Vodafone was the buyer and Hutchison of Hong Kong was the seller that made the capital gain, the government claims the buyer, in this case Vodafone, is liable. Vodafone is arguing that, under Indian law, such overseas transfers of "beneficial ownership" are not taxable because the exchange of the "capital asset", the shares, took place in a foreign jurisdiction.
The transaction was between a Dutch company, owned by Vodafone, which paid $11bn to a Cayman Island entity, owned by Hutchison, for another Cayman Island company that indirectly held a controlling stake in India-based Hutchison Essar.
However, the government is countering that, as Hutch-ison Essar's operating assets were based in India it is justified in trying to tax the transaction.
To make this argument, it is invoking common law principles, such as "lifting the corporate veil", a way of cutting through complex corporate structures to find the ultimate beneficial owner of an asset.
The government has also introduced an amendment as part of the annual budget last month in a move analysts say could strengthen its ability to recover the withholding tax should Vodafone lose its initial case.
Vodafone has declined to comment on the case. Following the budget, it said: "We have been advised that there should be no tax arising on the transaction and Vodafone will continue to defend its position vigorously."
Tax consultants say the court could decide to defer the case to allow the budget amendment to become law. But no matter what happens, they anticipate the matter will run for many months, with both sides likely to appeal if they lose.
India could also face heavy international lobbying over the case, which multinationals claim could inhibit inward foreign investment at a time when Indian companies are engaged in an unprecedented overseas acquisition spree.
India is not the only country in Asia whose tax authorities have wanted to grab a share of the proceeds of lucrative merger and acquisition deals between foreign companies that have involved domestic assets.
US private equity fund Lone Star in Seoul has faced tax hurdles over its planned sale of Korea Exchange Bank to HSBC.
