Mumbai: Vodafone might just see around $3 billion go up in smoke if it loses its legal battle with the Income Tax department in India over its acquisition of the erstwhile Hutch in India.

Reports said tax experts say if Vodafone loses its $1.7-billion tax claim at the courts, it could have to pay punitive damages in terms of ''compulsory interest'', and a penalty if the revenue department decides to levy one.

A report quoting an unnamed international taxation expert said that the government would be well within its rights to impose a penalty that would be sufficient to double the amount under dispute, with the contingent liability coming to around $2.5 billion including interest, ''if the matter is cleared by June 2009.''

Moreover, the tax department's initial claim on Vodafone for capital gains could also be hiked if the department decided to levy penalties and ''compulsory'' interest.
Vodafone had acquired the controlling stake in Hutchison Essar Ltd, by acquiring Hutchison Telecom International registered in the Cayman Islands in 2007.

In early 2007, Hutchison Telecom sold its 67 per cent interest in the Indian mobile phone network Hutch Essar to Vodafone for $13.1 billion, of which $2 billion was debt. Vodafone is challenging a $1.7-billion tax notice over its acquisition saying that a share purchase deal between two foreign companies was not taxable in India.

Other reports quoted sources as saying that it would be a bad case for levying penalty, as the tax liability of around $1.7 billion, the recovery could not be more than $2.1 billion.

However, Indian law sets the maximum potential penalty of up to 300 per cent, which would make the final figure soar. Typically, the penalty would be levied in smaller cases, but reports quoted sources as saying that revenue officers would not levy a penalty exceeding 100 per cent, that too if Vodafone shows that there was no malafide intention to subvert tax.'

At best, if the case pans out as a simple legal dispute, reports said, the penalty would not be enforced, so long as Vodafone shows reasonable cause which can be established. Penalty is typically levied in cases of wilful default. However, interest on the amount falls in the mandatory category, so the ultimate amount could well go up.

The squabble for now continues unabated, with the income tax department accusing Vodafone of not providing important documents, including the agreement to acquire Hutchison Telecommunications International's (HTIL) stake in Hutchison Essar.

The IT department needed the primary agreement to assess assess tax by assessing the nature of the deal by which Vodafone acquired HTIL's 67 per cent interest in Hutchison Essar. The agreement would have revealed the amount paid to HTIL, based on which the income tax authorities would have assessed applicable capital gains tax.

Reports suggested that the income tax department has argued that as the company did not provide this document, its writ should not be entertained on account of ''the conduct of the petitioner (Vodafone)".

The income tax authorities is arguing that the transaction is prima-facie taxable in India as it basically amounts to a "transfer of a capital asset in the country".

Vodafone says it acquired a foreign entity, not any assets in India, and therefore the question of tax does not arise.

It also said that it did not suppress "any vital documents" as alleged by the income tax authorities, and said that there was no question of furnishing any documents to the department as they had not requested for any papers.