Yesterday the High Court in Mumbai High dismissed Vodafone's plea against US$2 billion (â‚¬1.578 billion) tax liability imposed by the Indian authorities.
This was a serious blow to the operator and could put off other overseas companies looking to invest in India.
Vodafone argued the Indian tax authorities did not have the right to levy tax on the UK group's US$11bn acquisition of Indian mobile company, Hutchison Essar.
Vodafone bought a 67% stake in Hutchison Essar (now Vodafone Essar) from Hong Kong-based conglomerate Hutchison in February 2007.
India's tax authority insisted that although Vodafone was the buyer and Hutchison the seller, the UK group should have withheld an estimated US$ 2billion of capital gains tax on behalf of the government, in effect acting as a tax collector for the Indian government.
Stunned, Vodafone said the sale of shares took place between foreign companies, which, according to precedent, exempted the transaction from taxation in India.
The Financial Times reported that Vodafone paid the money paid for Hutchison Essar stake to a Dutch company controlled by Vodafone, which in turn paid it into a Cayman Island entity run by Hutchison. It was then moved into another Cayman Island account belonging to a company that indirectly held a controlling stake in the India-based mobile operator.
The newspaper report also quoted Mukesh Butani, partner and head of taxes at consultancy BMR & Associates, saying, "The decision is very significant. The bottom line is that if they've lost the case, there will be an impact on several other offshore transactions that the central government wants to tax."
The only glimmer of hope, according to the FT is that there were indications that the court's ruling might have been based on procedural issues rather than those related to the substance of the case.
The court might have decided Vodafone should have gone through the normal taxation department channels for dispute resolution, including arbitration, before resorting to legal action.
The tax department has also demanded Rs4.5 billion (US$90 million) from Tata Industries, part of the Tata group, for its Rs6.6 billion purchase of a stake in mobile operator, Idea Cellular, from AT&T of the US in 2005, the Economic Times has reported.
Vodafone also ran into trouble with Indian authorities when it tried to launch its M-PESA mobile payments service there. Days before the service was due to go live, the Bank of India said that as Vodafone wasn't a bank, it could not run what it described as a banking service.