India's top court on Friday rejected a $2.5 billion tax bill slapped on British phone giant Vodafone over its purchase of a local operator in a ruling closely watched by foreign investors.
Vodafone's clear-cut victory in the bitter legal dispute was seen as a boost to cross-border mergers and acquisitions in India.
"Indian tax authorities had no jurisdiction to tax Vodafone," the Supreme Court said in its decision, overturning a previous ruling.
Indian authorities imposed the $2.5 billion tax bill on Vodafone and sought an equal sum in penalties over the company's $11.1 billion purchase in 2007 of a majority stake in the Indian mobile unit of Hong Kong-based Hutchison Whampoa.
Tax officials contended Vodafone should have withheld the amount the vendor was due to pay in capital gains tax when it bought the stake.
However, Vodafone, the world's largest mobile operator by subscribers, maintained that Indian law did not require it to deduct tax on the deal because it took place in the Cayman Islands and both buyer and seller were foreign.
Vodafone also noted it was the purchaser and not the seller and made no gain on the deal.
In the ruling, Supreme Court Justice Radhakrishnan Nair compared the Indian tax demand to "capital punishment on capital investment."
A lawyer for Vodafone, Abhishek Manu Singhvi, expressed delight over the company's win in which the Supreme Court ordered the tax department to return the British company's $554 million tax deposit "with interest."
"Here is a very clear, thumping, unequivocal unambiguous verdict in favour of certainty, clarity -- and in favour of foreign investment," Singhvi said.
The company said in a statement that the the three-judge Supreme Court bench had concluded that Vodafone "had no liability to account for withholding tax on its acquisition" of Hutchison Essar, now renamed Vodafone India.
The firm is a leading mobile operator in India's fiercely competitive mobile market.
The dispute was being closely tracked by international investors with experts saying the case could have implications for big-ticket purchases of Indian firms by other foreign companies.
Foreign investment in India has slowed amid concern over rampant corruption, bureaucratic delays, lack of progress on economic reforms and an uncertain regulatory climate.
Vodafone's foreign investment in India, the world's fastest-growing mobile market, was intended as a move to expand revenues in the face of saturated cellular markets in Western Europe.
But Vodafone has faced a rough ride, with cutthroat competition forcing down call rates in India to below a cent a minute and hitting the company's earnings