Mumbai/ New Delhi: Ending a four-year relationship, Vodafone Group Plc, the world’s largest mobile telephony company by subscribers, on Friday agreed to purchase Indian partner Essar Group’s 33% stake in Vodafone Essar Ltd (VEL), India’s third largest mobile telephony company by subscribers, for $5.46 billion (Rs 24,352 crore) in cash, $460 million more that what was originally envisaged.

The deal marks the exit of the steel-to-oil conglomerate Essar Group from the mobile telephony business.

The sale is part of a 2007 agreement between the two and obliged Vodafone to pay at least $5 billion for the stake.

Vodafone purchased a 22.03% stake from Essar Communications (Mauritius) Ltd (ECML) for $3.32 billion on Friday. The remaining 10.97% from Indian firm ETHL Communications Holdings Ltd (ECHL) will be bought for $1.26 billion by 15 February 2012.

“The total cash outflow from Vodafone, including cash already paid for the first tranche of ECML’s shareholding in VEL, is expected to be approximately $5.46 billion," said a Vodafone release. That figure is inclusive of withholding tax.

“The stake buyout is in line with the strategy of streamlining its shareholding in markets where it has minority holdings. Wherever it has not been possible," such as in Poland and France, Vodafone “has given up its minority stake, unlike in India," said James Crawshaw, a telecom analyst with Standard and Poor’s (S&P) in London.

According to the company release, a net payment of $3.32 billion is being made for the 22% stake in VEL held by ECML after withholding tax of $880 million.

“Whilst Vodafone and Essar continue to believe that no tax is due on this transfer, it was viewed as prudent to pay withholding tax on a ‘without’ prejudice basis," VEL said in an emailed statement.

This is significant in the light of the court case over the tax demand of more than $2 billion contested by Vodafone and related to the acquisition of its stake in the Indian company in 2007. The case is to be heard in the Supreme Court next month.

“This is not the end of the road for Essar, but the beginning," said a senior executive at the Essar Group. “Now we will be able to focus and develop other business more effectively and efficiently," the executive said, requesting anonymity.

Another Essar official said the money will be used to repay debt at ECML and ETHL, raised to buy steel plants, refineries and coal mines overseas.

The Newbury, England-based mobile company will own 74% of VEL directly through subsidiaries. The remaining 26% will be controlled by local shareholders.

“It is expected that 1.35% of the shares in VEL will be transferred to an Indian investor to ensure Vodafone’s continued compliance with Indian foreign direct investment rules," the release said. An overseas mobile firm cannot own more than 74% in an Indian company.

The transaction will give Vodafone complete control of its Indian operations as Essar will give up board representation.

Other stakeholders of the company are Analjit Singh, founder and chairman of the Max India group; Infrastructure Development Finance Co. Ltd; and Asim Ghosh, former chief executive officer of VEL.

“It is to be seen how the regulatory environment pans out in India and whether the company will have to pay taxes and 2G (second-generation) spectrum fees with retrospective effect," said Crawshaw of S&P. “In a market where the company is not profitable, it is a major concern." Crawshaw expects the firm to further bolster its position by weighing opportunities arising out of any consolidation in the telecom sector in India.

While Vodafone has decided to withhold tax of $880 million on its purchase of shares in VEL from the two Essar companies, the firm maintained that the transaction was not taxable.

The group withheld the tax as a precautionary measure, anticipating a tax demand from the Indian authorities, said advisers familiar with the deal.

The Essar firms selling stakes in VEL are incorporated in Mauritius, with which India has a double-tax avoidance treaty. Vodafone believes this makes the deal non-taxable in India.

However, in order for the tax department to be satisfied, Essar will likely have to demonstrate that the companies in Mauritius are genuinely resident there and not merely conduits, according to Daksha Baxi, executive director at law firm Khaitan and Co.

“Essar would then file its tax returns claiming that no tax is due. This will be subject to a normal assessment procedure, which might take three-four years," she added.

The company may have taken a cautious view in light of the case over the $11.2 billion acquisition of Hutchison Telecom International Ltd’s stake in a Cayman Islands company through which Vodafone entered the Indian market in 2007.

The income-tax (I-T) department had asked Vodafone to pay 11,218 crore as tax that the company is opposing on the ground that the deal doesn’t come under Indian jurisdiction.

Earlier in the day, Euro Pacific Securities, a wholly owned subsidiary of Vodafone International Holdings, withdrew its application before the Authority of Advanced Ruling (AAR) seeking clarity on whether it is liable to withhold tax on its purchase of shares in VEL from the two Essar group companies.

The firm, incorporated in Mauritius, had filed an application with AAR in August seeking clarity on whether it is supposed to withhold tax.

The implication of the withdrawal is that Vodafone will have to deduct withholding tax, said Central Board of Direct Taxes chairman Prakash Chandra. The I-T department estimates the tax implication of the deal could be 3,500-3,700 crore, he added.

P.R.Sanjai in Mumbai contributed to this story.