The Mumbai High Court on Wednesday dismissed a challenge by Vodafone against a $2bn tax case in a blow to the UK group and a potential setback for other companies looking to make investments in India.

Vodafone had challenged whether Indian tax authorities had the right to assess the tax on the UK group’s $11bn acquisition of a local mobile company, Hutchison Essar.

Vodafone said it would appeal against the ruling to the Supreme Court in New Delhi, the country’s highest court, using an eight-week extension of an order temporarily preventing the tax department from taking any action.

“Vodafone, based on advice received, continues to believe that the transaction is not subject to tax in India and is confident of a positive outcome ultimately,” the company said.

Although the court rejected the petition, the full text of its decision has not been released, leaving it unclear on what grounds the judges rejected the company’s case.

In February last year, Vodafone bought a 67 per cent stake in Hutchison Essar, now known as Vodafone Essar, from Hutchison of Hong Kong.

India's tax department argued that even though Vodafone was the buyer and Hutchison was the seller, the UK group should have withheld an estimated $2bn of capital gains tax on the deal on the government’s behalf.

Vodafone has countered by saying the sale of shares took place between foreign companies, which under past practice would normally have exempted the transaction from taxation in India.

Under the Hutchison Essar sale, a Dutch company controlled by Vodafone paid the $11bn to a Cayman Island entity run by Hutchison, for another Cayman Island company that indirectly held a controlling stake in the India-based mobile operator.

“The decision is very significant,” said Mukesh Butani, partner and head of taxes at consultancy BMR & Associates. “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.”

However, 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.

Investors were adopting a wait-and-see attitude to the case, which they expected to run for a long time. “Vodafone has told us that whilst this is a disappointment this makes a capital gains tax liability no more or less likely,” said Jonathan Groocock of Investec Securities.

The deal has given Vodafone an important foothold in the world’s fastest growing large emerging market for telecoms.

The group has risen from the fourth-largest operator in the country at the time of the deal to the third-biggest today with 56.7m subscribers at the end of October.

The Vodafone case is just the largest of several mergers and acquisitions that the Indian tax department is thought to be focusing on.

Another potential case involves Genpact, a back-office outsourcing centre set up by General Electric. It became independent in 2004 when GE sold a 60 per cent stake to the private equity firms Oak Hill Capital Partners and General Atlantic.

GE said it had not received any direct correspondence from the tax department. Instead, the tax office has written to Genpact India seeking information about the transaction.

The tax department has also demanded Rs4.5bn ($90m) from Tata Industries, part of the Tata group, for its Rs6.6bn purchase of a stake in mobile operator, Idea Cellular, from AT&T of the US in 2005, the Economic Times has reported.