Roll back of retrospective tax

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Introduction

Legal stability and predictability are a fundamental part of what people mean by the Rule of Law (Schwarzschild 2007, 686). In the absence of stability and predictability in law, citizens have difficulty managing their affairs effectively (Eskridge and Frickey 1994).[1]

In today’s world, all democratic governments are required to justify their actions in accordance with legal standards and established norms. Policymakers frequently overlook the fact that stability, certainty and predictability in the aspect of policy framework is one of the most important driving forces of a country’s competitive advantage in the eyes of investors. Overnight shift in policy making its application retrospective has repercussions range from violation of Bilateral Investment Treaty, strangulating India’s investment growth and damaging its reputation in the international arena.

When it comes to taxes, it’s no different. The Finance Act of 2012 was amended retrospectively, going back till 1962, indicating that any similar transaction that took place in the past four decades might be reopened and new taxes imposed. Although the amendment resulted in tax demands in 17 cases, Vodafone International Holdings BV, Vedanta Resources and Cairn Energy Plc & Cairn UK Holdings Limited are the three significant cases against the Indian government that have garnered the most attention.

The retrospective amendments intended to tax non-residents’ capital gains on the sale of foreign companies with underlying Indian assets were always disputed. Since its inception, debates have raged about their legitimacy and scope. Notably, two arbitral decisions made under India’s BITs found the amendments to be in violation of India’s commitment to treat foreign investors fairly and equally. As a result, measures were made to enforce the arbitration verdict against some of India’s assets located outside of the country.

In order to make amends, the Taxation Laws (Amendment) Bill 2021 has now been passed by the Lok Sabha, to make the tax clause provision which allows government to collect taxes retrospectively invalid.

Origin of retrospective tax fiasco:  

Facts of the Vodafone cases from which the issue of retrospective taxation stems from;

In May 2007, Vodafone B.V a Dutch corporation acquired 100% shares of a Cayman Islands company, which also owned 67 percent share of a telecoms business in India.

Hutchison, a Hong Kong-based company, made its investment in India through a Hong Kong-listed company, which held 100% shares Cayman Islands companies, which in turn held shares in some Indian and Mauritius companies, and these companies then held shares in an Indian holding company (Hutchison Essar Ltd. India) that controlled “operational subsidiaries in India”. Cayman Islands Mauritius owned 67 percent of Hutchison Essar Ltd. (India) and Essar owning the remaining 33 percent. When Hutchison chose to leave India, Vodafone, which was ready to join the Indian market, agreed to acquire Hutchison Telecom’s business in India. As a result, on 11th February ‘ 2007, Vodafone International Holdings BV (Netherlands) and Hutchison Telecommunications International Ltd (Hong Kong) signed a Share Purchase Agreement (SPA) in which HTIL agreed to sell Cayman Islands Mauritius shares.[2]

The deal was conducted in the same way as any other: Vodafone bought a company in Hong Kong that was under the listed company, giving them stock interests and control of all downstream companies, and therefore control over the Indian business. The agreements were made in England and Hong Kong, the payment was made outside India, and ownership was taken over by replacing the boards of directors of the businesses in the Cayman Islands and Mauritius and other places.

The question was whether the transfer of ownership between two foreign companies, resulting in the transfer of a foreign company’s controlling stake in an Indian company to another foreign company, constituted “transfer of capital assets” in India and if it was subject to Indian taxation.

The Indian tax authorities claimed that capital gains flowing from such a transfer were deemed taxable in India since it entailed a “transfer of controlling interests and rights in an Indian firm”. The Indian tax authorities contended that “the transfer of shares of the Cayman Island company led to the transfer of a capital asset situated in India and income from such transfer was taxable in India”. Vodafone contested this claim, and the issue moved to the Supreme Court in 2012, which ruled that Vodafone owes no tax to Indian authorities and that the Income Tax Act only allowed for the taxation of gains originating from the transfer of capital assets located in India. As a result, the sale of Cayman Island Company shares attracted no tax liability. [3]

However, government amended the tax legislation in 2012, giving it the authority to pursue mergers and acquisitions (M&A) agreements dating back to 1962 if the underlying asset was in India. Hence, overriding the Supreme Court’s ruling.

Similarly, the Cairn Energy Tax dispute started 15 years ago in 2006-07. Cairn UK transferred Cairn India Holdings’ shares to Cairn India, prompting the Income Tax Department to issue a tax demand of Rs. 24,500 crores, citing the reason that Cairn UK had generated capital gains. Due to dispute regarding the as to what should be considered capital gain the matter moved to Income Tax Appellate Tribunal (ITAT) and the Delhi High Court.

An international arbitration case was filed against the Indian government by Cairn Energy Plc in 2015. The Permanent Court of Arbitration decided in December 2020 that India had breached its obligations to Cairn under the India-United Kingdom Bilateral Investment Treaty.

Legal Aspect

Until now, one of the most significant and contentious retrospective amendments has been the inclusion of indirect transfers in the tax bracket by the Finance Act of 2012.

In the case of Vodafone, the Supreme Court ruled that Section 9 of the Income Tax Act does not allow tax authorities to tax capital gains originating from the indirect transfer of shares of an Indian company which took place between two foreign companies to acquire a foreign company which has majority stake in the Indian company. Emphasis must be laid on the fact that the amount of transactions and taxes foregone by the tax department as a result of this Supreme Court decision was enormous. As a result, the Government of India through Finance Act 2012 amended Section 9 and inserted Explanation 4 and Explanation 5 to Section 9(1)(i) of the Income-tax Act, 1961, in order to restate the legislative purpose in terms of scope and applicability, as well as to make additional amendments to provide legal clarity.

Section 9(1)(i) of the Income-tax Act, 1961 states that – “all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India 4 or through the transfer of a capital asset situate in India”. [4]

Section 9 was amended to state that shares or interests in a foreign company/entity are regarded to be based in India if their major value is derived from assets situated in India. Capital gains arising from the “transfer of such shares or an interest in a foreign business with significant assets in India” will be subject to taxation.

The Supreme Court stated in Vodafone’s case that the word “through” in section 9 does not mean “in consequence of.” Explanation 4 was added to address these concerns by clarifying that “the expression ‘through’ in section 9(1)(i) shall mean and include and shall be deemed to have always meant and included ‘by means of’, ‘in consequence of’ or ‘by reason of’.”[5] Section 9(1)(i) does not include indirect transfers of capital assets/property located in India, according to the Supreme Court in Vodafone case. Explanation 5 was added to clarify that an asset or a capital asset (defined as any share or interest in a company or entity registered or incorporated outside India) is deemed to be and will always be deemed to be located in India if it derives substantially of its value from assets located in India, whether directly or indirectly.

The government also made it retrospective from 1962. With this retrospective change, the Vodafone case, in which the whole transaction was already completed and a decision was already issued by the Supreme Court, was asked to pay tax.

Key criticism of retrospective tax amendment 2012:

The 2012 retrospective amendment was severely criticized by several other countries and business fraternity. Prime Minister Gordon Brown wrote to Prime Minister Manmohan Singh while the issue was still before the Indian courts, objecting to the retrospective application of tax rules stating that transactions of similar nature have never been taxed in the past. In order to maintain clarity, stability, and public trust in the dispute resolution process, laws should not be altered frequently. The retrospective tax fiasco tarnished India’s reputation as a well-run country with a strong rule of law and stable legal framework, as well as caused uncertainty in the investment climate. In today’s world, when international investment is the lifeblood of economic progress in emerging nations, certainty is one of the most vital elements. This type of tax law unpredictability and unfairness raises the cost of doing business in India by increasing the risk of conducting business.  This will inevitably have an impact on economic development and productivity. What defines the norms for fair taxes are universally agreed upon by jurists and economists. Equity and justice, clarity, tax neutrality, economic development and efficiency, transparency and visibility are among the 10 generally recognized norms. Major modifications to tax legislation that retroactively modify fundamental principles are clearly in violation of each of these norms. The amendment was also introduced to override the ruling of the Supreme Court of India, this undermines the rule of law’s foundation, in which the courts [rather than the executive] have the final say in statutory interpretation. While the amendment may pertain to a single sector, the heightened reach of risk is cross-sectoral since it typically generates a sense of uncertainty regarding the system of rule of law. The world, like the Indian economy, is changing at a rapid rate. Globalization and unrestricted capital flow have given enormous value and prosperity to India, but they have also resulted in a significant shift in corporate culture and character. Economic governance now is expected to adhere to global standards of justice and openness.[6]

Why do government want to bury the retrospective tax?

In 17 cases, the government raised tax demands, with Vodafone and Cairn receiving the most attention. Cairn has sought for seizure of Indian assets, including the state-owned national carrier Air India’s aircraft, in courts in the United States, Mauritius, Canada, Netherlands and Singapore earlier this year. Moreover it also secured a judicial order in France freezing about $24 million real estate assets owned by India in Paris. The Government may have been forced to roll back the retro tax due to defeat in arbitration suits and seizure of India’s assets overseas.

Moreover, the Bill stated: “It is argued that such retrospective amendments militate against the principle of tax certainty and damage India’s reputation as an attractive destination… The country today stands at a juncture when quick recovery of the economy after the COVID-19 pandemic is the need of the hour and foreign investment has an important role to play…”

As a result, the dispute intensified, prompting the present proposal to completely eliminate retrospective applicability. This move of Government is in the right direction and would also soothe past injustices caused.[7]

Salient features of Taxation Laws (Amendment Bill) ‘2021:

The bill attempts to diminish the effects of the levy on indirect transfers by nullifying its retrospective effect and expanding it to both pending and finished proceedings with such revenue. There are two separate circumstances addressed in the amendment Bill.

In the case that the assessment proceedings involving indirect income transfers are not concluded prior 28 May 2012, the bill stipulates that – “such proceedings will be completed without giving effect to the amendments made vide Finance Act, 2012 and any taxes that have already been paid on such indirect transfers would be refunded along with applicable interest upon the completion of such pending proceedings”.

If proceedings have already been concluded and assessment or penalty orders for income from indirect transfers have already been issued before 28 May 2012, the bill specifies that it should be considered as if such orders had never been passed. This shall be subject to the withdrawal of cases and forfeiture of all legal remedies against the government by the taxpayer. If these conditions are satisfied then, the tax amount that was already deposited by the taxpayers would be reimbursed sans interest. This bill will not lead to the revocation of the 2012 amendment, instead, would simply limit the applicability of the latter to instances when the taxpayer agrees to drop all claims and pledges to desist from any future recovery action. 

Conclusion:

The government took nine years to rescind the retrospective taxes reforms, maybe due to the unfavorable verdicts in international arbitration proceedings. This is a long-overdue, but much-welcomed step. This step will put an end to policy uncertainty for potential investors. The Bill’s passage into law should comfort the business community about India’s tax policy’s intentions and direction, as well as the government’s ability to make bold and transformative decisions. The government should be commended for taking the significant step of restoring the idea of tax certainty, even if it means a revenue loss.

It’s a positive start toward settling ongoing issues in a variety of forums, including international ones. With the implementation of retrospective taxation of indirect transactions in 2012, the tax department reopened the assessment in a few cases, claiming the retrospective amendments. The aforementioned cases were pending in several high courts and, in certain circumstances, in arbitration. The tax department will not classify the aforementioned assesses as in default under the present amendment if the pending litigation is dropped. This effectively settles the conflict.

This may also help restore India’s reputation as a fair and predictable government, as well as put an end to needless, lengthy, and costly litigation. As we’ve witnessed, any legislative changes made without careful and thorough consideration of the consequences may be devastating, and it can take years to undo.


[1]  “STABILITY, PREDICTABILITY AND THE RULE OF LAW: STARE DECISIS AS RECIPROCITY NORM”, available at: http://citeseerx.ist.psu.edu/viewdoc/summary?doi=10.1.1.614.4067 (visited on 15th September’2021)

[2]  “Vodafone wins arbitration against India in retrospective tax case, available at: Vodafone wins arbitration against India in retrospective tax case (taxguru.in) (visited on 11th September’ 2021)”

[3] “Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613”

[4] Section 9(1)(i) in The Income- Tax Act, 1995, available at: https://indiankanoon.org/doc/1220884/ (visited on 10th September’ 2021)

[5]   “Analysis of Taxation laws amendment bill’ 2021”, available at: https://www.taxmann.com/post/blog/9055/analysis-of-taxation-laws-amendment-bill-2021/ ( visited on 12th september’2021)

[6]   “A pragmatic saying to rest of the retrospective tax ghost” , avilable at: https://www.livemint.com/opinion/online-views/a-pragmatic-laying-to-rest-of-the-retrospective-tax-ghost-11628528203611.html  ( visited on 11th september’2021)

[7]  “Why is retrospective tax being scrapped ,available at: https://www.thehindu.com/business/Economy/explained-why-is-retrospective-tax-being-scrapped/article35790901.ece ( visted on 11th september’2021)”

Author: Vaishnavi Chandrakar, Hidayatullah National Law University (HNLU), Raipur

Editor: Kanishka VaishSenior Editor, LexLife India.

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