Retro Tax: Justice Delayed But Not Denied
If there is one tag that the Narendra Modi government has been fighting to shake off, it has been “tax terrorism”. Exhibit A for actions that gave the tag to India is the retrospective amendment relating to indirect transfers. The government has done well in both its terms to implement small and large measures to address this. But the decision taken on Aug. 5, 2021, as the Finance Minister moved the Taxation Laws (Amendment) Bill, 2021 in the Lok Sabha, can be perceived as the most significant one thus far.
The bill proposes to amend the tax laws to provide that no tax demand can be raised in the future on the basis of the retrospective amendment and to provide that demands already raised would be nullified on the fulfillment of specified conditions by the litigants.
The amendments effectively make the famous ‘indirect transfer’ tax prospective in nature to be applicable only on a transfer made subsequent to May 28, 2012 – the day the original amendment became effective.
The Story This Far
The issue involved here is the taxability in India of gains arising from the transfer of shares of a foreign company or any entity incorporated or registered outside India or from ‘indirect transfers’ as it is often referred to. The test case and the lead case here was the Vodafone case. The Vodafone Group acquired the telecom business of Hutchison in India by acquiring control of an overseas company that held the Indian telecom operator. The law as it stood taxed gains of non-residents only in respect of assets situated in India. Shares of a foreign company were not assets situated in India.
The income-tax department interpreted the law to include taxability of such gains in India although no Indian asset was transferred and raised demand on Vodafone for not having withheld taxes on payments to Hutchison. The demands were challenged and eventually, the Supreme Court of India decided the matter in favour of Vodafone.
It is at his point that the then Finance Minister Pranab Mukherjee amended the income-tax law to ‘clarify’ that transfer of shares of an overseas company that derived substantial value from assets in India was liable to tax in India. This ‘clarification’ was made applicable retrospectively from 1961.
Demands were also raised in respect of transactions that were carried out by Cairn Energy in the past. Vodafone and Cairn challenged the tax demands under bilateral investment treaties and dragged the Indian government to arbitral courts. The arbitration awards went in favour of Vodafone and Cairn Energy.
The claims of both the entities were allowed, costs awarded along with interest on sums refundable. Indian government appealed against these awards and no monies were paid back. Cairn started evaluating options to recover the dues including options such as approach overseas courts seeking permission to attach assets owned by the Indian government.
The Taxation Law (Amendment) Bill
The Amendment Bill moved on Aug. 5 and passed by the Lok Sabha seeks to make these ‘indirect transfer provisions’ prospective. No fresh demands can be raised even in those cases where proceedings are underway, if any. Any orders passed raising demands for transactions prior to 2012 stand nullified provided that the litigation is withdrawn and there is no claim against the Government for costs, damages, etc. The amounts collected from taxpayers will be refunded, without interest.
The statement of objects and reasons states “this retrospective clarificatory amendment and consequent demand created in a few cases continues to be a sore point with potential investors. 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 in promoting faster economic growth and employment”.
Amongst one of the most important messages is this acknowledgment by the government that foreign investment and investor sentiment is indeed impacted by the tax policies.
The government could have very well chosen not to appeal against the arbitral awards in the case of Vodafone and Cairn Energy. That would have meant two things.
Firstly, the relief would only be to those two litigants and the issue of retro tax would have still been alive.
Secondly, the Indian Government was to have paid substantial amounts by way of costs and interest on the sums to be refunded.
The way the amendments are proposed, the Indian government is attempting to put the entire issue to rest forever. The litigants would not be entitled to costs and interest.
While Vodafone and Cairn have been the most talked-about cases, there are 17 cases in which demands have been raised. The litigation in those cases is at various levels. Out of the said seventeen cases, arbitration under Bilateral Investment Protection Treaty with the United Kingdom and the Netherlands had been invoked in four cases, including Vodafone and Cairn.
The proposed amendment requires the litigants to “either withdraw or submit an undertaking to withdraw the claim” under the existing litigation route they are pursuing. This would mean that the litigants who have challenged existing demand will have to give up their claims for interests and costs.
While it may seem not attractive at the first glance, one needs to remember that the principal tax would be refunded in full. Further with ‘the settlement’ being codified in the tax law, it leaves no scope for any mischief in the future. On balance, this is a fair proposition for both the litigants.
It is too early to comment but one would be surprised if the large litigants do not choose to accept this offer to end the litigation.
While questions can be raised about the right timing for this decision, it is always better late than never. Could the government have taken this decision earlier? Maybe. But that is moot now. This together with multiple other decisions such as the faceless assessment scheme, if implement in the right spirit, has the ability to change the image of the Indian tax administration. This also sends out a strong signal to the international investor community that justice even if delayed is never denied in India.
Dinesh Kanabar is founder and CEO, and Ajay Rotti is Partner, at Dhruva Advisors. The authors have earlier been associated with both Vodafone and Cairn on matters relating to the tax disputes in question.
The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its editorial team.