Retrospective Tax Repealed: A Step in The Right Direction?

By Kumar Shubham [1]

INTRODUCTION

The passing of The Taxation Laws (Amendment) Bill, 2021, the 14 years controversy of retrospective taxation has ended. This bill seeks to amend retrospective tax on the transfer of value of foreign shares if those shares accrue value from assets in India. The primary objective is to refund Rs 8100 crore collected through retrospective tax law, which sought to impose taxes on transfers before May 28, 2012. This bill is likely to end the ongoing legal spat between the Government and Cairn and Vodafone. They are more likely to endorse the decision. The retrospective tax has been a sore point for potential investors until now, and they have constantly been vying for its removal. Naturally, the removal has seen a positive build-up amongst investors and companies alike.

WHAT IS RETROSPECTIVE TAX?

Retrospective means ‘looking back over past’ or simply in legal terms means taking effect from a date in the past. So, retrospective tax means a tax on transactions applicable from a specific date in the past. It intends to create an additional tax levy.

Retrospective tax in India was introduced in 2012 by an amendment to the finance act, which enabled the Government to levy tax on a transaction involving the transfer of shares in a foreign company with assets situated in India.

EVOLUTION OF THE CONCEPT

The taxation of income from offshore assets within section 9(1)(vii) of the Income-tax Act, 1961 was first discussed in Ishikawajma – Harima Heavy Industries Limited. v. DIT. [2] Herein, the Court elaborated on the principle of ‘territorial nexus’ and held that “the entire services have been rendered outside India, have nothing to do with the permanent establishment, and can thus not be attributable to the permanent establishment and therefore not taxable in India.”

To dilute the effects of this judgment, an explanation was added to section 9(2) of the income tax act,1961. The said explanation was to have a retrospective effect and clarified “that any income by way of services, royalty or income of a non-resident shall be deemed to accrue or arise in India by way of service, royalty or income in respect of interest shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India or the non-resident has rendered services in India.”

This pattern of adding clarification and making it applicable retrospectively continued through. This slowly evolving pattern became a tussle point between the companies and the Government. Two major tax disputes that resulted in an intense legal battle and financial consequences for India came ahead.

VODAFONE CASE

The Vodafone case [3] was the main factor that propelled the Government to bring retrospective tax amendment in 2012.

Vodafone acquired stakes in CGP investment Ltd. from a Hong Kong-based company named Hutchison Telecommunications in the year 2007. Entire transactions transpire outside India. The I.T. department issued a show-cause notice to Vodafone as to why taxes were not deducted on instalments paid to Hutchison as a CGP shares transaction impacted the indirect transfer of shares from Indian assets.

The matter reached the apex court, and the issue that was framed was whether “the transfer of shares between two foreign companies, resulting in extinguishment of controlling interest in the Indian Company held by a foreign company to another foreign company, amounted to transfer of capital assets in India and as such chargeable to tax in India.” The Court observed that the “basis of levy of tax is the source and such source is the location where a particular sale takes place and not the place from where a product is purchased or derived from. Since the sale between VIH & HTIL took place outside the country, the source must be considered outside the country. It held that the selling of HTIL’s CGP shares to Vodafone or VIH does not amount to transfer of capital assets under the scope of Section 2(14) of the Income Tax Act and therefore not chargeable under capital gains tax on all rights and entitlements resulting from the shareholder agreement, etc., which form an integral part of GCP’s shares.”

Therefore, the Court ruled that the I.T. department is not empowered to levy tax on two non- resident entities if they transact to acquire a stake in a resident (India) company.

Then Government became unsettled with this decision. So, they amended the tax law retrospectively in 2012 to get the demanded money.

CAIRN CASE AND ITS RELEVANCE

The dispute of Cairn goes back to 2006 when Cairn, U.K., through IPO reorganization, transferred its share in Cairn India holdings to its Indian subsidiary Cairn, India – backed by the retrospective tax; the I.T. authorities made a tax demand worth Rs 20,495 crore. The tax demand was sought on the alleged capital gain that Cairn made through the 2006 IPO reorganization.

Cairn interpreted the text of Indian law differently and refused to pay. Aggrieved by the order, Cairn pursued various domestic remedies and later filed a case before the Permanent Court of Arbitration (PCA). PCA rendering its judgment ruled that the “Tax demand against the claimants (Cairn Energy Plc and Cairn U.K. Holdings Limited) in respect of AY (assessment year) 2007-08 is inconsistent with the treaty and the claimants are relieved from any obligation to pay it and orders the respondent (Indian government) to neutralize the continuing effect of the demand by permanently withdrawing the demand.” Consequently, it awarded nearly Rs.8000 cr. to Cairn.

WHY DID GOVERNMENT FEEL IT NECESSARY TO BRING THE LEGISLATION?

The Government had constantly been facing criticism for its retrospective tax legislation since its inception. Many business lobbies had been invariably appealing for the reversal of this legislation. For instance, a business lobby group in the USA had written the erstwhile Prime Minister Manmohan Singh that “the sudden and unprecedented move (retrospective tax amendment bill) has undermined confidence in the policies of the government of India towards foreign investment and taxation and has called into question the very rule of the law.”

Apart from these, various cases were filed against the Government in international arbitration. In 2014, Vodafone initiated arbitration in Hague under Article 9 of the Bilateral Investment Treaty between India and the Netherlands. Article 9 of the said treaty says that “an investor of one contracting party and the other contracting party in connection with an investment in the territory of the other contracting party” shall as far as possible be settled amicably through negotiations.

The Permanent Court Arbitration, Hague, ruled in favour of Vodafone. The Court observed that India had violated the Bilateral Investment treaty between India and Netherlands and termed the act of the income tax department as a breach of the ‘fair and “equitable” treatment principle. It held that any attempt by the Indian Government to enforce this tax demand would be a violation of its international law obligation and would attract severe consequences.

After Vodafone, Cairn also filed a case in the Permanent Court of Arbitration, Hague challenging the Indian order of retrospective taxation related to 2006-07 internal rearrangement. the Court ruled in its favour granting it an award of $1.2 billion.

Orders by PCA giving the power to seize India’s sovereign assets gave a severe dent to the reputation of India when it was trying to portray itself as an investor-friendly state. To save its face from international embarrassment and convey the clear message that India would auto-correct even when its situation is not conducive, it brought The Taxation Laws (Amendment) Bill, 2021. This bill seeks to amend retrospective tax on the transfer of value of a foreign share if those shares accrue value from assets in India.

WHAT LIES AHEAD?

Currently, 17 companies are litigating against the Government of India against retrospective taxation. The Government conveyed that they would start the refund to the companies, withdrawing the litigation and arbitration cases against it. Out of 17, at least 7 of the companies have approached the Government to settle the dispute. Nevertheless, Government is yet to come up with the rules for retrospective tax and procedure for the refund.

This move will likely settle the dispute as companies like Vodafone and Cairn have shown interest in reaching an amicable solution. It is likely to boost the confidence of foreign investors in India who have long seen India as an unfair and unpredictable regime and would also help end unnecessary and prolonged litigation.

CONCLUSION

The scrapping of retrospective tax has given confidence to companies like Vodafone and Cairn. The end of retro-tax serves a dual goal. First, it is more likely that companies like Vodafone and Cairn would not pursue any further arbitration or litigation proceedings given their business in India. Second, it has cleared the image of India as an unpredictable or unfair regime as the end of retro-tax has provided an image of policy stability for future India. The decision also reiterates India’s commitment to honour the rule of law and treaty obligations.

[1] 4th Year B.A. LLB (Hons.), Gujarat National Law University, Gandhinagar.

[2] (2007) 3 SC 481.

[3] [2012] 1 S.C.R. 573.

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