Retrospective Taxation

Why in news?
  • Recently, the Taxation Laws (Amendment) Bill, 2021 was introduced in Lok Sabha.
  • Specifically, the bill aims to revoke tax demands that were made on indirect transfers of Indian assets by retrospective legislation in 2012.
  • In this bill, the Income Tax Act of 1961 and the Finance Act of 2012 are amended.
  • To prevent income tax demands from being retroactively raised.
What is retrospective taxation?
  • In retrospective taxation, the government passes a rule on taxing certain products, items, or services
  • Generally, a retrospective tax is applied to correct anomalies in a country's tax policy that have allowed companies to take advantage of such loopholes in the past.
  • The retrospective tax, however, hurts companies that knowingly or unknowingly misinterpreted the tax rules.
  • Other countries, including the USA, the UK, the Netherlands, Canada, Belgium, Australia, and Italy, have imposed retrospective taxes on companies in the past.

Vodafone’s retrospective taxation case:

  • Vodafone-Hutchison deal:
    • In May 2007, Vodafone had bought a 67% stake in Hutchison Whampoa for $11 billion.
    • This included the mobile telephony business and other assets of Hutchison in India.
  • India’s demand for tax and its stand:
    • In September 2007, the Indian government raised a demand of Rs 7,990 crore in capital gains.
    • The company should have deducted the tax at the source before making a payment to Hutchison.
  • Case in India:
    • Vodafone challenged the demand notice in the Bombay High Court, which ruled in favour of the Income Tax Department.
    • In 2012, Supreme Court gave rulings in favour of Vodafone and said that it did not have to pay any taxes for the stake purchase.
  • Government Action:
    • In 2012, the government passed the amendment bill ‘Finance Act in 2012’ and gave the Income Tax department the powers to tax retrospectively such deals.
    • Hence, the onus to pay the taxes fell back on Vodafone.
  • Clause 9 of the Bilateral Investment Treaty (BIT):
    • This led to domestic and international criticism for by-passing the rulings of the highest court of the land.
    • Vodafone Group invoked Clause 9 of the Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995.
    • According to the clause, companies present in each other’s jurisdictions would be “at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other”.
  • Rulings of Permanent Court of Arbitration at The Hague:
    • It termed that act of India as a violation of the BIT and the United Nations Commission on International Trade Law (UNCITRAL).
Cairn Energy Case:
  • Case:
    • In 2006, Cairn UK transferred shares of Cairn India Holdings to Cairn India as part of its restructuring for an initial public offering (IPO). 
    • In 2011, the business of Cairn India was sold to the Vedanta group and the Indian tax department alleged that Cairn made the capital gains through restructuring.
    • The Indian government in 2015 imposed a draft tax assessment of ₹10,247 crores for the corporate restructuring that took place in 2006.
    • The government tried retrospectively to bring the indirect transfer of Indian assets within the tax authority's ambit.
  • Ruling:
    • Cairn sued India before an investor-State dispute settlement (ISDS) tribunal.
    • It alleged that the imposition of taxes retroactively violates the India-United Kingdom bilateral investment treaty (BIT). 
    • The ISDS tribunal ruled in favour of Cairn.
    • It held India guilty of violating the fair and equitable treatment (FET) obligation of the India-UK BIT. 
Shome Committee observations:
  • The retrospective amendment was wrong, running counter to the basic tenets of the law.
  • These provisions of the 2012 act should be applied prospectively.
  • Clear definitions are necessary to apply these provisions in the future.
  • The government must exercise its constitutional power to amend tax laws retrospectively only in the 'rarest of rare' cases.
  • In ‘indirect transfers’, the tax should only apply to the seller of an asset who makes capital gains.
  • The tax department should avoid levying interest and penalties on the tax due if the retrospective amendment kicks in.
Provisions of the Taxation Laws (Amendment) Bill, 2021:
  • The new bill nullifies the tax claims made on offshore transactions before 28 May 2012, the date that the Income Tax Act was amended.
  • Moreover, the Government proposes to refund any expense incurred by companies in legal disputes without charging interest.
  • The move was intended to send a positive message to investors, according to government sources.
Significance of the bill:
  • Despite maintaining the "sovereign right to taxation," the amendment provides companies with an opportunity to settle the issue.
  • It will result in an increase in foreign investments by increasing investor confidence.
  • In line with the government's commitment to promote a non-adversarial tax environment.
  • Taxpayers have the opportunity to close all previous disputes and avoid the cost of future litigation.
  • It is estimated that the move will end litigation with 17 companies, including Vodafone and Cairn.
  • It will resolve criticism about uncertainty in India's tax policies.
  • Way Ahead

    • Clear Taxation Policy and dispute resolution mechanism:
      • Avoid amendments to laws retrospectively to nullify adverse judgments/awards as judgements reduce arbitrary uncertain legal system. 
      • Establish a consistent and predictable legal system.
      • Establish a clear dispute resolution mechanism to solve issues within borders rather than going to international courts.
    • Long-term vision:
      • Make necessary amendments to implement Shome Committee recommendations.
      • Create a conducive environment for investment
      • Formulate agreements and their provisions keeping long-term goals.
  • To prevent disputes from reaching international courts and to save time and money, India ought to devise meaningful and clear dispute resolution mechanisms in cross-border transactions.

  • India must be generous in its settlements with the companies affected by this policy that was counterproductive to India's development.

Posted by Jawwad Kazi on 8th Jul 2021