Finance Minister introduced the Taxation Laws (Amendment) Bill in the Lok Sabha to nullify the tax clause provision that allows the government to levy taxes retrospectively.
The bill seeks to withdraw tax demands made using a 2012 retrospective legislation to tax the indirect transfer of Indian assets.
The government has been fighting legal cases against Vodafone and Cairn Energy on taxes it has claimed retrospectively on transactions these entities entered into relating to operations in the country.
Both the U.K.-based companies have won international arbitration rulings that held the Indian government in breach of bilateral investment protection agreements with the Netherlands and the U.K. respectively.
What are the proposed changes in the Taxation Laws (Amendment) Bill?
- The Bill says that 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.
- The Bill proposes to do away with retrospective taxation on the sale of assets in India by foreign entities executed before May 2012, with a caveat, the companies that will benefit from the amendment must withdraw all legal cases against the government and forfeit interest, costs and any damages.
- The government, on its part, is willing to refund any tax dues it may have collected or seized.
Meaning of Retrospective Taxation:
Retrospective Taxation allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time behind the date on which the law is passed.
Countries use this route to correct any anomalies in their taxation policies that have, in the past, allowed companies to take advantage of such loopholes.
Apart from India, many countries including the USA, the UK, the Netherlands, Canada, Belgium, Australia and Italy have retrospectively taxed companies.
Background: What is the genesis of the retrospective tax imbroglio?
- In May 2007, Vodafone bought Hong Kong-based Hutchison’s controlling stake in Hutchison Essar for $10.9 billion.
- The transaction took place in the Cayman Islands where Hutchison’s unit which in turn was acquired by Vodafone’s Netherlands-based Vodafone International Holdings.
- That September, India’s Income Tax Department served a notice on Vodafone for failing to deduct tax at source from the amount it paid to Hutchison in lieu of the capital gains tax it contended the seller Hutchison was liable for. The case went to court.
- In January 2012, India’s Supreme Court backed Vodafone, ruling that indirect transfer of shares to a non-Indian company would not attract tax in India.
- Separately, in 2006-07, Cairn Energy U.K. had reorganised its Indian oil and gas exploration business ahead of a planned IPO in India and subsequently sold part of its stake in Cairn India Ltd., first to Malaysia’s Petronas, and then the Vedanta Group during the 2009-11 period.
- In the Union Budget of 2012, the then Finance Minister, introduced an amendment to the Finance Act, which allowed the government to retrospectively tax such transactions.
- In 2014, the Income Tax Department froze Cairn’s remaining shares in Cairn India. The next year, Cairn initiated international arbitration against the government under the India-U.K. bilateral investment treaty.
Why did the government decide to rescind the provision?
- Though the government had raised tax demands in 17 such cases, Vodafone and Cairn attracted the most attention.
- Both initiated international arbitration under bilateral agreements.
- Vodafone got a favourable ruling in September 2020 at the Permanent Court of Arbitration at The Hague in the ₹22,000-crore case.
- In December, an Arbitral Tribunal ruled in favour of Cairn, awarding it $1.2 billion plus interest and costs in damages, which came to $1.7 billion in total.
- Government insisted that, by introducing this bill would help in establishing an investment-friendly business environment, which can increase economic activity and help raise more revenue over time for the government.
- This could help restore India’s reputation and improve ease of doing business.
How are global investors likely to react?
- Even after the Bill becomes law, entities such as Cairn Energy must convince its shareholders and accept the caveats.
- Prospective investors, however, may take heart from the fact that the government has shown the intent not to claim tax retrospectively and demonstrated a willingness to undo a measure that was seen as hurting the inflow of foreign investment.
- US-India Strategic and Partnership Forum (USISPF), applauded the Indian move to withdraw the retrospective law relating to tax on indirect transfers.
- India needs to craft meaningful and clear dispute resolution mechanisms in cross-border transactions to prevent the disputes from going to international courts, and save the cost and time expenditure.
Government argued that Taxation Laws (Amendment) Bill introduced will only encourage more international investments into India and is a welcome relief for companies who have long invested in the country.
The government has informed Parliament that at least 17 companies will benefit from the move including Cairn Energy Plc and telecom giant Vodafone.
Some experts welcomed the move as it will end the spectre of policy uncertainty for potential investors who have seen the Vodafone and Cairn cases unfold over the past decade.
The amendments may put an end to arbitration cases from the past “which have created great embarrassment for India in international circles”, while most observers lamented that the issue had been allowed to linger for far too long.
This could help restore India’s reputation as a fair and predictable regime apart from helping put an end to unnecessary, prolonged and expensive litigation.