Recent legislation passed by the government of India prohibiting tax authorities from charging retroactive taxes is seen as progressive and prudent.
According to the Finance Minister, “Retrospective taxes were implemented in order to clear up issues. There was some disagreement, and we, when in opposition, said that they were anti-legislation. Former Finance Minister Arun Jaitley promised a top-level committee would examine it.”
Further, she added,
“No fresh cases were filed. It was necessary to wait for two court cases to reach their logical conclusion”, she says. “In light of those cases coming to a conclusion, and, in line with Mr. Jailtey’s commitment and the belief of the BJP that is against retrospective taxation, I bring forward this bill.”
When was the retrospective law introduced?
As a result of the Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995, Vodafone initiated arbitration against India in 2014 at the Court of Arbitration in The Hague. According to the court’s unanimous analysis, India had breached the agreement and should cease efforts to recoup the taxes.
Furthermore, in 2007, Cairn UK transferred shares of Cairn India Holdings to Cairn India which led the Income Tax authorities to claim the company made capital gains. An arbitration court ruled against India’s claim that it failed to pay taxes to Cairn.
As a result of a 2012 Supreme Court decision, gains arising from indirect transfers of Indian assets were not taxable under the then existing laws. Due to this, the then government amended the income tax law through the Finance Act, 2012, with retrospective effect.
Section 9(1)(i) was amended to add the words “or through the transfer of a capital asset situated in India.” Thus, any income arising from the transfer of a capital asset situated in India would be liable to be taxed with retrospective action.
This retrospective tax law was enforced in the case of Vodafone to override Vodafone’s demand from the Income Tax department for Rs. 11,000 crores in tax refunds. The retrospective tax provision was also applied to Cairn in January 2014 during its exit from Cairn India Ltd. The initial demand was for Rs 10,570 crore.
It gave the income tax department the power to make retrospective tax demands for gains from shares of foreign firms whose assets are based in India.
Reason behind the new bill
In explaining her proposed amendment, Sitharaman said: “Additionally, it is proposed to provide that any demand made for the indirect transfer of Indian assets before 28th May 2012 shall be nullified upon the fulfillment of specified conditions, such as withdrawal of current litigation or providing an undertaking not to claim costs, damages, interest, etc.”
Moreover, it is proposed that the amount paid for these cases be refunded without any interest,” she added.
According to people familiar with the matter, it’s an attempt to end around 18 contentious legal disputes, particularly with Cairn and Vodafone. In addition, the government will be required to refund companies such as Vodafone and Cairn some of the tax they already paid.
Aftermath of removal of retrospective application
Cairn and Vodafone are grappling with disputes involving significant amounts of money, ranging between Rs 20,000 crore and Rs 30,000 crore. These laws are anachronistic based on the fact that the Cairn deal was from 2006. Vodafone was also ruled in favor by the Supreme Court, but the retroactive rule pushed it back.
The withdrawal of such a measure sends a positive signal to companies looking to invest in India. Investing in a country where the laws change retrospectively puts players at risk of regulatory changes. Governments cannot avoid these things, but retroactively enacting the law is never a good idea, no matter how appealing it might appear.
Providing a better enabling environment to do business has been in India’s efforts to attract foreign investors. Tax laws are even more critical since they directly affect companies. Businesses are always at risk of tax laws changing in any domain. Making any new tax law effective before the effective date would increase regulatory costs and send an incorrect signal.
From the government’s perspective, it is possible to argue that there is an income loss possible. In such cases, however, litigation is often necessary, as was the case in the Cairn case, where the cost of time and money increases in addition to sending conflicting signals.
Due to the time required to recover such amounts if imposed, these amounts are not typically buffered in the budgets. Therefore, such a law is fiscally neutral and has only a positive effect as it is passed.
The government should consider a similar approach whenever tax exemptions are withdrawn, or savings instruments change in the domestic economy. During the implementation of capital gains on equity, grandfathering was introduced. When debt mutual funds were taxed on capital gains for three years rather than one, it was retroactively applied. Thus, it is necessary to ensure that the prohibition of retrospective enactment also applies in the domestic context so that domestic investment is also assured.
Investments are influenced by the concept of stability in the environment. Regulatory structures provide this at the time of investing. Legislation may change over time without warning. Nevertheless, when it comes to taxation, doing so with a retroactive effect sends the wrong signals, and removing this rule is necessary. The government’s efforts to refine the smoothness of doing business environment will be reflected well by this change of prohibiting the retrospective applicable of tax law.
This post was written in collaboration with Asif Yahiya Sukri LLP. Asif Yahiya Sukri LLP provides unparalleled personalized financial services to a broad range of clients across different geographical locations. With a presence in the USA, India and the MENA region, they ensure that all of your financial decisions are made carefully and with your best interests in mind. They are innovators who understand what goes into building companies.
You can also reach out to them on info@aysasia.com
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