Bury the spirit of retroactive taxation

Amid the turmoil in parliament, the Narendra Modi government tabled a bill on Thursday aimed at correcting a momentous mistake in contemporary tax law history.

This error relates to the infamous 2012 retrospective amendment to the Manmohan Singh Government’s Income Tax Act. After the government lost a tax dispute to Vodafone over the taxation of the indirect transfers of Indian assets, the government overturned the ruling by amending Section 9 (1) on. (i) of the Income Tax Act retrospectively. Taxation on the indirect transfer of Indian assets involves the taxation of the gains on the transfer of Shares by a non-resident of a foreign incorporated company where the value of the Shares is derived, directly or indirectly, primarily from assets in India.

This regressive legislative development, which was later extended to the internal restructuring of Cairn Energy, resulted in a flurry of litigation. Vodafone and Cairn Energy are suing India in the Investor-State Dispute Settlement Courts (ISDS) formed under the India-Netherlands and India-UK Bilateral Investment Agreements (BIT).

Also read | Center Postpones Bill In House To Stop Retroactive Taxes

The Bharatiya Janata Party (BJP) valiantly resisted retrospective change while in opposition. Hence, many assumed that the Modi government would correct this mistake when it came to power. But the new government vigorously pursued these claims. Both ISDS tribunals indicted India for violating the obligation to fair and just treatment (FET) under the two BITs. India failed to comply with the arbitration awards, forcing Cairn Energy to initiate enforcement proceedings to seize Indian assets in several countries.

At last, it seems, common sense has prevailed. The Tax Act states that the amendment to Section 9 (1) (i) does not apply to indirect transfers of Indian assets on or before May 28, 2012. Put simply, the law governing the taxation of profits from indirect transfers applies. Indian assets are said to have a future.

The removal of the retrospective aspect of Section 9 (1) (i) implies that the Tax Authority will not have any tax claims against Vodafone and Cairn Energy for their pre-2012 transactions involving indirect transfers of Indian assets. The taxes collected would be refunded without interest. This bill removes the legal measure underlying Vodafone and Cairn Energy’s ISDS claims against India, hopefully lifting the curtain on the arduous international litigation.

However, this law is subject to certain riders. Both Vodafone and Cairn Energy must withdraw their legal claims against India under international law. In addition, investors must waive the assertion of legal claims to subsequent taxes. This means that Section 9 (1) (i) and the associated tax regulations would continue to apply retrospectively if investors fail to meet these conditions.

While it is pretty obvious that the negative ISDS rulings triggered this change, India still doesn’t seem to accept the decision of the two tribunals. The fact that India is only paying back the principal, not the interest, is a clear indication of this. For example, the ISDS Tribunal sentenced India to pay $ 1.2 billion (the tax levied) plus interest and other costs, totaling approximately $ 1.7 billion to Cairn Energy. According to the law, India will only return $ 1.2 billion (the main amount) to Cairn Energy. So Cairn Energy is still losing about $ 0.5 billion. It remains to be seen whether Cairn Energy and Vodafone will accept this as an honorable agreement. It is also not clear whether India would stop challenging the Vodafone and Cairn arbitration awards in Singapore and The Hague, the respective arbitration tribunals.

While this change will boost foreign investor confidence and boost general economic sentiment, a bigger question needs to be asked. What did India gain from this mishap that lasted over nine years? It will not generate the much-needed revenue that it has always hoped for. In addition, taxpayers’ money and other scarce resources have been spent fighting costly trials in international courts. In addition, India’s reputation in the eyes of the world as a prime destination for foreign investment was tarred, shaking India’s history of growth.

The key takeaways from this nine year filthy episode are as follows.

First, before introducing such drastic legal and political changes, those in power should carefully and transparently weigh and weigh the benefits and costs. Legal security is an aspect that foreign investors value enormously. A foolish, pennies approach often turns out to be a disadvantage.

Second, there must be better government internalization of India’s BIT obligations.

Thirdly, although tax law is a sovereign right that has been certified by numerous ISDS courts, this right has its limits. An abuse of tax law against foreign investors will spark claims under international law. Changes in the legal system through taxation should be appropriate and proportionate to the desired common good.

Fourth, changing tax laws retrospectively is a bad idea. The Shome Committee – a special committee appointed by Manmohan Singh to investigate the impact of the 2012 amendment – said categorically that retroactive application of tax law should be exceptional in order to counteract grossly abusive tax planning rather than broadening the tax base. It is hoped that our policymakers and lawmakers have now learned their lessons.

Prabhash Ranjan will soon join the Jindal Global Law School, OP Jindal Global University, as Professor and Vice Dean

The views expressed are personal

Please log in to read further

  • Get access to exclusive articles, newsletters, notifications and recommendations
  • Read, share and save articles of lasting value