India deducts retro tax: what’s subsequent?

On August 5, 2021, the government proposed the Taxation Laws (Amendment) Bill 2021 to amend Section 9 of the Income Tax Act 1961 (ITA). It was announced as law on August 13, after it was passed by both Houses of Parliament and received the approval of the President.

Section 9 provides for the taxation of income believed to have originated in India under strict nexus rules.

This part of the law became controversial in 2012 when the then government retrospectively amended it to include in its scope the indirect offshore transfer of stocks that draw significant value from assets in India.

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This was in response to the Supreme Court ruling in Vodafone where the top court ruled that capital gains from indirect offshore stock transfers did not fall within the scope of Indian law, particularly in the absence of a clear legal mandate or similar provision under the General Anti -Avoidance Rules (GAAR) in other jurisdictions.

The government disagreed with the ruling, finding that it was inconsistent with the legislature’s intent. After the 2012 change, several investors turned to international investment courts for redress, and two of those disputes, Vodafone and Cairn, were ruled in favor of the investors.

1. Analysis of the Tax Laws Act (Amendment), 2021

The result of the awards created a belief that India’s tax policy is not investor friendly and has a negative impact on the current and potential investment environment.

Hence, the 2021 Act is an attempt to regain investor confidence and prevent India from getting involved in international disputes, including its assets attached as a result of arbitration enforcement.

The 2021 law provides for the cancellation of the tax claims made based on the retrospective amendment of 2012 and for the refund of previously collected taxes.

The proposal assumes that the respective parties withdraw their claims from national or international dispute settlement forums and refrain from any future claims.

It also states that the refund is limited to only the tax collected, relieving the government of any liability for interest, costs, or damage.

While discussions between the center and affected investors continue, it is important to understand what the latest move means for foreign investors.

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2. Has retrospectiveness been completely adopted?

On many occasions, the incumbent government had distanced itself from the retrospective amendment and rejected it, calling it “tax terrorism”, even before it took power in 2014.

The Statement of Objects categorically states that the retrospective change has become a “sore point for potential investors”.

Still, it took nine years to reverse the retrospective change. It continues to apply retrospectively, but provides for an exemption for the aforementioned (17) investors who meet certain conditions.

This is to avoid future legal disputes and also confirms the government’s view not to make retrospective changes.
To resolve the ongoing dispute, the center may have to repay more than Rs.8,000 billion raised from investors. This is on top of the substantial costs it incurred in challenging matters in international forums.

3. How the settlement of tax disputes will develop

This change in policy has implications for the future that need special attention.

A. Domestic Settlement Mechanism

What emerges as a clear message is the government’s reluctance to litigate tax matters and its desire to bury past cases.

The proposal itself is a form of comparison. The center had taken several measures in the past to ensure that tax matters were prevented and regulated in a timely and cost-effective manner.

For example, the restructuring of the authority for preliminary rulings (as a preliminary ruling body), the introduction of the dispute settlement committee, the Vivad se Vishwas 2020 program for tax disputes and the issuing of guidelines for the implementation of the Mutual Agreement Procedure (MAP).

The revision of the MAP is in line with the peer review process proposed within the framework of the OECD BEPS in order to strengthen dispute settlement within the framework of tax treaties (measure 14). We have yet to see how these mechanisms will reduce the burden of contractual disputes, but the positive intent is laudable.

B. International Tax Equalization Mechanism

Although India is a signatory and contracting party to the Multilateral Instrument (MLI) of the OECD, it has refrained from accepting mandatory arbitration for reasons of sovereignty.

However, as the country supports the OECD’s proposals on the first and second pillars, it is expected to be part of the international tax community in setting up a review body recommended under the first pillar.

The body was proposed with the aim of creating more security by creating a mechanism that would allow the rules of acquisition of profits of multinational corporations to be accurately applied, which are subject to market jurisdiction.

India’s approval of the decision by the Review Board is seen as a welcome step towards arbitration on digital tax.
C. International Investment Arbitration

A major government concern caused by the retrospective controversy has been investors turning to international forums under bilateral investment treaties (BIT) to challenge tax measures.

Based on the principle of “fair and equitable treatment”, Vodafone and Cairn received awards in their favor holding the center liable and opposed its view that the request violated its sovereign rights to design and enforce tax laws. The 2021 law requires investors to withdraw such proceedings initiated in international forums.

The revised model of the bilateral investment treaty, on the basis of which India is currently negotiating its BITs, provides for a tax outsourcing in its area of ​​application. If the clause survives the negotiations, it will prevent a foreign investor from using the investment agreement for a tax measure in the future. In other words, the 2021 law marks the conclusion of tax disputes that are being waged in the BIT space.

4. Conclusion: Imagine the future of Indian tax policy

The tax landscape in India is changing dramatically, with lawmakers consistently emphasizing the need for investor security and trust.

For example, the introduction of the Taxpayers’ Charter in 2020, which sets out the rights and obligations of a taxpayer, aims to build trust between the taxpayer and revenue.

The retrospective change proved to be an obstacle to achieving these goals. Building on the 2021 Act, in addition to resolving current disputes, the government must ensure that the revised national and international approaches to tax disputes containment and dispute resolution are effectively implemented and accessible to existing and potential investors.

Incorporating international best practices in tax law and administration can help put India at the forefront of foreign investment and further fuel the aspirations of the 1.2 billion-strong nation.

(Mukesh Butani, Managing Partner at BMR Legal. Supported by Akshara Rao, Associate at BMR Legal.)