Finally, Retro Tax Out

Finally, retrospective tax has been done away with, with an amendment to an earlier amended tax law. Despite the view that Vodafone took advantage of a loophole in the law to gain assets in India without paying capital gains, the amendment was needed to send out the right signals to the world investing community that India has stable tax laws, with no nasty surprises

The monsoon session of Parliament has just got over. This session has been chaotic. Yet a few bills were passed. Because of the noise, the bills could not be discussed and even the public could not know about the nuances of these bills. One such bill was a direct tax amendment bill. This bill has been unique as it proposed an amendment to an earlier amendment, brought about in the year 2012.

Amendment to amendment

Why amendment to an amendment? Was the 2012 amendment to the income tax provision wrong? If the earlier amendment was erroneous then why did it take nine years to rectify the mistake? This column is a modest effort to analyse the issue. To begin with, it becomes imperative to place the facts in the right perspective along with the position of the law.

The Income Tax Act mandates to tax the income of a person, which accrues or arises in India in the relevant previous year. ‘Person’ in this context has an inclusive definition and the same includes individual, partnership firm, company, association of persons, body of individuals and artificial juridical person, etc. Income before assessment is first segregated under the prescribed heads: salary, income from house property, business or profession, capital gains and income from other sources (residuary head). There are related provisions such as deeming provisions when income, even if not directly arising in India, can be deemed as accruing or arising in India and thus, making it taxable in India. There are also related provisions about the status of a person as being resident or non-resident or not ordinarily resident. The residential status of a person has a direct impact on the computation of tax.

An asset acquired

Income under the head capital gains arises due to the transfer of an asset. In the year 2007, Vodafone acquired a stake in Hutchison Essar for $11.2 billion. Hong Kong-based Hutchison held a major share in the Indian mobile company, through its Cayman Islands-based associate company. Vodafone, another non-resident company completed the transaction by acquiring the shares held by the Cayman Islands entity. The Income Tax department held that capital gains had arisen, as the assets sold belonged to an Indian operation and were located in India. Vodafone was held a representative assessee of Hutchison and was asked to pay the tax including a penalty of about Rs.22,000 crores.

The Bombay High Court upheld the stand of the Income Tax department. However, the Supreme Court decided in the favour of Vodafone. The stand of Vodafone was accepted that there cannot be capital gains tax in India if both the buyer and the seller are not based in India irrespective of the location of the asset. The Supreme Court held that even the ownership of the asset in India was tagged with the shares and they were registered outside India and transferred outside India. Hence, while proposing the Budget of 2012, the income tax provision was retrospectively amended by the Government and the decision of the Supreme Court in the Vodafone case was nullified. The amended provision plugged the loophole and clarified that the capital gain is linked with the asset in India. The inserted amendment is the only clarificatory and nobody can question the sovereign right of the country for making such legislation.

Done retrospectively

However, the controversy arose as it was done retrospectively. There was no such law in 2007 when the transaction took place. In total, 17 cases were hit by this retrospective legislation, which was apparently against Business Investment Treaties (BITs) and the arbitration awards came in their favour. Cairn started to get back the collected tax by approaching foreign courts for the attachment of assets of the Indian Government located abroad.

Shoot down bad law

The amendment proposed in the present monsoon session is to pronounce the death of the bad law. The amended clarificatory law of 2012 has not been annulled, but what has been killed is its retrospective operation. Thus, the 17 companies including Vodafone and Cairn come out of the tax net for their transactions done prior to 2012 when the retrospective amendment was brought about. The new amendment also proposes to refund the collected tax if the concerned companies do not ask for interest and undertake that they will avoid going into litigation. The government is looking for a wider goal to present India as a good country for foreign direct investment (FDI). The new bill has evoked wide appreciation.

There is no doubt that the Income Tax Act is important as it gets resources for the country in the form of taxes. But it is equally important that the enacted tax laws should not be such that they harm the country. Together with our taxes, we also need more employment opportunities for our youth, and for this, we require more investment in our business. We even have to attract global investors. Investors seek ease of doing business in the country and here, tax laws play an important role. Tax rates should be globally competitive and investors should also have faith in our system.

"The amendment proposed in the present monsoon session is to pronounce the death of the bad law. The amended clarificatory law of 2012 has not been annulled, but what has been killed is its retrospective operation"

Stable, predictable

The present amendment shows to the investors that the country is ready to accept mistakes and correct it. The Supreme Court while deciding the case in favour of Vodafone held that while deciding such issues, a holistic view has to be taken instead of becoming too technical. Nullifying the decision of the Supreme Court in 2012 was a grave mistake and it placed India in a bad light. There is nothing wrong with prospective legislation but its retrospective operation unsettles the business climate. Global investors go to countries where tax laws are stable and where they can plan their business accordingly in advance. Even domestic investors move out if there is tax terrorism. Today, many global investors are moving out of China and in this scenario, India has to portray herself as a good alternative destination. The present amendment ensures that.

The Income Tax Act is not only a tool for the collection of taxes but it is also used for economic and social development. This is done by not levying tax at all or levying tax at a concessional rate in sectors that need development. For example, subject to few conditions, there is no tax in cases of public charity done by registered Trusts or Societies. Similarly, from time to time, there has been an incentive given to the construction sector, export sector or startups. The present amendment is meant to promote the ease of doing business, as any retrospective operation of law makes things difficult for doing business.

The economy can grow only if all the stakeholders become active participants. No doubt, the government is an important stakeholder and it is the job of the government to make things convenient for doing business but even the industry has to come forward taking risks and making fresh investments. We cannot expect the government to ease business when there is no supportive action from the industry. Sometime back, the government drastically reduced the corporate tax and thus lost a big chunk of revenue but no big move has been noticed on the part of the industry.

Cherry-picked loophole

The Vodafone case is an illustration that mistakes are committed by our lawmakers but even the industry is not innocent. The income tax department had picked up the case of Vodafone for investigation, as an unintended loophole in the legislation was cherry-picked by the giant international company to acquire a business in India without paying capital gains tax. An amendment was needed and it was done in 2012 to correct the mistake. Making the correction with retrospective effect was going overboard.

The transaction for acquiring business in India was concluded in the Cayman Islands which is a tax haven territory. This island has about 40,000 population and about 80,000 registered companies. These companies are mainly post-box companies. The ownership of Indian business acquired by Vodafone was also done with one such post-box company associated with Hong Kong-based Hutchison. The facts of the case indicated that the transaction was not beyond doubt and some big legal brains had applied their mind to save tax. The decision finally went in the favour of Vodafone as the buyer, seller and ownership papers (shares) were all located outside India. It is hoped that industry will play its role constructively in widening our economy while going for tax planning. Saving tax is part of doing business but it cannot be the business itself. “Not everything that counts can be counted and not everything that can be counted counts”, had said Einstein.