Scrapping of Retro Tax Law: A Pragmatic Move

The Union Finance Minister, Nirmala Sitharaman has introduced the Taxation Laws (Amendment) Bill in the Lok Sabha proposing to nullify the retrospective income tax law introduced in 2012. According to it, no tax demand shall be raised in future on the basis of the said retrospective amendment for any indirect transfer of Indian assets if the transaction was undertaken before May 28, 2012. It is also proposed to nullify any demand raised for such indirect transfer of Indian assets made before May 28, 2012 subject to fulfilment of specified conditions such as withdrawal of pending litigation and furnishing of an undertaking not to claim cost, damages, interest, etc. It is also proposed to refund the amount paid in these cases without any interest thereon. Analysts felt it as a very progressive move taken by the government, albeit with a caveat. 

This belated move to correct a retrogressive tax law that was introduced by the then Finance Minister, Pranab Mukherjee in the year 2012 appears to have been taken by the present government after being embarrassed by the Cairn Energy’s act of securing an order from a French court to seize about 20 properties of Indian government in Paris. Embarrassment aside, such retro tax provisions are known to corrode and weigh down the confidence of investor community. That is what the genesis of this whole episode indeed points to. 

In 2007 Vodafone bought the controlling stake in Hutchison Essar from the Hong Kong-based Hutchison Whampoa for $10.9 bn. This transaction took place in Cayman Islands. Later, the same was acquired by Netherland-based Vodafone International Holdings. This transaction prompted Income tax department to serve a notice on Vodafone for failing to deduct tax at source—contending that the seller Hutchison was liable for paying capital gains tax—from the amount paid to Hutchison. The case finally went to court. The Supreme Court ruled that indirect transfer of shares to a non-Indian company would not attract tax in India. Yet, with the amendment to Income Tax Act, IT department continued to chase Vodafone. 

In 2006-07, Cairn Energy UK, as a part of an internal group reorganization, transferred shares of Cairn India Holdings—a fully-owned subsidiary of Cairn UK Holdings, which in turn was a fully-owned subsidiary of Cairn Energy—to Cairn India. Income Tax Department had contended that through this transaction Cairn UK made capital gains. Later, using the retrospective amendment, IT department levied capital gains tax on Cairn India—seized the balance holding of Cairn Energy in Cairn India, besides freezing payment of dividend by Cairn India to Cairn Energy. Indeed this retrospective clause did effect 17 other related firms. 

As a result, both these companies, Vodafone and Cairn, initiated international arbitration under bilateral agreements. And both the firms won their cases: Vodafone got a favorable ruling at the Permanent Court of Arbitration at The Hague, which indeed made a derogatory comment: conduct of India’s tax department is in breach of fair and equitable treatment. Similarly, Cairn too got a favorable ruling from Arbitral Tribunal, which said that India’s tax claim of 10,247 cr in past taxes over the internal reorganization of Cairn’s Indian business was not a valid demand and had also awarded damages. Empowered by this ruling, Cairn had indeed applied in courts in the US, Canada, Singapore, Mauritius, and the Netherlands for seizure of Indian assets. 

It is needless to say here how litigations of this nature in international arena would vitiate government’s efforts to improve India’s ratings on the World Bank’s ‘ease of doing business’ index. As rightly observed, “such retrospective amendments militate against the principle of tax certainty and damage India’s reputation as an attractive destination.” That being the reality, no one knows why it took so much time for the government to scrap this amendment from the law books. 

Even now, government has a big job on hand: it has to convince these companies to accept the refunds sans costs, damages, interest, etc. Nevertheless, this pragmatic move of the government is all set to send a strong signal to foreign direct investment community that India respects rule of law and indeed strives to promote a conducive investment climate. Along with our recent corporate tax cuts and changing geo-political scenario, this doing away with the retro tax law is more likely to give a boost to government’s disinvestment plans, besides encouraging foreign capital inflows.