Retrospective Taxation – Is It The Right Way Forward
Posted in Finance Articles, Total Reads: 2043
, Published on 06 November 2014
What is Retrospective Taxation?
Retrospective means something concerned with or related to the past. Retrospective taxation means taxing old proceedings according to new laws. Using this taxation law, the government can tax any transaction which happened even before the law was passed.
To understand it better, let us take an example. Assume that the current tax rate is x% and the previous year the tax rate was (x-2) %. Now, if the Income Tax department or the government realises that previous transactions should also be taxed at x%, it can do so by giving itself the power of retrospective taxation. This allows it to look back into past time transactions, revaluate its policies and make corrections.
The government of India introduced the retrospective taxation system in 2012 by amending the Income Tax Act 1961 and announcing that the amendments would be in effect retrospectively from 1st April 1962. Through this amendment, the Government acquired the ability to tax more than 50 years old overseas transactions involving Indian assets. This decision was based on the Vodafone Tax Case between the Government of India and the British telecom major, Vodafone.
Image Courtesy: freedigitalphotos.net, Stuart Miles
The genesis of tax avoidance can be traced back to the double tax avoidance agreement (DTAA) between nations such as India and Mauritius. This agreement was signed to attract foreign investments at the time of the launch of the first wave of 'economic liberalisation'. According to this agreement if India has signed a DTAA, the taxpayer can pay tax in either of the two countries. Now, as Mauritius has no capital gains tax, a company doing a Vodafone-like deal in Mauritius will escape without paying any tax whatsoever.
Vodafone Tax Case
In 2007, Vodafone acquired 67% of Hutch-Essar, a joint venture between the Hutchison group and the Essar group, one of the leading cellular telephony providers in India.
This acquisition was made by Vodafone International Holdings BV (VIH) (part of the Vodafone group and a company resident for tax purposes in the Netherlands) of CGP Investments (Holdings) Ltd (a company incorporated in Hong Kong but resident for tax purposes in the Cayman Islands) on February 11, 2007 for about INR 55,000 crore from Hutchison Telecommunications International Ltd (HTIL). The firm, CGP Investments, controlled 67% of Hutchison Essar Limited (HEL) through various intermediaries. All this meant that buying CGP investments gave Vodafone controlling stake over Hutch-Essar.
It was clear that this convoluted transaction was made to avoid taxes. This was abundantly clear from the headquarters of the holding companies involved in the transaction. The Income Tax department of India contended that as Hutch-Essar was an Indian company, the transaction was liable to tax capital gains under Section 9(1)(i) of the Indian Income Tax Act 1961 (2) as although CGP Investments was not a tax resident in India, the underlying assets were in India and so was the profit generated from its business. Therefore, Vodafone had an obligation to pay the tax in India, before making the payment to Hutchison. The tax demand was INR 11,000 crore. Vodafone contested, stating that neither Vodafone nor Hutch was liable to pay the tax as both the companies were located outside India and the deal happened outside India.
Vodafone filed a writ petition in the Bombay High Court challenging the jurisdiction of the tax authorities. The Bombay High Court ruled in favour of the IT department which led to Vodafone appealing in the Supreme Court of India which overturned the High Court’s verdict and ruled in favour of Vodafone. (For details please read the entire verdict on Supreme Court of India’s website)
The Government of India, looking to lick it wounds from defeat and ensuring that this kind of deal never again deprives itself of taxation, amended the IT act 1961 and introduced the retrospective taxation to make sure that a company is unable to avoid tax by operating out of tax-havens like Cayman Islands or Lichtenstein. With the law in its favour, IT department of India slapped Vodafone with a INR 20,000 crore penalty in 2012. Although both parties have tried to resolve the issue amicably, the dispute is still ongoing.
There are other companies facing similar situations with the IT department. Nokia is facing a INR 21,000 crore tax demand for violating the capital gains regulations. Shell India is facing a tax demand of INR 5,500 on charges of underpricing an intragroup share transfer. IT department has also sent a tax demand of $2bn retrospective tax bill to Mitsubishi and a $600mn retrospective tax bill to Honda.
Impact of retrospective taxation
Although the retrospective taxation may help Indian Government to gain at least INR 30,000 crores in tax money, the amendment has been and will continue to negatively impact India’s reputation as a place for doing business. India’s ranking on ease of doing business index is 134 and it cannot afford to take any more hits if it intends to attract foreign investors. International firms are already concerned about India’s slowing economy and growing budget deficit. This amendment decision exacerbates concerns about the country’s reputation for policy paralysis and erratic legal rulings. It has created uncertainties in business environment and disincentives businesses planning to set up shops in India.
M Damodaran, former SEBI chief and head of the panel for looking into retrospective taxation effects resonates similar feelings when he says that death and taxes are certain and although both are undesirable aspects of life, death is never retrospective. It is imperative for a nation to have certainty and continuity in its rules and regulations.
Retrospective Taxation is also against the true spirit, nature and scope of the Double Tax Avoidance Agreements (DTAA). Another loophole if this amendment is that now IT Act will be applicable even if they are less beneficial to the taxpayer while earlier the taxpayer could avail the act which was more beneficial to him/her.
Though such taxation laws are needed in some cases such as situations where the transaction has not been taxed anywhere in the world and has underlying assets in India, the ease with which the Supreme Court’s ruling has been sidestepped is alarming. This would make investors think twice before investing in India and also puts the position of India as an investment place at stake. The statement in 2012 by Finance secretary RS Gujral "Are you saying that this transaction should not be taxed and instead excise duty should be raised from 12% to 14%?” could be seen as bullying and does not serve the government any better.
The retrospective taxation should be avoided as a principle as it creates confusion, uncertainty and lack of confidence in a nation’s ability to welcome foreign investments. Countries across the world such as Brazil, Greece, Mexico, Mozambique, Paraguay, Peru, Venezuela, Romania, Russia, Slovenia and Sweden have prohibited retrospective taxation.
Corrective steps by Government and what the future holds
Since the day Indian Government announced its plan for retrospective taxation, it has been facing flak from all corners. It formed two committees: Parthasarathi Shome Committee and M Damodaran Committee to look into the matter.
The Parthasarathi Shome Committee assess that the amendment was wrong and was against the basic doctrine of law. It also suggested that the law to be used sparingly to clarify grey areas in the law.
The M Damodaran committee echoed similar views as The Parthasarathi Committee. The committee suggested changes in the appointments in the regulatory agencies and use of information technology in a more productive way. It also suggested that this kind of kneejerk reactions and changes should be avoided and advocated for simpler drafting of rules to avoid misinterpretation.
The new Finance minister of India also made the government’s position crystal clear. Although arguing that retrospective taxation is a sovereign right of the nation, a high-level committee under the Central Board of Direct Taxes (CBDT) has been set up to examine any new case based on the retrospective amendments of 2012 in direct transfers, to avoid further legal action. He has also ensured that no retrospective tax creating fresh liabilities will be imposed by the government.
Retrospective taxation is a retrograde idea and the above decision is a step taken in the right direction. The idea behind the law and its implementation were poles apart. There should be strict tax laws which make non payment of taxes impossible but these should not suffocate the business environment. These tax amendments were made with positive objectives, which were to spoil creative attempts to transfer control over Indian property without paying taxes. But without more exhaustive rules, such amendments are a sign of heavy-handedness at best. The government must either add clarifications to the current legislation through legislative amendments or make sure the Direct Tax Codes comes into effect as soon as possible.
This article has been authored by Apoorv Sarwahi from NMIMS Mumbai
1) Retrospective Taxation - A discussion paper by the Chartered Institute of Taxation
2) KPMG - Retrospective Taxation: A discussion paper by the Chartered Institute of Taxation
3) Retrospective Taxation – the Indian Experience by Harish Salve
4) Indian Express website (http://indianexpress.com/article/business/economy/union-budget-passed-arun-jaitley-blames-upa-for-indias-economic-woes-says-civility-in-tax-regime-coming/)
5) DNA India website (http://www.dnaindia.com/money/report-budget2014-to-tax-and-please-retrospective-taxation-and-vodafone-1998059)
6) Business Standard website (http://www.business-standard.com/article/opinion/n-s-nigam-the-vodafone-amendment-is-more-than-a-retrospective-issue-114072101195_1.html)
7) Economic Times website (http://articles.economictimes.indiatimes.com/2014-07-25/news/52026728_1_retrospective-tax-finance-minister-early-signs)
8) Infochange India website (http://infochangeindia.org/corporate-responsibility/analysis/whats-really-at-stake-in-the-vodafone-tax-case.html)
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