A practical burial of the retroactive tax spirit

A 14-year history has come to an end with the Government of India’s intention to repeal the “retroactive tax change” introduced in the Union budget for 2012-13. This is a happy ending from the perspective of potential investors and global corporations waging tax disputes against the government.

The story began in 2007 when UK-based Vodafone acquired Hutchison Essar, which provided telecommunications services in India, for $ 11 billion. Although the deal didn’t go through in India, Vodafone was struck down with a huge income tax claim. After a protracted legal battle, Vodafone was exonerated by the Supreme Court of India, which ruled that Indian authorities should not tax a deal made in the Cayman Islands.

It was this ruling that led to the 2012 amendments to India’s income tax law that brought such indirect corporate transactions into the country’s tax network. If an Indian asset was held by a foreign company and an acquirer bought that holding company, such a transaction was considered to be taxable in India because the underlying asset was located in India. More importantly, this change was applied retrospectively from 1962, a decision that was clearly aimed at making the Vodafone transaction taxable among other such deals.

The retrospective applicability of this provision met with sharp criticism. None other than then British Prime Minister Gordon Brown voiced his country’s concerns about India. Taxation is a sovereign right and it is not common for heads of state to comment on other countries’ tax policy decisions.

On August 5th, the spirit of this additional tax was buried. The government introduced the Taxation Laws (Amendment) Bill 2021 to repeal the insidious provision in the 2012 Finance Bill. It was passed in the Lok Sabha the next day without any doubt that the Rajya Sabha had been erased and put into effect. This will potentially help resolve up to 17 cases of such income tax claims. In two high-profile cases, Cairn Energy and Vodafone Plc, the companies contesting the tax claims had already won various legal and arbitration awards.

Reclaiming the retrospective clause is comprehensive. The government will not collect tax claims in such cases if the transaction occurred before May 28, 2012. Claims already made will be withdrawn and the main amount of taxes charged will be repaid.

In cases where a legal dispute is pending, this will be done after the corporate party concerned has undertaken not to contest the case any further.

A key feature of this decision is that all cases, and not just the big two Cairn Energy and Vodafone, can now be exempted from India’s retroactive tax claims. If the Indian government had only decided not to appeal against the two cases mentioned or to accept the corresponding arbitral awards, it would have settled these cases but also left the other 15 in the lurch.

The decision therefore goes a step further to possibly restore Cairn and Vodafone’s confidence in Indian tax policy, but also offers a deal for other post-tax cases. Of course, both firms that have won interest and costs in arbitration awards can continue to litigate instead of accepting the middle ground offered by the government. But given their business interests in the country, they can definitely accept the offer. Your choice should be clear in the coming weeks.

Defeating the retroactive tax specter is a welcome move that embodies a practical implementation plan. By abolishing the concept of retrospective taxation, the government has created the conditions for future political stability. The most important aspect of any tax system is its predictability and this serves that purpose. The decision also reaffirms India’s commitment to respect the rule of law and obligations under international treaties.

Nor is it that the change will only benefit foreign companies. Indian companies that have acquired shares in foreign companies were also made liable for the withholding tax retrospectively as part of the 2012 amendment and tax claims were raised against them. These Indian companies should also benefit from this decision, provided that the prescribed conditions are met.

Taxation on indirect sales of assets in India is still in the country’s law books, but it is fully visible and understood by any party wishing to conduct such a transaction.

India has expressed its ambition to become an Atmanirbhar Bharat, a country in its own right. Aside from various reform measures and incentives, contract integrity is a key factor that every investor looks at before deciding whether to invest in a new company or expand their business in the country. The end of retroactive taxation will help build that confidence.

The step is right, pragmatic and courageous at the same time. A retroactive tax was against our international obligations. As the post-pandemic recovery deepens and we embark on a rebuilding project, our focus must be on the future rather than dangling a sword of uncertainty over potential investors for past deals. Such decisions require political capital, and the government has done well to use its reserves.

Aashish Chandorkar is designated advisor to the Permanent Mission of India to the World Trade Organization in Geneva and writes on public policy

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