What made the Government scrap the Retrospective Tax Law?

By – Tisha Bajaj

Finance Minister Nirmala Sitharaman, on August 5 introduced the Taxation Laws (Amendment) Bill, 2021 in Lok Sabha to do away with the retrospective tax law implemented in 2012.

This headline gives rise to a lot of questions like what exactly is retrospective effect, what made the government introduce retrospective tax law in the Finance Act 2012, what made the government finally scrap this law in August 2021 and whether this move of centre is justified or not. Let’s now look into the entire story.

Retrospective means looking back or dealing with the past events or situations and a Retrospective tax is one that is charged for transactions in the long past from a time before the date on which the law is passed. Countries use this form of taxation to rectify deviations in the taxation policies that, in the past, allowed firms to take benefit from any loophole in the law.

All this started in May 2007 when Vodafone, a British multinational telecommunications company, settled a $11.1 billion deal with Hong-Kong based company Hutchison Telecommunications International Limited (HTIL). HTIL was a telecommunication giant providing mobile and internet services in countries like Indonesia, Sri Lanka, etc. HTIL had one of its subsidiaries CGP Investments in Cayman Islands which was a “Tax Haven”, which is generally an offshore country that offers foreign individuals and businesses little or no tax liability. So, the entire deal took place in the Cayman Islands and not in India wherein Vodafone settled a deal to buy CGP investments from HTIL. The real intention of Vodafone behind the deal was to take control of Hutchison Essar Ltd. which was a joint venture between Hutch and Essar, one of the leading telecom companies in India. Vodafone in order to save itself from the tax liability, used an indirect method and acquired CGP investments which was holding 67% stake in Hutchison Essar Ltd. This is the way Vodafone indirectly got 67% of the shares in the Indian Telecom company. Hutchison Essar became Vodafone Essar and this should have ended here but in this Billion Dollar deal, which included the transfer of Indian assets with NIL tax liability, the Tax department just couldn’t let it go like this and….

In September, 2007 the Income tax department issued a legal notice to Vodafone International Holdings and Vodafone Essar claiming around $2.1 billion in taxes. The Tax department alleged that VIH failed to deduct tax on source on the consideration paid to HTIL as per Sec 195 of the Income tax act 1961 and thus VIH should be treated as an assessee in default, but Vodafone challenged the notice in the Bombay High Court on the ground that the transactions happened between two foreign entities and didn’t involve any direct transfer of an Indian asset. After all, how can the Indian Government claim tax on a transaction that involved the sale of one foreign company to another. The Bombay High Court however dismissed Vodafone’s petition. The High Court also ruled in favour of the tax department in September 2010.

The legal tassel didn’t stop here and Vodafone moved to the Supreme Court. In January 2012, in a landmark decision, the Supreme Court reversed the decision of the Bombay High Court and held that Vodafone Group’s interpretation of the IT Act 1961 was correct and they were under no obligation to deduct the tax at source and the tax department had to pay back $2.1 billion with interest to Vodafone. This would have ended here but in the same year, the then Finance minister, late Pranab Mukherjee proposed an amendment in the Finance Act 2012 in respect of the scope and applicability of section 9 and 195. The Amendment implied that any capital gain from transfer of shares or interest in foreign company deriving its substantial value from assets located in India would be taxable in India. The government made it retrospective from 1962, now this would mean that the Vodafone case where the entire transactions were already carried out and the ruling was also made by the Supreme Court could become taxable with this retrospective amendment. Vodafone didn’t stop here, in April 2014 it moved to the Permanent court of arbitration at the Hague and in September 2020, tribunal ruled in favour of Vodafone. The Vodafone case became famous as “The Retrospective Taxation Case.” India’s defeat in the case underlines that the retrospective taxation amendment must go as much energy, reputation, money and goodwill have been wasted and India surely needed a smooth tax regime to attract foreign investments. And you would be surprised to know that it did happen…

The retrospective tax is now back in the news again. In August 2021, the Finance Minister Nirmala Sitharaman moved a bill in the Lok Sabha to repeal the retrospective taxation, the bill proposed that demand under retrospective tax law raised before May 28, 2012, shall be nullified on fulfilment of specified conditions and the amount of tax demand raised under the law shall be refunded, but no interest under section 244A shall be paid on that amount.

Wondering why the government after 9 long years decided to make amendments in the retrospective tax law ? Following are the main reasons for the repeal-

  1. The IT department raised demand in 17 cases. Out of these 17 cases 2 have pending assessment on account of court stay order. Arbitration under the Bilateral Investment Protection Treaty with the UK and the Netherlands had been invoked in 4 cases, out of which in 2 cases – Vodafone and Cairn Energy Arbitration ruled against the IT department. While the government has no liability against Vodafone, it still has to pay $1.2 billion to Cairn as Arbitration award. The move comes as Cairn Energy is threatening to confiscate overseas Indian assets.
  2. Foreign investment is a much needed development as the country looks to reverse the Covid-19 pandemic impact on the economy. The removal of the retrospective law would build India’s reputation as an attractive investment destination.

This move of the Government is greatly appreciated, it will help close past disputes and future litigation costs and bring an end to the messy litigations and arbitrations. It is a much needed change for the ‘Make in India’ dream and to make India reach the goal of a $5 trillion economy. 

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