India’s Taxing Journey in Withdrawing Retrospective Tax
By - Ahan Mohit Gadkari
The Indian Parliament enacted The Taxation Laws (Amendment) Bill, 2021 (hereafter 2021 Law) on 9 August 2021, effectively nullifying retrospective tax.1 This was a long-overdue step, arriving only after the Indian government came under fire for its position in the Vodafone and Cairn conflicts. This 2021 Law is significant because it repealed the retrospective tax scheme enacted by the Finance Act, 2012. This piece will begin by examining why the 2012 Law was controversial. It will then discuss how the Indian government’s retrospective tax provisions were challenged in international courts, drawing criticism. Finally, it will assess the impact of the 2021 Law and the future expectations for foreign investors.
Contentious Provisions of the 2012 Law:
Non-residents are obligated to pay tax on income earned via or deriving from any business link, property, asset, or source of income located in India under the Income Tax Act. The 2012 Law emphasized that even if a corporation is formed or incorporated outside India, its shares are presumed to be or have always been in India if they draw a considerable portion of their value from Indian assets. As a result, individuals who sold such foreign company shares before the 2012 Law’s implementation (i.e., May 28, 2012) became liable for tax on the income earned on such sale.
The 2012 Law treated the preceding clarification as having been in effect when the Income Tax Act was enacted on April 1, 1962.2 This meant that all transactions involving the transfer of shares or interests in foreign corporations that derive significant value from Indian assets would be liable to capital gains tax in India, and interest would be charged on late payments. This allowed Indian revenue to levy taxes on all transactions completed in the 50 years preceding the 2012 Law, effectively reversing the Smithian canon of tax certainty.
International Jurisprudence on the law:
This change affected around 17 cases, the most significant of which were Vodafone and Cairn Energy. Vodafone faced a demand of about USD 295 million, and Cairn faced a demand of approximately USD 1,600 million due to the retrospective modification.3 The corporations had instituted international arbitration procedures against the Indian government in accordance with the applicable bilateral investment treaty. The companies contended that India had violated the bilateral investment treaties’ commitment to fair and equitable treatment.
The Indian government contended in response to the arbitration claims that the Tribunal’s exercise of jurisdiction over a national tax issue is unlawful. Additionally, the claim is predicated on claimed violations of Indian income tax regulations, which the bilateral investment treaty does not cover. After years of protracted litigation, the Arbitration Tribunals found in favor of the taxpayers in both cases. Accordingly, the Indian government was ordered to return taxes collected plus interest and fees.
Reasons for the government facing criticism:
Regarding the Vodafone matter, Vodafone initially committed itself to the jurisdiction of Indian courts and litigated all the way to the Supreme Court as part of its legal remedies. The Supreme Court originally ruled in favor of Vodafone.4 However, it was only after this judgment that the Indian government made retrospective revisions and employed the legislative to do what the judiciary could not. Even without the benefit of the detailed submissions made on behalf of India before the Tribunal, it is evident that the law of the land favored Vodafone until the retrospective modification was made. Furthermore, when Vodafone approached the international Tribunal, it contested, among other things, the Indian government’s decision to make a fundamental modification to the statute retroactively and then term it a mere clarification. In other words, Vodafone attacked not an existing rule or regulation but the act of altering the prevailing law to its detriment. Given that India’s highest court originally ruled in favor of the investing business, it would be impossible to apply even the stringent ELSI test in favor of India before an international tribunal. Cairn also faced similar consequences, given its investments in India predate the date of retrospective legislation. It is reasonable for an investor to anticipate that the host country’s laws will be regulated within the confines of its legal framework, which the host country’s courts will safeguard. When the law is altered, particularly retroactively, it cancels out and destabilizes any bona fide calculations the investor performs.
Any nation’s tax system must be certain and predictable. The absence of these two characteristics discourages investors, harming the host country’s total economic growth. Moreover, these indirect transfer tax issues established precedents and drew widespread criticism against the Indian government. The retrospective application stunned investors and shook investor confidence in India’s tax climate, which had been considered unpredictable by the international world since then.
Changes made by the 2021 Law:
In a commendable yet surprising step, the Indian government, via the 2021 Law, has rescinded the 2012 Law’s retrospective application to transactions completed prior to 28 May 2012 (i.e., the date on which the 2012 Law had received Presidential assent). As a result, all pending assessments must be deemed complete without regard for such revenue. Certain circumstances apply, including the taxpayer resigning or providing an undertaking to withdraw from pending lawsuits and agreeing that no claim for costs, damages, or interest will be made. Additionally, taxpayers will lose interest in tax demands that they already deposited throughout the process. If the taxpayer elects to take advantage of this benefit, any tax demand notice issued pursuant to the 2012 Law will be annulled, and any sum paid pursuant to the 2012 Law would be reimbursed without interest.
Thus, Vodafone and Cairn, and other taxpayers would immensely benefit from this reform because they would no longer have to contend with the Indian government and would also receive a refund of any taxes paid (without interest) any.
It is hoped that the 2021 Law will put an end to the overwhelming volume of litigation on this subject. Additionally, the Government has said that no new demand will be made for indirect transfers made before 28 May 2012. Although it is unknown whether the 2012 Law resulted in any tax collection, it succeeded in portraying India as an unfavorable tax destination for a foreign company. Despite the delay in repealing this contentious legislation, the Indian government has taken a pragmatic step to provide tax clarity and possibly enhance optimism for foreign investment.
While the move is delayed, it does bring an end to a nearly decade-long judicial struggle waged by the government seeking the retroactive implementation of this tax law. After losing in arbitration, this move demonstrates the Indian government’s stance on the matter. Reversing an old law that did not correspond well with the country’s broader policy purpose demonstrates the government’s willingness to bend for the greater good.
Ahan Mohit Gadkari is a fourth-year student at JGLS.