India’s Budget 2014: Whither Amendments To Tax Laws Applied Retroactively?

By Mukesh Butani, Sumit Singhania and Rahul Yadav

The new BJP-led government of Prime Minister Narendra Modi presented the Union (or Federal) budget to Parliament in July 2014, barely two months after taking office. The budget was presented in the backdrop of unprecedented expectations and business aspirationscaused by hopes that, at last, the new government would live up to its campaign promises to revive India’s economy. Faced with difficult macro-economic challenges and daunting deficit targets, the new government had a tough task at hand. Nevertheless, Finance Minister Arun Jaitley managed to pull off a delicate balancing act between economic growth and an agenda of reforms in government expenditure, which was evident in his long speech to Parliament.

Broadly, his key announcements were short-to-medium term vision-based and aligned to the theme reflected of the railway and the finance budgets such as big ticket investments based on private and public sector collaboration, and high technology induction and experimentation with new financial products and sources. The Budget scores well on regulatory policy front, too, by elevating the composite Foreign Direct Investment (FDI) cap to 49 percent in the defense and insurance sectors. And the roll-out of several infrastructure projects under the public-private-partnership model should catalyze new investments in this capital-starved sector.

The new budget included a clear commitment to tax policy reforms. The Budget’s Economic Survey 2014 underlined the need for structural reforms in Indian tax policy and administration. These reforms are designed to move away from the present industrial-policy based tax system to a simplified and more equitable regime. Significantly, Mr. Jaitley mentioned two tax policy reforms—the introduction of a Goods & Services Tax (GST) and a Direct Taxes Code (DTC), but unfortunately he failed to provide a definitive time frame for the transition.

No Intention to Repeal Retrospective Tax Legislation

On the wider tax policy reform agenda, the Finance Minister recognized the pressing need to providecertainty and a robust, yet investment-friendly,tax regime. This includes resolvingthe tension between the legislative and judicial viewpoints on retrospective amendments of tax laws effecting indirect transfers. Retrospective tax law (i.e., laws which have retroactive effect) have been referred to as “tax terrorism” and ‘”ax adventurism,”on the part of the outgoingCongress Party-led government. However, in the run-up to the budget, one could only wonder if the new governmentwould practice what it preached by repealing the most controversial retrospective pieces of legislation in recent times concerning taxation of indirect transfers. This legislation has often been described by the investors’ community as a knee-jerk reaction to nullify a Supreme Court decision in the celebrated Vodafone caseas opposed to a well-thought tax policy action. (See Vodafone Int’l Holding B.V. vs. Union of India [2012] 341 ITR 1 [SC]).

The Story So Far

The Finance Act 2012, introduced multiple amendments having retrospective effect—specifically sections 9 and 2(47) of the Income Tax Act (“the Act”). These amendments were legislated in the form of Explanations appended to section 9 of the Act.The stated legislative intent underlying the amendments was to bring within the ambit of Indian taxation, the sale of shares of a foreign company if such shares derive ‘substantial value’ from underlying assets located in India. The 2012 amendments to charging provisions had the effect of rendering a Vodafone transaction and others like it liable to tax in India, with retrospective effect. In short, under the garb of retrospective clarificatory amendments, the legislature nullified in a single stroke long-standing judicial precedents which had recognized the separation of powers between the legislative and judicial branches. These amendments which were enacted to nullify the Supreme Court’s verdict in theVodafone case were widely criticized as an unconstitutional attempt of the Legislature to usurp judicial independence.

The legislative competence for enacting retrospective legislation(s) and constitutional and judicially recognized parameters within which such laws must be enacted have been discussed in our previous article.Butani, Mukesh and Rahul Yadav. “Does retrospective legislation compromise judicial independence? The constitutionality of the Vodafone legislation.” India Law News Vol. 4 Issue 1 Winter/Spring 2013: 1. We opined that the retrospective amendment of taxation of indirect transfer could not be held to be clarifying the intent of the Act, so as to include the off-shore sale of shares by one foreign company to another foreign company (such as Vodafone) within the ambit of section 9 of the Act. Such amendments ought to be regarded as substantive amendmentscausing levy of new charge of tax and thus, could not be given a retrospective operation as per settled legal principles. The following developments have taken place since then.

Taxpayers Move Court to Challenge TheConstitutional Validity Of The Amendments

In the wake of the retrospective amendments, certain taxpayers moved the High Courts of appropriate jurisdiction, by filing writ petitions under Article 226 of the Constitution of India, challenging the constitutional validity of such amendments.McLeod Russel (India) Limited, SABMiller Limited (an Australian Company) and IHC Mauritius Corporation have filed writ petitions before the Calcutta and Bombay High Courts, respectively.Decisions are pending in these, which was the reason the finance minister gave in his budget speech for no action for the time being by the legislature on this issue. This is keeping in line constitutional convention not to intervene in matters before the judiciary. Most observers believe that the new Government could have acted boldly and repealed the law. As the constitution empowers the legislature to legislate a retrospective clarifying law, it includes the power to repeal any law as was done with respect to the Fringe Benefits Tax – a law which was repealed four years after it was passed.

Government Sets up Shome Panel

The retrospective amendments of 2012 evoked strong reactions from investors, prompting the then government to set up an expert panel under the chairmanship of eminent tax policy commentator, Dr. Parthasarthi Shome. The Expert Panel’s primary recommendation was that provisions relating to taxation of indirect transfers should be implemented to have prospective effect. It was noted in the Panel’s report that the retrospective amendments were not clarificatory in nature; instead,it had the effect of widening the tax base. The Panel recommended that its application be made prospective so as to bear the principles of equity and probity in the implementation of commonly recognized taxation principles.

However, recommendations of the Expert Panel were not implemented and translated in the statute book by way of supplementary legislation. Non-implementation of these recommendations was seen as another instance of indecisiveness and lack of sensitivity towards investor sentiments by the former government. In effect, the 2012 law was left toothless, though, it did not prevent certain segments of the tax administration from pursuing recovery of taxes on the basis of the impugned law.

Vodafone Initiated Arbitration Under theIndia-Netherlands Bilateral Investment Treaty (“BIT”)

In April 2012, Vodafone invoked the dispute settlement process under the India-Netherlands Bilateral Investment Treaty (BIT). Under the mechanism provided under BIT, which follows the United Nations Commission on International Trade Law (UNCITRAL) rules, Vodafone initiated conciliation with the Government of India. Even if the new government agrees to arbitrate, it remains to be seen whether tax disputes are covered under international arbitration, despite the fact that the primary objective of such BITs is to protect foreign investment.

The New Government Has Shied From Repealing TheRetrospective Amendment And Has, Instead, Set Up A High Level Committee For Investigation Of Disputes

In his budget speech, the Finance Minister stated that the new government intended to legislate or enforce retrospective amendments with utmost caution and judiciousness, keeping in mind the impact on the overall investment climate of the country. This is important particularly in the wake of the over 150 retrospective amendments that have been enacted in the last decade. The majority of these were under the garb of clarificatory amendments, which unsettledestablished tax principles and precedents. At a policy level, the government’s stated reluctance to introduce retrospective amendments is an enormous relief and is consistent with its policy of providing a stable tax regime. This augurs well for the investor community at large.

Contrary to popular expectations, the new government stopped short of repealing or amending the law on taxation of indirect transfers to make it applicable only prospectively. Instead, the government has proposed to constitute a high level committee under the aegis of the Central Board of Direct Taxes (CBDT), which is the highest administrative authority responsible for administration of direct tax laws in the country. The CBDT would scrutinize all fresh cases that could fall within the ambit of the retrospective amendments of 2012, before the Revenue Department could seek to enforce tax payments under retrospective legislation.Such a move should bring a degree of stability to the way Revenue decides to pursue tax claims in indirect transfer cases. Although investors willcontinue to feel stranded in the absence of legislative clarity on the scope of such amendments.

The new government probably shied away from repealing the retrospective amendment for two reasons. The more obvious one is that it is the custom for the legislature to let challenges to the constitutional validity of legislation to work their way through the judicial system before delivering a legislative riposte. Second, while there is no question as to the legislature’s power to enact and repeal laws, the new government probably did not wish to risk a political outcrybarely two months in office by repealing retrospective amendments enacted by its predecessor government.

Investors have already taken tentative notice of the government’s announcement to set up a high-level committee to scrutinize cases arising out of retrospective amendments. Cairn India, one of the litigants challenging the constitutional validity of the amendments, has withdrawn its petition from the Court–ostensibly to pursue settlement by waiting for the CBDT’s high-powered committee to weigh in on the controversy. This is an indication that the measures taken by the new government have been well received and that others in the investor community may well be prepared to place its trust in the new government’s stated intention to exercise caution in enforcing retrospective legislation.

In sum, despite great expectations from the new government, investors continue to be cautiously optimistic that measures expressed in the new budget regarding fiscal consolidation and socio-economic reforms will translate into further long term macro-economic reforms in next year’s budget. Investors also remain hopeful, as they wait and watch, that either the judiciary or the legislature itself will jettison the controversial retrospective application of the law of indirect transfer taxation. There are going to be more twists and turns in this story before the matter is resolved.

Taxation of ‘indirect transfers’ hogs the limelight at IFA’s 68th Congress 2014s held in Mumbai October 12 to 17, 2014

Legislation to tax ‘indirect transfers’ has come in sharp focus globally, following the high-stake tax disputesin cases such as Vodafone and Chongqing case reported in India and China respectively. The subject received spirited attention at 68th Congress of the International Fiscal Association (IFA) held in Mumbai earlier this month. Panels of experts from divergent jurisdictions (India, Chile, the Netherlands and Australia) debated the implications of indirect transfer taxability under the respective domestic legislation, key tax policy-related concerns including extra-territorial reach of domestic legislation; divergent countrypractices and implementation of domestic legislation without disregarding tax treaty provisions (the latter panel was chaired by co-author of this article, Mukesh Butani). Two keys aspects of the debate that emerged were (a) whether and to what extent the customary international law could constrain a jurisdiction to enforce the indirect tax legislation, if the taxation in one of the treaty partner countries is contrary to generally accepted taxation principles or to the provisions of a tax treaty, and (b) whether constitutional law empowered the legislature to enact legislation with retrospective effect to levy tax, and if yes, whether such retrospective law could unilaterally usurp tax treaty provisions.

Arguably, there are no immediate answers and it is, therefore, imperative that the respective jurisdictions, while enacting complex legislation in international tax matters,adapt their approach to international conventions and best practices to avoid embroiling taxpayers in frivolous disputes.

Mukesh Butani is the Managing Partner of BMR Legal and specializes in International Tax and Transfer pricing with over 25 years’ experience in advising Fortune 500 multinationals and Indian business houses on a wide range of matters. He is a member of the Advisory Group on International Tax and Transfer Pricing constituted by the Indian Ministry of Finance. He is also a member of the OECD Business Restructuring Advisory Group, the International Fiscal Association’s Permanent Scientific Committee and the OECD-BIAC committee. Mukesh can be reached at Mukesh.Butani@bmrlegal.in.

Sumit Singhaniais a Director with BMR & Associates LLP and specializes in Corporate International Tax and transaction advisory. He has significant experience in advising multinationals and Indian business in Energy & Infrastructure sector on investment structuring, tax issues and contract structuring, dispute resolution, etc. Sumit is active speaker at conference organized by industry bodies in and outside India, and has several publications to his credit. He has been named in International Tax Review’s 2012 World Tax Guide as one of the leading tax advisors in India. Sumit can be reached at sumit.singhania@bmradvisors.com

Rahul Yadav is an Advocate and international tax dispute expert at BMR Legal and has worked extensively on several cross border transactions. Rahul can be reached at rahul.yadav@bmrlegal.in.

 

 

 

 

 

 

 


 

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