VODAFONE RETROSPECTIVE TAXATION- LEGAL & ETHICAL PERSPECTIVE
In every budget session, the ministry of finance presents its union budget to the house which covers aspect of previous financial year, the proposals and plans concerning the allocation of revenues across sectors and changes in regards to tax law provisions (both direct and indirect tax), etc. Such changes are called amendments and are incurred by on-going developments, the welfare of taxpayers, loopholes that could not be included in the earlier version. Once these amendments are accepted by both the houses and approved by the president, it becomes the law of the land. These amendments can be classified into two categories based on the specified date of their application:
1. Prospective amendment
2. Retrospective amendment
Prospective amendment: defined as any changes done in the existing law that becomes effective in the future either from the date of enactment of new legislation or any specified future date.
Retrospective amendment: Such an amendment comes into effect from the specified date in the past. Because of its backward-looking approach, it becomes cumbersome to implement for the executive and creates dissatisfaction among the affected parties. States enact retrospective amendments to undo the decisions of judicial bodies because the decisions went against legislative intent. The government also brings such amendments to remove any anomalies in law or simply to lessen any hardship faced by the taxpayers.
In the case of Vodafone which was served notice by the tax authority to pay the tax of nearly Rs 11000 crores on the capital gain from its purchase of Hutchinson Essar Telecom company from Hutch, the dispute was that whether the Income Tax department has the authority to collect taxes for the indirect transfer of property located in India under the relevant section of 9(1)(i) of the Income-Tax Act. Indirect transfer means when the shares of the company are transferred, assets of that company are also handed over to the buyer. The dispute reached the supreme court, and the supreme court, in its verdict, noticed that the tax department does not have the right to tax the deal. The supreme court noted that both the companies were foreign and made a deal in other international companies that held 67% of shares of Hutchinson Essar India Limited. Hence Vodafone needs not to pay tax for the deal.
Following the setback in the supreme court, the government has amended section 9(1)(i) of the income tax act. The amendment clarified that when a share transaction takes place between two non-resident entities that result in an indirect transfer of assets lying in India, such an income will be taxed in India. But the amendment brought in 2012 was implemented retrospectively since 1962.
Hutchinson, a Hongkong based group, invested in India through a listed company in Hongkong, that listed company, in turn, held shares in the downstream companies in the Cayman Islands, these downstream companies, in turn, held shares in downstream companies based at Mauritius favored investment destination for investment in India due to a favorable tax treaty. Mauritius companies then held shares in an Indian holding company that controlled operational subsidiaries in India. When Hutchinson planned to exit from India, Vodafone, which was keen to enter India, agreed to buy out Hutchinson India Telecom operations. The deal was structured as such that Vodafone acquired an appropriate company below the listed company in Hongkong, the acquisition of which gave Vodafone control over all the
downstream companies and thereby over the Indian operations. The whole deal took place outside India; hence the capital gain accrued from this deal was outside the jurisdiction of the Indian Income Tax department. The income tax department served show-cause notice that Vodafone India has not paid tax on the capital gain. The tax amount was whopping $2.9 billion dollars.
Vodafone challenged this order and reached out to the Supreme Court. In its judgment, the Supreme Court of India held that the transactions will not be taxable in India. It rejected the suggestion of the Government of India that there had been an attempt of tax avoidance in part of Vodafone by resorting to artifices, finding that the creation of the existing structure had been driven by commercial interest and could not be termed as a Tax saving device.
In the Finance Act, 2012, the Government of India amended the income tax and provided clarification regarding section 9(1)(i). In its clarification, the document read: “Certain judicial pronouncements, including the Supreme Court judgment in the case of Vodafone International Holdings, have created doubts about the scope and purpose of sections 9 and 195. Further, there are certain issues in respect of income deemed to accrue or arise where there are also conflicting decisions of various judicial authorities. Therefore, there is a need to provide a clarificatory retrospective amendment to restate the legislative intent in respect of scope and applicability of section 9 and 195 and also to make other clarificatory amendments for providing certainty in the law.” The amendment also provides a clarificatory explanation for section 2(47) and section 2(14) regarding the definition of transfer and clarification of the meaning of capital assets, respectively. The amendment resulted in a verdict against Vodafone, and Vodafone was asked to pay the taxes retrospectively
LEGALITY
The parliament has the power to bring any amendment or laws regarding Taxation, which will come into effect retrospectively. One such case of Lohia Machine Ltd and Union of India. It was the first controversial retrospective amendment in 1983. The Income-tax act granted exemption upon setting new industry as a percentage of capital employed in such undertakings.
A similar judgment was passed in the Chhotabhai vs union 1962 in which the court has cited the decision of privy council in colonial’s sugar refining Co ltd versus Irving which had stated the position with clarity-if the parliament has the power to impose tax conferred by the constitution, the legislature could equally make the law retroactive and impose the tax from the date earlier than that from which it was imposed.
The Finance Bill, 2012 proposed a retrospective amendment to sections 2(14), 2(47) and 9 of the Income Tax Act, 1961, and this amendment implied to be clarificatory.
Section 2(14) — This provision defines a “capital asset” as- “It is hereby clarified that ‘property’ includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever”
Section 2(47) — This provision defines a “transfer” as “it is hereby clarified that “transfer” includes and shall be deemed always to have included disposing of or parting with an asset or any interest therein, or creating any
interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise,
notwithstanding that such transfer of rights has been characterized as being effected or dependent upon or flowing from the transfer of a share or shares of a company incorporated outside India.”
Section 9 — This provision defined that when income is deemed to accrue or arise in India- “It is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside
India shall be deemed to be and shall always be deemed to have been situated in India, if the share of the interest derives, directly or indirectly, its value substantially from the assets located in India.”
POST-RETROSPECTIVE AMENDMENT- VODAFONE CASE
There has been a considerable international disquiet over the retrospective amendment. Unfortunately for the government, Vodafone seeks to remediate under bilateral investment treaties. It created a serious dent in FDI proposals in India. In view of this, the government of India appointed an expert committee for rendering advice on the matter and was headed by one of the prominent economists of the country- Mr. Parthasarthy Shome. The committee concluded that retrospective taxation should occur in the rarest of rare cases with particular objectives:
1. To correct apparent mistakes and anomalies in the statute
2. To apply to matters which are genuinely clarificatory in nature, in other words, to remove technical defects, particularly in the procedure, which has the substantive law.
3. To save tax base from highly abusive tax planning schemes which have the main purpose of avoiding tax, but not to expand the tax base.
Hence such laws create an environment of distrust, which is detrimental to do business freely. India ranks low in ease of doing business published by the world bank, lower than Rwanda, Azerbaijan, and Chile. Retrospective taxation creates an undesirable effect of uncertainties in the business. It constitutes significant disincentives for a person wishing to do business in India. A probable compromise could be a waiver of interest and penalty; however, the government also appears to raise tax demands on such deals to gain revenues. Long battle between MNCs and the Government of India could also risk huge penalties at either end incurring massive loss. Former FM Jaitley remarked that “at the end of the day we have not been able to collect those taxes and we scared the investors away,” investors want stability and predictability and they don’t want to hit by a surprise that upsets the business planning and “therefore it is important that standards of fairness in taxation must be maintained.” The legislative amendment can be held valid only in cases where the intent is to cure inadvertent defects and increase clarity and transparency.
