116 B, Mittal Towers, Nariman Point, Mumbai, India

Introduction

Retrospective tax can be defined as a tax imposed on a transaction or deal that was conducted in the past. Ideally, a retrospective tax is charged by authorities in order to make adjustments when policies in the past and the present are inconsistent in terms of the amount of tax paid by a particular entity - usually when the amount of tax paid by them is lesser. In such a case, a taxation scheme like this could correct the situation by imposing tax that falls in line with the existing policy regime. Several countries such as USA, UK, Australia, Belgium, Canada, and Italy have used this form of taxation in order to rectify any deviations in the taxation policies that, in the past, allowed parties to take benefit from any loopholes present in the taxation policies. In India, retrospective tax was introduced as part of the Finance Act, 2012 (‘the Amendment’) - an amendment to the Income Tax Act, 1961 (‘IT Act’). According to this Amendment, such tax would be imposed on transactions executed after 1962 under Section 9 of the IT Act, which involves transfer of shares in a foreign entity which had assets in India.

The entire debate around retrospective taxation in India has received prominence in the aftermath of two events -

  1. In 2006, Edinburgh-based Cairn Energy created a new company - ‘Cairn India’ and transferred all of its India assets to this entity. After transferring the assets, the company listed Cairn India on the various stock exchanges through an Initial Public Offering (‘IPO’). Later, in 2011, Cairn Energy sold its majority stake in Cairn India to Vedanta for $8.67 billion, leaving only a 9.8% stake to itself. Subsequently, after Cairn India’s merger with Vedanta in 2017, Cairn Energy held a 5% stake in Vedanta Ltd along with some preference shares valued at over $1 billion. The IT Department slapped taxes on Cairn Energy subsequent to these events.
  2. In May 2007, UK-based telecommunications company Vodafone International BV (‘Vodafone’) acquired 67% stake in the Hong Kong-based Hutchison Whompoa’s ‘Hutchinson Essar’ for $11 Billion. The Union Government, through the Income Tax Department (‘IT Department’), imposed a tax demand of Rs. 7,990 crore on Vodafone due to ‘capital gains’ that emanated from the purchase of this stake. In 2010, Vodafone challenged this tax demand notice in the Bombay High Court, which ruled in favour of the IT Department. Subsequently, they appealed against the High Court judgment in the Supreme Court of India (‘SC’), which in 2012 ruled that Vodafone’s interpretation of the IT Act was accurate, and there is no necessity to impose any taxes for the stake purchase in India by the IT Department.

How did Retrospective Tax come into India’s Taxation Policy?

The then Finance Minister Pranab Mukherjee (under the UPA-led government) brought in the Finance Bill, 2012, which was passed by the Parliament and received President’s assent. The purpose of this move was to retrospectively tax companies to pay taxes on mergers and acquisitions (M&As) that took place before 2012 - based on retrospective changes to India’s tax laws. This acted as a starting point for the debate and deliberations around retrospective taxation and its requirement in India.

In furtherance to this, in 2013, the IT Department once again slapped a tax demand of Rs. 3,700 crore to Vodafone for another transaction involving the sale of a call centre business. In December 2013, the Income Tax Appellate Tribunal demanded Vodafone to deposit Rs. 200 crore in this regard. Further, in 2015, the IT Department raised a demand for Rs. 24,000 crore as Cairn Energy had made capital gains of Rs. 24,503 crore as part of the internal reorganisation in 2007.

Due to these consecutive tax demands, both Cairn and Vodafone filed lawsuits in international courts against the Indian government’s retrospective tax policy, as follows -

  1. Cairn Energy initiated international arbitration against India in 2015 in Paris. It claimed that the Indian government’s actions violated the India-UK bilateral investment treaty, which aimed at promotion and protection of the rights of their respective investors. The Permanent Court of Arbitration ruled in Cairn Energy’s favour in December 2020, handing it an award of $1.7 billion in cumulation; India had filed an appeal against this verdict at The Hague on 22nd March 2021, challenging the $1.2 billion award on grounds of sovereignty and tax avoidance;
  2. In 2014, Vodafone served an arbitration notice to the Central Government over its Rs. 20,000 crore tax dispute with the IT Department. On 25th September 2020, the Arbitration Tribunal at the Hague passed an award that the tax authorities’ demand for Rs. 22,100 crore is not valid in nature, and India's imposition of tax liability on Vodafone, as well as interest and penalties, breached an investment treaty agreement between India and the Netherlands. India had appealed against this decision in the Singapore High Court at the end of 2020.

Meanwhile, once the NDA-led government came into power in 2014. They took a stance to not retrospectively create any fresh tax liabilities, and that all fresh litigations arising out of the 2012 Amendment would be scrutinised by a high-level committee before any action is initiated. In light of this, no action could be taken as pending litigations were taking place on this issue across jurisdictions.

Understanding the Taxation Laws (Amendment) Bill & its Implications

Following this, on 5th August 2020, the Union Government introduced a bill in the Lok Sabha which sought to scrap retrospective tax demands that it had made on various entities, including Cairn Energy and Vodafone, among others. Finance Minister Nirmala Sitharaman introduced a Bill titled ‘The Taxation Laws (Amendment) Bill, 2021’ (‘2021 Bill’), in order to amend the provisions of the IT Act, as amended by the Finance Act 2012, with the intent to place a reversal on taxation demands made to Cairn Energy and Vodafone. The same was introduced as a ‘Money Bill’ in the Lok Sabha and has been passed by its members. On the other hand, the Rajya Sabha has returned the Bill, as it has limited powers over deciding upon a Money Bill.

This 2021 Bill proposes to amend the IT Act so as to provide that no tax demand shall be raised in future on the basis of the said retrospective amendment for any indirect transfer of Indian assets if the transaction was undertaken before 28th May 2012 (Section 9(1)). However, offshore deals on foreign holdings will still be taxable, but only if done after the Finance Bill, 2012 came into force. (Explanation 5 to Section 9(1)).

In the ‘Statement of Object and Reasons’, the Bill has acknowledged that the tax demand arising out of the retrospective tax policy “continues to be a sore point with potential investors” whereas “quick recovery of the economy after the COVID-19 pandemic is the need of the hour and foreign investment has an important role to play in promoting faster economic growth and employment.” The Bill has also proposed to provide that "the demand raised for indirect transfer of Indian assets made before 28th May 2012 shall be nullified on fulfilment of specified conditions such as withdrawal or furnishing of undertaking for withdrawal of pending litigation and furnishing of an undertaking to the effect that no claim for cost, damages, interest, etc., shall be filed."

ThisBill, now that it has been passed in the Parliament, will not result in withdrawal of the 2012 Amendment, but would instead only limit its application in cases where the taxpayer agrees to withdraw all claims and undertakes to refrain from any recovery action in future. Although the 2012 Amendment will continue to remain, the retrospective application before 2012 will not be applicable.

The 2021 Bill comes as a welcome move for the following reasons - the withdrawal of the retrospective amendment would reignite the choice of India as a favourable investment destination coupled with low tax rates, and favourable FDI policies. Further, this Bill should help contain the widespread litigation that has been caused across jurisdictions, similar to that of Vodafone and Cairn Energy - a total of seventeen (17) entities will benefit in total. As per the text of the Bill, those entities that are involved in any ongoing litigation will have to withdraw their case, only then IT Department would not treat their assessment in default.

This move by the government make one question the utility of retrospective taxation. Regardless, this Bill shall help India move one step forward in its aim towards improving its ‘ease of doing business’ image for investors across the globe as there shall no taxation disputes moving forward. The SC in the Vodafone ruling inter alia had impressed upon ‘the need for legal certainty to promote FDI by scuttling ominous tax demands enforced retrospectively upon offshore re-organisations and transactions of Indian corporate structures and assets’ - this Bill has definitely acted as a starting point in this direction.