Address India’s Retrospective Taxation on Cross Border Investments

By Mukesh Butani —

Source: Verchmarco’s flickr photostream, used under a creative commons license.

Status: Not Started  The government has not amended the Income Tax Code in a way that precludes applying law retrospectively, particularly on cross-border transactions. It, however, did take several measures to address its rigor. First, the government formed a new committee in the Ministry of Finance that has blocked fresh attempts to use the “retrospective” principle to foreign investors. Second, the government passed a law in 2016 that includes a limited window to settle tax disputes arising out of retrospective application of law by foregoing interest & penalties. Lastly, the Vivad Se Vishwas Scheme of 2020 (or Direct Tax dispute settlement scheme) covers all forms of disputes.

Medium Difficulty: No Opposition, Requires legislation which could prove contentious. However, since most amendments to the Income Tax Code are included in the omnibus Finance Bill, further amendments seem possible, as has been the trend including changes in the Finance Act of 2020.

This is the twenty-sixth installment in a new series of articles on the India Reforms Scorecard: 2019-2024 by the staff and experts at the Wadhwani Chair in U.S.-India Policy Studies. The series seeks to provide analysis on why reforms marked as “Incomplete” or “In Progress” have not been completed, and the impact such reforms can have on specific sectors or the economy at large.

When the present government won majority in 2014, they pledged to initiate tax reforms as a key priority, and to reverse India’s stance on retrospective tax amendments. To foreign investors, the focus of reforms was the amendments to the Income Tax Act that were introduced in 2012 to undo Vodafone’s withholding tax victory in the Supreme Court.

The Modi government’s first budget in July 2014 announced a clear intent not to legislate retrospective law — although it was noted that the Parliament retains the right to legislate in situations where courts have not interpreted the law by keeping in mind its legislative intent. This was keeping in mind the balance of power under the Constitution which enjoins upon the Parliament to be supreme unless it disturbs the basic structure of the Constitution. So far, the government has adhered to its commitment and not launched new tax cases retrospectively. So why does this “solution” not resonate with investors? The reality is that most in India’s tax fraternity believe that the government missed an opportunity to reverse the 2012 law. The threat of tax disputes arising out of long-past tax years is still a possibility.

Rather, the Modi government announced a series of measures including a host of subordinate legislation, FAQ’s for interpretation, reopening of past cases — which required an approval of a committee, an enabling framework for settlement, and discretionary power to waive interest and penalties. This was followed by a law in 2016 which specifically offered all forms of taxpayers to pay up taxes voluntarily in situations of tax incidence due to retrospective law. The only exceptions were taxpayers who were either dealt with by the administration or were awaiting adjudication, including cases that were taken up in arbitration. Few investors decided to pursue their claims under the bilateral investment treaties. The most significant retrospective tax cases — Cairn and Vodafone — are still awaiting outcome of the investment arbitration. More recently, the Finance Act of 2020 adopted the Vivaad se Vishwas scheme which gives a window of opportunity for cases that are locked up in litigation. Under the scheme, there are provisions for interest & penalty waiver provided to the taxpayers.

The Parliament reserves the right to legislate retrospective laws, and it equally has powers to repeal the law retrospectively. Understandably, in a democracy such actions may trigger public interest litigation where they would be tested in the courts. Looking at revenue considerations, given the quantum of tax revenue involved in these disputes, the government must determine the merits of pursuing such cases and weigh that against creating an enabling investment climate and certainty on tax policy. From a taxpayer standpoint, decision to forego tax revenue for fulfillment of a promise will boosted investor confidence.

The Vodafone case hit headlines not just in the business and investment fraternity, but also attracted attention of tax administrators of several emerging economies. Following China and India’s experience, the Organization for Economic Cooperation and Development initiated a set of anti-avoidance measures to deal with such situations and bring to tax income in source jurisdictions. The tax profession has recognized that such offshore transactions would attract taxes in the new world order, as India has done. The difference being its applicability for periods before the law was introduced and if it would bind parties to an agreement keeping in mind the law as it existed or was understood to be ordinarily interpreted.

The other unique aspect of retrospective taxation laws, when read with the subordinate legislation, is that the strictest interpretation is applied to all forms of offshore internal business reorganizations. The debate is not about extra-territoriality of retrospective taxation, but the outcomes that result from exempting offshore business reorganizations or stocks listed in overseas recognized stock exchanges, among others.

Despite making progress on tax reforms and creating provisions for fast-tracking and incentivizing the resolution of tax disputes, the government has stopped short of reversing the 2012 amendments. The government must address retrospective taxation of cross border investments not only to stay true to its earlier commitment but to further bolster investor confidence.

Mr. Mukesh Butani is a Non-Resident Senior Associate with the Wadhwani Chair in U.S.-India Policy Studies at CSIS, and the Managing Partner at BMR Legal. Follow him on twitter @mukeshbutani


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