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Retracting the retrospective tax: Will India bury the ghosts that spooked investors?

V Lakshmikumaran of Lakshmikumaran & Sridharan discusses India’s tax levy on indirect transfers and why recent changes made by the government are a positive step forwards.

“A tax collector should collect taxes from a taxpayer just like a bee collects honey from a flower in an expert manner without disturbing its petals.” This famous quote of Chanakya from Kautilya’s Arthashastra, an ancient Indian Sanskrit treatise on statecraft and economic policy, cannot be more relevant than today. India’s bitter experience with retrospective tax levy on indirect transfers in the last decade shows how much we can learn from the wisdom available in our ancient texts.

It is not uncommon for any legislature to make retrospective amendments in tax laws, especially when such amendments are clarificatory in nature. However, the changes introduced in 2012 in the Indian Income Tax Law to levy tax on indirect transfers to overcome the judgment of the Supreme Court in Vodafone case invited unprecedented levels of criticism both domestically and internationally. 

There has been a lot of debate about the sovereign right or legislative competence to impose such a retrospective levy. Such debate seems to be misplaced in this context. The mere fact that India had a sovereign right to enact a law imposing tax on retrospective basis does not ipso facto mean that such exercise of such right was reasonable or appropriate. 

Though there may not be any equity and good conscience when it comes to interpretation and implementation of tax statues by courts, the same cannot be completely ignored when it comes to tax policy making.

The ill-advised move exposed India to multiple international arbitration proceedings on the ground that such levy was in breach of fair and equitable treatment promised under various bilateral investment protection treaties. 

Going by the arbitrations awards already granted in favour of taxpayers like Vodafone and Cairns, the Indian government is undoubtedly staring at the liability of having to payback huge amounts collected along with interest and damages/legal costs. In a matter of embarrassment, some of the foreign courts have already sanctioned attachment of foreign assets of the India to recover these dues.

Apart from the financial implications in the form of the above pay outs, the entire episode had majorly dented the confidence of the international investors. By the Indian government’s own admission, it has proved to be counterproductive to India’s attempt to position itself as an attractive destination for investment and to increase ease of doing business.

In the face of these setbacks suffered in the international proceedings, the Indian government was still defending its sovereign right to tax retrospectively and has challenged the arbitral awards by way of appeal. Such defiance on the part of the government had further spooked the international investor community at a time when India is desperately looking for foreign investments to spur domestic economic growth.

In this backdrop, it is a bold corrective measure by India, especially in political terms, to roll-back the retrospective impact of the provisions introduced in 2012. While promising not to initiate any fresh dispute for indirect transfers which took place prior to May 28 2012, the government has also proposed to settle the past disputes by agreeing to refund back the amounts already collected albeit without any interest.

Most significantly, the precondition imposed for settlement is that the taxpayers must withdraw any pending litigation/arbitration and must give up any further claim towards damages and costs. We have to wait and see whether companies like Vodafone and Cairn will accept this offer, which entails substantial reduction in their awarded claims. 

Apart from the considerable amount of interest, the taxpayers have also incurred a significant amount of legal costs over a period of time in pursuing the matter before multiple international forums. Many of the taxpayers may still decide to call a truce and avoid further prolonged, especially keeping in mind their long-term business interests in India.

The question remains as to whether it is a case of too little, too late. Even though the present political dispensation had condemned its predecessor for introducing the measure in the first place, it has taken them a good seven years in power to muster the political will and courage to roll it back. Over the period of time, the interest and other costs have mounted and now leaves the taxpayers with a hard choice to forgo a substantial portion of their claims to settle the dispute.

Be that as it may, it is still a probably the strongest statement of intent on the part of the Indian government to abide by its international commitments and regain investor confidence. It is a step taken by India in the right direction and it sends out a very positive signal to the international community. However, there are many more steps to be taken by India to create a stable, predictable and investor friendly tax environment in India. 

India must resist temptation to use its legislative powers and must make such retrospective tax levies a thing of the past. It should also avoid frequent sweeping changes in the tax policies and must provide a stable tax regime for businesses to invest, operate and grow. 

There have been many reforms in the area of tax assessment and administration in the past few years. Steps must also be taken to strengthen the alternate dispute resolution mechanisms, especially the facility for obtaining advance rulings. The government should also take a pragmatic approach to tax litigation and systems should be put in place to check unreasonable and unsustainable demands raised by the taxman.

Welcome move

It is indeed a welcome move on the part of the Indian government to roll-back the draconian retrospective levy on indirect transfers. It is probably a case of better late than never. Considering the impact the retrospective levy has had on the psyche of the international investor community, India needs to take many such confidence building measures in the near future. 

The present government has demonstrated its political will to take tough decisions in the larger economic interest of the country. Hopefully, we will successfully bury the ghosts of the past and stride towards a new India, which becomes the investment destination of the world.

V Lakshmikumaran
Managing partner, Lakshmikumaran & Sridharan

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