August 2021
1. Introduction
In 2007, UK-based Vodafone acquired a telecom services company Hutchison Essar, for a consideration of about USD 11 billion. It was a case of an indirect transfer of shares of a foreign company that derived substantial value from assets located in India and which is discussed further in the next section. Briefly, while the deal did not happen in India, the income-tax authorities imposed a huge tax demand on Vodafone towards capital gains and withholding tax, positing the company should have deducted the tax at source before making a payment to Hutchison. Vodafone challenged the demand notice in the Bombay High Court, which ruled in favor of the tax department. So, an appeal against the High Court order was filed in the Supreme Court (“SC”) of India. After a long-drawn-out legal battle, there appeared to be some light at the end of the tunnel when, in 2012, the SC issued a landmark judgment in Vodafone International Holdings B.V. vs Union of India and Ors and ruled that the transfer of shares of a company incorporated outside India would not be taxable in India and Vodafone did not have to pay any taxes for the purchase.
The government at the time considered the verdict of the SC to be inconsistent with the legislative intent and introduced “clarificatory” amendments to the Income-Tax Act[1] and made transactions, involving indirect transfers, taxable in India, and that too retrospectively from April 1, 1962. This effectively meant if an Indian asset was held by a foreign company and such company was sold to an acquirer, then, in that case, such a transaction was deemed to be taxable in India because the underlying asset was located in India. The onus to pay the taxes fell on Vodafone. The amendment was criticized globally and India was projected as a nation with an uncertain tax regime for investors.
In view of the criticism levelled towards India on this retrospective tax[2] and the ensuing uncertainty in the tax regime, nine years later, on August 5, 2021 the government introduced a bill to repeal the 2012 tax changes. This newsletter discusses the suggested changes and their impact.
2. The Evolving Tax Landscape
Before delving into the new bill, it is important to set out the context in the Indian landscape.
After the introduction of 1992 economic reforms, India was on the path of becoming a market economy where foreign investment was actively encouraged and several multinational companies started to move here. Given the foreign investment that came in, tax law witnessed significant changes to deal with the evolving, but exponential economic growth and provisions were enacted for (a) taxing in India offshore income of non-residents that had an India nexus; (b) determining transfer pricing among associated enterprises operating within and overseas so that fair amount of income attributable to in India could be brought within the ambit of domestic tax law. Additionally, in order to provide certainty, the legal framework permits non-residents to secure advance tax rulings. Under section 245N(a) of the Income-Tax Act, advance ruling means a written opinion or an authoritative decision by an authority empowered to render it with regard to the tax consequences of a transaction or proposed transaction or an assessment in regard thereto. This demonstrates Indian tax law witnessed significant changes to deal with and adapt to the economic changes where a substantial portion of tax revenues flow from corporations doing business in India or from cross-border transactions with one non-resident party receiving income.
It is also essential to provide a little more detail on the Vodafone matter.
Before the transaction which caused a tax furor, Hong-Kong based Hutchinson had invested in India through a HK listed entity. This listed company owned companies in Cayman, which held shares in downstream companies in Mauritius. The Mauritian companies then held shares in an Indian holding company, which controlled operational subsidiaries in India. Vodafone acquired a subsidiary of the listed HK company and through which it acquired equity interest and control on the various downstream companies, including in India. It was evident everything happened outside India – the agreements, deal consideration and change of control. The last occurred when boards of Cayman and Mauritius entities were changed.
The law, as it stood then, did not provide for a situation to tax capital gains accrued via such an acquisition. When the legal battle reached the SC, the court rejected the suggestion that there had been any attempt at impermissible tax avoidance. It determined that the structure used was created and driven by commercial considerations and could not be condemned as a tax saving device. The verdict of the SC led to the 2012 changes to India’s tax law, described in the Introduction, and use of this power to modify the tax regime retrospectively was termed as “tax terrorism.”
Once the 2012 amendment came into force, numerous tax demands were raised in several high-profile cases and, in some, the affected parties commenced arbitration under the Bilateral Investment Treaty (“BIT”) executed between India and the country which was the primary “residence” of the investing company. Specifically, when all attempts to resolve the matter failed, Vodafone invoked the relevant provision of BIT executed between India and the Netherlands.[3] The tribunal ruled in their favor[4] and even stated that since it had been established that India had breached the BIT, it must stop efforts to recover the taxes from Vodafone.
There was considerable international angst over the developments in India, but the government took no tangible steps to end the controversy. Since there was a downward dip in foreign investment to India, eventually an expert committee was created to advise who, in a nutshell, concluded that retrospective tax application cannot and should not become the norm. It is a foregone conclusion that both in-country certainty and stability plus message to the global business community require that laws (and more so, tax laws) are not changed frequently, and, particularly to suit the whims of the bureaucracy or assessing officers. When the government changed in 2014, the new Finance Minister too did not support the levy of retrospective tax; rather called the Vodafone tax erroneous. Yet, despite this position, the new government abstained from withdrawing the tax.
The saga of the legal battles continued.
3. The Taxation Laws (Amendment) Bill, 2021 & Impact
Levy of a retrospective tax is against the very basis of India’s global commitments. In a world drastically changed by the pandemic, now more than ever, recovery is possible through clear, strategic thinking and predictable policies and systems. It appears that the Indian government has emerged from its deep slumber after expending millions of dollars in defending its position in disputes.
In a statement with the draft bill, the finance minister observed “The country today stands at a juncture when 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 scope of 2021 Bill is to cover the following important points.
- No future tax demands will be made based on the retrospective amendment of 2012 regarding indirect transfer of Indian assets
- No assessment to be made, no enforcement of tax demand, no notices to be issued in respect of indirect transfers undertaken prior to May 28, 2012
- All the demands already raised regarding such transfers will be nullified, once certain specified conditions are fulfilled
- The conditions involve (a) withdrawal of, or submission of an undertaking to withdraw appeal before any appellate forum, or writ petition before any high courts or the SC; (b) where any proceedings for arbitration, conciliation or mediation have been initiated under any bilateral investment treaty or any other international agreement, or any other law, such claims have to be withdrawn or an undertaking for such withdrawal has to be submitted.
- While there will be refund of payments already made, but only of the principal amount and without any interest that may have accrued
A clear, visible and far-reaching consequence will be the possibility to settle all the pending disputes in this area, worth billions of dollars, languishing at various stages. As noted, since it was passed the 2012 retrospective law has been a significant contentious and a sore point with foreign investors and successfully cemented India’s reputation as an unstable tax jurisdiction. Undoubtedly, the move of August 5 by the Indian government is directed to restore the confidence of foreign investors through enacting rules that demonstrate commitment to tax predictability.
Since the tax amounts involved in the disputes of different companies are vast, the efficacy of the 2021 Bill and its success will still depend on several factors, including
- The ability of disputing taxpayers to actually withdraw their pending disputes
- The willingness of the taxpayers to agree to absence of interest on any refund of taxes paid
- The ability of the litigants to write-off of the litigation cost (it is an assumption of the author that they will need to write-off such cost) incurred by them; and
- The acceptance of the language of the undertaking through which parties shall agree to withdraw the disputes.
It goes without saying that any retrospective application of tax law should occur in exceptional cases and for limited objectives, largely to rectify apparent mistakes in the statute and/or issue genuine clarifications to remove ambiguities. At this stage, given the protracted painful path from 2007 till this year, the 2021 Bill is a step in the right direction. It would need a lot of pragmatic and transparent rules to ensure that the spirit of the 2021 Bill is implemented in an efficient manner and without any dogmatism. Through the enactment the government has created conditions for policy stability in the future and ended the nebulous situation created by delays caused also by an obdurate bureaucracy. At the cost of repetition, the most important aspect of any tax regime is its predictability and, hopefully, at the bare minimum, the 2021 Bill will serve that purpose, albeit 14-years later. Perhaps, it will pave the way towards a paradigm for fair taxation and ensure the myth becomes a reality.
Author
[1] This amendment was introduced by the finance minister in the previous government from a different ruling party
[2] Imposition of a tax retrospectively allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time prior to the date when the law is passed. US, UK, Canada, Netherlands, have passed retrospective tax laws
[3] India and the Netherlands signed a BIT in 1995 for promotion and protection of investment by companies of each country in the other’s jurisdiction. The treaty provided that both countries would strive to encourage and promote favorable conditions for investors of each other and ensure that companies present in each other’s jurisdictions would be at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other
[4] The Hague tribunal considered the retrospective amendment to be a breach of India’s BIT obligations. It ruled in favor of Vodafone, against Indian government and said the tax levied against the company was “in breach of the guarantee of fair and equitable treatment”