India Puts End to Retrospective Amendment for Indirect Transfers

The Indian Finance Minister has introduced a crucial tax-policy move announced on 5th August, 2021 with introduction of a Bill in the Parliament to undo a retrospective amendment carried out in 2012.

Fundamental changes were carried out in the Finance Act of 2012 by which Indian Income Tax law was amended, retrospectively, to reverse the landmark decision of the Supreme Court (SC) in case of Vodafone. The SC had inter alia impressed upon the lawmakers the need for legal certainty to promote FDI, thereby scuttling an ominous tax demand enforced retrospectively upon offshore reorganisation of Indian corporate structures and assets. The government of the day did not relent and continued to claim its sovereign entitlement to employ tax measures with retrospective effect. As was expected, the 2012 law drew the ire of investors as well as global taxpayer fraternity and, continued to remain irksome, inviting criticism from the investor and domestic court disputes as well as claims under Bilateral Investments Treaty (BIT). The recent awards by the Tribunals issued under BITs, in particular, diluted the sheen of the over ambitious reforms introduced by the Government in 2012, including in streamlining the application of retrospective law.

The former FM in Parliament, declaring off-limits any future retrospective legislation, and in 2014 there was an administrative curtailment of tax-officer’s discretion to reopen past cases and effectively scuttle them, investors were not impressed by half-baked amelioration measures. Constitutional challenges were raised in courts and international fora alike, spreading thin the Centre’s resources in defending its tax policy and the 2012 law. In particular, the flurry of precipitate action initiated in other countries by Cairn to enforce the Hague Tribunal award it secured by invoking Bilateral Investment Treaty invited bad press for the nation, with international media characterising the government as unkind and arrogant—despite its otherwise decent, if not impressive, record of tax reforms.

The Government so far posited ‘tax sovereignty’ perspective to insist upon the correctness of the retrospective indirect transfer tax and in particular, its enforcement against entities such as Vodafone and Cairn. This position now is reversed. In a bold, pragmatic and positive step, the Government has tabled an amendment bill in the Parliament seeking its sanction to amend the Income Tax law and thereby withdraw the application of the retrospective amendment.

Some of the key features of the proposal are given below:

  • The retrospective provisions are not being withdrawn but their application is being curtailed subject to satisfaction of certain conditions. The main condition for closure of the disputes arising out of the retrospective provisions (i.e., in 17 cases where it has been invoked) is that the concerned taxpayer must withdraw from the litigation(/s) challenging the application of these provisions. The withdrawal shall apply not just to cases before Indian Courts but shall also encompass cases under arbitration and BITs. In short, the issue would be given a complete quietus both by the Government and the taxpayer. ​
  • The Government shall, further, refund the tax in the cases where the application of retrospective provisions is being withdrawn. However, no interest shall be paid by the Government.
  • Simultaneously, it is now being legislatively sanctioned that “no tax demand shall be raised in future on the basis of the said retrospective amendment for any indirect transfer of Indian assets”. This was being practically achieved through an administrative mechanism earlier, though, with this proposed amendment bill, it will be legislatively mandated (and no longer discretionary on the tax-administration) to not reopen any past cases.

The proposal covers both classes of taxpayers, i.e., taxpayers to whom the capital gains accrued and taxpayers who were made responsible to withhold taxes on such offshore indirect transfers.

The official reason ascribed by the Government reads, “[t]he 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.” This is besides the acknowledgement that “this retrospective clarificatory amendment and consequent demand created in a few cases continues to be a sore point with potential investors.”

This proposal is a significant reform and improvisation of the 2016 dispute resolution wherein the concerned taxpayer (who had been subjected to the retrospective amendment) was required to discharge the tax dues to seek immunity from interest, penalty, and other consequences. Another way of describing the proposal is that it effectively translates the retrospective amendments into prospective, thereby ascribing legal certainty and fairness, a cornerstone that the Government was unable to translate for the retrospective laws despite a categorical statement in the Parliament to the effect.

The proposals are subject to approval of both houses of the Indian Parliament, of which the lower house has approved the bill, and now the upper house and the president’s approval is awaited. This change of stance is clearly in line with incumbent Government’s outlook of ushering reform in tax policy and law, a feature which has been consistently and regular embedded in its public policy statement.

This Bill, if passed by Parliament, won’t result in withdrawal of the 2012 amendment, and would instead only limit the latter’s application in cases where the taxpayer agrees to withdraw all claims and undertakes to refrain from any recovery action in future. The 2012 law would continue to remain but sans its harshness, and prospective application, unless the concerned taxpayer does not wish to settle.

A key question is, if the government is indeed magnanimous, then why are case-specific conditions attached to the application of the new proposal, and instead, why not withdraw the retrospective law wholesale. Mere reversal of the 2012 law would imply a one-sided concession by the government where it foregoes its claims whereas the private parties can continue to litigate and press for restitution measures. With the conditionalities, the government would ensure that there is no windfall or undue favour to any party, and that the issue stands resolved only when the taxpayer is aligned with the objective of giving a complete quietus to the dispute.

What does one expect next? First, the withdrawal will soothe investors’ nerves, especially those that are keen on India’s growth story, but have been dithering, citing lack of investor protection. This move is likely to boost investor sentiment, coupled with 15% corporate tax rate for manufacturing, exemption of income for investments by sovereign wealth and pension funds, etc, besides the major clean-up due to settlement of tax disputes. Second, the 2012 law has been applied retrospectively only in 17 cases, Vodafone and Cairn being the most prominent. It is obvious that their complexities and stakes were such that they could not be settled under Vivad-se-Vishwas or other amnesty schemes. Also, the refund obligation may result in outflow of Rs 80 billion. This is a small price to pay considering the funds required for economic recovery. Third, by reversing the retrospective application, the government has now got an upper-hand in economic diplomacy generally and particularly in the ongoing negotiations for larger economic partnerships with the EU and the UK, considering both Vodafone and Cairn are from these jurisdictions. The move will give a fillip to FDI, Gift-City, Sovereign-Wealth Funds, Pension Funds, and other prominent investments avenues. Notwithstanding the delay in the change of stance, there appears to be no perceivable downside, and it is certainly a harbinger of economic activity.

Contributing Advisors