India Inc. doesn’t like it. Foreign investors hate it. But the taxman, to steal a phrase from McDonald’s, is clearly “lovin’ it”. Which is why, just when we thought that the fires lit by the retrospective amendment to tax laws had finally been doused by the soothing assurances of Prime Minister Narendra Modi and Finance Minister Arun Jaitley, the Income Tax authorities once again fanned the embers back into the flames this week, by slapping a whopping ₹30,700 crore penalty on Cairn Energy, the erstwhile U.K. parent of India’s largest private sector crude oil producer, Cairn India.
This is just the penalty. With the original tax demanded, the total jumps to over ₹40,000 crore, an amount large enough to make governments sit up and take notice. Explanations 4 and 5 to Section 9(1) (i) of the Income-Tax Act, 1961 (Indirect Transfer Provisions), as amended in 2012 — otherwise known as India’s infamous “retrospective tax amendment” — is back in business with a bang.
Still in the statute books
That the tax authorities are persisting with their demands — firing off demands to the two high-profile assesses who have run afoul of the retrospective amendment: the Netherlands-based telecom major Vodafone PLC and the U.K.’s Cairn Energy — like clockwork every year is not in itself surprising. The retrospective amendment has made such demands legal. And as Mr. Jaitley himself has admitted candidly, a tax officer who does not pursue a legal demand, that too of such proportions, is liable to get into trouble with the Comptroller and Auditor General of India and with his own internal vigilance department.
No, the issue is not that the tax authorities are persisting with their efforts to collect the money. The issue is why the retrospective amendment is being allowed to continue in the statute books, that too by a government which has more than once asserted its determination to root out “tax terrorism”, and has rolled out the red carpet to foreign investors with its ‘Make in India’ initiative.
For those who may have forgotten, or been too distracted by more pressing matters of state like Sonu Nigam’s tonsure, here’s a quick recap. Both the Vodafone and Cairn cases involve a transfer of ownership of an Indian entity by way of an overseas transaction involving parties which did not fall under Indian tax jurisdiction. In the Vodafone case, Vodafone International Holdings B.V., a Dutch company, acquired 67% of an Indian company, Hutchinson Essar Limited, by buying 100% stake in CGP Investments (Holdings) Limited, a Cayman Islands-registered company, which owned the Indian assets of Hutchison Essar.
In the Cairn case, the assets held by Cairn India Holdings had to be transferred to a company registered in India, which was done by Cairn India (an Indian entity) buying the entire stake in Cairn India Holdings from Cairn U.K. Holdings.
In both cases, the tax authorities argued that though the deal was between two overseas entities, the shares derived their value from assets held in India, and hence were liable for capital gains tax. The retrospective amendment itself came about after the Supreme Court struck down the demand in the Vodafone case. The government then amended the law to allow indirect transfers which derive substantial value from assets located in India to be subjected to tax.
Changing rules
There are two problems with this. The first is that the amendment was used to nullify a judgment of the Supreme Court. The second, and by far bigger problem, is that the amendment kicked in with retrospective effect from April 1, 1962.
Most foreign investors would, naturally, like to pay little or no tax, but actually have no quarrel with even a punitive or confiscatory tax regime, provided they can factor it into their business models. The problem arises when, after having started doing business, the rules are changed, with implications on business already done in the past.
The amendments would not have created anything like the controversy they generated, or caused as much damage to India’s reputation as a safe destination for investments governed by the rule of law, if they had been made with prospective effect. Instead, any deal done after April 1962 is fair game. And as long as the provisions exist, the babus will try to use it.
The demands have already cost India dear. It is fighting two international arbitration battles under provisions of bilateral investment treaties with the Netherlands and the U.K. and may well lose both. This will lead to significant quantifiable financial damages, quite apart from the non-quantifiable losses of potential investments missed out.
