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Retrospective tax: Shome committee works to allay investor fears

Retrospective tax: Shome committee works to allay investor fears

The retrospective tax amendments in last year's Budget violated basic principles of Indian law, says the Shome Committee.

The broad contours of the recommendations made by the Parthasarathi Shome Committee , tasked by the finance ministry to re-examine the last Union Budget's controversial retrospective tax amendment, have proved to be just what Finance Minister P. Chidambaram needed to nullify it. The committee has argued that the retrospective amendment was wrong, running counter to the basic tenets of law.

Archive: Chidambaram goes for a policy somersault
Shome, who was Chidambaram's adviser during his last stint in the finance ministry, was handpicked by Prime Minister Manmohan Singh in July to head the committee. The government was clearly worried that the tax laws proposed by then finance minister Pranab Mukherjee would unsettle foreign investors.

Mukherjee had proposed amending the law retrospectively to bring indirect transfer of Indian assets within the tax authority's ambit.


The committee recommends that these provisions (retrospective amendments), after introducing clear definitions as recommended in this report, should be applied prospectively


It was meant to cover cases such as the one involving Vodafone International. An indirect transfer of assets happens when an Indian company is a subsidiary of a foreign company. If the overseas company changes hands, as it happened when Vodafone bought Hutchison's Indian telecom business, the seller can sidestep tax on profits from the deal in India.

The Supreme Court in January 2012 ruled in Vodafone's favour, pointing out there was a loophole in the law that companies had a legitimate right to use. Mukherjee chose a retrospective amendment to nullify the verdict, adding to the uncertainty over India's business environment.

"The committee recommends that these provisions (retrospective amendments), after introducing clear definitions as recommended in this report, should be applied prospectively," Shome panel says in its report.

The group's dismal view of far-reaching retrospective amendment is not without international precedent. Two emerging markets, Russia and Brazil, explicitly prohibit retrospective amendments in their statute books. In Europe, Sweden too has done the same.

Pranab Mukherjee's retrograde measure

{mosimage}THE ISSUE: Investors use a loophole to sidestep taxes when they sell Indian assets. They indirectly transfer assets by selling holding companies located abroad

GOVERNMENT'S RESPONSE: In Budget 2012/13, Finance Minister Pranab Mukherjee amends law with retrospective effect to tax indirect transfer of assets

IMPACT: Foreign investors panic as past transactions can be reopened by tax authorities

The clear stand taken by the committee has delighted industry lobby groups.

"It is hoped that recommendations would bring about a much needed certainty in the tax policy and would lay down the ground rules for retrospective legislation in tax matters in future," said R.V. Kanoria, President of lobby group FICCI, in a statement on October 9 soon after the recommendations were placed in public domain.

Tax consultants lauded the report too.

"Perhaps for the first time in independent India, an expert committee has very clearly articulated the need for the government to exercise its constitutional power to amend tax laws retrospectively only in 'rarest of rare' cases," said Sudhir Kapadia, National Tax Leader at Ernst & Young, in a media statement.

"It is noteworthy that this term is used in awarding death sentences in criminal law jurisprudence and the committee rightly believes that this is a drastic weapon in the hands of government that ought not be used indiscriminately just to increase the tax base," the statement added.

Despite Mukherjee having vacated the finance minister's office, the controversial proposal could not have been quietly dropped. In May, with Mukherjee still finance minister, it was Chidambaram's own party, the Congress, which spearheaded a move to turn the budget proposal into law, and the Lok Sabha duly voted in favour of doing so.

1. How did it start?
Hutchison's subsidiary in Cayman Islands held a majority stake in an Indian telecom company. Vodafone bought the Cayman company, an indirect transfer of control in an Indian company

2. What was the dispute about?
India's tax authority felt the seller, Hutch, should have paid tax. Vodafone and Hutch felt a Cayman Island transaction was outside its purview

3. Who went to court?
Vodafone International first went to court in 2007 when tax authorities felt it should have deducted tax from the amount it paid Hutch. Vodafone argued the transaction was outside India's purview

4. What was the court's verdict?
In January 2012, the Supreme Court ruled in Vodafone's favour

5. What happened next?
In the Union Budget of 2012/13 presented in March, finance ministry retrospectively amended laws to tax Vodafone kind of transactions, thereby neutralising the Supreme Court's verdict. The move spooked foreign investors and affected business sentiment.
This is where Shome comes to Chidambaram's aid with some well thought out suggestions. Some recommendations seem to assume that the government will continue to retain the essence of the retrospective amendment on indirect transfers.

Thus the Shome Committee suggests that the tax should only apply to sellers. In the Vodafone case, its recommendation implies the tax department ought to pursue the entity Vodafone bought its Indian telecom services from, the Hong Kong-based Hutchison Telecommunications.

So far it has been the buyer, Vodafone, from whom the government has been seeking tax on the deal - along with penalty and interest - claiming it should have deducted the amount before paying Hutchison.

Indeed, another key recommendation is that the tax department avoid levying interest and penalties on the tax due if the retrospective amendment kicks in.

Shome Committee's recommendations are still at the draft stage, with public feedback having been invited. The final report is still awaited.

Assuming the final report retains most of the draft, the question is how Chidambaram will implement the proposals.

"Most of the recommendations are far-reaching and would need a (legislative) amendment," says Sunil Jain, partner at legal firm J. Sagar Associates. The next Union Budget is a little over four months away and, typically, that is when legislative changes in direct taxes happen.

E&Y's Kapadia agrees, though partially. Some big changes such as the one restricting the liability to the seller require another amendment, he says. However, some other changes, such as the one waiving interest and penalty can be done through an executive decision, he points out. This could be in the form of a circular issued by the Central Board of Direct Taxes (CBDT).

According to Jain, a circular is binding on the tax department. A circular can also be withdrawn by the CBDT, imparting an in-built flexibility to adapt to contemporary challenges.

Whatever eventually happens, the Shome Committee has taken the first step toward neutralising the perception that arbitrariness underpins India's law making.

Pranab Mukherjee