Retro tax rollback: Will it help India woo foreign investors?

In January 2012, the Supreme Court (SC) gave relief to foreign investors through its landmark decision in Vodafone International Holdings BV v. Union of India ('Vodafone case'). 

However, in a matter of months, the ratio laid down by the apex court was rendered infructuous by way amendments to Income-tax Act ('IT Act'), which were made retrospectively applicable from 1961. 
 
Considering the controversies surrounding these amendments, now the Taxation Law (Amendment) Bill, 2021 ('the Bill') seeks to undo the retrospective effect of the amendments.  

Also Read: Exclusive: Expect fast resolution of retro tax cases, says revenue secretary 
 
Background 

In the Vodafone case, a Dutch company, Vodafone B.V., purchased all of the shares of a Cayman Islands company which in turn held 67% of shares in an Indian telecommunications company. 
 
The Indian tax authorities considered the capital gains arising from such transfer to be taxable in India since it involved a transfer of controlling interests and rights of an Indian company. 

The tax authorities contended that the transfer of shares of the Cayman Island company led to the transfer of a capital asset situated in India and income from such transfer was taxable in India. 
  
As Vodafone B.V. had failed to withhold tax on the purchase of shares of the Cayman Island Company, the tax authorities sought to recover the entire tax demand of $2.2 billion from Vodafone B.V. The contention of the tax authorities was upheld by all judicial forums uptill Bombay High Court. 
 
In appeal, the SC decided the issue in favour of the taxpayers and held that the provisions of the IT Act only permitted the taxation of gains arising from the transfer of capital assets situated in India. Thus, the sale of shares of the Cayman Island Company failed to qualify this test. 

Also Read: Lok Sabha passes Taxation Laws (Amendment) Bill 2021 to end retro tax

Finance Act, 2012 - The start of uncertainty 

To overcome the decision of the Supreme Court, the government made two retrospective amendments to the IT Act. Firstly, it was clarified that shares or interest in a company incorporated outside India will be deemed to be capital asset situated in India if such shares or interest derived substantial value from assets located in India. 
  
This was coupled with retrospective validation of notices of tax demand (even where the judicial precedents were pronounced in favour of taxpayers) with respect to income arising from indirect transfer of capital assets situated in India. 
 
Therefore, in one fell swoop, the department was now able to go after indirect transfers of assets situated in India which had occurred prior to the introduction of the Finance Act, 2012 and realise any demand raised on taxpayers, even where the taxpayer had a favourable judgment from the top court.

Effect of retrospective amendments 

In the post amendment era, taxpayers who were residents of countries having treaties with India were able to escape the shackles of tax on indirect transfers. 

However, regardless of this fact, the amendments were deeply unpopular and led to widespread criticism and condemnation of the retrospective levy. 

The amendments also led to the initiation of arbitration proceedings against the government under various bilateral investment protection treaties. In certain cases, awards were announced in favour of taxpayers which were sought to be enforced against the Centre's assets in various countries.   
 
Taxation Laws (Amendment) Bill, 2021 - Relief after all 

Cognizant of the criticism from various stakeholders and in a bid to attract foreign investment in India, the government has introduced the bill in the Lok Sabha. The bill seeks to dilute the impact of the levy on indirect transfers by nullifying its retrospective effect and extending this relief from retrospective operation to both pending and concluded proceedings involving such income. 
 
In cases where the assessment proceedings involving income from indirect transfers made before May 28, 2012, are yet to be completed, the bill provides that such proceedings will be completed without giving effect to the amendments made vide Finance Act, 2012. 

Any taxes that have already been paid on such indirect transfers would be refunded along with applicable interest upon the completion of such pending proceedings. 
 
In other cases where proceedings have been completed and assessment orders or penalty orders have already been passed in respect of income from indirect transfers made prior to May 28, 2012, it shall be deemed as if such orders were never passed. 

This is subject to the taxpayer withdrawing all cases and forfeit all legal remedies against the government. If the conditions regarding such concluded proceedings are satisfied, the amounts of tax already deposited by the taxpayers will be refunded, but without any interest.  
 
Conclusion 

Following the amendments introduced by the bill, it would be interesting to see how taxpayers such as Vodafone B.V. and Cairn react to the development. 

The question would be whether these entities would be willing to forego significant amounts of interest and costs awarded to them in arbitration in exchange of settling under the new provisions and accepting the olive branch extended by the government. 
 
Another interesting thing to note is that while the Centre has responded to the criticism regarding the retrospective taxation of indirect transfers of assets situated in India, it has chosen not to amend other similarly criticised provisions introduced by the Finance Act, 2012 for the retrospective taxation of software licence fee and satellite transmission charges under royalty. 
 
Regardless of everything though, the bill is a welcome move on the part of the government, that should boost investor confidence in India by providing some much-needed tax certainty. 

(S. Vasudevan, Executive Partner & Tanmay Bhatnagar, Senior Associate, Lakshmikumaran & Sridharan Attorneys.)