In the Wealth of Nations’ published in 1776, Adam Smith postulated four canons of taxation; Equity, Certainty, Convenience and Efficiency.
There is consensus regarding certainty since Smith’s postulation that taxes should not be arbitrary ,the taxpayers should know their tax liability, when and where to pay it. Retrospective tax legislation overtones this principle.
Retrospective or Ex-post factor Taxation imposes or increases tax charged on certain products, items or services prior to the taxation being introduced. Though there is constitutional prohibition against criminal legislation applying retrospectively under Article 20(1) of the Constitution, there is no prohibition of the civil legislation (including taxation laws) applying retrospectively as such.
Proponents of this taxation justify this on the ground that there are certain grey areas in Indian Tax legislation set up, specially in Income Tax Act 1961, which is exploited by the taxpayers leading to tax evasion and avoidance. So, there is need of piercing the corporate veil and putting substance over form, by introducing the Retrospective Taxation in order to thwart the illegitimate tax avoidance strategies. Even in UK, labor government introduced retrospective provisions in 2004 to counter schemes designed to avoid tax on employment income.
Retrospective taxation is viewed as carrying a perverse sense of vindictiveness and is perceived as unleashing tax terrorism.
It creates a situation of ambiguity in the market which negatively affects investors climate and is a threat to good governance. It harms India’s Ease of Doing Business rankings in enforcement of contracts category and doesn’t behoove well with the country who aims to be superpower. Recent Twin tax blows before Permanent Court of Arbitration(PCA) , Hague in the case of Vodafone in September, 2020 and now in Cairn case, in a series of three months have come as a double whammy for India.
In the case of Vodafone, the same Dutch based company acquired controlling stake of 67% in Hutchison Essar (Hongkong based) in 2007 through a purchase/transaction that took place overseas in Cayman Island in a deal valued at $11.2 billion. Income tax department issued a demand notice of Rs.22,000 crore against which Vodafone went to Bombay High Court and ultimately filed an appeal in Supreme Court where they won. Treating it as a moral hazard, a loophole in the taxation system and to circumvent the Supreme Court ruling, Income Tax department amended the Finance Act in 2012 retrospectively from 1962 with the clarification that indirect transfer of assets located in India was always taxable as capital gains tax under the income tax act and it applies to transactions that took place overseas.
Vodafone sought arbitration on the exorbitant tax claim at International Arbitration Tribunal, Hague where the tribunal unanimously ruled that India’s imposition of tax liability by retrospective legislation on Vodafone was in breach of Clause 9 of Bilateral Investment Treaty (BIT) of 1995 between India and Netherlands, which specifically mentioned that two countries must ensure the companies present in each other’s jurisdiction at all times be accorded fair and equitable treatment. The stand of the government that BIT doesn’t cover tax issues as taxation is a sovereign right that cannot be challenged under BIT , was discarded.
In the case of Cairn Energy, the government actually went ahead in recovering retrospective taxes. Income tax department said that Cairn UK had made capital gains of Rs.24,000 crore before the public listing of Cairn India. So, claim of Rs.10,247 crore in past taxes was slapped on Cairn. Government sold Cairn’s 5% holding in Vedanta , seized dividends and withheld tax refunds. Cairn approached PCA, Hague in 2015 who recently in December 2020 unanimously ruled that India’s claim was not a valid demand and ordered to return unto $1.4 billion to Carin Energy of UK. The tribunal further said that India failed to accord the claimant investments fair and equitable treatment under Bilateral Investment Treaty (BIT) of India and Britain and ordered the government to desist from seeking such tax.
Both these cases are in for a long haul, wherein India has challenged Vodafone arbitration ruling in Singapore based Appellate Tribunal mainly to delay its enforcement. Cairn award, even if not challenged, has to face a hurdle in the enforcement of the Tribunal award in India considering the uncertainty in the Indian legal regime.
In India, mechanism for enforcement of domestic and foreign arbitrary awards is contained in the Arbitration and Conciliation act (A & C), 1996. However, India while acceding to the New York Convention on recognition and enforcement of foreign awards (NYC) made a reservation to apply the convention only to awards that are considered ‘commercial’ in nature. In the court’s biter, investment arbitration disputes and its awards may not satisfy the commercial test in order to qualify for enforcement under the India’s A & C act. So, any party applying for enforcement of a BIT award under A & C act, would first have to overcome the jurisdiction hurdle with respect to in applicability of A & C Act to the BIT arbitration.
Will Rogers phrase ‘If you find yourself in a hole, stop digging’ needs to be applied in the current scenario where there is very feeble chance of winning these cases when even your nominee has voted against you. There is need to respect the decision and move away from the vicious cycle of arbitration and appeals which are ultimately lost and move towards achieving ‘Vivad Se Vishwas.
Providing modicum of stability by forming coherent investment strategy will boost investors confidence. We need to increase the scrutiny net and plug the loopholes so that tax evasion be reduced to a minimum. As long as the retrospective taxation law is there, temptation to use it will always exist, so repealing the retrospective provisions by amending the income tax act will assuage the concerns. India must reassure the world by start refilling the hole and close the chapter by burning the ghost of retrospective taxation.
Award Winning Article Is Written By: Mr.Ayush Sarna, Assistant Advocate General, Punjab and Tax Consultant
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