RETROSPECTIVE APPLICATION OF TAX PROVISIONS: VODAFONE AND CAIRN INDIA VERDICT (By-Yash Sahu & Golak Bihari Mahana)

RETROSPECTIVE APPLICATION OF TAX PROVISIONS: VODAFONE AND CAIRN INDIA VERDICT

Authored By-Yash Sahu & Golak Bihari Mahana

Abstract

Retrospective taxation means when a country makes certain rules regarding taxation by introducing or amending the laws which helps the government to levy tax in any transaction which was made earlier. The government introduces such kind of law or rules when they feel that there has been some anomaly in the country's taxation policy in the past , and also to eliminate the loopholes present earlier in the act. Here we discussed the Vodafone and Cairn India verdict.  In 2012 , SC held that the Vodafone group's interpretation is accurate and it does not have to pay any tax. The permanent court of arbitration has said that the changes made in relation to the retrospective taxation by the Government of India is wrong as it was a clear violation of the treaty which was signed in 1995 between India and Netherlands and the Government of India shall not demand any tax from the Vodafone company. This court also ruled that the Indian government which applied the retrospective taxation on Cairn was not relevant. The ruling said that the Indian government must pay for the damages of approx ten thousand crore rupees to the company Cairn. The IT authorities contended that the company Cairn had made Capital Gains and gave a tax demand of approx twenty five thousand crore rupees. Cairn India lost the case at ITAT(Income tax appellate tribunal). After that Cairn moved to the Permanent court of Arbitration which ruled that the issue was not only tax related but also an investment related dispute under the international arbitration court. This article talks about the impact of retrospective taxation and where did the country go wrong and what changes were made in the provisions of law by the government after the Vodafone case.

Introduction

Before every financial year, on first of February, Finance Ministry of India presents a financial budget which contains every details, about how in the previous year taxes were collected and used also what are the recommendation or plans in terms of revenue allocation to different sectors for the upcoming financial year, change related to tax laws for both direct and indirect taxes, etc. Such changes made in provisions of law, generally known as amendments and while presenting these amendments, the developments going on in the country, benefits for the taxpayers, gaps which could not be mentioned earlier and suggestions given by various stakeholders were kept in mind. For example, introducing some new exemptions, introducing certain new tax liability on the taxpayer, new tax slabs and so on. When this budget is passed in  both the houses of parliament and receives Honorable President’s assent, it becomes an enacted law. The tax authorities check all the previous transactions made and demand for tax, which is known as “Retrospective Taxation”.  As the word “Retrospective” itself means something which is related to the past.  Retrospective Taxation simply means demand of taxes on earlier transactions with the new laws made.

In the year 2012, the Government of India introduced the system of Retrospective Taxation by making some changes in the Income Tax Act, 1961 and declared that this amendment would be in effect from 1st April, 1962. According to this system, the Government could demand for taxes by looking into any previous transactions done and this decision was taken by considering the Vodafone Tax Case.

VODAFONE CASE
Vodafone International Holdings B.V. (VIH or Vodafone) filed an international court case against the Government of India, over a retrospective tax provision made in India.

The Permanent Court of Arbitration (PCA) ruled that “the imposition of taxes by a retrospective amendment of domestic tax laws was in breach of the Agreement between India and the Kingdom of the Netherlands provision for equal and equitable care.” Furthermore, any effort to impose a tax claim on Vodafone will be a violation of the injunction.

The agreement's primary goal is to promote and protect investments between India and Netherlands.This award would not bring an end to the controversy, as the Government of India has the option of appealing it to the Singapore High Court.

The tribunal award's complete transcript is not accessible to the public. But the retrospective amendment regarding imposing of tax liability here is held to be a breach of fair and equitable treatment provided under sub-section 1 of “Article 4” of the India-Netherland BIT.

The Permanent Court of Arbitration in The Hague ruled that India's claim for Rs 22,100 crore in capital gains and exemption of tax imposition for a 2007 contract with Vodafone Company violated the agreement's clause on equal and equitable care.

The Indian government recently filed a lawsuit in Singapore against the arbitration decision.The government believes that the issue of taxes is not protected by the treaties and that taxes is a country's sovereign right.[1]

The award is permanent and binding on the parties to the case, according to the International Centre for Settlement of Investment Disputes (ICSID) and the United Nations Commission on International Trade Law (UNCITRAL). In the absence of any general law requiring previous awards to be binding precedent, international arbitration tribunals operating under the auspices of ICSID and UNCITRAL do deem previous awards to be binding precedent. to have a persuasive value.

The fact analysis in both cases will determine if the Vodafone arbitrary judgement has any compelling merit in the Cairn UK arbitration proceedings. Both cases included an indirect movement of Indian properties due to the implementation of a retrospective amendment in 2012.

OUTCOME OF THE CASE
Since losing a lawsuit against Vodafone in an international arbitration court, the government has received a lot of flak for keeping India's "retrospective" tax on asset transactions.

It's worth noting two broad criticisms :-

1. Governments can never make retrospective tax reforms.

2. To draw international (or even domestic) investment, tax laws must be stable.

 3.Vodafone had also known that transferring assets to India would result in capital gains. It appears to have gotten a cheaper price from Hutchison, the telecom company's controlling shareholder, by changing the applicable jurisdiction to a tax haven.As a result, the aim seems to be a case of tax evasion by using a loophole in Indian tax law.

Experts also stated that in order to encourage foreign investment, tax laws must be clear and predictable.A taxation policy that is more liberal would encourage FDI into India.According to a few observers, the SC may have recognized this question, hence the judgment is in favour of the foreign investor (Vodafone).

India did not comply with the terms of the arrangement, according to the arbitration tribunal, and it was confirmed that India had violated the agreement's provisions. As a result, the government must consider pursuing Vodafone for tax evasion.

In 2012, the Indian government overturned the Supreme Court's decision by making an amendment to the Finance Act, giving the Income Tax Department the authority to tax those transactions retroactively.[2]

Impact Of Retrospective Taxation

The UPA Government had introduced the scheme of Retrospective Taxation in India which had a huge impact in collection of taxes. However, the Government earned a massive proportion of revenue by taxes, but it affected the country’s position and reputation as a place for doing business. Idea of changes in the country's taxation system has resulted in a decline of foreign investors in India. Foreign investors show their interest in those countries where taxation systems are stable. This change has created some uncertainties in the ease of doing business.

After this the Government of India, formed two committees to find out the problems of Retrospective Taxation. One of them was the “Parthasarathi Shome Committee” which said that “the Government against implementation of tax rule changes retrospectively and had favoured prospective taxation. Also suggested that retrospective taxation should be done in the rarest of rare cases.” And the other committee was the “M. Damodaran Committee” which opined that “this kind of sudden changes should be avoided and suggested that it is important for a nation to follow certain and continuous rules and regulations. It also further opined that Retrospective Taxation is against the concepts of Double Tax Avoidance Agreements (DTAA).”

The scheme of Retrospective Taxation should be used in those cases, where no taxes have been charged for the transaction, any place in the world and has the primary assets in India. However, the Income Tax Department has ignored the judgement of the Supreme Court by making  some changes in the provision of the act.

The Government should escape from the implementation of Retrospective Taxation as it bars the foreign investor or companies from investing in the country. “Some countries across the world such as Brazil, Greece, Mexico, Mozambique, Paraguay, Peru, Venezuela, Romania, Russia, Slovenia and Sweden have prohibited Retrospective Taxation.”

MAJOR RETROSPECTIVE TAXATION AFTER THE VOAFONE CASE
 A court’s decision can only be altered or changed when it is fundamentally incorrect. The government cannot just make a law to which the verdict of the court shall not bind as such an act which is equal to reversing the decisions of the court, the Constitution does not provide such power to the legislative authority[3].

However, the government has power to change the basis of the verdict and thus the law in general affecting a larger group of people but government cannot make any law which overturn the decision of the court in such way that it affect the rights and liabilities of an individual[4].

According to the doctrine of separation of powers provided in the Constitution, all the three  organs (legislative, executive and judiciary) are independent and thus a law can be set aside only when it violates the principles of equality as provided in the Article 14 of the Constitution. Further it provided that the High Court and Supreme Court has power to determine the validity of any law made by the government[5]. Therefore,  the government cannot bring into effect any law which overrides the court's verdict and affects the rights of an individual alone as in the landmark case of Vodafone. But it has the right to affect laws affecting a class of people in general.

Till now one of the major and most contentious retrospective amendments implemented was in the year 2012, including the indirect transfer under tax category in the Finance Act 2012.

The Supreme Court in the Vodafone case clearly stated that “Section 9 does not authorize tax authorities to collect tax on capital gains derived from indirect transfer of shares of an Indian company while the main transaction was between two foreign companies to acquire a foreign company which had majority shares in the Indian company.” It is important to note that due to this decision of the Supreme Court, the amount of transaction and tax foregone by the tax department was huge.

Accordingly Government of India (Ministry of Finance) made some changes in Section 9 of Income-tax Act, 1961 in the year 2012 and introduced that “shares or interest in any foreign company or entity shall be deemed to be situated in India if such shares or interest derives its substantial value from assets located in India.” So, transfer of any shares or interest to a foreign company whose substantial assets were located in India could be considered as capital gain and it will come under the purview of tax liability. Government not only amended the provisions but also made this an effective retrospective from 1962. Result of this retrospective amendment would mean that the whole transaction which is already carried out by Vodafone and the decision given by Supreme Court could be brought to taxation.

VALIDITY OF RETROSPECTIVE TAX
Here we can see that sudden changes in tax laws are not so easily accepted by taxpayers because it puts some additional tax liability on the previous transaction to which they already paid  tax according to the previous provisions of law. Every citizen plans his or her finance and tax liability according to the provisions and rules provided by law at that point of time. By retrospective taxation or amendments it is unjust and unreasonable for them although it can be noted that retrospective taxation by itself can not be unreasonable. Effectiveness of retrospective taxation or amendments varies from (facts or conditions) case to case and it should be examine on the basis of facts and conditions under which such amendment is made. It simply means that any retrospective taxation or amendment which is for welfare of the citizens is very well accepted and those retrospective taxation or amendment which is for clarificatory purpose is acceptable. However, it would be unjust and unreasonable to put a new tax liability on the citizens for a transaction, made earlier and is closed in the preview of the then existing law, therefore its validity need to be examined before implementation.

CAIRN ENERGY - INDIAN GOVT DISPUTE
The case between The Cairn and Income Tax department of India arose due to the issue of retrospective taxation.

In 2006-2007, Cairn India Limited (CIL) became a public company after the initial public offering announced by the company.

But , before the Cairn India goes public it sold all its subsidiary company to a company named Cairn India Holdings Limited (CIHL) incorporated in Jersey USA. After the IPO in India , Cairn India Holding Limited (CIHL) then transferred the shares of the company back to Cairn India Limited(CIL).

After audit , the Income Tax Authorities decided to impose the Capital Gain tax of 22,500 Cr.

According to the Government of India , the Cairn India Limited has involved different companies , earned profit in Capital Gains which was taxable in India to avoid the taxes.

 Cairn India argued that the provision of  retrospective taxation goes against the investment agreement, shall not be held liable to pay the tax.

After Cairn India limited lost the case in Income Tax Appellate Tribunal (ITAT) and also in the High Court Of Delhi , Cairn India Limited dragged this case to Permanent Court of Arbitration (PCA) in 2017.

Permanent Court Of Arbitration Ruled

In 2020, the PCA at  the Hague, held whatever be the case between Cairn India Limited and Indian Authorities , the issue was not just related to taxation but an investment related dispute. So the PCA had jurisdiction to rule the subject matter. Furthermore held, that Cairn India Limited has no liability to pay the tax. Also Indian Government has to pay 1.2 Billion Dollars as compensation to Cairn India.

"Tax demand against the inquirers (Cairn Energy Plc and Cairn UK Holdings Limited) in regard of assessment year 2007-08 is conflicting with the deal and the petitioners are diminished from any commitment to pay it and orders the respondent (Indian government) to kill the proceeding with impact of the interest by for all time pulling out the interest," the three-member arbitration board said in its judgment .

The arbitration tribunal additionally said that India should not make additional endeavors to revive "the alleged tax liability or any premium as well as punishments emerging from this supposed risk through some other methods".

Conclusion

The Vodafone and Cairn cases are a harsh token of cutoff points put by worldwide law upon States' sovereign privileges of taxation. The principal contention for maintaining arrangement commitments, in the wake of other sovereign forces, is that deals likewise establish sovereign responsibilities by the State to ensure unfamiliar interest in their territory . This spots sovereign forces characterized under public laws against sovereign responsibilities under global law.

Tax disputes present a solid case for non-arbitrability under lion's share public laws. They are additionally defended by uncommon resolutions, exceptional fora and explicit review systems. Most States would ask that extraordinary legal systems be completely used before thumping the entryways of fora under global speculation arrangements. Further, accessibility of change under exceptional worldwide duty deals could likewise eliminate charge debates from the ambit of a speculation deal and spot them before a unique substitute discussion.

It very well might be feasible as far as possible on worldwide law responsibilities. For example, it could be feasible to receive understandings that limited the extent of deal application, confine the passing necessities of 'speculation' and 'financial backers', confine the principles of treatment to specific conditions, or decipher suggested prohibitions without express ones. What wins will along these lines rely upon the language of the arrangement and the inventive understandings received by legal counselors and courts.

In the Cairn case, as much as in the Vodafone case, a few inquiries identifying with jurisdictional complaints appear to have been settled by acknowledgement of ward by the Tribunal. The vast majority of these complaints and decisions could become exposed as India has tested the honor in the Vodafone case in Singapore on December 24, 2020 - the last day of the limit time of 90 days since the honor was passed on September 24. Almost certainly, India will challenge the honor in Cairn case also under the watchful eye of the Dutch courts. Ideally, this will illuminate main points of interest chosen by the Tribunal.