The blunder of retrospective tax
Following major tussles with Vodafone and Cairn over retrospective tax, in an attempt to attract investments, the controversial tax was rolled back through a bill passed in Lok Sabha. Through the Taxation Laws (Amendment) Bill, 2021, India also looks to refund the Rs. 8,100 crores were collected through the retrospective tax law. Let’s take a look at the nature of the law, the controversy, what led to it being passed, and what to expect from the amendment.
Nature of the Law
A retrospective tax is a tax imposed on deals or transactions executed in the past. In 2012, the retrospective tax was introduced as an amendment to the Financial Act following the government acquiring the right to levy taxes on deals executed after 1962 involving the sale of shares of foreign entities holding assets in India.
The retrospective law was introduced to increase tax revenue through taxes on the indirect sale of Indian assets. However, at the same, it also increases the potential tax liability for several foreign firms holding or previously held assets in India. Naturally, the ease of doing business went down with a law that could be invoked at the will of the government and increase taxes. Furthermore, the possibility of reactionary levies on Indian firms holding assets abroad could not be ignored.
Why was such a law passed then?
Before passing the law, India had tussles with Vodafone and Cairn over deals executed in 2007. The case of these two companies is of importance. An overseas subsidiary of Vodafone bought Hutchinson’s entire stake in GCP investments for $11 billion which owned 67% of Hutch Essar.
Cairn had a similar run-in with the retrospective tax, however, in this case, the government claimed Cairn made capital gains by restructuring its subsidiaries in 2006-07 and by March 2015 had demanded Rs. 31,881 crores.
After a successful challenge of the notice by Vodafone in the Supreme Court, pushing for the taxes once again, the government then under Finance Minister Pranab Mukherjee amended the Finance Act to include the retrospective tax and laid the groundwork for governments demands. In 2014, when Cairn was about to sell its final 10% stake in Cairn India Ltd to Vedanta Resources, the government invoked the retrospective tax to attach and then sell the stake. The Indian government also sent a notice to Vodafone saying it should have withheld tax worth Rs. 11,218 crores and sought an additional Rs. 7,900 crores in penalties.
While it may be within a country’s rights to tax on the sale of assets within its boundaries, the nature of the law itself and the sheer amount of taxes and penalties raised eyebrows. Retrospective taxation is a delicate subject and can, in a way, affect investor mentality. In a protectionist environment, a firm might even seek international arbitration and be successful at it. The probability is higher in India’s case as it has been going through an economic crisis and would play in the interest of the foreign entities to challenge the tax and seek compensation for the seized assets.
Pushback and International Tribunals
After Cairn sought arbitration, the international tribunal asked the Indian government to return the value of the shares it had seized and sold, tax refund withheld, and the dividend confiscated to enforce the retrospective tax demand. India refused the decree of the international tribunal. This resulted in Cairn moving to a US Court and sought to seize the assets of Air India, as it is a public entity. Cairn also had a French Court rule in their favor, which can now seize 20 Indian properties in Paris to recover Rs. 8,897 crores plus interest and penalties.
The retrospective tax law on the indirect sale of Indian assets not only increased investor anxieties but also the possibility of pushback by foreign governments. By acting as a deterrent for foreign investment and putting Indian firms at risk of receiving the backlash; doubts regarding the net benefits of the retrospective tax law were raised. While the possibility for reactionary taxation policies can’t be ignored, in the current crisis it is prudent to do away with factors increasing investor anxiety. The economy appears to be in dire straits and is not seen as an investment destination currently, thus requires moves like these to increase the ease of doing business to retain and attract foreign investments.
Seen as tax terrorism by some, the law has remained controversial and perceived deterrent to foreign investments in India. The move to do away with the retrospective tax law might come from the possibility of reactionary policies from foreign governments. While the ability to tax on the indirect sale of Indian assets is retained, the amendment should ease foreign investors.
Will the rollback be enough?
Currently, India is going through an economic crisis, ease of doing business is a major factor to attract and retain foreign investments. Known for its blunder with the demonetization and the haphazardly executed Goods and Services Tax, the move to roll back the retrospective tax law is certainly welcome and although the government is refunding the tax collected without interest it certainly is a step in the right direction. It certainly improves the ease of doing business in India for foreign entities. Although it is unrealistic to expect major changes from the rollback of one taxation law, the focus of the government comes into question.
Having made minimal remittances to the poor and minimal relief to the MSME (Micro, Small, and Medium Enterprises) sector, the focus looks to be on improving the ease of doing business for foreign entities. However, if the focus is on FDI (Foreign Direct Investment) in this crisis, it might be a tall order to attract investments and even harder for those investments. Trickle-down economics in an economy with a demand deficit is a bad call. Trickle-down economics with FDIs in a demand deficient economy is a worse call. One might call attention to India’s meteoric rise in Ease of Doing Business Rankings over the years, however, the authenticity of the rise has been questioned by the World Bank.
The current crisis has hit the poor and corroded their savings. It is crucial to provide relief to the poor not only because of the intrinsic value of alleviating the effects of poverty but also because of their high spending propensity. A demand deficiency existed even before the COVID-19 pandemic which has only worsened. The MSME sector which provides employment for roughly 110 million people and is intertwined with the rural economy could also be a focus area to improve the overall economic condition of the country.
Digant Shetkar a graduate of Jai Hind College, Mumbai University. He is a columnist with The Policy Observer.(The opinions expressed in this publication are those of the author/s. They do not purport to reflect the opinions or views of The Policy Observer or our members.)
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