The government must use its majority in the Lok Sabha to get rid of the 2012 amendment

By: Prabhash Ranjan

In the last two years or so, foreign investors have repeatedly expressed concerns about India’s tax environment, including on retrospective taxation, to Prime Minister Narendra Modi. During his recent visit to Saudi Arabia, Modi, once again, assuaging the fears of investors, clarified that retrospective taxation is a thing of the past. The finance minister has also said on multiple occasions, including in his budget speech of 2016, that foreign investors should not worry about retrospective taxation and that India is committed to providing a stable and predictable taxation regime. Yet, why is it that the Modi government, which we are told represents economic ‘right’, is finding it so difficult to convince foreign investors that India offers a stable and predictable tax environment? This is because somewhere along the line there appears to be a gap between government’s statements and its actions. The following facts corroborate this.

First, the Modi government, despite winning a massive mandate in the 2014 elections, so far, has not repealed the 2012 amendment to the Indian Income Tax of 1961, which allows for retrospective taxation of a share transaction between two non-resident entities that results in indirect transfer of assets lying in India. As is well known, this amendment was brought in to overturn the SC decision in Vodafone versus Union of India. In his maiden budget, in 2014, the finance minister recognised the ‘sovereign right of the government to undertake retrospective legislation’ and merely declared the intent of his government that it ‘would not retrospectively create a fresh tax liability’. This promise was repeated in the 2016 budget speech. However, foreign investors have doubts about government’s benign intentions because government’s stated position is contrary to the law of the land, which continues to allow for retrospective application of the tax law in a Vodafone-kind of economic transaction. Second, India’s new model Bilateral Investment Treaty (BIT)—that protects foreign investment under international law—completely excludes taxation from its purview. In other words, India is striving to build an international legal regime on foreign investment where foreign investors shall not be able to challenge taxation matters under international law, no matter how unreasonable or confiscatory such taxation measures are. It is very difficult to square this exclusion with India’s claim of providing a tax-friendly environment to foreign investors. An integral aspect of a tax-friendly environment is to provide an opportunity to foreign investors to challenge unreasonable tax measures both under national and international law.

Third, the manner in which the government has dealt or is dealing with Vodafone and Cairn, who are fighting international legal battles on imposition of retrospective taxes, has also sent out mixed signals. Initially, when Cairn brought the dispute against India—in March 2015—under the India-UK BIT, seeking $1,000 million in compensation, the government argued that the BIT does not provide for arbitration of taxation matters. Thus, India didn’t appoint an arbitrator despite the clear legal requirement, as per Article 9(3)(c)(i) of the treaty, to do so within two months from the date when Cairn informed the government of its intention to bring the dispute. Consequently, Cairn, under Article 9(3)(c)(ii), was forced to request the president of the International Court of Justice (ICJ) to intervene. Following the ICJ intervention, the government named a Singapore-based lawyer J Christopher Thomas as its arbitrator. Vodafone, reportedly, has also approached the ICJ for the appointment of an arbitrator who would preside over the arbitration tribunal because there is no consensus on who would be the third arbitrator. This is not to suggest that India, if it has decided to fight the legal battle, should not contest the case on merits. However, dilly-dallying and dragging one’s feet is not the right approach, especially when the government is keen to reassure foreign investors.

Also, right in the middle of the Make-in-India week in February this year, when Modi was promoting a tax-friendly environment for foreign investors, the income tax department asked Vodafone afresh to pay R14,300 crore due in taxes; else, its assets in India will be seized. A final assessment order has also been sent to Cairn asking it pay R29,000 crore due in taxes. Hiding behind technical arguments, like these notices are routine legal formalities, is a classic example of not being able to see the wood for the trees!

Finally, the recent budget proposal of the finance minister offering a one-time scheme of dispute resolution to companies such as Vodafone and Cairn also sends out mixed signals. As per the proposal, subject to these companies withdrawing BIT cases against India, the cases can be settled merely paying the principal tax amount with interest and penalty being waived. A proposal such as this shows that though on the one hand government claims not to believe in retrospective taxation in principle, on the other hand, it won’t mind collecting the money due from application of tax law retrospectively.

Of course, imposing taxes is an inherent attribute of a State’s sovereignty. However, this power should not be exercised to change the rules of the game once the match has started, especially when it is intended to nullify the ruling of the country’s apex court. The best way for the government to prove its bona fide intentions on taxation is to use its majority in the Lok Sabha to scrap the law that retrospectively creates a fresh tax liability. This would also have the advantage of bringing to an end India’s BITs disputes with Vodafone and Cairn. Talking alone is not going to be enough!

The author is an assistant professor of law at the South Asian University, New Delhi. Views are personal

This article appeared in the Financial Express on 19th April 2016. The article can be accessed by clicking here. Views expressed here are the author’s personal.