The Government of India recently introduced the Taxation Laws (Amendment) Bill, 2021 in the Lok Sabha. This bill was presented with the aim to withdraw tax demands that were made utilizing a 2012 retrospective legislation for taxing indirect transfers of Indian assets.
Background
The retrospective tax law was enacted in 2012, post the Supreme Court’s verdict in favour of the US-based company, Vodafone. The Dutch subsidiary of Vodafone Group had acquired a company based in the Cayman Islands in 2007, which indirectly had a majority stake in the Indian firm Hutchison Essar Ltd, later renamed as Vodafone India. This deal was worth $11 billion.
Post this, an amendment was made to the Finance Act, which allowed the tax department to impose retrospective capital gains tax on deals involving the transfer of shares in foreign entities located in India, dating back to 1962. While initially aimed at Vodafone, this amendment impacted other companies as well, leading to a plethora of problems for India. To date, it is viewed as one of the most disputable amendments to the income tax law.
International Arbitration and Past Cases
In 2020, India lost a case in an international arbitral tribunal at The Hague. This was against imposing taxes on Cairn Energy Plc and Cairn UK holdings Ltd for alleged capital gains made during their business reorganization in India in 2006, prior to listing the local unit.
Proposed Changes in the Bill
The bill proposed amendments to the Income-tax Act and Finance Act of 2012, stating that no tax demand would be raised for any indirect transfer of Indian assets if the transaction took place before 28th May 2012. It added that tax raised for the indirect transfer of Indian assets before this date would be nullified on the fulfillment of specific conditions such as withdrawal of pending litigation and an assurance that no claims for damages would be filed.
This bill proposes to refund the amount paid by companies involved in these cases, however without interest.
Significance of the Bill
The introduction of this bill marks progress towards addressing the longstanding demand of foreign investors who have been urging for the removal of retrospective tax for better tax clarity. It attempts to foster an investor-friendly business environment, which can propel economic activity, leading to increased revenue for the government in the long run. This change could potentially improve India’s reputation and enhance the ease of doing business.
About Retrospective Taxation
Retrospective taxation permits a country to implement a law for taxing certain products, items, or services and charge businesses retrospectively from a time before the legislation was enacted. Countries resort to this approach to rectify any flaws in previous taxation policies that allowed companies to exploit loopholes. However, it adversely impacts those companies that interpreted the tax rules differently, either knowingly or unknowingly.
Capital Gain Tax
Profit resulting from the transfer of a capital asset forms part of ‘income’ and is thus, taxable. This tax levied on the profit is known as the capital gains tax and can be of two types – short-term or long-term. Long-term Capital Gains Tax applies to profits from the sale of assets held for over a year. The rates can be 0%, 15%, or 20%, based on the tax bracket. Short-term Capital Gains Tax is applicable to assets held for a year or less and is taxed as ordinary income. Capital losses stemming from selling a taxable asset for less than its original purchase price can be deducted from capital gains.
Way Forward
To prevent disputes from reaching international courts, India needs to establish clear and meaningful dispute resolution mechanisms for cross-border transactions. This would not only save cost but also enhance the country’s ease of doing business by improving the arbitration ecosystem.
