What is the controversy related to retrospective taxation in India?

One of the most controversial economic issues in the last five years was the tax dispute between Vodafone and the tax department.

The case originated after the revenue’s (tax department) notice to Vodafone that the company has to pay a capital gains tax of nearly Rs 11000 crores from its purchase of Hutchison Essar Telecom Company from Hutch.

The entire dispute centered on the question that whether an indirect transfer of property located in India can be taxed under the relevant section 9(1)(i) of the Income-tax Act. The section instructs imposition of capital gains tax when the capital assets are transferred directly from one company to another.

Indirect transfer means when the shares of a company is transferred, the underlying asset is also transferred to the buyer.

At the final stage of the dispute, the Supreme Court verdict that tax department doesn’t have the right to tax the deal. This is because the relevant income tax Act (Section 9 (i) (i)) doesn’t instruct tax authorities when capital asset (machinery building etc) lying in India is transferred indirectly by transferring the shares by foreign companies abroad. Both Vodafone and Hutch were foreign companies and they made deal in another foreign company which held 67% of shares of Hutchison Essar India Limited. Hence Vodafone need not pay tax for the said deal.

Retrospective taxation under the Income Tax Act

After the setback in the Vodafone case, government has amended Section 9 (i) (i)). The new amendment clarified that when a share transaction take place between two nonresident entities that results indirect transfer of assets lying in India, such an income will be taxed in India.

But the most important point about the 2012 amendment of the income tax act was that it was amended with effect from 1962. This means the amendment has retrospective effect.

A retrospective tax law is one that takes effect from a date before it is passed. Here, the law imposing tax on indirect transfer of assets in India was enacted in 2012, but the tax will be applicable to all transaction that took place from 1962 onwards (Income tax rule was passed in 1962).

The controversy was that whether it is fair to impose a tax with retrospective effect. A company’s business decisions are based upon the tax situation that exists today. It is very difficult to organize its activities today based on a future law that will be made applicable from today.

An ideal tax system should be predictable certain and stable. Hence retrospective implemetation is a bad move.

Later, the government has asked Sri Parthasarathi Shome to make recommendations about the retrospective implementation.

Recommendations of the Shome Committee

The Shome Panel had recommended that any taxation involving indirect transfer of assets located in India should be prospective and not retrospective.

The Committee concluded that retrospective application of tax law should occur in exceptional or rarest of rare cases, and with particular objectives. Moreover, retrospective application of a tax law should occur only after exhaustive and transparent consultations with stakeholders who would be affected.

The controversy surfaced again recently when the tax department issued notice to Vodafone. Vodafone is not ready to pay taxes after the SC verdict. The company has indicated that it will approach Netherlands government (its registered office) for invoking the India- Netherlands Bilateral Investment Protection Agreement.

In the next budget, it is expected that the government may discontinue retrospective clause of the amendment.

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