A government which sacrifices growth for revenue, wrote the eminent jurist Nani Palkhivala, will get neither growth nor revenue.
This message is our main learning from the 15-year-old saga which slowly plays itself out this year after the government nullified certain retrospective amendments to the Income Tax Act which it had controversially — introduced in 2012. Ultimately, the government has been compelled to acknowledge an earlier mistake, providing much needed relief to 18 foreign companies from tax demands of Rs 1.1 lakh crore. In response, these companies are currently in the process of withdrawing all litigation seeking the attachment of the assets of the government abroad, after international arbitration tribunals ruled against the latter. Cairn Energy is the latest to do so.
The retrospective amendments of 2012 overruled the Supreme Court’s judgement in the Vodafone case. They provided inter alia that when non-residents transact to transfer shares in companies registered abroad, a tax on capital gains would be attracted in India, in the hands of the transferor, if the underlying asset (such as a company in this case) was situated in this country. There was nothing intrinsically wrong with these provisions and many tax jurisdictions accept this position. They proved contentious in India only because the legislature gave unprecedented retrospective effect to them, dating back 50 years to 1 April 1962, the year the present Income Tax Act first came into force.
The tale starts in 2007. Hutchison Telecommunications International Ltd (HTIL), a company resident and incorporated in the Cayman Islands and listed in Hong Kong and New York, transferred to Vodafone International Holdings (VIH) its entire shareholding in a subsidiary named CGP Investments (Holdings) Ltd (CGP). CGP was a company, resident of and registered in the Cayman Islands. Through this company and a complex web of other subsidiaries and intermediaries, VIH, for a consideration of US $11.08 billion, acquired a 67 per cent share in Hutchison Essar Ltd (HEL), an Indian subsidiary of CGP.
The Income Tax Department was convinced that this transaction constituted a taxable event in India; accordingly, it issued a notice on to HEL, as agent of VIH, a company resident in the Netherlands, to deduct tax at source under sections 195 and 197 of the Income Tax Act on the capital gains that had accrued to HTIL. VIH then filed a writ petition before the Bombay High Court, challenging its liability.
At this stage, many of us who had, by then, spent a life-time in the Income Tax Department, felt that the revenue side had a good case and the Bombay High Court agreed. Speaking for the court, no less a legal luminary than Dr D Y Chandrachud ruled that the transfer of the entire holding by way of a single share of CGP in Cayman Islands was in practical terms much more than the transfer of a single share from HTIL to VIH. It represented the transfer, for a consideration of $11.08 billion, of a capital asset situated in India, namely, a controlling interest in HEL that ultimately entitled the transferee to a 67 per cent share in the profits earned by HEL from its mobile telecommunications business. The Bombay High Court thus held that the Indian tax authorities were justified in issuing notices to HEL as an agent of VIH in India.
In an equally well-reasoned judgement, the Supreme Court disagreed: the transaction, it pointed out, needed to be examined holistically. HTIL, VIH and CGP were non-resident companies registered outside India. Indian tax laws did not permit the levy of a tax on capital gains when both the transferor and the transferee were non-residents and the capital asset itself was situated outside India. The assessing officer was, therefore not competent to issue a notice to HEL, as an agent of VIH, for failing to deduct at source.
Both parties to the dispute thus had a strong legal case. The department had put its best foot forward and lost. Ordinarily, matters should have rested there. However, we were taken aback when the department decided to amend the law retrospectively from 1962. This appeared to be an over-reach, and could be questioned both constitutionally and ethically.
Tax jurisprudence in India recognises that the sovereign power can legislate retrospectively, although the contours of such power have never quite been codified. Judge made law, however, stipulates clear limits on the exercise of such power. It recognises the Latin maxim lex prospicit, nonrespicit, namely, that ordinarily the law looks forward, not backwards. When it does look backwards, the legislative intent should be unambiguous and clear; the amendment itself should not seek to change the character of a transaction that has already occurred, impose a fresh obligation that did not exist earlier, modify an accrued right, or directly enact a law overriding or revising the judgement of the court or nullifying its directions to the parties.
It is highly doubtful whether the retrospective legislation of 2012 met these stringent tests, but its constitutionality was never really tested before the Supreme Court. Instead, some of the affected parties — VIH and Cairn Energy successfully dragged the government to international arbitration. The tribunals in both cases held that India had violated the fair treatment clause of the respective investment treaties. Parliament then had no option but to nullify the impugned laws.
In the aftermath of this saga, we learn that national interest goes much beyond maximisation of short term tax revenues. When extended to fiscal matters, laws passed with retrospective effect are difficult to administer, introduce uncertainty, unsettle settled law, diminish the credibility of the government and embarrass its relations with other countries and their investors. In the long run, they may also adversely impact investment, economic growth and revenues.
The danger in future is that another government, in a different set of circumstances, may be tempted to use this power again to impose obligations retroactively. A national consensus should, therefore, be built to codify and limit its use, if not, eschew it altogether, not only in the field of taxation; but also, as the very instrument of governance.
(The writer was Chief Commissioner of Income Tax and Income Tax Ombudsman)
Hardayal Singh retired as Chief Commissioner of Income Tax, Delhi in 2007 and thereafter was Ombudsman to the Department in Mumbai till 2009.
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