Karmik justice for Vodafone? Government might roll back retrospective amendment on indirect transfers
The Economic Times
National tax leader
Ernst & Young
When Vodafone decided to invest in the telecom business in India by buying shares of a Hutchinson Group holding company outside of India, it must have believed in performing 'good karma' of being the highest foreign direct investor in India at that time. It also performed its karmic duty to ascertain there was no withholding tax liability on the purchase consideration and was advised by every conceivable legal opinion in India that indirect transfers of underlying assets in India through transfer of shares located outside of India would not be taxed in India under the prevailing laws of the country.
After being challenged by the Revenue on the same, Vodafone would have believed that it had attained a 'karmic' victory when the Supreme Court in its verdict dated January 20, 2012, ruled in favour of Vodafone. However, what the Supreme Court proposed, the Parliamentary Godfathers summarily disposed by passing a retrospective amendment to the Income-tax Act giving rights to the Revenue to tax such indirect transfers from the inception of the Act, i.e., April 1, 1962.
The 'karmic wheel' seems to have come a full circle with the unambiguous recommendation of the Shome Committee that retrospective application of tax laws should occur in exceptional or rarest of rare cases and with particular objectives, namely, first to correct apparent mistakes or anomalies in the statute, second to remove technical procedural defects which have vitiated the substantive laws and third to protect the tax base from highly abusive tax avoidance schemes. However, retrospective application of tax laws should never be used to expand the tax base as is the case in respect of taxation of indirect transfers.
The committee has noted the objective of maintaining certainty, predictability and stability of tax laws in India so as to remove uncertainty in the minds of investors about shifting interpretations of the Indian Revenue seriously impacting the perception of safety of investing in India. This is indeed a commendably bold recommendation by the committee that, perhaps, for the first time in India has sought to spell out the circumstances under which the government ought to consider retrospective amendments in tax laws.
The committee has further proceeded to consider the possibility of government retaining the retrospective amendments and even here has made some specific suggestions vis-a-vis both the purchaser of the foreign shares as also the seller thereof. The committee has recommended that the purchaser should never be treated as a taxpayer in default in respect of retrospective amendment as this would amount to imposition of burden of impossibility of performance. In other words, government could apply the retrospective provisions only on the taxpayers who earns capital gains from indirect transfers. Moreover, even for the seller, who earns capital gains there should be no levy of interest and penalties on such back taxes.
The Shome Committee has also fully incorporated the recommendations made by the Parliamentary Standing Committee on Finance to clarify 'substantial value' as 50% or more value derived from assets located in India and carve out exceptions for internal reorganisations. Finally, the Shome Committee has sought to allay the fears of the foreign institutional investors (FIIs) and private equity (PE) investors by recommending that indirect transfers inter se or to third parties by investors in FII or PE funds overseas ought not to result in taxation in India.
The 'karmic wheel' has thus turned full circle possibly leaving the government in a peculiar quandary. Let us remember that the then Revenue Secretary at the time of moving the budgetary provisions in March 2012 mentioned a tax mop up of around Rs 45,000 crore from various companies involved in such indirect transfers. If government now accepts the Shome Committee recommendations, how does it expect to meet this tax collection target?
Just a month ago, the Kelkar Committee report on fiscal consolidation has painted a grim picture of India's fiscal deficit and has predicted a rise in fiscal deficit of around 6.1% against the budgeted estimate of 5.1% of GDP if immediate mid-year corrective actions are not taken. It has also mentioned a likely shortfall in gross tax revenues by around 60,000 crore which apparently would not have considered a likely loss of an additional 45,000 crore if retrospective amendments were done away with.
The Kelkar Committee has ominously concluded that India's economy may be encountering a 'perfect storm'. So what are the options for the government in dealing with the Shome Committee Report in the face of such a 'perfect storm'? This is a classic conundrum of short term exigencies versus long term sustainability of tax revenues. In other words, if the government gets tempted by the current dire fiscal situation and disregards the recommendation of the Shome Committee to roll back the retrospective amendment on indirect transfers, it runs the risk of continuing to dampen foreign investment sentiments and potential loss of tax revenues in the long term.
The question is whether the government has enough elbow room on the expenditure side to allow itself the luxury of sacrificing income by way of tax revenues? The current finance minister has already made it clear that certain subsidies on food and fertilisers cannot be wished away and are here to stay.
So, will the government be tempted to adopt the balancing approach suggested by the Shome Committee to retain the retrospective amendment but provide for waiver of interest and penalties? The dilemma for the government here would be that it might weaken its legal stance before the courts where it is already facing a challenge to the retrospective amendment in two cases. The fact of the matter is that these amendments are so complex in nature and so exhaustive in their reach that to justify them as mere clarificatory was by itself an unreasonable move by the government.
With its new found boldness and conviction, the government might spring a pleasant surprise and roll back the retrospective amendment in Parliament with a reasonably achievable assumption of attracting far greater investments in the remaining months to 2014 whereby both the fiscal deficit and political capital can be protected.
(The author’s views are personal)