Retrospective tax is a tax levied on a deal or transaction which was conducted in the past. The amendment introduced in 2012 in the Finance Act enabled the government to impose retrospective taxes on transactions conducted after 1962 involving shares transfer in a foreign equity which owned assets in India.

This was introduced to fix existing loopholes in the then existing tax regime and was triggered by the Vodafone Hutchinson deal in 2007 when Vodafone purchased 67 per cent stake in Hutchinson. The tax demand raised by the authorities was to the tune of ₹7,990 crore in capital gains and withholding tax.

In case of Cairn Energy in 2014, tax reassessment proceedings for the 2006 internal corporate restructuring transaction was initiated. A tax demand of ₹10,247 crore on capital gains made by it during the corporate restructuring undertaken in 2006 prior to the listing of the local entity was issued.

Cairn Energy appealed before the Income Tax Tribunal in India for which in March 2017, the ITAT upheld the capital gains demand after which the company approached the High Court in Delhi.

In the interim, Cairn Energy in March 2015 also initiated an international arbitration under the 1994 Bilateral Investment Treaty (BIT) between India and UK. On December 21, 2020, the international arbitration tribunal constituted in case of Cairn Energy Plc and Cairn UK Holding Ltd. in Hague ruled in favour of Cairn Energy and declared that India should pay damages worth $1.2 billion to Cairn Energy. The ruling stated that India had failed to comply with its obligations under the purview of the 1994 India-UK BIT.

Post the ruling in its favour, with the Indian government refusing to comply with the order and filing for an appeal, Cairn started identifying overseas assets owned by the Indian government which could be seized in the absence of a settlement. It also initiated proceedings in the court of law of countries such as US, UK, France, the Netherlands, Quebec and Singapore in an effort to enforce the ruling in countries where the Indian government had assets.

Pragmatic move

In light of the above, the government has acted pragmatically and laid to rest the ghost of the retrospective tax, though initially, there was thinking within the government to challenge the verdict by the Arbitration Council. The entire focus was mainly on long-term interests of the economy for which attracting investment is a prerequisite.

This long drawn battle between the company and the Indian government is a fine example of a dilemma between sovereign authority and the need to attract investment.

The Indian Constitution gives the Government the right to tax individuals and organisations. However, the tax being levied is required to be supported by a law passed by the legislature or Parliament.

Importantly, the canons of taxation i.e. the characteristics or qualities that a good and efficient tax system should possess should be borne in mind while deciding on tax laws: (i) Equity; (II) Certainty; (iii) Economy; and (iv) Convenience.

Interestingly, while the first is debatable on the ground of doubtful interpretation or a case of ego move by the then government, the concept of introducing a retrospective tax certainly sidelines the other three principles especially in terms of long-term damage to the economy.

Not to miss, follow up developments with Cairn Energy dragging the government to International Arbitration Council, more so move to get assets owned by PSUs are certainly against the principle of sovereign rights broadly accepted by the comity of nations and legally debatable. No country can surrender sovereign rights against an individual corporate entity.

On the flip side, from the viewpoint of showcasing India as an attractive destination for foreign and domestic investors and making India into a manufacturing hub, certainty in tax regime and transparency of tax laws are a key requisite. A stable and unambiguous tax regime is necessary to promote domestic and foreign investments.

The government’s move on August 5, 2021 to scrap the retrospective tax law is certainly welcome and should be applauded, keeping in view the overall Ease of Doing Business and need to attract foreign investment.

Pending cases

The matter should have been handled with maturity especially when the new government took over in 2014. There were similar other 16 such cases which had resulted in a lot of ambiguity for investors.

Though the then Finance Minister late Arun Jaitley made a statement that there would be no more retrospective tax , at the same time the government retained the right to impose it. Moreover, pending cases were left untouched for the 17 litigations. Cairn Energy’s recent move may have emboldened other companies.

Application of the amended tax provision to the ongoing cases is based on the condition that cases against the government should be withdrawn. There should not be any problem as sensible corporate entities would not like to take on the government and find themselves on the other side of the discussion table. However, the government should also engage with the companies using negotiating skill in the overall interests of the economy.

The government’s move to scrap the retrospective tax is a step in the right direction and the need of the hour. It is certainly a laudable step from the point of Ease of Doing Business in India, especially at a time foreign investors have started withdrawing from China and are exploring other attractive destinations to set up their manufacturing units and operate their businesses.

This government’s bold move would act as a booster at a time when the economy has just started reviving from the Covid-19 induced economic crisis.

Shettigar is Professor and Misra is Associate Professor of economics at Birla Institute of Management Technology, Greater Noida

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