Among the many fiscal challenges India faces this budget season, one relates almost entirely to how the law is read on retrospective taxation. What hangs in balance is over Rs 50,000 crore, or more, that may be owed to the exchequer by Cairn Energy Plc and Vodafone BV. While two international tribunals have recently ruled against India in both the above disputes, there is much that belies these seemingly one-sided legal contests.
The Vodafone tax battle
It started more than a decade ago with the Indian tax department issuing a notice to Vodafone BV for capital gains tax – which it was required and reminded to withhold – when it bought Hutch’s India business in 2007. Vodafone claimed the transaction, wrapped in a transfer of shares from one offshore holding company to another, was beyond India’s taxing authority. In 2010, the Bombay High Court reasoned that the statutory phrase “all income accruing or arising, whether directly or indirectly…through the transfer of a capital asset situate in India” would mean that such “composite” transactions would be taxable to the extent they derived value from assets in India. In 2012, the Supreme Court reversed that interpretation vigorously, even commenting that it would amount to “imposing capital punishment for capital investment”.
Faced with the prospect of losing over a billion dollars in revenue over thin interpretative nuance, the Indian Parliament (resisting significant international pressure) amended the statute retrospectively in 2012 and effectively overruled the Supreme Court’s decision. In September 2020, an international tribunal found such retrospective amendment to have breached the “guarantee of fair and equitable treatment” under the (now lapsed) India-Netherlands Bilateral Investment Treaty 1995.
Many view the recent tribunal award as validation of the damaging criticism suffered by India all this while with calls to now “settle the issue”. But there is the other side to this seemingly straightforward story.
Retrospective taxation: India is no outlier
Consider retrospectivity first. As any worthy commentary on Indian constitutional law will confirm, retrospective amendments, including those which may overrule Supreme Court decisions, are an accepted feature of Indian jurisprudence (their permissible limits having been articulated by the Supreme Court itself). With some further effort, one can also learn that India’s federal taxing statutes have in fact been retrospectively amended over two hundred times in a 20-year period (1998-2017). That representative spectrum — some retrospective amendments clarifying contentiously narrow court interpretations (occasionally even to the benefit of the taxpayer) — is how the Indian tax machinery has worked. That was certainly no surprise for either Vodafone or Hutch who had already accounted for potential retrospective taxation in their very transaction documents.
It is even less remarkable when considered that retrospective taxation is not just an Indian phenomenon, for among others, the UK, Germany, the US, Canada and Australia have all previously used a sovereign power to counter tax abuse retrospectively e.g. United States v. Carlton (U.S.), Proctor and Gamble v. Ontario (Canada), Chevron v. Commissioner of Taxation (Australia).
Combating BEPS, India’s leading role
Second, in what is rarely noted if ever, India’s stance in looking to tax the Vodafone transaction catalysed a global shift to combat ‘base erosion profit shifting’ (BEPS) as the phenomenon of offshoring profits came to be termed. A string of developing countries — now alive to the phenomenon — fortified their laws to prevent such profit shifting and offshoring of capital gains. Supplementing the G-20’s leading effort on the issue, the International Monetary Fund (IMF), the Organisation for Economic Cooperation and Development (OECD), and The World Bank collaborated with a striking singularity of purpose to jointly issue regulatory ‘toolkits’ to assist countries to combat BEPS. Further, the Multilateral Convention 2016 (negotiated specifically to prevent BEPS) now provides the option to pursue tax defaulters across jurisdictions more efficiently.
In a way, it is as if the world changed and in a manner none too flattering for the Indian Supreme Court’s decision. On the other hand, while reviled in business press, Indian tax officials were instead complimented and given steering roles in international bodies on tax collaboration as the unassuming leaders of policy on the issue.
The defaming of India’s tax climate
Far from such nuance however, it was mostly unthinking invective (‘tax terrorism’) that became damagingly commonplace to describe India’s investment climate. Notwithstanding that India recovered not a rupee from Vodafone at any point, the record needs a setting right separately too.
For instance, in 2016, the government offered all entities aggrieved by the retrospective tax amendment to settle claims by paying just the principle amount of tax (the ‘Direct Tax Dispute Resolution Scheme 2016’) exempting all interest and penalties. Accounting for the time value of money, that meant a settlement was being offered for significantly lesser than the tax due at the time of the (then nearly decade old) transaction.
Later, in 2018, the tax department chose not to object to the merger of Vodafone India with Idea Cellular which it was ostensibly entitled to do given the potential outstanding tax owed by Vodafone’s parent company. For all the criticism then, the retrospective tax never really was a problem much less a terror. One is tempted to add that taxes in general seem never really to be a problem for multinationals who operate in a certain way (in 2010, Vodafone settled a £7bn tax dispute with the UK HMRC for approximately £1bn amid public outcry).
Some numbers are in order. The Vodafone tax liability in India works to approximately Rs 22,000 crore with the international tribunal’s award now under challenge in Singapore. The Cairn tax liability in India works to approximately Rs 30,000 crore with the government contemplating challenging the tribunal’s award (even as Cairn has instituted enforcement proceedings against India in multiple courts across the globe to recover a separate $1.2 billion it was awarded in the same arbitration).
These numbers are especially prominent in a year where a creditable Budget has had to reduce the annual allocation to education to just over Rs 90,000 crore. It is not often that such numbers hang on the razor edge of legal interpretation. It is even rarer for them to crack open a question that spurs a global shift. No matter what the outcome, the fact remains that at the centre of this all is an unsung and stretched tax department, which has been standing against the odds for over a decade. And for that, chapeau!
Manu Sanan is a lawyer with experience in international disputes and was part of India’s international counsel team in the Vodafone arbitration. Views are personal. The facts disclosed are public.