Vodafone-Hutch deal | Retrospective change to I-T Act

Vodafone-Hutch deal | Retrospective change to I-T Act

New Delhi/Mumbai: The government introduced a retrospective clarification to the Income-Tax (I-T) Act, 1961, virtually amending the law to ensure that cross-border transactions such as the $11.08 billion (around Rs55,735 crore today) Vodafone-Hutchison deal are taxable. The Supreme Court had ruled this deal as not being taxable in India.

The amendment becomes crucial because a review petition by the government on this case is pending before the Supreme Court, which might now have to consider the changes in tax laws when it revisits its judgement.

The provision was disclosed in the Union budget on Friday although it wasn’t mentioned by finance minister Pranab Mukherjee in his budget speech to Parliament. At the post budget briefing, finance secretary R.S. Gujral disclosed that the clarification could earn the exchequer Rs35,000-40,000 crore in back-dated revenues.

The amendment will apply from the assessment year 1962-63, meaning several foreign investments will now be open to taxation, especially those completed in the last five years since the February 2007 Vodafone deal.

The changes clarify that the law inherently allowed such cross-border deals to be taxed.

“For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India," reads one of the explanations inserted into the I-T Act. On 20 January, after extensive hearings from August to October last year, the Supreme Court rejected the tax department’s claim of jurisdiction over a share transfer carried out overseas, under which Vodafone was served a notice to pay withholding tax of Rs11,218 crore.

In his ruling, Chief Justice S.H. Kapadia said: “It is for the government of the day to have them (clear tax laws) incorporated in the treaties and in the laws so as to avoid conflicting views. Investors should know where they stand. It also helps the tax administration in enforcing the provisions of the taxing laws."

Vodafone counsel Harish Salve said the Indian government was “back to its old socialist ways."

“Bureaucratic obstinacy has always triumphed over good sense," said Salve, borrowing the words of famous tax lawyer, Nani A. Palkivala. “I think this is morally obnoxious. The department went after this transaction thinking they had the power. The Supreme Court said ‘no’, you’ve got it wrong."

Salve was deeply critical of the United Progressive Alliance’s budget on the whole. “We should show that we have institutions in this country which work. I think the country will pay a dear price for this. I think we are on course for elections this year. It’s a government which is politically rattled. They don’t want to take tough decisions and introduce reformist measures. This is waging war on foreign investment. If a client asked me ‘should I invest in India today?’ I would say ‘no’," he said.

Britain’s Vodafone Plc believed that there would be no impact on it despite the clarifications issued in the Budget and Finance Bill: “We are examining this proposed decision with our lawyers, but we do not believe this retrospective change in tax law should have any impact on the final judgment handed down by the Supreme Court in our tax case. We continue to have faith in the Indian judicial system."

Chennai-based chartered accountant M.R. Venkatesh said: “We did a campanign for the insertion of this clarification. I wrote to the FM (finance minister). Morally, though a retrospective amendment is not the best way to deal with such situations, having come from a tax haven, you (Vodafone) cannot claim any immunity. Cayman Islands is one of the worst tax havens. Supreme Court had held that there is no constitutional bar (for retrospective amendments). There have been several instances where Indian entrepreneurs have had to face retrospective amendments. So why do we care if the foreigner is affected? This is a way of life in India."

Venkatesh said he didn’t particularly care for foreign investment. “I’m saying this is anti-investment, but don’t say this is anti-foreign investment. Recently, India has given a commitment to G-20 nations to tax such transactions that are routed through tax havens at the maximum marginal rate," he added.

Any government plan to tax Vodafone’s takeover of Hutchison’s Indian operations and similar transactions retrospectively won’t pass the scrutiny of the courts, said Fereshte Sethna, a Mumbai-based partner at Dutt Menon Dunmorrsett.

Sethna represented Vodafone in its dispute with the tax office in the Mumbai high court and the Supreme Court. “To my mind, it’s a closed chapter as far as the courts are concerned," she said.

“I don’t really see this at all adversely affecting Vodafone. I would have serious doubts that something like that could withstand judicial scrutiny," Sethna said. “They may seek quite clearly to bring other transactions within (the net, but the) Vodafone judgement cannot be reversed in that backhanded manner."

Retrospective amendments to the I-T Act have been upheld by courts in the past, said ALMT Legal’s Mumbai-based partner Hitesh Jain.

In 1987, the government retrospectively amended the Act to introduce a compulsory tax on offshore drilling contracts by increasing the number of nautical miles from shore that would be affected, he said.

“I don’t think it’s unconstitutional. In the past there have been cases where a retrospective levy has been upheld," said Jain, who represented Vodafone in the early stages of the dispute, adding that the government’s move had been expected.

Jain also said the proposed amendment will put India on a “circumspect list" with foreign investors, although it would not discourage them significantly from investing in the country because of its strong fundamentals.

Additional solicitor general Mohan Parasaran said the move didn’t amount to an amendment to the law.

“It is just a clarificatory legislation and it is what Parliament intended from the beginning," he said.

Parasaran was the I-T department’s counsel before the Bombay high court (where Vodafone lost in September 2010) and before the Supreme Court, where he assisted solicitor general Rohinton F. Nariman. When the suggestion was put to Parasaran that the goal posts were being changed, he said: “That is a bogey which is being created by the other side. As far as the tax department is concerned, we have been saying this since 2007. No foreign investor will leave or any such thing. Look at China, they also have a similar law. Has anyone left them or stopped investing there?"

Lalit Bhasin, managing partner of Bhasin and Co. and president of the Society of Indian Law Firms, said the retrospective amendment will dent the confidence of foreign investors in India. The government “should honour the Vodafone judgement rather than trying to frustrate the entire exercise," he said. The government has also introduced general anti-avoidance rules (GAAR) to check tax evasion. Besides this, to reduce litigation in transfer pricing, it has decided to introduce advance pricing agreements. The finance ministry said the legislative intent of Parliament was to enable taxation of transactions with “actual economic nexus" to India.

It goes on to say that “certain judicial pronouncements have created doubts about the scope and purpose of sections 9 and 195. Further, there are certain issues in respect of income deemed to accrue or arise where there are conflicting decisions of various judicial authorities."

Finance secretary Gujral said: “The intention of the legislature from the initial phrase was very clear that transactions like Vodafone are taxable in India where the underlying assets are in India. We are not introducing an amendment. It is a clarification reiterating the original intent."

He said the move would impact the AT&T and Sanofi cases (see graphic).

“If you see the Supreme Court judgment, it highlights the need to ensure tax certainty. Introduction of GAAR will address this. All of these cases which we have mentioned, these are not cases of double taxation, but of no taxation," Gujral told reporters. According to section 113 of the Finance Bill, the government doesn’t need to issue a fresh tax demand to Vodafone. In October 2010, it had issued Vodafone a possible Rs11,218 crore tax demand, part of which Vodafone had to deposit with the Supreme Court for its appeal to be heard. With section 113, the old tax demand, which was put to rest with the court’s ruling, will come back to life if Parliament passes the Finance Bill.

Arun Giri, editor of Taxsutra.com, said: “The retrospective amendment, if passed by Parliament, will surely be challenged by Vodafone for its constitutional validity. There have been quite a few retrospective amendments in the last five decades ever since the I-T Act, 1961, was enacted and most of the them have survived judicial scrutiny. If the constitutional validity is upheld, a host of other similar cases, too, will be affected."

“The real story of the budget, however is the GAAR provisions, which have the impact of almost nullifying what many considered as important observations of the SC on tax avoidance in the Vodafone decision," Giri said. “In the Vodafone case, the apex court criticized the government on the loopholes in different laws and called for express provisions in the legislation to clamp down on tax avoidance. The finance minister has done exactly that, but in a way that will have huge repercussions for corporates, the I-T department and tax professionals alike."

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