To tax and to please

| Updated on December 27, 2020

India can well make the claim of sovereign right to tax, but shouldn’t do so retrospectively

The government has decided to contest the September arbitration ruling given in Vodafone’s favour, and is likely to do so with respect to a similar ruling last week on a tax claim against Cairn Energy. The two cases entail a tax claim of about ₹22,000 crore and ₹10,250 crore, respectively — over which The Hague court has simply said that they militate against the bilateral investment treaties (BITs) with the Netherlands and UK, respectively. The government is likely to argue before the Singapore arbitral court that BITs cannot overrule the sovereign right to tax. In fact, the BITs in question have lapsed and not been renewed; a model BIT which has been in circulation for about three years does, in fact, seek to define the State’s domain in clearer terms. Earlier BITs have triggered arbitrations (nearly 20 in recent years). Therefore, the task ahead is to frame pacts that balance the State’s right to tax with a climate of certainty for investors. India’s low rankings on contract enforcement in the ‘ease of doing business’ indices are linked to not just judicial delays, but also ambiguities and flip-flops in the law.

The retrospective amendment to the Income Tax Act, following the Supreme Court’s 2012 ruling in the Vodafone case, is a huge source of uncertainty. The apex court had said that the existing provisions of the Act did not permit it to tax a transaction between two overseas entities whose underlying assets were situated in India. Following this judgment, the then finance minister, the late Pranab Mukherjee, moved an amendment to the law in the 2012-13 Budget. An amendment to Section 9 of the Act clarified that a company located outside India will be deemed to be in India if its primary assets are located here — implying that any transfer of these assets would attract tax in India. The only trouble with this amendment was its retrospective application from 1962, as a result of which Vodafone and Cairn came under scrutiny. This was patently unfair, smacking of the sort of arbitrariness which cannot have done India’s reputation as an attractive investment destination any good.

The Centre has time and again said that it will not pursue retrospective taxation. But to walk the talk, it must remove the retrospective element in its forthcoming Budget. That said, G-20 and OECD efforts to check Base Erosion and Profit Shifting practices have assumed more importance in the context of the resource crunch brought upon by Covid. According to OECD, $240 billion is lost annually due to tax avoidance by MNCs.As for India, it should be transparent and consistent in its tax policies. The appeal against the Vodafone ruling on grounds of a sovereign’s right to tax, while fair, may also send out a negative signal to investors. The only way that the Centre can counter this is by legislating to remove the mischief of retrospective taxation from the Income Tax Act.

Published on December 27, 2020

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