This article has been written by Shohom Roy, from Symbiosis Law School, Noida. This article is a critical analysis of retrospective taxation laws in India and the urgent need to discard them.

Introduction

In the Wealth of Nations, the renowned Economist Adam Smith had suggested that an ideal taxation system must be based on the principles of equity, certainty, convenience, and efficiency. The time of payment, procedural formalities, the quantity of payment must not suffer from arbitrariness and should be clear to the taxpayer as well as every other individual. While taxes might appear to be an obligatory economic duty to finance the services provided by the government, the notion of tax is based on the social contract theory of governance. Taxes are considerations paid by the individual for the economic benefits provided by the government and society as well as an instrument for the redistribution of wealth between the rich and the poor. Therefore the proper functioning of a democratic system relies on a fair and just taxation system. The introduction of retrospective amendments in taxation laws creates an obligation in the past when the statute might not even exist. The Indian government has utilized the mechanism of retrospective amendments to defeat judicial pronouncements and create unfair tax obligations for many companies. The Taxation Laws (Amendment) Bill, 2021 marks the end of the era of ‘Tax Terrorism’ and creates a positive environment for foreign investments by scrapping the retrospective tax provisions.

Challenges to the constitutionality of retrospective taxation laws

Retrospective comes from the Latin words “retro” meaning “backwards” and “specere” which means to look at. Therefore laws that are retrospective in nature deal with events that have happened in the past. This is a contradiction to the legal maxim of “lex prospicit non respicit” or the prospective principle behind legislation that is binding from the present point in time. Generally, retrospective laws are presumed to be unjust and oppressive since people could be prejudiced by laws that were not present when they were breaking them. It appears to be counterintuitive to the notion of equity, fairness, and natural justice. Therefore, the retrospective laws must be used very carefully and rarely to prevent a gross miscarriage of justice. However, Indian legislators have introduced retrospective statutes time and again in the sphere of taxation. This trend has been influenced by the legislative predisposition to undo certain judgments and rectify certain ambiguities or inconsistencies in the existing laws. The government has exploited the principle of presumption of constitutionality while implementing retrospective legislation. The law mandates a heavy burden of proof to rebut this presumption of constitutionality. However, the judiciary has relied on the reasonability test to strike down any laws that appear to be unreasonable. With respect to retrospective taxation laws, the Supreme Court had held that the imposition of an unreasonable tax burden would deter people from carrying out their profession, which could be interpreted as a violation of the right to practice any legitimate profession and trade guaranteed by Article 19(1)(g) of the Indian Constitution.

Judicial opinion on retrospective taxation laws  

One of the most important judicial decisions on retrospective taxation laws came in the case of Chhotabhai Jethabhai Patel & Co v. Union of India (1961). The government declared that duty on manufactured tobacco would be effective not from the day it was passed by the Parliament but from the day the bill was introduced by the Parliament. The petitioners sought relief against this retrospective law from the Supreme Court. The Court relied on foreign judgments to determine whether the retrospective law was constitutional and whether it was in contravention of Part III of the Constitution. While an absence of explicit constitutional restriction on retrospective laws created room for the Parliament to implement such laws, the Apex Court held that Part III of the Constitution was applicable to the taxation laws. However, imposition of tax retrospectively does not always make the statute arbitrary and unconstitutional. This legal precedent led to the misuse of legislative power and prompted the government to proceed from repairing small defects in its enactments to implementing major changes retrospectively. It was only in 1978 that the Supreme Court of India while hearing the case of Maneka Gandhi v. Union of India, clarified that the legislature is bound by fundamental rights restrictions while introducing a retrospective law.  

The judiciary has allowed retrospective amendments that cure defects in existing laws and help achieve their intended target. Even if the amendment is not expressly made retrospective, the law mandates that the clarificatory or explanatory nature of the amendment must be examined to determine whether it is retrospective in nature. In the case of Lohia Machines Ltd and Anr. v. Union of India (1985), the Parliament added a rule to the Income Tax Act, 1961 which was applicable retrospectively. While it was challenged that the newly added rule was inconsistent with the rest of the Act and defeats the intended effect of the Act, the Supreme Court held that the retrospective amendment was merely clarificatory in nature and therefore valid. In certain circumstances, even a prospective amendment may be held as retrospective in application. This is usually in the case where a statute suffers from certain omissions which are inserted by later amendments that must be construed to be retrospective in nature for the desired implementation of the statute. In the case of Commr. of Income Tax v. Alom Extrusion Ltd. (2009), an amendment to a statute resulted in several tax-payers losing out on the benefit of obtaining deductions on their taxable income due to the prospective implementation of the statute. The Supreme Court held that people should not be deprived of the intended benefits of a statute due to an error of the legislature. Retrospective amendments in taxation laws that are merely declaratory or curative in nature have been consistently validated by the judiciary.

However, a substantive change in the law that results in an altogether new obligation retrospectively would be in contravention with the spirit of the Constitution. This was clarified in the case of Union of India v. M/S Martin Lottery Agencies Limited (2009), where the Supreme Court held that amendments cannot be made to existing laws under the garb of clarification without a reasonable cause. The imposition of new tax liabilities which are retrospective in nature defeats the fundamental rights under Article 19(1)(g) and Article 14 of the Constitution.  Even in the case of declaratory or curative amendments, the law mandates that inconsistencies must be resolved in favor of the public. In the case of Ansal Housing and Construction Ltd. v. ACIT (2017), the High Court of Delhi held that an amendment to a tax statute must be intended to remove any obstacles faced by the taxpayers and not the tax authorities. The lack of clarity regarding the rules and regulations imposed by the retrospective amendment could introduce ambiguities in the statute and render it unconstitutional. In the case of Commr. of Income Tax v. NGC Networks India Pvt. Limited (2019), the High Court of Bombay have relied on the maxim of “lex non-cogit ad impossibilia” to establish that a party could not be expected to perform the impossible task of predicting the future and comply with a law that would be introduced at a later point in time. This puts a check on the abuse of legislative power and prevents taxpayers from bearing the burden of an unreasonable tax.

Recent controversies regarding retrospective taxes

Vodafone International Holdings BV v. Union of India

• In the case of Vodafone International Holdings BV v. Union of India (2012) is a company incorporated under the laws of the United Kingdom. In 2007, a show cause was sent to the UK-based company which had recently entered the Indian telecom industry, for the non-payment of tax on the indirect transfer of assets in India. 
• In the same year, Vodafone had acquired rights to a company named CGP Investments (Holding) Ltd. for USD 11 billion located in the Cayman Islands. CGP was a subsidiary of the Hong Kong tycoon Li ka Shing’s Hutchison Telecommunications International Ltd, which was also situated in the Cayman Islands. CGP owned 67% of Hutchison Essar Limited, an Indian Company. Since Vodafone had acquired CGP it had also purchased its subsidiary Hutchison Essar Limited. 
• The issue arose regarding the payment of tax on the transfer of shares before the Supreme Court of India. The Court examined the nature and intention of the transaction between the two foreign companies and came to the decision that the major purpose of the transaction was the transfer of GCP’s shares and not that of Hutchison Essar Limited. Furthermore, while interpreting Section 9(1)(i)  of the Income Tax Act, 1961, the Apex Court clarified that tax obligations arise where there is a direct or indirect income and not a transfer of capital assets. Since there was a sale of shares and not capital assets, it was a nontaxable transaction under Section 2(14) of the Income Tax Act, 1961. The tax must be levied on the source i.e. the location where the transaction has taken place and not from where the products have derived their value.
• The Indian legislature passed the Finance Act, 2012 after the Supreme Court’s verdict in this case, in order to bypass the judicial pronouncement. The retrospective amendment to Section 9(1)(i) of the Income Tax Act created tax liability for non-residents or companies incorporated outside the territorial jurisdiction of India if they are involved in the transfer of shares whose values are derived from assets in India.
• The act of deliberately changing legislation to impose tax liability has prompted Vodafone to seek relief from the Permanent Court of Arbitration, Hague. The arbitral tribunal has ruled in favor of the company by deciding that the retrospective amendment of the taxation law is in contravention with the fair and equitable treatment guaranteed by the Indian government under the India-Netherlands Bilateral Investment Treaty and the India-United Kingdom Bilateral Investment Treaty.

Cairn UK Holding Limited case

In light of the events that ensued after the Supreme Court’s verdict in the Vodafone case, the Income Tax Department of India imposed a capital gain tax on Cairn UK Holdings Limited on account of the internal corporate restructuring of the company in 2006. Cairn UK had transferred its entire stake in one of its subsidiaries located in Jersey, the Channel Islands to Cairn India. Later the Indian subsidiary had launched an Initial Public Offering divesting about 30% of its shares to the mining conglomerate Vedanta PLC. Tax demand of Rs 22,100 was made against Cairn.  

The Permanent Court of Arbitration, Hague while adjudicating on this issue held that the retrospective amendment to the statute cannot be termed as a clarificatory amendment. The amendment of the domestic law was against the Bilateral Investment Treaty between India and the UK. Therefore demanding tax from the company would be against international law. Furthermore, a tax penalty of USD 1.2 billion was imposed on the Indian government as a way of compensating for the damages suffered by Cairn. Subsequently, the Indian government had entered into negotiations with the promise to waive 50% of the tax liability. However, Cairn filed for an enforcement decree of the arbitral award in the USA and sought to confiscate properties owned by Air India. The company has argued that the government-owned enterprise is representative of the Indian government and therefore liable to pay the dues of the government.

It seeks to pierce the corporate veil and acquire Indian assets which are located all over the world. Several suits have been initiated all over the world to seek enforcement of the arbitral award. Recently a French court has allowed the UK-based company to freeze over 20 Indian assets in Paris worth around 20 million Euros.  

Taxation Laws (Amendment) Bill, 2021

The amendments to Section 9(1)(i) of the Income Tax Act by the Finance Act, 2012 established that the shares of a domestic or foreign company shall be deemed to have been always situated in India if the shares derive a substantial part of their value from assets situated in India. Since the tax regime obligates non-residents to pay tax on the income gained from business, property, assets, or any other source of income in India, this subsequent amendment was applied retrospectively creating an unreasonable burden on various businesses. Hence, people who sold shares of foreign companies before the enactment of the Finance Act, 2012 were also subjected to a tax on the income earned from such trade.  The Taxation Laws (Amendment) Bill, 2021 seeks to amend the Income Tax Act, 1961 and the Finance Act, 2012 in order to nullify the provision that imposes a retrospective tax liability on the income derived from the sale of shares of a foreign company. The amount paid due to the retrospective tax on indirect transfer of Indian assets would be returned to the taxpayers without any interest from gross tax receipts of the government. Furthermore, it has clarified that this tax liability shall be nullified after the fulfillment of the following conditions:

• Withdrawal or an undertaking of withdrawal of any appeal or petition filed against these retrospective tax laws.
• Withdrawal or an undertaking to do the same with respect to any arbitration, conciliation, or mediation proceedings initiated or ongoing against these retrospective tax laws.
• An individual must submit an undertaking to waive the right to pursue any remedy or claim that might be available due to any law or bilateral agreement

The Government has assured that all assessment or reassessment directives issued by the Income Tax Department would be dissolved and the deducted amount will be refunded without any interest.

Conclusion

The opinion of the international tribunals with respect to India’s retrospective tax regime has prompted the government to initiate a process of making much-awaited changes. Although India seeks to establish that the domestic taxation laws fall under the ambit of its right as a sovereign, the decision of the Permanent Court of Arbitration in favor of the tax-payers and against the Indian Income Tax Department has culminated into the introduction of the Taxations Laws (Amendment) Bill, 2021. The government seeks to put an end to the seventeen arbitrations proceedings initiated against it under the Bilateral Investment Protection Treaty with the United Kingdom and the Netherlands. The consumer protection regulations that compromise the business model of Walmart-owned Indian e-commerce powerhouse Flipkart as well as the dispute over the end-to-end encryption feature provided by Facebook Inc.’s Whatsapp is a glimpse of the inadequacy of Indian law to adapt to the changing needs of the society. The scrapping of the retrospective laws could encourage the flow of foreign investment in India and create a transparent and reliable tax regime for global investors.

References 

• https://www.biicl.org/files/6722_panel_two_harish_salve.pdf
• https://prsindia.org/files/bill_track/2021-08-05/Taxation%20Laws%20(Amendment)%20Bill,%202021%20Text.pdf
• https://prsindia.org/billtrack/prs-products/prs-bill-summary-3765
• http://164.100.47.4/BillsTexts/LSBillTexts/Asintroduced/120_2021_LS_E.pdf

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