This article is written by Gursimran Kaur Bakshi. This article deals with how the issue of tax terrorism emerged in India.
Table of Contents
What is tax terrorism
In legal parlance, tax terrorism can be referred to as an act of colourable legislation. It can also be considered as an exercise of arbitrary state powers where the changes in the tax administration are done indirectly through use of unreasonable powers. That is why the Prime Minister Narendra Modi referred to it as an adversarial approach of the tax administration.
Tax terrorism is a way to terrorise honest taxpayers to pay unreasonable taxes but through legal means. The discourse on tax terrorism in India is usually discussed in reference to the infamous move of the Government of India to levy taxes through retrospective amendment in Section 9 of the Finance Act, 2012 on foreign companies. Presently, the amendment has been redacted under the Taxation Laws (Amendment) Act, 2021 (2021 Amendment). However, the collateral damage has already been in terms of tarnishing India’s image before the foreign investors because it spooked investors and created an unfavourable environment for them to invest.
How has tax terrorism emerged in India
As mentioned above, the debate on tax terrorism in India is referred to in the context of the retrospective amendment made to the Finance Act, 2012. The background in which the government decided to levy retrospective taxes was to force the Vodafone company to pay taxes for a transaction that took place as a part of an offshore share transfer agreement. But there are other ways as well, such as depriving the foreign investors to seek protection against domestic authorities in the matter of taxation under the investor-state arbitration.
India’s BIT model excludes taxation measures outside the purview
Every country willing to open its economy for foreign investment has a Bilateral Investment Treaty (BIT) Model. India first published its draft BIT Model in 1993. However, in 2016 substantial changes were made to the BIT Model which excluded the right to seek domestic taxation measures out of the purview of the investment treaty as per Article 2.4 (ii). This is also the reason why in terms of investor-state arbitration, India is considered the most-sued country for either lacking standard protection of foreign investors or not complying with the same. Since details of the arbitration can be kept confidential, not all disputes filed against India at the Investor-State Dispute Settlement (ISDS) Tribunal are published in the public domain. Excluding the taxation measures outside the purview of the investment, the Treaty can lead to regulatory abuse since powers to determine whether a measure is taxable or not is given to the domestic authorities. This can turn out to be unfavourable to foreign investors.
Levying of retrospective taxes – Vodafone case
Facts of the Vodafone case:
Vodafone International Holdings B.V. is a Netherlands entity (VIHBV). In 2007, a Hong Kong entity, Hutchison Telecommunication International Limited (HTIL) sold its stakes in Cayman Islands-based investment firm CGP Investments (Holdings) to VIHBV. The CGP Investments indirectly held shares of the Indian company, Hutchison Essar Limited (HEL). The consideration involved in the transfer took place through an offshore share transfer agreement for USD 11.1 Billion whereby HTIL earned capital gains.
The Indian tax authorities under Section 195 of the Income Tax Act, 1961, considered the acquisition of stakes by VIHBV in HEL liable for tax deduction at source. It was based on the ground that there was an indirect transfer of assets located in India and thus the company will have to pay for the capital gains. However, VIHBV failed to pay taxes as against the consideration made to selling HEL. The Indian Tax authorities raised demands on VIHBV under Section 201(1A) and Section 220(2) of the Income Tax Act for the non-deduction of tax.
Chronology of orders
- The tax notice was challenged by the VIHBV in the Bombay High Court. The Court in Vodafone International v. UOI (2010) ordered in favour of the tax authorities on the ground that the provisions have extra-territorial effect.
- Against this order, VIHBV filed a special leave petition under Article 136 of the Constitution of India in the Supreme Court.
- A judgment of the Supreme Court was passed in favour of the VIHBV where the government ordered to take back its claims and on top of it, the government was asked to pay compensation. The Court observed that the Act does not have a ‘see-through provision’ which can be stretched to include indirect transfers within its ambit.
- The government of India brought a retrospective amendment in the Finance Act, 2012, to nullify the order of the Supreme Court by including ‘indirect transfer of assets’ taxable under Section 9 of the Income Tax Act.
- VIHBV’s parent company invoked the Netherlands-India BIT and issued a notice of arbitration against the government of India for violating the BIT provision on fair and equitable treatment in 2014. A second notice of arbitration was issued under the UK-India BIT in 2017.
- The second notice of arbitration was challenged in an injunction proceedings that were filed in the Delhi High Court. The Indian government argued that simultaneous proceedings by vertical corporate chains lead to the abuse of the process. However, the Court refused to grant permanent injunction. It ordered that the BIT proceedings before the ISDS Tribunal can be consolidated and the challenge to the abuse of process can be taken before the same.
- Lastly, the arbitral award, Vodafone International Holdings BV v. The Republic of India (2020), was passed in the arbitration proceedings. However, the award is not made public. The award was not based on the levying of retrospective taxes by the Indian government in general. It was based on India’s violation of the India-Netherlands BIT provisions wherein, the Tribunal held that levying such taxes amounts to unfair treatment to foreign investors.
Current update on the case
The Indian government refused to accept the foreign award and filed an appeal against the same. However, as per the 2021 amendment, the government did away with the provision of retrospective taxation and has decided to pay the compensation to the Vodafone company but only the principal amount. However, this is based on the condition that the Netherland-based company will withdraw all the cases against the government.
According to the 2021 amendment, the government has removed the provision for allowing retrospective taxes to be levied on Vodafone. At the same time, it added a provision for a refund of the amount that was deducted. The government has also clarified that it would be willing to pay the refund on the condition that the company withdraws all cases against India.
Levying of retrospective taxes – Cairn case
Facts of the Cairn case
Cairn Energy is another case based on retrospective taxation against India in investor-state arbitration. In 2020, the Permanent Court of Arbitration announced an arbitral award against India for breaching its obligation of fair and equitable treatment.
The dispute started in 2006 when Cairn UK transferred shares of Cairn India Holdings to Cairn India as a part of an internal rearrangement process. The Indian tax authorities issued a notice for the unpaid taxes of Rs. 10, 247 crores. Post this, the same was challenged in the Income Tax Appellate Tribunal and the Delhi High Court. But Cairn UK lost the case in the Tribunal. Due to this, the Indian Tax authorities issued a notice to Cairn UK to pay capital gains tax which was valued at Rs. 24, 500 crores for making capital gains which were inclusive of penalty. The Tax authorities also restricted Cairn UK to sell all its stakes of the Indian business, Cairn India, to Vedanta because of the pending payment of taxes. The payment of dividends from Cairn India to Cairn UK was also frozen.
- Cairn sued the government of India before an ISDS tribunal for imposing retrospective taxes being violative of the 1994 India- United Kingdom BIT. The tribunal ruled in favour of Cairn and held that the Indian government is responsible for violating the fair and equitable treatment obligation of the BIT. But the ruling was based on the obligation laid down in the treaty and not on the amendments made by the Indian government under the domestic legislation.
- After the revised demand of the taxes, the Cairn UK could not seek remedy under the Indian law and they approached the Permanent Court of Arbitration at the Hague under the 1994 India- United Kingdom BIT. The tribunal ordered in favour of Cairn UK.
Current position of the case
- The Indian government refused to honour the arbitration award and because of this, the foreign company moved domestic courts in different jurisdictions to seize the property of the Indian government.
Excessive use of powers by the tax authorities
Another issue that has emerged as a part of tax terrorism is the use of excessive powers by the tax authorities to reassess the income tax returns of the taxpayers. The officials of the Central Board of Direct Taxes (CBDT) are allowed to send scrutiny notices to the taxpayers under Section 148 of the Income Tax Act on a mere suspicion that one has underreported or miscalculated his taxes. Section 147 of the Income Tax Act allows the tax authorities to reassess the income tax returns.
In Gkn Driveshafts (India) Ltd v Income Tax Officer And Ors(2002), the Supreme Court observed that the powers given to the tax authorities under Section 148 should be cautiously used. The reopening of the income tax assessment is void if the assessing officer has not disclosed cogent reasons for the same. The assessing officer is bound to furnish the reasons within a reasonable period of time.
How to prevent tax terrorism
Avoiding complex taxation system
In India, even before the Good and Services Tax (GST) was introduced, there were different types of indirect taxes that were applicable. This is a larger part of a complex tax structure that often results in ambiguity on one hand and exploitation on the other. This was tackled with the help of GST which established an integrated form of indirect taxation.
Double Taxation Avoidance Agreement
Double Taxation Avoidance Agreement (DTAA) is an international bilateral agreement signed by the countries to prevent dual levying of taxes on the same income. DTAAs are an important element in foreign investment that not only protects the foreign investor against any unfair treatment in the host country of investment but also offers concessional rates on certain taxes to the investor. Lastly, offering better domestic protection to the investors in the BIT is indeed non-negotiable and that can definitely be done by offering better standards of fair and equitable treatment.
The changes brought by the government are welcoming and it would now offer stability in terms of better protection to the foreign investors. Nevertheless, tax terrorism is something that is not supposed to be fought but prevented since it should not have been introduced in the first place. The government has now offered transparency to the investors but it would not be easy to revive its lost reputation in the eyes of the foreign investors since it has consistently refused to honour its international obligations under the BIT including challenges made to the foreign arbitral awards. The impact of the same is huge in the investor community.
Apart from this, the recent amendment can still be considered partially hostile against Vodafone and Cairn since the government has only agreed to pay the principal amount and not the interests that have also been incurred. It would be interesting to see whether these companies back down against the offer of the government or refuse to accept the conditions of the Indian government. If the latter happens, it is going to be difficult for the Indian government to dodge the issue since it has already adopted all the tactics against these companies to refuse to pay any amount. In case the government does that again, it is going to be disappointing for the investor community.
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