India must bury retrospective tax ghost, but it’s not that simple…
India has lost two international arbitrations against the previous Congress-led government’s decision to retrospectively tax certain categories of business transactions. Pursuing these and new cases further will only hurt India’s investor-friendly image that the Modi government has worked so hard to earn, but the politics is not that simple, writes India Inc Founder and CEO Manoj Ladwa.
Mitsui Corporation of Japan is the latest global company to drag India to international arbitration over the Indian Income Tax Department's claims of more than $300 million as retrospective tax in respect of a 2007 transaction on which the Japanese company had paid all taxes that were due at the time.
This comes on the back of an international arbitration panel awarding Cairn Energy, one of the UK’s leading independent oil exploration companies, $1.2 billion in damages for shares and dividends seized by the Indian tax authorities in lieu of retrospective tax demands that have now been set aside.
The genesis of the retrospective mess
The genesis of this dispute goes back more than nine years. In 2012, then Finance Minister (later President of India) Pranab Mukherjee amended the Finance Bill to retrospectively tax Vodafone for its $10.9-billion acquisition of another telecoms company, Hutchison Essar in May 2007.
Supreme Court had quashed tax demand on Vodafone
The Indian tax authorities had demanded about $1.9 billion (at the then prevailing exchange rate) from Vodafone as capital gains and withholding taxes. The tax department contended that under the law, Vodafone was required to deduct tax at source before making any payment to Hutchison.
Vodafone disputed this demand and went to court. The case found its way to the Indian Supreme Court, which quashed the tax authorities demand notice as it lacked the authority of any law.
It was to overturn this judgment that the government amended the Income Tax Act 1961 with retrospective effect.
The tax demand on Cairn was also raised under this retrospective amendment – for capital gains when Cairn Energy UK, in an internal restructuring in 2006-07, transferred the assets of Cairn India Holdings to Cairn India.
Similar demands have also been raised against French pharmaceutical major Sanofi over its 2009 acquisition of a majority stake in Indian drug company Shanta Biotechnic. In this matter, the government has filed an appeal before the Supreme Court against an Andhra Pradesh High Court order that went in favour of Sanofi.
Modi’s 2014 sweep raised hopes that retrospective tax law would be scrapped
When the Modi government swept to power in 2014, there were expectations that it would undo the retrospective tax amendment that had not netted a single penny in revenues but done great damage to India’s reputation as a safe investment destination.
Former Finance Minister, the late Arun Jaitley promised that the government would not reopen any further old cases but had left the existing cases launched under the retrospective amendment untouched. This meant the law remained in the statute books and it continues to hang like a sword over the heads of all investors.
Vodafone, Cairn sought arbitration, government lost both cases
Vodafone and Cairn challenged the retrospective tax demands in the Permanent Court of Arbitration in The Hague. The Government of India lost both cases and has filed an appeal against the Vodafone ruling in Singapore.
And even as the government is filing an appeal against the Cairn award, the company is reported to be taking steps to enforce the award in its favour by moving to seize Air India planes and foreign bank accounts and other assets of Indian public sector corporations in foreign jurisdictions. To put it mildly, if any of this actually happens, it will be a huge embarrassment for India.
India’s investor-friendly image will get hurt
The Modi government has worked very hard to rebuild India’s image as one of the world’s leading investment-friendly destinations after the damage inflicted on it by the previous Congress-led government that was rife with corruption scandals and economic policy drift. Foreign investors seem convinced – the record levels of FDI and FPI inflows into India prove that. The huge buy-in from top-flight global investors to the production-linked incentive (PLI) scheme for 13 sectors corroborates that further.
It’s still an incipient trend and needs tailwinds to gain momentum. Under the circumstances, pursuing the retrospective tax demands from one international court of appeal to another may not inspire investor confidence.
Then, international media reports of Cairn chasing Indian assets are doing India’s global image no good, especially at a time when it is receiving a lot of negative coverage – some of it undeserved, – over its handling of the second wave of Covid-19.
Ties with UK, France, Japan could be strained
Also, the UK, France and Japan are among India’s closest allies. There’s a possibility that the relentless pursuit of tax claims that are widely seen to be arbitrary and unfair could impact at least some aspects of the warm relationship India shares with those countries.
Best of all, the Modi government will not have to sacrifice any domestic political capital by scrapping this retrospective amendment. It’s a UPA-era law, piloted by a Congress minister that can undo much of the good work that Modi and his team have done over the last seven years.
However, there are two other issues that have not received adequate attention in the media. One is a “Brexitesque” argument – the soverign right of the Indian Parliament to make laws as it sees fit; this includes the right to levy taxes. The arbitration awards can be interpreted as abridging this right. By seeking ways to challenge this narrow but significant aspect of the recent ruling, the Modi government is following the instinct of most self-respecting governments anywhere in the world.
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Then, there is also the issue of optics. And these days the optics out of India haven’t always been great. Paying out billions of dollars to foreign companies in the middle of a debilitating pandemic will not go down well with the voters. Therefore, such a decision will be politically difficult to justify at this time even though it is an unwelcome legacy of the previous government that Modi would be all too keen to brush away.
India does need to bury the spectre of retrospective tax once and for all – but the timing may need to be politically calibrated, and I suspect that this will be in the minds of the powers that be in Delhi.
Foreign companies will need to mix their persistence with a healthy dose of patience – at least for now.