The Taxation Laws (Amendment) Bill, 2021 ("2021 amendment") passed by the Lok Sabha will undo the retrospective taxation introduced by the Finance Act, 2012 ("2012 amendment"). The 2012 amendment had provided for retrospective taxation of income arising from the sale of interest in an overseas entity that derived, directly or indirectly, its value substantially from assets located in India. An entity was deemed to derive its value "substantially" from assets located in India if the value of such Indian assets exceeded ten crore rupees and represented at least fifty per cent. of the value of all the assets owned by the overseas entity
The 2012 amendment deemed the above clarification to have been in effect from the promulgation of the Income Tax Act on April 1, 1962. This meant that all transactions involving a transfer of shares or interest in foreign entities which derived substantial value from the Indian assets would be subject to capital gains tax in India, and interest amounts would be levied for delay in payments from the time the tax became due. This enabled Indian revenue to raise tax demands on all transactions that been consummated any time in the 50 years prior to the 2012 amendment, clearly standing the Smithian cannon of tax certainty on its head.
The 2021 amendment finally corrects the wrongs of the 2012 amendment by removing its retrospective effect. It provides that no tax demand will be raised in future based on the 2012 amendment for any overseas transfer of shares or interest undertaken prior to the date of the 2012 amendment, i.e., May 28, 2012.
Retrospective taxation, consequent demands, entirely avoidable domestic litigation and international arbitration has been a cause of severe criticism and embarrassment to the Government. Following the 2012 amendment, demands were issues in seventeen cases. Of these, two have been stayed by High Courts and arbitration was invoked in four cases under bilateral investment protection treaties. In two ongoing arbitrations (by Cairn Energy Plc and Vodafone Group Plc), international arbitration tribunals have ruled against the Government, further demonstrating the unfairness of retrospective taxation in a modern democracy governed by the rule of law.
The 2021 amendment finally provides the government an opportunity for course correction and much needed damage control. It provides that all tax demand notices based on the 2012 amendment shall be nullified if the taxpayer agrees to withdraw all legal proceedings challenging such notices in India or overseas, and furnishes an undertaking waiving its rights to pursue any such remedies or claims against the Government in India or overseas. If the taxpayer chooses to avail the benefit such nullification, any tax demand notice issued under the 2012 amendment would be nullified and any amount paid by the taxpayer under the 2012 amendment would be refunded, without interest.
Arguably, the 2021 amendment has come 9 years too late, but thankfully it is a case of "better late, than never". Reversing the retrospective effect of the 2012 Amendment, nullifying pending demands and offering to refund the amounts collected, all indicate towards a realisation that the government had lost far more than it thought it would gain from a legislative act aimed at reversing the Supreme Court's decision in favour of Vodafone. If Cairn agrees to take up the benefit of nullification provisions, and abandon its enforcement proceedings against the international assets of the government (e.g. aircrafts and overseas property owned by Air India), then it will allow the government to avoid more imminent embarrassment.
Finally, it will help in restoring tax certainty and credibility of the Indian legal system among international investors and help in attracting greater foreign investment, as the country recovers from the ravages of the Covid19.
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