The impact of the retrospective tax

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Earlier this month, India made waves in the business world by announcing the removal of one of its most controversial tax laws. Retroactive tax law. This law led to a bitter legal battle between giant foreign investors and India for nearly a decade and tarnished India’s image as an investment hub. India has not only abandoned this controversial policy, but the Ministry of Finance has also announced the full reimbursement of the principal to litigants. While we will briefly dwell on why this law came into being, this article will also cover the reasons why it will be removed and its potential impact on the Indian economy.

Retrospective tax: a quick overview

In May 2007, when telecommunications giant Vodafone bought a controlling stake in Hutchison Whampoa for $ 11 billion, the Indian government demanded 7,990 crore yen in capital gains and withholding tax from Vodafone. They cited that the organization should have withheld tax at source before making a payment to Hutchison. In the same year, Cairn UK transferred shares from Cairn India Holdings to Cairn India. Almost immediately, the Indian Income Tax Department demanded 24,500 yen crore. These claims were contested in a legal battle by Vodafone and Cairn.

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Vodafone won when the Supreme Court of India ruled that the group’s interpretation of the Income Tax Act 1961 was correct in 2012. However, the court also ruled in favor of Cairn and ordered the Indian government to pay them $ 1.23 billion in damages, plus costs and interest. As a counter-offer to circumvent the Supreme Court’s ruling, then-finance minister Pranab Mukherjee proposed amending the finance law. This ruling gave the Indian Department of Income Tax the power to retrospectively tax companies that merged in 1962 if the underlying asset was present in Indian territory.

Impact of the retrospective tax

The retrospective tax meant that the government could impose and collect a tax on a transaction or transaction that had taken place in the past. It is not a rare event. There have been cases of retrospective changes to tax laws, but the changes have been clarified each time this has happened. In this case, it was pretty obvious that the amendment made by the Indian government in 2012 was aimed at overcoming the Supreme Court ruling in the Vodafone case. This has led to much criticism of the Indian government at home and abroad. While it is debatable whether or not a country should impose a retrospective levy, the context of the levy in this case made the whole scenario entirely controversial.

The Indian government admitted that this decision turned out to be quite counterproductive. Moreover, the retrospective tax has led to a maze of complicated international arbitration proceedings, declaring that the tax violates the fair and equitable treatment promised by several bilateral investment protection treaties.

What changed?

In a word? COVID-19 has arrived. The Indian economy contracted 7.3% in the fiscal year ending March of this year. At this point, the recovery of the economy is crucial. In a media statement, Minister of Finance and Business Affairs Nirmala Sitharaman said: “In recent years, major reforms have been initiated in the financial sector and infrastructure, which have created a positive environment for the economy. investment in the country. However, this retrospective clarification change and the resulting demand created in a few cases continue to be a sore point for potential investors. The country today finds itself at a time when a rapid economic recovery from the Covid-19 pandemic is the need of the moment, and foreign investment has an important role to play in promoting economic growth and faster job. “

India is potentially considering multi-billion dollar arbitral awards, some of which have been handed down in favor of parties like Vodafone and Cairn; not to mention the additional interest charges owed and legal fees – there will be a huge repayment liability. The loss of confidence of foreign investors wishing to invest in India adds fuel to this fire.

What impact will this have on our country?

Once the various companies have removed their limitations and presented an undertaking, they will no longer claim damages. In addition, the tax on indirect transfers of Indian assets from 1962 to May 2012 will be canceled. India has pledged to initiate any new litigation or appeal on indirect transfer disputes before May 2021. The Indian government will settle past disputes by refunding the full principal amount to organizations. At this point, India is unwilling to reimburse any interest or legal fees incurred in these high profile cases. The organizations have yet to respond to India’s proposal – it may cover some of the damage they have suffered, but not in full.

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As China and the United States clash over import and export control policies, several companies are looking to move their operations to other countries in Southeast Asia and South Asia. Therefore, the abolition of the retrospective tax is a welcome initiative and likely to attract the attention of foreign investors. Moreover, the new changes will end long-standing litigation and present India in a new light, hopefully as a fair and just tax nation.

India ranked 63rd out of 190 countries on the Ease of Doing Business scale, surpassing rank 77 by 14 in 2018. This was the fastest scale level for a large country in almost a decade. The removal of the retrospective tax is likely to be a cornerstone that could roll the dominoes and create an image of India as an investor-friendly nation. Hopefully this will lead to other important reforms to accelerate the growing interest in FDI, including better compliance with laws, efficient tax management and further digitization of tax operations.

The views expressed in this article are the personal opinion of Anil Paranjape, Independent Director of the Board of Avalara India.

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