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Tax Turmoil: Impact of the proposed retrospective amendment

April 30, 2012
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The central government’s recent proposal to tax overseas transactions involving local assets retrospectively has created an upheaval amongst industry groups in the country. Most experts believe that such an amendment would impact the certainty in the Indian tax law environment and undermine the role of the judiciary as its implementation would conflict with the Supreme Court’s recent verdict in the Vodafone-Hutchison case. Others believe that the amendment was long awaited; however, its timing is unfortunate. Industry experts share their views on the proposed amendment and its impact…




What are your views on the government’s proposed amendment to tax overseas transactions involving local assets retrospectively?

Aseem Chawla

While the Indian government may exercise its prerogative to further India’s source-based taxation by imposing tax on transactions that entail indirect transfer of underlying assets situated in the country, its attempt to do so retrospectively toys with the ideal of certainty, which is the foundation of any equitable fiscal system.

Vishal Gada

The proposal to retrospectively tax overseas transfers (involving underlying Indian assets) is unfortunate and would only bring in more uncertainty with regard to Indian tax laws. In today’s challenging times, when foreign investment is one of the key drivers of the country’s GDP, this is not a positive step.

N.C. Hegde

The amendment is retrograde as it seeks to tax indirect transfers. It also seeks to nullify a ruling by the Supreme Court. This is most unfortunate as it undermines the role of the Indian judiciary.

Vishal Malhotra

The proposed amendment has created a lot of uncertainty for multinationals operating in the country.  The controversy surrounding the indirect transfer of shares, which was seemingly settled by the Supreme Court judgment in the Vodafone case, is running rife again. While the investor community is not averse to the taxation of indirect transfer of interests, the proposition to tax such transfers prospectively would perhaps not have caused as much distress as the retrospective amendment proposal has caused.

The amendment as well as certain other proposals which are to be introduced with retrospective effect, such as taxation of payments for software and process royalties, are completely retrograde and disregard the decisions pronounced by the Indian judiciary.

Further, a validation clause has been proposed, which validates all tax demands raised and notices issued by the revenue authorities in connection with indirect transfer of assets. The consequence of the validation clause would be to nullify the impact of all judgments and court orders.

India has been trying to project itself as a mature economy with sound tax laws and a judicial system with the power to implement the rule of law. However, the retrospective amendments, which appear to indicate the government’s disagreement with the Supreme Court’s judgment, together with the validation clause have completely unsettled such a perception.

Janmejay Rai

The proposed amendment is not completely unexpected. The industry should not be surprised as there is always a possibility of the government introducing changes in tax policies. However, the timing of such a proposal is unfortunate as it clashes with the recent verdict of the Supreme Court in the Vodafone-Hutchison case.

The Income Tax Act was put in place in 1962, when there were not many instances of indirect transfer of assets. Over the past two decades the country has witnessed several such transactions, so the government should have been proactive with regard to amending the laws earlier. This amendment should have been in place several years ago.

However, to say that such a proposal is a bolt from the blue would not be right. The government permits tax planning but taking advantage of the loopholes in the Income Tax Act to not pay taxes is not exactly tax planning. For instance, in the McDowell and Company versus Commercial Tax Officer case, the Supreme Court held that the principle of “substance over form” should be taken into account while considering any transaction.

The substance in the Vodafone-Hutchison case was that the transaction took place overseas and was without any commercial substance since the assets being transferred were located in India. Thus, Hutchison, which earned capital gains, avoided taxes in the host as well as the home country. The Supreme Court’s ruling in this regard, though, was different. Further, Vodafone took an indemnity from Hutchison that any loss arising from the taxes would be borne by the latter. Hence, Vodafone was not completely unaware of its exposure if such an amendment was enacted. Going forward, the government is highly unlikely to rollback its proposal.

What are the key issues with this proposal?

Aseem Chawla

The primary issue with the proposal to tax indirect transfers of underlying assets situated in India is its retrospective application and the concomitant disability it has imposed on several taxpayers in calculating their tax liability. Furthermore, the proposed legislation is drafted in wide terms, thereby encompassing the transfer of any share or interest in an offshore company that derives its value from assets located in India. The Ministry of Finance’s intermittent reassurances to the investor community that the proposed legislation would be used sparingly offers little solace, given the wide and empowering language of the proposed legislation.

Vishal Gada

Not only is the retroactive aspect of the proposed legislation discouraging but the draft amendment also lacks clarity, which is likely to give rise to interpretation issues. It is debatable whether the provisions can compel a payer to withhold taxes for transactions that occurred in the past. Also, there is lack of clarity with regard to transfer of overseas assets deriving “substantial value” from Indian assets.

N.C. Hegde

The proposal seeks to legitimise the tax revenue demands made on several foreign companies that were involved in the indirect transfer of assets. This would mean significant revenue for the tax department on indirect transfers.

Vishal Malhotra

The amendment proposed in the Finance Bill, 2012 would create the impression that a share or interest in a company/ entity registered/incorporated outside India is situated in India, if the share or interest directly or indirectly derives its value substantially from assets located in India. However, what would constitute “substantial” has not yet been specified. This would create uncertainty amongst the investor community.

Further, the explanatory memorandum to the Finance Bill states that it was and had always been the intention of the legislature to bring within the ambit of taxation, transactions involving the indirect transfer of Indian assets. If such was the intention of the legislature, the amendment could have been introduced much earlier so that the investor community could plan its businesses accordingly. In addition, as stated above, the retrospective nature of the amendments proposed by the Finance Bill is the biggest issue threatening the corporate world. The amendment is a short-sighted measure aimed at making a short-term gain, without realising the potential impact it could have on the Indian economy in the long term.

If approved, how significant will its impact be on foreign investment inflow into the Indian telecom sector?

Aseem Chawla

More than the particular proposal, it is the government’s uncertain policies that are likely to result in a decline in foreign investment inflow. Foreign investors feel secure as long as they are in a position to envisage the costs entailed in making investments in the country, before making the economic decision to do so. However, little can be done in a situation where there is no objective criterion on which the investor can rely to ascertain the fate of their investment.

Vishal Gada

The Indian telecom sector is already plagued by various regulatory issues, so it would be difficult to predict the impact of this specific proposal on the sector. However, the proposed amendment only adds to the fire.

N.C. Hegde

The amendments should not have a significant impact on foreign investment movement directly. However, the retrospective amendments would create the perception that the country is not business-friendly, which would impact foreign investments.

Vishal Malhotra

The retrospective amendments proposed in the Finance Bill are a major concern for corporates. The government has shown a complete disregard for the Indian judicial system by making these amendments retroactive in application. This would also significantly increase the risk profile of India as an investment destination.

Janmejay Rai

The amendment is not likely to have a major impact on any sector as it is the size of the Indian market that is the biggest attraction for any foreign investor.  Certainty in a country’s tax laws is important to attract investments; however, it is just one of the several criteria that an investor considers before entering a country.

In fact, the amendment, once passed, is likely to bring clarity to the Indian tax environment and may even provide a fillip to investments in the country as investors would be fully aware of their exposure.

Besides Vodafone India, which other companies are likely to be impacted by the proposed legislation?

Aseem Chawla

The Vodafone tax controversy is one of the several cases that entailed indirect transfer of underlying assets in India. Other reported Indian tax controversies similar to this involve companies such as GE, SAB Miller, Cadbury, AT&T, Sanofi and Vedanta.

N.C. Hegde

This information is not available in the public domain. Newspaper reports have spoken of some deals that are currently under the scanner for indirect transfers. However, one does not know if the information is accurate.

Vishal Malhotra

Apart from reopening the Vodafone case, this move by the government could embolden the revenue authorities in its tax cases against companies such as AT&T Inc. and SAB Miller. These cases are at various stages in Indian courts and the companies’ positions could be adversely affected.

Janmejay Rai

Some other cases to be affected by the retrospective amendment are Krafts-Cadbury, SAB Miller-Foster’s, the GE-Genpact deal, and the Tata and the Aditya Birla groups’ acquisition of AT&T’s stake in Idea.

What is the international experience on similar proposals?

Aseem Chawla

India is certainly not the only nation that is aggressive with regard to source-based taxation. The Jiandu City State Tax Bureau in the Jiangsu Province, China, collected approximately $25.4 million as capital gains tax on an indirect transfer of 49 per cent equity interest in a Chinese company pursuant to the Guoshuihan (2009 No. 698 “Circular 698”) which had been issued to deal with “indirect offshore share disposals” undertaken by investors.

Similar cases have been noted worldwide, for instance the Heritage Oil and Tullow Oil case in Uganda (January 2010) wherein capital gains tax was sought to be imposed on a transaction implemented outside the country. Peru has also enacted a law (Law 29663) with effect from February 16, 2011, which widens the scope of income that qualifies as a source income chargeable to tax in order to bring capital gains derived from an indirect transfer of shares within the ambit of the country’s tax net.

Vishal Gada

China seems to have taken a similar line, though it has not attempted to tax any transaction retrospectively.

N.C. Hegde

Many countries do not tax such kind of indirect transfers. China has recently enacted a law to tax indirect transfers. Some other countries tax indirect transfers, where the underlying assets involve transfer of real property.

Vishal Malhotra

Though gains on indirect transfer of interests are subject to taxation in some foreign countries such as the US, Australia and Canada, the laws of these countries lay down clear conditions subject to which such transfers are taxable.

For instance, under Australian law, the disposal of a non-portfolio interest (a direct or indirect holding of 10 per cent or more) in an Australian or foreign entity by a foreign resident is subject to capital gains tax if the value of the entity’s assets is principally derived from Australian real property.

In most economies, for instance the US and the Netherlands, retrospective amendments of anti-tax payer provisions are rare. In Germany, the government is very careful with retroactive tax legislations, and generally avoids them. In such economies, retrospective amendments are, at best, implemented from the date when the proposal was placed in the public domain.

Janmejay Rai

China has made a similar amendment to its taxation policy recently to tax gains arising from indirect transfer of underlying assets in the country.

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