Is the regime over?

The recent advice of Attorney General Mukul Rohatgi not to pursue the Vodafone transfer pricing case against the judgment of the Bombay High Court reflects the motive of the government.

If the government finally decides on the advice, investors may see that decision as a signal that the fear of the retrospective tax is almost over.

Union Finance Minister Arun Jaitley has expressed this opinion on many earlier occasions and almost scrapped the retrospective tax in his first budget (but made clear that pending cases will not be squashed). He made clear that the new government will provide a stable and predictable taxable regime and suggested that all cases arising out of retrospective amendment of 2012 will be scrutinised by a high level committee to be constituted by the Central Board of Direct Taxes (CBDT) before any action is initiated.

This constitutes a strong indication from the finance minister—without abolishing retrospective tax, which was passed by parliament—that no new retrospective tax notices would be given without CBDT screening and that he hopes for an early resolution of ongoing tax cases.

Now, the move by the attorney general, implemented against the wish of the tax authorities, will certainly make it clear that the present government is committed to a stable tax regime. The decision on the Vodafone case is significant, as it would also have implications on other ongoing cases, against Shell India, HSBC Securities, Essar Group firms and other two dozen companies. It seems the government may decide in favour of Vodafone, as the court has made it clear that the Vodafone case is not about capital transactions and, therefore, taxing according to transfer pricing norms does not stand.

The debate over retrospective tax and the fear of investors, particularly foreign investors, started in 2012. The introduction of the General Anti Avoidance Rule (GAAR), its amendments and subsequent postponement resulted in a lot of speculation about the retrospective tax regime. In 2007, Vodafone bought a company in Cayman Islands which had shares equivalent to 67 per cent stake in Hutchison Essar, a mobile operator in India.

Therefore, it was an indirect purchase by Vodafone, where the Indian company Hutchison Essar was not involved. Neither company is Indian, but Vodafone has been accused of avoiding capital gains tax of $2.6 billion at the time of purchase. Taxmen suggest that underlying investment in India and the appreciation of value accrued due to facilitating policies and infrastructure provided by the Government of India over the years, make for logical case for Vodafone to pay capital gains tax.

A 1961 tax law with retrospective effect could result in Vodafone paying taxeson a transaction to buy a controlling stake in the Indian mobile phone unit of Hong Kong-based Hutchison Telecommunications International Limited (HTIL). The 2012-13 budget had proposed to amend 1961 tax law.

Earlier, the court had ruled in favour of Vodafone and instructed that the government cannot levy capital gains tax on an overseas sale or share transfer where the underlying assets are in India. The Finance Bill 2012, in some way, violated the legal protections granted to the company under an international investment treaty. This has created vulnerability among foreign investors and reflects lack of policy stability in India.

The introduction of the GAAR, which comes from the Direct Tax Code (DTC) 2009, could override any other existing international investment treaty/law, and implies that any transaction under the Double Taxation Avoidance Agreement (DTAA) treaty could be overruled. This has further aggravated the situation. The difference between the GAAR and the DTAA is not healthy for foreign investors.

The amendments proposed to the GAAR in 2012 include taxing shares and funds, which may be owned by a foreign entity, where the underlying investment is in India or derives value from assets located in India. The proposal included a case-by-case evaluation of change of ownership and an extension of the time limit for re-assessment of tax liability to 16 years.

Tax benefits

The GAAR would make the law effective retrospectively, to reduce tax avoidance which is happening through round tripping, black money, tax avoidance deals, transfer pricing, etc. by empowering tax authorities to deny tax treaty benefits. It is meant to deny tax benefits for transactions or arrangements which do not have any commercial substance or consideration other than achieving the tax benefits.

The GAAR empowers the authorities to tax ‘impermissible avoidance agreements’ unless the person obtaining tax benefit proves that obtaining the tax benefit was not the main purpose of the arrangement. Impermissible transactions are those that disguise the value, location, source, ownership or control of funds, and location of asset or transaction or place of residence party which would not have so located for any substantial commercial purpose.

An expert committee headed by Parthasarathi Shome sought feedback on the GAAR from stakeholders, studied its provisions and proposed that the GAAR be made effective from April 2012, but deferred by one year. Finally, it is to be effective from April 2016.

The committee also proposed that tax on capital gains from listed securities be abolished; places like Mauritius and Singapore be kept out of the purview of the GAAR; the GAAR should not apply to tax benefits exceeding Rs 3 crore, P-notes through FII, or to those who avail tax benefits under tax treaties, and that investments made before 2010 will not be scrutinised.

Overall, there have been effort to assure foreign investors not to worry about the retrospective tax, and the immediate fear would go away if the government does not appeal against Vodafone.  However, tax avoidance is a serious issue and many countries have laws against it.