Will retrospective amendment in Income tax Act will affect FDI – Is it specific to Vodafone case.

[C.A.Sapna Avasthi]

Government through its budgetary proposals in Union Budget 2012-2013 had proposed to levy tax on Merger & acquisition deals (M&A deals) involving overseas companies with interests in Indian firms. This step has been seen by corporates/investors and tax advisers as the move which will impact investments into the country and goes against the Supreme Court order that had held that the Hutch-Vodafone deal was outside the jurisdiction of Indian authorities as it was an "offshore" transaction.

Supreme Court on 20^th January, 2012, gave a landmark decision in case of Vodafone that it was not liable for withholding taxes on its 11 billion $ acquisition, in 2007, of a single share of a Cayman Islands company bringing a relief to foreign investors in India. See Vodafone International Holdings B.V. vs Union India & Anr (2012 - TMI - 208574 - Supreme Court Of India).

Crux of the case: Vodafone had entered into a Share Purchase Agreement with Hutchison Telecommunications International Limited ('HTIL') for purchasing the singular equity share of CGP Investment (Holdings) Ltd ['CGP'], a Cayman Islands based company. CGP in turn, directly and indirectly, owned approximately 67 percent of the share capital of Vodafone Essar Limited ('VEL'), an Indian entity. The acquisition resulted in Vodafone acquiring control over CGP and its subsidiaries, including VEL. The Revenue authorities issued a notice to Vodafone, treating it as an assessee-in-default for failure to withhold taxes on gains arising to HTIL on the transfer of shares of CGP. Revenue seeks to tax the capital gains arising from the sale of the share capital of CGP on the basis that CGP, whilst not a tax resident in India, holds the underlying Indian assets. Vodafone filed a writ petition before the Bombay High Court which was subsequently dismissed, but however, reversed by the Supreme Court on further appeal by Vodafone.

Supreme Court, consequently quashed the demand of nearly Rs. 12,000 crores imposed by way of capital gains tax holding that it would amount to imposing capital punishment for capital investment and directed Revenue to return the sum of Rs. 2,500 crores, with interest at the rate of 4% p.a. within two months from date of order. Aforesaid ruling has caused a deep hole in the kitty of the tax department.

Such slippage in direct tax revenue collection and increased subsidies has pushed the fiscal deficit to 5.9 percent of the Gross Domestic Product in the Revised Estimates for 2011-12. Consequently, the direct tax collection has fallen short by Rs 32,000 crore of the 2011-12 Budget estimates.

In view of the above facts, it was widely anticipated that the Government will incorporate a range of amendments in the Income-tax Act, 1961 while presenting the upcoming Union Budget of 2012-13 as a counter attack to the Vodafone ruling which it did and surprisingly from retrospective effect.

Section 2(14) of the Act dealing with the definition of 'capital asset' has been amended retrospectively w.e.f. 01.04.1962 by clarifying that the term 'property' as used in Section 2(14) includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.

Further, the definition of 'transfer' as contained in Section 2(47) has been amended retrospectively by clarifying that it includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterized as being effected or dependent upon or flowing from the transfer of a share or of a company registered or incorporated outside India.

Supreme Court in the aforesaid ruling accepted the contention of Vodafone that in the absence of 'look-through' provisions in Section 9 of the Act dealing with income deemed to accrue or arise in India, the substance of the transaction could not be questioned. Against this, Government has retrospectively amended Section 9 of the Act by clarifying that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India. However, the point in time when the above test has to be applied has not been clarified. Also, the meaning of substantial value is not clarified.

Amendments have also been made to tax withholding provisions to provide clarity that the obligation to deduct taxes at source as per Section 195 of the Act always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident irrespective of whether such person has a residence or place of business or business connection or any other presence in any manner whatsoever in India.

Aforesaid amendments were regarded by Ministry of Finance as not an "amendment" but a "clarification on what was already provided in the law". Finance Minister in its post-budget interaction asserted that the changes being sought are not Vodafone-specific but are an enabling provision to protect the fiscal interests of the country and avert the chances of a crisis. He clarified that India is a not a ‘no tax' or ‘low tax' or even a ‘tax haven.' Such amendments would bring tax certainty and would also make it clear that India has a right to tax similar transactions. It was further clarified that this would not mean that the government would start re-examining tax cases from 1962 onwards.

However, such proposals in Budget have earned all-round criticism at home and abroad. General apprehension is that the retrospective amendments would create negative sentiment for FDI and this would belittle India's attractiveness among foreign investors. If change in legislative intention is proposed it should be prospective in nature. "Supreme Court" is in fact the highest court within the hierarchy of many legal jurisdictions and has the final say on matters of the law. The purpose of such amendment seems to counter the judgment of Supreme Court. These retrospective amendments poses a great threat to legal system of country, legislation process, and judicial processes. This would certainly shackle stability and certainty of law.