The Vodafone Case & Retrospective Amendments to Income Tax Act
March 29, 2012
On January 20, 2012, after extensive hearings from August to October last year, the Supreme Court rejected the Income Tax (IT) Department’s claim of jurisdiction over a share transfer carried out overseas, under which Vodafone was served a notice to pay withholding tax of about $2.2 billion. The judgment was a landmark, based on the court’s interpretation of Sections 5 and 9 of the I-T Act, that the Indian authorities did not have the powers to tax the 2007 Cayman Islands transaction under which Vodafone Group Plc entered the Indian mobile phone market. The court also directed the IT Department to return $495 million to Vodafone with 4 percent interest.
However, on March 16, following the Budget speech of the Finance Minister, the government announced that it will seek a retrospective amendment to the IT Act of 1961 to bring such deals under the tax jurisdiction of the state. The amendment in the Income Tax Act would come into effect retrospectively from April 1, 1962 and will “accordingly apply in relation to the assessment year 1962-63 and subsequent assessment years,” says the Memorandum to the Finance Bill, 2012, to all past transactions concerning assets in India.
What does this seek to do?
Under the proposed amendment, all persons, whether resident or non-residents, who have business connection in India will be required to deduct tax at source and pay it to the government even if the transaction is executed on a foreign soil. The amendment will apply to all past transactions concerning assets in India. Vodafone argued that the government had no jurisdiction over a transaction between two foreign companies occurring on foreign soil. For now, if the amendments were to be enacted into law, Vodafone could face a tax bill of at least $2 billion for the near $11.2-billion deal with Hutchison in 2007.
What prompted this move?
Despite the denial by the Finance Minister Pranab Mukherjee that this was not ‘case-specific’, the most immediate compulsion behind this amendment appear to be the recent court reprieve granted to Vodafone. The government wants to ensure that cross-border transactions such as the $11.08 billion Vodafone-Hutchison deal are taxable, and that it does not lose out on revenue on offshore deals, by bringing all future transactions under the tax net.
Have such amendments been made in the past?
Retrospective amendments to the I-T Act have been upheld by courts in the past. In 1987, the government retrospectively amended the Act to introduce a compulsory tax on offshore drilling contracts by increasing the number of nautical miles from shore that would be affected.
What is the significance of this amendment?
The amendment is crucial because a review petition by the government is currently pending before the Supreme Court, which might now have to consider the changes in tax laws when it revisits its judgment. It is possible that not just Vodafone, but even other large acquisitions of Indian assets would be up for review. Inflows from Mauritius currently top the list for FDI, and observers worry that even this much-favored route may be seriously affected. In cases where tax demands are contested in courts, the companies concerned may see their positions weakened.
Following the Vodafone judgment, analysts predicted that the government would introduce changes to bring such deals into the tax net in the future, but the retrospective clarification appears to have taken the industry and tax professionals by surprise. Vodafone’s counsel Harish Salve called it “waging war on foreign investment”. Some leading lawyers feel that this will not stand up to judicial scrutiny in the end, while others believe the move doesn’t amount to an amendment to the law, but is just a “clarificatory legislation”.
The changes in the Income Tax Act, according to experts, will also have a bearing on about 500 overseas deals of similar kind, experts said. As per the proposed changes in the IT Act of 1961, any asset which is registered or incorporated outside India shall be deemed to be situated in India “if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.
What next?
The tax department has already sought a review of the Supreme Court verdict in the Vodafone case. The next few weeks could even see the tax department issue a fresh notice to Vodafone and the company challenging that notice. The retrospective amendment, if passed by Parliament, is likely to be challenged by Vodafone for its constitutional validity. If the constitutional validity is upheld, a host of other similar cases, too, will likely be affected. For now, in a note circulated by the Finance Ministry, the government sought to argue that the decision to amend the I-T Act with retrospective effect would not impact foreign investment flows.