Explained | What is retrospective tax and why the Centre buried it

The Government of India on Friday passed a Bill in the Lok Sabha that buries a controversial tax law that put Centre in an ugly legal spat with companies like Cairn and UK's telecom giant Vodafone.

'The Taxation Laws (Amendment) Bill, 2021' aims to refund Rs 8,100 crore collected in a 2012 retrospective tax law on indirect transfer of Indian assets prior to May 28, 2012.

Termed "tax terrorism" by some, retro tax cases were overturned by international arbitration tribunals in two high profile cases -- Vodafone and oil producer Cairn Energy.

Centre has long stood for its "sovereign right to tax," but by eradicating the law, new doors of certainty open for investors thus removing ambiguity over taxation in India.

The tax law remains intact prospectively, meaning the sale of shares of a foreign entity is taxable in India if those shares garner value from assets in India.

What is retrospective tax and where did it all began?

A retrospective tax is a tax imposed on a transaction or deal that was conducted in the past. It was introduced in a 2012 amendment to the Finance Act, which enabled imposition of retrospective tax on deals executed after 1962 involving transfer of shares in a foreign entity which had assets in India.

In 2007, Vodafone acquired Hutch for an $11 billion deal through an overseas holding company. (A subsidiary of Vodafone bought Hutchison's entire stake in CGP investments, which owned 67 per cent of the telecom operator Hutch Essar)

India sent a notice to the UK telecom company saying it should have withheld tax on the purchase and sought Rs 11,218 crore, later added Rs 7,900 crore in penalties.

Vodafone challenged the notice in Supreme Court and subsequently, the judgment favoured the company. The government then, under Pranab Mukherjee as Finance Minister, amended the tax law retrospectively, providing a legal framework for the government's demand.

Also read: Tax move may not be enough to repair India’s bad reputation

Curious case of Cairn

While the case of Vodafone involved a purchase, Cairn entered tax authorities' crosshair when it reorganised its subsidiaries. In 2006-2007, the Cairn UK transferred shares of Cairn India Holdings to Cairn India. The government decided the company had made capital gains out of the process and sought taxes. By March 2015, the government demanded Rs 31,881 crores in taxes.

When Cairn was to sell its final 10 per cent stake in Cairn India Ltd to Vedanta Resources Ltd in 2014, the government invoked the retrospective law to attach the stake and to later, sell it.

The company moved arbitration and the international tribunal asked the Indian government to return the value of the shares it had seized and sold, tax refund withheld and dividend confiscated to enforce the retrospective tax demand.

Centre refused to respect the order and Cairn moved a US court and sought to seize assets of Air India, as the airline is a public entity. A French court then ruled in favour of Cairn, which can freeze 20 Indian properties in Paris to recover Rs 8,897 crore plus interest and penalties.

Tussle's impact

The order endangering sovereign assets was largely seen as a dent on an emerging power like India. Especially when the country is trying to portray itself as an investment destination on its road to recover from the economic impact of the Covid-19.

The new law proposes to refund the taxes collected under the legislation, with Cairn being a major benifeciary of about Rs 7,900 crores, without interest, provided the taxpayer withdraws all legal cases.

“This retrospective clarificatory amendment and consequent demand created in a few cases continues to be a sore point with potential investors,” Sitharaman said