International Tax Panorama

Vodafone Group Plc has finally won a decade-long battle against the Indian tax department’s demand arising from its retrospective tax law. The Permanent Court of Arbitration in the Netherlands passed an order in favour of Vodafone and directed the Indian government to cease any tax demand, interest and penalty against the company. Also the tribunal held that any attempt by India to enforce the tax demand would be a violation of India’s international law obligations. The tribunal also directed the government to reimburse 60% of Vodafone’s legal costs and 50% of the fees paid by the company to the appointing authority.

Brief Background of the case

In 2007 Vodafone International Holdings BV had acquired the entire share capital of CGP Investments (Holdings) Ltd. located in Cayman Islands. As a result of this offshore transaction, Vodafone effectively acquired a 67% interest in Hutch Essar (Indian company) from Hutchison Telecommunication International Ltd. The revenue department sought to tax on the basis that the underlying asset of the offshore transaction between two non-residents was in India, and asked the Netherlands-based holding company to pay capital gains tax of around Rs 12,000 crore plus interest and penalty.

Vodafone contested this demand, and eventually won against the tax department before the Supreme Court of India in 2012. The Indian Supreme Court ruled in favour of the taxpayer stating that this indirect transfer of shares was outside the tax jurisdiction of the Indian tax authorities and was thus not subject to any withholding tax in India.

Despite this ruling, the Indian government introduced retrospective amendments to its tax law that would have resulted in the Vodafone transaction’s being subject to tax in India. As a result, the Finance Act 2012 was passed, where retrospective amendments were made via clarifications to section 9. The act clarified that income deemed to be accruing or arising to non-residents directly or indirectly through the transfer of a capital asset situated in India is to be taxed in India with retrospective effect from April 1, 1962.  Once Parliament passed the retrospective amendment to the Finance Act in 2012, the onus to pay the taxes fell back on Vodafone.

As a result Vodafone Group  invoked Clause 9 of the Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995. The BIT strives to “encourage and promote favourable conditions for investors” of the other country. Under the BIT, the two countries would ensure that companies present in each other’s jurisdictions would be “at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other”.

Order under the  Permanent Court of Arbitration at The Hague 

The Court of Arbitration ruled in favour of Vodafone due to the violation of the BIT and the United Nations Commission on International Trade Law (UNCITRAL).

In terms of the BIT violations, the tribunal held that the tax demand by the Indian government through restrospective legislation, notwithstanding the Supreme Court’s order, is in breach of the guarantee of fair and equitable treatment laid down in Article 4(1) of the Agreement [India-Netherlands BIT], as is the imposition of interest on the sums in questions and the imposition of penalties for non-payment of the sums in questions.

So the arbitration tribunal held that since it had been established that India had breached the terms of the agreement, it must now stop efforts to recover the said taxes from Vodafone.

Impact of the case on the proposed Taxpayers Charter

The Taxpayers’ Charter was  launched by Prime Minister Narendra Modi on August 13, 2020 in order a maintain a balance between Taxpayer Responsibilities and Taxpayer Rights, with the overriding goal being that the tax system of a particular country, should be fair.  It is high time to include the “Right to certainty” as one of the rights of taxpayer under its proposed tax charter, which has been recognised in taxpayers charters by international organisation s (OECD) and different jurisdictions. 

Why Right to certainty needs to be included under the Taxpayers’ Charter ?

The right to certainty requires taxpayers to be assured of the correctness of information that will help them determining the tax consequences of actions to be undertaken. 

Owens argues that the notion of transparency should include clarity, simplicity and reliability. Furthermore, Owens correctly states that “greater transparency between the taxpayer and the tax authorities is a good thing as it will lead to greater mutual understanding, fewer disputes, and a relationship based on cooperative compliance”. Along the same lines, Gribnau argues that “some uncertainty about the meaning of the law is inevitable”. Furthermore, Gribnau properly addresses the difficulties for law-makers in balancing the inevitability of change and the need for legal certainty. Thus, it is required to maintain the balance between the need for jurisdictions to enforce their tax rules and the taxpayer right to have certainty as regards the tax rules applicable to their business activities. The problem get exacerbated when tax authorities lack technical knowledge and administrative resources to deal with abusive and aggressive tax planning. In order to implement right to certainty in true sense, there must be legal certainty and transparency on the part of tax authorities in terms of availability, clarity, simplicity and reliability of rules, including those containing anti-avoidance provisions.

How Retrospective legislation is a direct violation of the taxpayers’ right to certainty? 

A legislature may either introduce anti-avoidance rules with presumptions that will be later further fleshed out by the tax authorities, may change the rules retrospectively in order to tackle specific transactions, or may use anti-avoidance rules to justify expropriation for political reasons. In India, there was problematic application by the judiciary of transfer pricing rules in the Vodafone International Holdings B.V. case. The tax authorities tackled a holding company structure by applying a limitation on benefits provision through judicial interpretation in order to subject the taxpayer to withholding tax in India on the capital gains arising from an indirect transfer of shares. The Indian Supreme Court ruled in favour of the taxpayer on 20 January 2012, stating that this indirect transfer of shares was outside the tax jurisdiction of the Indian tax authorities and was thus not subject to any withholding tax in India.Despite this ruling, the Indian government introduced retrospective amendments to its tax law that would have resulted in the Vodafone transaction’s being subject to tax in India.

These was a watershed moment for foreign investors investing in India, as many became wary of the retrospective legislation. Implementation of Retrospective rules had an adverse impact on taxpayers right to certainty and also created an uneasy atmosphere of unpredictability that a State may use it as a last resort in order to overturn its own Supreme Court decision. 

GAAR and right to certainty

In order to overturn the Vodafone case, the Government introduced General anti-abuse rules (GAAR) under the Income Tax Act, 1961. The rules provide that an arrangement whose main purpose or one of the main purposes is to obtain a tax benefit and which also satisfies at least one of the four tests, can be declared as an ‘impermissible avoidance arrangements’, where the four tests are that the arrangement (a) creates rights and obligations, which are not normally created between parties dealing at arm’s length; (b) results in misuse or abuse of provisions of tax laws; (c) lacks commercial substance or is deemed to lack commercial substance; (d) is carried out in a manner, which is normally not employed for bonafide purpose.

However, it has been criticised that the rules confers wide powers with the tax-administration not just to disregard the actions of the taxpayers but also to interpret them in the manner which according to the tax-administration should yield the highest tax-revenue. The very fact that this exercise would be undertaken subsequent to the transactions having taken place and with the tax-administration antedating them post facto has an adverse bearing on the ‘principle of certainty’. In fact the omnipotent tool of GAAR enabling the tax-administration to mould the past in the manner which befits them would render the actions of the tax-payers as existing in a perpetual state of flux. Arguably the conferment of such wide powers upon tax-administration may create apprehension of exploitation and vindictiveness though the law. Hence GAAR hinges upon the right to certainty in the absence of any adequate safeguards to curb opportunistic behaviour by the members of tax-administration.

It is required to maintain the balance between the need for jurisdictions to enforce their tax rules and the taxpayer right to have certainty as regards the tax rules applicable to their business activities. 

Conclusion and Recommendations 

The ruling will come as a relief to the foreign investors, who were wary of investing in India as a result of retrospective tax changes. The verdict is definitely a blow for the aggressive position taken by tax department. The victory may finally signal an end to the constant retrospective tax changes made under the legislation that had damaged the reputation of the country for being aggressive. 

Hopefully, this award will impact other cases under arbitration being decided on retrospective amendment. On the other hand the government must ensure the right to certainty for its taxpayers via a taxpayers charter. 

In a statement after the ruling, the central government said that it will study the award and “consider all options and take a decision on further course of action including legal remedies before appropriate fora”. The Indian government could now either appeal the latest ruling in the Singapore High Court, or changes its tax law to make it prospective and not retrospective. However, the government must get rid of retrospective legislation, in the interest of maintaining taxpayers rights while complying with the international obligations. This will help to increase investors’ sentiments and further the narrative of ease of doing business in India. 

Right to certainty must be incorporated under the Taxpayers’ Charter. 

Right to certainty will help to  address the issue of retrospective legislation.

Also the tax authorities must be equipped with technical knowledge and administrative resources to deal with abusive and aggressive tax planning while interpreting GAAR or MLI PPT provisions. In order to implement right to certainty in true sense, there must be legal certainty and transparency on the part of tax authorities in terms of availability, clarity, simplicity and reliability of rules, including those containing anti-avoidance provisions.

Any Dispute resolution schemes must be bought forth with the primary aim to bring certainty for the taxpayers. For instance, schemes asking for deposit of additional amount in order to avail the benefits hinges upon the core issue of right to certainty.