Analysing the Taxation Laws (Amendment) Act, 2021

[Arya Mittal is a 3rd year B.A., LL.B. (Hons.) student at Hidayatullah National Law University, Raipur. The author would like to thank Dr. Anindhya Tiwari for his valuable inputs in the article.]

The Taxation Laws (Amendment) Act, 2021 recently received the President’s assent. The amendment came nearly nine years after some provisions were introduced in taxation laws that retrospectively taxed indirect capital transfers. The 2021 amendment has nullified the effect of this retrospective imposition of tax. It is interesting to see the reason and implications of this amendment which forms the scope of the present post.

Vodafone Case

The ruling of the Supreme Court in Vodafone International Holdings B.V. v. Union of India represents the inception of certain conflicts in question. Herein, Vodafone International Holdings B.V., a company incorporated in the Netherlands, acquired CGP Investment Holdings Ltd., a company incorporated in the Cayman Islands. CGP had a substantial controlling interest of 67 percent in Hutchison Essar Limited, an Indian company. As a result, there was an indirect transfer of Indian capital assets and an accruing income from the sale of such capital assets. The Indian income tax authorities contended that the same should be taxed as capital gain and that Vodafone was liable to deduct tax at source.

Negating the contention of income tax authority, the Supreme Court held that such indirect transfer of shares of an Indian company, through an international transaction, cannot be taxed as capital gain and would not fall under the purview of section 9(1)(i) of the Income Tax Act, 1961. It applied the ‘look at’ test and held that the transaction was a bona fide structured investment without any intention of avoiding the tax liability.

Amendments by the Finance Act, 2012

To invalidate the effect of the Vodafone case, Parliament introduced two significant amendments in taxation laws through the Finance Act, 2012.

The first change related to the insertion of explanations 4 and 5 in section 9(1)(i). Explanation 4 has been added, which makes section 9 a look-through provision, as it uses the words “by means of, in consequence of or by reason of”. In the Vodafone case, the Court rejected the contention of income tax authority that section 9 was a look-through provision. Rather, it adopted the ‘look at’ approach and, as stated earlier, held that the investment was a bona fide one without any intent of tax avoidance. Further, the Government considered that the insertion of explanation 5 was merely clarificatory in nature and, thus, it retrospectively taxed indirect capital transfer of shares situated even outside India, if a substantial interest is derived from assets in India. The effect of this amendment has been discussed in the subsequent section.

Secondly, section 119 of the Finance Act, 2012 validated such taxes in nature of a capital gain which occurred by way of indirect transfer of capital assets. The provision nullified the effect of the Vodafone case by inserting a non-obstante clause. Thus, notices sent by income tax authority and levy, demand, assessment, imposition, collection or recovery of tax in this regard, were made applicable retrospectively.

Analysis

Taxation Jurisprudence

The taxation laws are often juxtaposed with criminal laws and, hence, retrospective amendments create a level of concern with taxation laws. On various occasions, the legislature has introduced taxation laws with retrospective applicability, and they have been upheld by the courts. Nevertheless, it is imperative to note the decision of the division bench of the Supreme Court in Commissioner of Income Tax v. Avani Exports, where it recognised that retrospective amendments can be brought by the legislature, but that such amendments should not be detrimental to the assessees, even if they are fewer in number.

Canon of Certainty

One of the canons of taxation, as enunciated by economist Adam Smith, is certainty. The levy and collection of tax should be certain and not unreasonable in nature. There ought not to be ambiguity and arbitrariness regarding the tax liability of a taxpayer. The same has been upheld by the Supreme Court recently in South Indian Bank Ltd. v. Commissioner of Income Tax. The verdict of the Court clearly indicates the applicability of principles of taxation in the Indian regime and, thus, it is the duty of the Government to uphold the same.

Retrospective application of taxation laws would be against the principle of certainty. Nevertheless, with the enactment of the 2021 Amendment Act, this legal defect has been cured as the statute has clarified that the tax will not be imposed retrospectively, and that any pending or concluded assessment shall be disposed of as discussed hereafter.

Interpretation of Section 9(1)(i)

The provision uses the word ‘indirectly’ while stating what forms a part of Indian income. However, it is important to understand the rationale behind using such a term before reaching any conclusion. The reason is to avoid a person (engaging in an offshore transaction) from escaping tax liability on income that is within the Indian jurisdiction. To simplify, it should not be a “sham or preordained tax avoidant transaction” as held in the Vodafone case.

Moreover, a bare reading of section 9(1)(i) without explanations 4 and 5 would reveal that the provision takes a ‘look at’ approach and not a ‘look through’ approach. Even if it has been the intention of the legislature to take the latter approach, it should be provided explicitly in the statute to keep it in conformity with the principle of certainty. Therefore, in such a scenario, a retrospective application should not hold good and the 2021 Amendment Act has justified the same.

Effect on Assessments

As regards pending assessments, the fourth proviso to explanation 5 of section 9(1)(i) stipulates that any assessment, reassessment or order in respect of income accruing from indirect transfer of capital assets situated in India shall not be subjected to any tax obligation and would automatically be disposed of if such transfer has taken place before May 28, 2012.

Further, the fifth proviso stipulates that in the case of concluded assessments, i.e. where assessment, reassessment or order has already been passed and such person has paid tax on any such indirect transfer which took place before May 28, 2012, such person shall be entitled to refund. However, the person shall not be entitled to receive any interest on the refund amount as provided in the sixth proviso.

Effect on International Relations

India has been a part of several trade and investor protection treaties and the discussed amendments of 2012 have been in contravention of these treaties. Consequentially, these treaties were invoked by parties before arbitration tribunals. Further, it would have severely affected the trust of potential foreign investors to make investments in the country and affect the country’s rank in the Ease of Doing Business Index. Hence, it was important to nullify this retrospective effect of laws.

Conclusion

The introduction of the Taxation Laws (Amendment) Act, 2021 has been a right step by the Parliament in regards to invalidating the retrospective effect of the 2012 Finance Act. Retrospective application of taxation is clearly against the principle of certainty and, therefore, should not be prevalent in the Indian taxation system. Further, nullifying this retrospective application would surely yield benefits for the economy as it will help to regain the trust of foreign investors.

Arya Mittal

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