Pragmatism prevails with the withdrawal of retrospective tax

I have been an enthusiastic supporter of the tax claim by the Government of India on Vodafone, which had been endorsed by the Bombay High Court, set aside by the Supreme Court and made tenable by a retrospective clarification in the tax law. The issue at stake is simple. GoI has a right to any kind of tax because it arranges the affairs of the nation in such a fashion as to allow the conduct of business and generation of profits.

Suppose fake police encounters, lynch mobs, and general lawlessness was the order of the day in Karnataka, Maharashtra, Andhra Pradesh, Telangana, Orissa, NCR and Tamil Nadu. Would India’s output be what it is today, and would anyone invest in the country?

When a Dutch subsidiary of the British telecom company Vodafone purchased the Hong Kong-based Hutchison’s entire stake in a Cayman-based company, CGP Investments, that owned 67% of the Indian telecom operator Hutch Essar, Vodafone got control of Hutch Essar. Hutch Essar remained majority-owned by CGP Investments.

Technically, Hutch Essar was not sold; its holding company abroad was sold abroad, the buyer and seller both abroad. Was such an indirect transfer of assets liable to capital gains tax in India when the company transferred owed its value primarily to economic activity in India?

Yes, said the tax department and wrote to Vodafone before they had made their final payment to Hutchison. The Bombay High Court agreed with the tax department. But when Vodafone challenged this view in theSupreme Court, the latter ordered that India’s tax law did not cover such a transaction abroad.

GoI made an amendment to the tax law, making indirect transfers of Indian assets liable to capital gain tax, and added the line that it had always been the intent of the law to make such transfers taxable in India. This provided a legal basis for taxing the Vodafone-Hutchison deal. Of course, the capital gain accrued

to Hutchison. But it was entirely open to Vodafone to withhold the tax amount from its payment to Hutchison and submit the tax so withheld to Gol.

So, the principled case for taxing the Vodafone- Hutch deal is clear. But then, GoI muddied it thoroughly.

One, by using the retrospective clarification to raise a tax demand on Cairn, which had reorganised assorted subsidiaries into a single entity, without any change in the ultimate beneficial owner. There is no reason to levy a capital gains tax on such a transaction. The increase in the value of the subsidiaries arising from reorganisation remains in India and could be taxed when the reorganised entity was sold. And this was what happened when Vedanta bought Cairn India.

Two, by burdening India’s telecom operators with wholly arbitrary charges on its adjusted gross revenues. Vodafone Idea has to pay Rs 58,400 crore as AGR dues, while its own estimate of its dues is Rs 21,533 crore. Such arbitrary levies on companies by the State undermine its claim to fairness.

The fact that the present political leadership, while in the Opposition, had been sharply critical of the tax claim on Vodafone and had used language such as tax terrorism made its own pursuit of the tax on Vodafone for its acquisition of Hutch Essar look opportunistic.

It should be noted that forgoing the tax claim on Vodafone will bring no direct relief to Vodafone Idea (Vi). Its financial troubles need to be addressed by conversion of a good part of the debt it owes the government into equity.

Vodafone had announced that it would not be in a position to pour any more money into its operations in India. Kumar Mangalam Birla has also disowned the company and asked GoI to take over his equity. The company desperately needs more than Rs 25,000 crore to tide over the next two months.

The removal of the retrospective tax demand is a peace offering to Vodafone, the British parent. It is an invitation to resume doing business in India. Whether it would prove, sufficient incentive remains to be seen. The present amendment being moved by GoI retains the 2012 amendment’s clarification that indirect transfers abroad of assets in India would be liable to tax, removing, as it does, only it’s retrospective application.

Many had criticised that 2012 amendment as bringing in tax uncertainty. The reality is that it had brought total tax certainty: if you buy or sell assets that accrue value primarily because of economic activity in India, you will pay tax in India. That should not be obfuscated.

(Views are personal)
Author T K Arun is widely read and is a senior member of the ET Bureau. The article originally appeared in Economic Times.