The introduction of the Taxation Laws Amendment Bill, 2021, dated 6th August, 2021, is no less than a revolutionary move for various foreign investors considering their years of litigation against retrospective tax and the billions they have had at stake. To understand the implications of this Bill, it is imperative to provide the background and what the amendment entails.
Background
The issue of retrospective taxation first arose in the Vodafone International Holdings (Vodafone) and Hutchison Telecommunication International Limited (HTIL) case. HTIL, based in the Cayman Islands, sold its wholly-owned subsidiary, CGP Investments, to Vodafone. CGP Investments held a 67% stake in Hutchison Essar Limited (HEL), the leading telecommunication giant in India. Due to this, Vodafone got control of HEL. As a consequence of this transaction, India’s tax department served notice upon Vodafone, in 2009, to recover billions as taxes since it involved an indirect sale of Indian assets. However, Vodafone contented the claim because this transaction was essentially between two foreign companies. The Supreme Court of India held in favour of Vodafone because there was no mala fide avoidance of tax in the scheme of things and even dismissed the review petition filed by the Indian Government.
However, in 2012, the Government amended the Income Tax Act 1961 (the ITA) itself and gave it a retrospective effect. Due to the retrospective nature of the tax, the amendment validated the notice served upon Vodafone. Subsequently, the Income Tax department issued a fresh notice upon Vodafone for the same claim. Vodafone took the matter to the Permanent Court of Arbitration (PCA) at Hague under two Bilateral Investment Treaties (BIT) in 2014. The PCA ruled in favour of Vodafone in 2020. Aggrieved by this decision, India again challenged this arbitration award in Singapore.
Given this history of long-running disputes, the Taxation Laws (Amendment) Bill, 2021, brings an end to all the endless litigation related to the retrospective tax, not just pertaining to the Vodafone Group but also to various other companies such as Cairn Energy Plc.
Transfer of Capital Assets before 28th May 2012
The Taxation Laws Amendment Bill, 2021, proposes the following amendments:
- An income accruing or arising from the transfer of an asset or a capital asset situated in India in consequence of the transfer of a share or interest in a company or an entity registered or incorporated outside India, made before 28th May, 2012, is not taxable in India. Furthermore, any assessment, reassessment or order passed for such transfers made before 28th May, 2012, would be void ab initio. Due to this, if any amount becomes refundable to a person, it would be refunded on fulfilment of certain specified conditions mentioned in the amendment, without any interest.
- Withdrawal of any pending litigation before an appellate forum, any High Court or the Supreme Court, against any order in respect of the said income. Besides this, the person would also have to withdraw any proceeding for arbitration, conciliation or mediation under any agreement entered into by India with any other country, or territory outside India.
- A person would also have to furnish an undertaking to waive their right to seek or pursue any remedy or claim related to such income which may be available to him under any law for the time being in force.
Transfer of Capital Assets after 28th May 2012
The transfer of capital assets post 28th May, 2012, is covered under the explanations of Section 9 of the ITA, 1961, as below:
1. An asset or a capital asset, being any share or interest in a company, or an entity registered or incorporated outside India, shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest directly or indirectly derives its value substantially from the assets located in India.
This means that the transfer of assets directly or indirectly outside India is deemed to be done in India in case their value is substantially derived from the assets located in India. Therefore, such assets are taxable in India. The meaning of ‘substantially’ was also defined under Explanation 6 by the Income Tax Department.
2. The share or interest shall be deemed to derive its value substantially from the assets located in India, without reduction of liabilities (whether tangible or intangible), if the value of such assets:
- exceeds the amount of INR 10 Crore, and
- represents at least 50% of the value of all the assets owned by the company or entity.
Therefore, the value of assets shall be considered substantial in case it exceeds INR 10 Crore and represents more than 50% of the value of all the assets.
It is important to note that the explanation introduced by the Income Tax Department cannot override the Double Taxation Avoidance Agreement (the DTAA) between India and foreign countries. The company can avail benefits of the DTAA during the transfer of capital assets.
Lessons to be Learnt for the Transfer of Capital Assets
The important points to be considered before the transfer of capital assets from an Income Tax perspective are as below:
- India has an income tax treaty with countries, like Mauritius, Singapore, and the Netherlands, among others, which provide favourable income tax or protection, especially in case of the sale of shares. It is always important to structure the transaction through the country having favourable tax jurisdiction.
- The place of effective management and the control of the investments are required to be vested in the jurisdiction of the company which is investing and is recognized by the income tax authorities.
- The legal documentation and information regarding the transaction must be carefully structured by the parties so that the rights and obligations only come to vest between the Indian company and the company investing in India. In case of any change in parties or any clause of the erstwhile agreement, proper procedure as defined in the erstwhile agreement must be followed.
- The interested parties should approach the Indian Tax Department for an advance ruling for the applicability of income tax in India to the transaction. The Income Tax Act 1961 provides that the Advance Ruling Authority should pronounce its ruling within 6 months of the receipt of the application. The advance ruling is binding on both the applicant and the tax authorities to the relevant transaction.
- The buyer is under an obligation to make the payment to the income tax department in case of remittance outside India or foreign payments. Thus, to avoid the interest or penalties which may be imposed on the buyer as a result of the failure to withhold income tax, every buyer must seek indemnification from their seller. The indemnification can be endorsed by escrow under the terms of the contract.
- Multinational companies possess assets through subsidiaries or branches across the globe. Companies should segregate their assets and rights based on each jurisdiction. This would restrict the applicability of income tax on the assets and rights having the nexus with an Indian operation.
Conclusion
The Taxation Laws Amendment Bill, 2021 seeks to ‘make amends’ for the 2012 amendment and its repercussions –
- Firstly, by levying the tax applicable from 28th May, 2012, which was the date on which the 2012 Finance Act’s backing to the Indian Government’s tax demands through the retrospective tax application was implemented.
- Secondly, by rendering the retrospective claims invalid, it also brings an end to the multiple disputes running for years in various tribunals because it solves the cause of these disputes and, therefore, makes litigation futile.
- Lastly, it provides for the withdrawal of the pending litigations for claims regarding refunds.
Therefore, the issue of retrospective tax has been dealt with very holistically under the Bill and is a big step towards ending litigations that have been going on for years. However, it is important to note that the transfer of assets directly or indirectly outside India post 28th May, 2012, is deemed to be considered in India in case its value is substantially derived from the assets located in India. As such, such assets are taxable in India and it becomes important to evaluate the transfer of capital assets directly or indirectly situated in India.
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