Taxation Laws (Amendment) Act, 2021 In Reference to Cairn And Vodafone Dispute

[By Anshika Agarwal & Shubhi Singhal]

Anshika Agarwal is a student at GGSIPU, Vivekananda Institute of professional studies, New Delhi and Shubhi Singhal is a student at the National Law Institute University, Bhopal. 

Introduction

Taxability of income arising from the indirect transfer of assets situated in India has been a subject matter of disputes for quite along. The issue has once again come into light with the introduction of the Taxation Laws (Amendment) Bill, 2021by the Finance Ministry on 5 August 2021. It was on 13 August 2021 that the said Bill received the President’s assent and the Taxation Laws (Amendment) Act, 2021 was notified. The said Act seeks to amend the Income Tax Act, 1961 (hereinafter “principal act”) and the Finance Act, 2012, thereby, cancelling the retrospective tax liability arising from the indirect transfer of the assets located in India. This means that all the tax demands raised for transactions relating to the transfer of Indian assets before 28 May 2012 will be nullified. The amendment can be perceived as a resolution mechanism in ending the far stretched Vodafone and CAIRN Energy tax disputes. The article aims to analyse the events leading to the introduction of the Taxation Laws (Amendment) Act and its overall impact.

Laws Prior to the Finance Act 2012 and Their Repercussions 

The principal Act of 1961 vide its Section 9 enlisted certain incomes, that were deemed to have arisen or accrued in India, to determine the scope of the taxability of the total income. As per Section 9(1)(i), incomes arising from or through an indirect or direct transfer of any capital asset or any property situated in India or any business having a connection in India will be deemed as income arising in India. The said transactions will be taxable for all the three categories of persons, i.e., Resident ordinarily resident (R-OR), Resident Non ordinarily resident (R-NOR) and Non-Resident (NR).

The Vodafone Dispute

The said provisions were, however, unclear to an extent that they failed to resolve the questions with respect to the taxability of income arising from the transfer of shares of a foreign company income.

The said issue was first raised in 2006 when a foreign-based company Hutchison Telecommunications International Limited (hereinafter “HTIL”) transferred its foreign subsidiary’s share capital to Vodafone International Holdings. The said transaction entitled Vodafone to a controlling interest of 67% in Hutchison Essar Ltd., an Indian based joint venture. It was in 2007 that the cause of action arose when Vodafone failed to deduct tax from its gains arising from the indirect transfer of Indian assets to HTIL. On account of this non-compliance, a due notice was served by the Income Tax Department to Vodafone. The matter went up to the Supreme Court and was finally decided in the favour of Vodafone.

Judicial Approach to the Vodafone Dispute

In this case, i.e., Vodafone International Holdings B.V v. Union of India, the apex court ruled that since Section 9(1)(i) does not cover indirect transfers of capital assets/property situated in India and the said transfer being an indirect one could not be charged under the head capital gains. Therefore, in the present matter, Vodafone was not liable to deduct tax from its gains arising from the purchase of a 67 per cent stake in Hutchison Whampoa for $11 billion. The Court further observed that the expression “through” in Section 9 does not mean “in consequence of”.

To circumvent the implication of the above decision, the Indian government came up with The Finance Act, 2012 which amended Section 9 of the principal Act.

Laws as per Finance Act, 2012

The 2012 Act inserted Explanation 4 and Explanation 5 to Section 9(1)(i). The ambiguity that arose in the Vodafone case regarding the interpretation of the expression “through” was clarified by inserting Explanation 4 to Section 9(1)(i). It stated that, the expression “through” shall mean and include, and shall be deemed to have always meant and included, “by means of”, “in consequence of” or “by reason of”. By doing so, the Act imposed a retrospective tax on the indirect transfer of capital assets. This implies that an asset or a capital asset shall be deemed to be and shall always be deemed to have been situated in India if they derived their value “substantially” from the assets located in India, either directly or indirectly. Therefore, any capital gains arising from the transfer of such assets being any share or interest of an offshore company as well as the transactions that took place between 28 May 2012 and 1962 will be taxable.

The CAIRN Dispute

With the commencement of the said legislation, issues with respect to the tax liability of the transactions undertaken prior to 28th May 2012 began to surface. A similar transaction was entered into by CAIRN UK Holdings Limited (hereinafter “CUHL”), a UK-based company.

CAIRN India Holdings Limited (hereinafter “CIHL”), a non-Indian wholly-owned subsidiary of CUHL was established in 2006 in New Jersey, USA. Further, CUHL transferred the shares of 9 of its subsidiaries to CIHL.

In the same year, another wholly-owned subsidiary named CAIRN India Limited (hereinafter “CIL”) was established in India. Eventually, CUHL sold shares of CIHL to CIL and a subsequent IPO offer was issued by CIL proposing 30% of its stocks to the Indian share market. As a result, CUHL experienced a gain of approximately Rs. 6,101 crores. Though quite late, this whiff of money being pocketed by CUHL reached the eyes, nose and ears of the Income Tax Department in January 2014 and a preliminary assessment of ₹10,247 crore as tax liability was imposed.

Arbitral Proceedings in the Matter of CAIRN and Vodafone

After failure on the part of Indian courts to settle the disputes, Vodafone and CAIRN approached the Permanent Court of Arbitration in Hague, Netherlands. Herein, the court granted relief in favour of Vodafone and CAIRN ruling that the retrospective tax application of the Indian government is inconsistent with the “fair and equitable” provision envisaged under Article 3(2) of Bilateral Investment Treaty (BIT), entered into by India and UK. As a result, the Permanent Court of Arbitration ordered the Indian government to pay $1.2 billion in damages to CAIRN and an undisclosed sum to Vodafone.

The Taxation Laws (Amendment) Act, 2021

The high-profile disputes of Vodafone and CAIRN cost India its reputation in the international market. Moreover, when the country stands at the juncture of the Covid-19 pandemic with the GDP constantly plummeting, foreign investments became a need of the hour. As a result, a business-friendly dominion aiming to facilitate foreign relations and promote economic growth was introduced.

The Taxation Laws (Amendment) Act, 2021 nullifies the retrospective taxation liability with respect to the indirect transactions of Indian assets prior to 28 May 2012. For this purpose, the Act inserts proviso fourth, fifth and sixth to Explanation 5 of Section 9(1)(i). Accordingly, all the assessment or reassessment or orders which are pending or have been concluded, on fulfilment of conditions mentioned in proviso six, shall be deemed to never have been made or passed.

The conditions envisaged under proviso six are as follows:

  1. the assessee should either withdraw or submit an undertaking to withdraw any appeal filed before an appellate forum or any writ petition presented before the High Court or the Supreme Court against any order in respect of said income;
  2. the assessee should either withdraw or submit an undertaking to withdraw any claim arising out of any arbitration, conciliation or mediation proceedings or has given a notice in respect of any agreement entered into by India with any foreign country, whether for the purpose of protection of investment or otherwise;
  • the assessee should furnish an undertaking, waiving his right to seek or pursue any legal remedy or claim in relation to the said income; and
  1. such other conditions as may be prescribed.

It is further provided that when any amount becomes refundable to a person and the above conditions are satisfied, then such amount will be refunded without any interest.

The Way Forward

The 2021 amendment Act can be regarded as a welcoming step towards easing the burden of the Indian judiciary and thereby avoiding unnecessary far-stretched litigation.

The retrospective tax liability imposed by the Finance Act 2012 portrayed India as an unfriendly host for foreign investments. However, the 2021 amendment act brings in a much more predictable and certain tax regime. With this, one can expect a gradual increase in the domestic and foreign investments in the country, consequently, promoting the economic growth of India.

With this being said, it would be an interesting affair to see whether the energy giant CAIRN and Vodafone would opt for withdrawal of the arbitration process as they may stand to lose out the interest on the demand already paid.

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