A REQUIEM FOR THE RETRO TAX
The union government has cut its losses by axing the controversial retrospective tax on cross-border sale of assets. EPISODE #35
Dear Reader,
A very Happy Monday to you.
Last week was a golden moment for India. A 23-year old serving fauji from Haryana, Neeraj Chopra, ended India’s drought for a medal in athletics at the Olympics. And in style at that. Embedded in Chopra’s achievement is the emerging story of ‘New India’. One where the narrative is dominated by the long overlooked subaltern. This is the underlying political economy of the incredible achievements of not just Chopra but all the sportspersons who played their heart out for India at the Olympics. Salute!
Apart from this the big policy news was the decision of the union government to walk back the retrospective part of the law introduced in 2012 to tax the cross-border sale of assets. It was long overdue and has cost the country serious brownie points with international investors. It is the talking point of Capital Calculus this week.
A big shoutout to Kapil, Gautam, Premasundaran, Vandana and Aashish for your informed responses, appreciation and amplification. Gratitude also to all those who responded on Twitter and LinkedIn. It is key to growing this newsletter community. And, many thanks to readers who hit the like button 😊.
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PRANAB MUKHERJEE’S LEGACY
Last week, after dithering forever as it were, the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) finally moved to bury the amendment to the tax law allowing for retrospective taxation.
It is baffling why it took so long.
All the more since it was part of an election promise against “tax terror” made by the BJP in the run-up to its audacious win in the 2014 general election. The move had undoubtedly spooked foreign investors and eroded their faith in India abiding by the rule of law. Further, this amendment was implemented by the Congress-led United Progressive Alliance (UPA), a regime intensely disliked by the BJP. Hence the NDA would not have lost face if it had reversed the legislative amendment and blamed the outgoing administration for all the bad press. Yet they didn’t!
Instead the then finance minister Arun Jaitley presented a convoluted defence of the widely dissed amendment while presenting NDA’s first union budget in 2014-15:
“The sovereign right of the government to undertake retrospective legislation is unquestionable. However, this power has to be exercised through extreme caution and judiciousness keeping in mind the impact of each such measure on the economy and the overall investment climate. This govt will not ordinarily bring any change retrospectively which creates a fresh liability.”
Subsequently Jaitley did modify his stance saying it was a bad idea, yet the government did not walk back the amendment.
Equally interesting is the stance of P Chidambaram, who succeeded Mukherjee as the FM and preceded Jaitley. As the clip below shows he launched a staunch defence of the move even though it was widely suggested that he opposed it in the Cabinet discussions.
Maybe he was taking one for the team, but the fact is that there is a consistent defence of what was always perceived to be a bad policy intervention by three different FMs—two of who believed it was a bad idea!
The Idea
The sad part is that the underlying principle behind the amendment to the tax law is very sound: it basically sought to tax cross-border sale of assets which are based in India. Since the transaction was conducted off shore the tax owed was evaded. In today’s world where money is fungible, geographic borders are not a bind and where consultancy firms make top dollar in pointing out tax loopholes, a law to tax this class of assets was very much par for the course.
Accordingly, in 2007, the Income Tax Department served a tax demand of $2 billion to Vodafone International for precisely such a cross-border transaction. Unfortunately this was on a wing and a prayer as the existing tax laws did not extend to such transactions. Precisely the ruling of the Supreme Court when it ruled in favour of Vodafone in 2012.
Exactly when the UPA decided to bring in amendments to the tax law to fix this gap. It actually fit the pattern wherein the government would, after losing a tax litigation, bring in an amendment to overturn the ruling. In fact the previous Finance Bills—listing the changes to the tax laws introduced in the annual Union Budget—were packed with such instances. This is in bad form, especially when used indiscriminately.
However, where Pranab Mukherjee, the then finance minister, went really wrong was in allowing for retrospective taxation. It is one thing to tax prospectively—it is the sovereign right of any country—and another to impose it retrospectively. And to be sure there is but a fine line between tax avoidance (by using existing laws) and tax evasion—as was happening with cross-border sale of assets located in India.
The NDA, in my view, made two mistakes. One, as we just discussed it failed to roll back the retrospective amendment. Second, it refused to see the writing on the wall: that it had no case and was merely delaying the inevitable.
This was bizarre. Expending so much of hard earned social capital to defend the erroneous legacy of a political opponent is baffling. Worse, the NDA had weaponised this support for UPA’s legacy in the hands of its critics—who have an oversized footprint abroad to amplify their case regardless of its merit.
The Rethink
This absurd drama may have continued to play out but for a convergence of circumstances.
The devastation caused by the covid-19 pandemic which originated in Wuhan, China had overnight elevated the status of foreign investors with deep pockets as the government went about rebuilding the shattered economy. Simultaneously the offensive unleashed by Cairn Energy, who was also served a tax notice retrospectively, to force India to pay up on the arbitration claims was creating fresh international embarrassment for the country. Especially after they got the go-ahead of a French court to attach government of India assets located abroad. This is when the NDA finally swung into action.
In fact, the amendment introduced by finance minister Nirmala Sitharaman in Parliament last week says as much.
“In the past few years, major reforms have been initiated in the financial and infrastructure sector which has created a positive environment for investment in the country. However, this retrospective clarificatory amendment and consequent demand created in a few cases continues to be a sore point with potential investors.”
“The country today stands at a juncture when quick recovery of the economy after the COVID-19 pandemic is the need of the hour and foreign investment has an important role to play in promoting faster economic growth and employment.”
The Lok Sabha duly passed the amendment. Presumably it has brought the curtain down on the entire episode. Hopefully the right lessons have been learnt. India, as it looks to claim a seat on the global high table, cannot afford such missteps.
At the same time, since many of the key characters in this episode have passed away, many questions remain unanswered. A mystery for a Hercule Poirot to resolve I guess.
Recommended Viewing
I am aware that all of us have seen this clip several times already. It is going to be 72 hours since Neeraj Chopra created history and yet as they say in Bollywood ‘dil mange more’. If you feel similarly then enjoy:
Till we meet again next week. Stay safe.
Dear Anil,
very interesting and informative.My opinion is as India strives to create its reputation as an investment friendly nation, it is essential for India to make pragmatic decisions with respect to foreign investment and foreign investors, and abide by its sovereign commitments to other nations under international treaties. The way forward is to recognize sovereign powers, but to exercise them in a manner that honors international law and practice.
Nirmala Sethuraman finally introduced the tax law changes on Thursday to repeal the retrospective provisions included in union budget 2012-13 by pranab Mukerjee. The Vodafone and Cairn cases had been lost by December 2020, the investors hoped the govt would follow the legal process and put an end to this saga. Instead appeals were filed with govt declaring that it would vigorously defend its right to tax and that it had never agreed to arbitrate a national tax dispute.
India needs to demonstrate greater clarity and consistency in policy across the board , whether its fluctuating trade tariffs or shifting GST rates and rules, to repair its shattered credibility.
Good sense prevailed, better late than never. Perhaps some short sighted decision maker/influencer thought about the immediate gain and forgot altogether the long term loss of trust, goodwill and credibility of the country as an investment destination. The names will tumble out sooner than later. But with a person like Modi at the helm of affairs, one would have expected this decision much earlier. But there probably are reasons for the delay, which are not known to us at present. India should be able to offer an attractive place to invest after this timely decision; the country needs a booster dose to get it going towards the targeted growth. Very important event to focus on Anil.