Govind Bhattacharjee
Other countries have also tried taxing MNCs retrospectively, but this ends up destroying these firms to the extent that the domestic economy and employment suffer
In the McCulloch vs Maryland case, 1819, while asserting that the Government had implied powers not explicitly enumerated in the Constitution, US Chief Justice John Marshall had famously warned governments against their arbitrary use: “That the power to tax involves the power to destroy; that the power to destroy may defeat and render useless the power to create.” Governments nevertheless use such powers. However, the mature ones hold back while immature governments exercise their powers arbitrarily, which hurts businesses and enterprise. The retrospective taxation legislation was one such arbitrary measure introduced by the Government, that India is still paying a price for.
The telecom sector was India’s success story as it had attracted multiple national and international giants as well as small operators. The global major Hutchison was one of the first telecom companies to enter India. Collaborating with its Indian partner Essar, Hutchison-Essar expanded its operations pan-India to become a leading market player. It got new licences for some telecom circles and operated in others by acquiring smaller telecom entities with licences for those circles. This led to a very complex ownership pattern, which, as Harish Salve pointed out, was not unusual for such global operators. The Hong Kong-based Hutchison held shares in downstream companies in the Cayman Islands, like CGP Investments, which in turn held shares in downstream companies based in Mauritius which in turn held shares in an Indian holding company that controlled Hutchinson’s subsidiaries in the country. Through the CGP, Hutchinson held 67 per cent stake in Hutchison-Essar. Cayman Islands and Mauritius, being tax havens, attracted multinationals (MNCs) with the operational flexibility of relocating their units to avoid taxes; this was also not unusual.
In December 2006, Hutchison decided to exit India and sold their operations to the Netherlands-based Vodafone at $10.8 billion in May 2007. Vodafone acquired CGP Investments whose acquisition gave them control over all downstream companies and hence control over its Indian operations. Taking advantage of the loopholes in Indian tax laws which did not make such transactions taxable even though the assets were located here, the entire deal and payments were transacted outside the country. Hutchison-Essar thus became Vodafone-Essar. The capital gains that accrued upon the acquisition of CGP was shown in the Hutchinson accounts as “profit from discontinued operations” which was not taxable in India under the extant laws; besides, it was also not the first time that such transactions were executed without attracting any tax liability.
But the Income-Tax Department (I-T Department) under Pranab Mukherjee reckoned the capital gains as taxable and in September 2007, raised a demand of Rs 7,990 crore from Vodafone. The I-T Department later admitted that it was a “test case” to make such transactions taxable.Vodafone challenged it before the Bombay High Court (HC) on the ground that Hutchison had sold a foreign company, CGP Investments, to another foreign entity, Vodafone, and a transaction between two foreign entities conducted and concluded outside India cannot be taxable here as it would amount to applying Indian law to a commercial transaction outside the country between two non-Indians. In December 2008, the HC ruled in favour of revenue which was overturned by the Supreme Court in January 2012 which absolved Vodafone of all tax liability, holding that the sale did not amount to tax avoidance. That should have closed the matter once and for all, with the legal loophole being plugged for the future. Instead Mukherjee introduced retrospective taxation by amending the I-T Act in the 2012-13 Union Budget to override the top court’s order. This not only defied economic logic but also went against the counsel of then Prime Minister Manmohan Singh, Sonia Gandhi, P Chidambaram and other Cabinet colleagues who cautioned that it would adversely impact the Foreign Direct Investment (FDI) that India needed so much.
In his autobiography ‘The Coalition Years 1996-2012’, Mukherjee justified this by saying that concerns about the potential effect of the amendment on FDI, “which might have persuaded them to give a decision against the revenue department, were unfounded”, because, first, this was not a case of FDI, and second, the FDI policy was entirely the executive’s prerogative. “Just because some foreign investors choose to structure their investments through tax havens, they should not, as a matter of policy, get away without paying any taxes”, he wrote, repudiating the apex court’s ruling that creation of a structure driven by commercial considerations was not a tax avoidance device.
The I-T Act was amended “with retrospective effect from 1962 to assert the Government’s right to levy tax on merger and acquisition (M&A) deals involving overseas companies with business assets in India” which was “an enabling provision to protect the fiscal interests of the country and avert the chances of a crisis.” Actually it was done to override every single argument of the top court.
The FDI inflow indeed fell sharply soon, reversing a growth rate of 64 per cent registered in 2010-11, from $37 billion in 2011-12 (two per cent of the GDP), it came down to $24 billion in 2012-13. It would take another three years to reach the 2011-12 level and in 2018-19 it stood at $51 billion, or 1.8 per cent of the GDP. Successive governments did nothing to change the law. The amendment forced Vodafone to approach the Permanent Court of Arbitration (PCA) at the Hague, under provisions of the Bilateral Investment Treaty (BIT) between India and the Netherlands signed in 1995. Under Article 9 of this treaty (which lapsed in 2016), both countries guaranteed each other fair and equitable treatment requiring any dispute to be settled amicably through arbitration.
In September 2020, the PCA ruled that the Indian Government’s retrospective demand of $2.7 billion on Vodafone was “in breach of the guarantee of fair and equitable treatment” under the BIT, warning that enforcing the tax demand would be a violation of India’s global obligations. India should have gracefully accepted the verdict and moved on, earning the goodwill and confidence of foreign countries and investors. Instead, it went on to appeal.
The retrospective amendment also entangled another MNC, the UK-based Cairn Energy. The Cayman Island-based Cairn India Holdings (CIH) was a fully-owned subsidiary of Cairn UK Holdings (CUH), which in turn was a fully-owned subsidiary of Cairn Energy. CIH owned the India operations of Cairn Energy in the Rajasthan oil field, the country’s biggest onshore discovery in two decades, and wanted to transfer its ownership to a new local entity, Cairn India, to prepare for the latter’s Initial Public Offering (IPO). In 2006-07 CUH transferred shares of CIH to Cairn India, acquiring 69 per cent of its stakes in the exchange. The share transfer was made prior to the Cairn India IPO, which gave rise to differing interpretations on whether CUH had made capital gains in the transfer. Taxmen held that CUH had made capital gains of Rs 24,500 crore and slapped a tax demand of Rs 10,247 crore on it in January 2014. In 2011, Cairn Energy had sold majority stakes of Cairn India to the mining conglomerate Vedanta. Exercising coercive power, the Government froze payment of dividend by Cairn India to Cairn Energy and also seized Cairn India shares transferred to CUH.
In 2015, Cairn Energy approached the PAC under the 1994-BIT between Indian and UK. The PAC ruled that India’s demand of retrospective tax was “in breach of the guarantee of fair and equitable treatment.” It also awarded damages to the firm worth Rs 8,842 crore. The court noted that during the 2014 general elections, the BJP had criticised the UPA Government for the amendment which had “negatively impacted the investment climate” and promised to end “tax terrorism.” It further cited Narendra Modi’s assurance that the NDA Government will not resort to retrospective taxation and will make the “tax regime transparent, stable and predictable.” The $4.3 billion final assessment order for Cairn Energy came in February 2016 after the NDA had been in power for almost two years.
No doubt both Vodafone and Cairn took advantage of the tax loopholes using tax havens. Other countries have also tried taxing MNCs retrospectively, but eventually this ends up destroying these firms to the extent that the domestic economy and employment suffer. It also erodes the confidence of foreign investors who want a predictable tax regime. If our snail-paced justice delivery system did not corrode that confidence completely, a legislation to overturn a judgment given by the apex court certainly did. The result is the dismal telecom scenario and a once-vibrant sector now gasping for breath.
