The BJP-led National Democratic Alliance government of Prime Minister Narendra Modi has scrapped a highly contentious amendment to the Indian Income Tax Act that had allowed the government to reopen tax cases going back to 1962. Retrospective taxation is a legacy of the last years of the previous United Progressive Alliance government and was introduced by the then finance minister Pranab Mukherjee in 2012. Nine years later, the NDA government recently passed the Taxation Laws (Amendment) Bill in Parliament to nullify those retrospective tax clauses that enabled the government to tax past indirect transfer of Indian assets.

The big question is why did India go for such an amendment in the first place. What does it signify in larger policy terms?

Pranab Mukherjee resorted to this measure to raise a retrospective capital gains tax demand on the UK telecom giant Vodafone for its USD 10.9 billion acquisition of the mobile telephone assets of Hutchison Essar in 2007. Vodafone held that it is not liable to pay this tax and initially sought legal remedies. The Supreme Court upheld its claims as it was a transaction between two overseas entities and the Indian tax authorities had no territorial tax jurisdiction. Mukherjee undid this judgment by amending the Income Tax Act. His justification was that it was an enabling provision to uphold the sovereign right to taxation and protect India’s fiscal interests.

Besides Vodafone, tax demands were slapped on other Multi-National Corporations like the oil major Cairn Energy Plc when it transferred its assets to Cairn India in 2006. The government even seized dividends, tax refunds and shares of Cairn to coercively recover this tax demand.

Both Vodafone and Cairn sought international arbitration. In September 2020, the Hague-based arbitration court ruled in favor of Vodafone. Later in December, Cairn too won an award of USD 1.2 billion in damages plus interest and costs as the levy of taxes using the 2012 amendment was held to be unfair to the company. Cairn has now sought to seize the government’s assets estimated at USD 70 billion.

Damage to India’s reputation

Obviously, these adverse arbitration awards and possible seizure of assets have been deeply embarrassing to the NDA government. There has been substantial reputational damage at a time it is desperately seeking foreign direct investments to build infrastructure so that the economy becomes a USD 5 trillion entity.

The move to scrap the retrospective tax amendments, however, has come seven years too late as the highest levels of the government in the first term of the NDA regime were acutely aware of its contentious nature. The then finance minister Arun Jaitley repeatedly reiterated that the government would not retrospectively create a fresh tax liability.

The NDA government’s move to belatedly bury this legacy issue is doubtless a settlement offer to Cairn, Vodafone and others in the guise of a Bill passed in Parliament. This enables the government to reimburse Cairn USD 1 billion if it agrees to drop outstanding litigation and forgo claims for interest and penalties. Vodafone stands to get USD 6 million. WNS Capital could get USD 6.5 million.

The government will also forgo past tax demands of USD 13.5 billion in outstanding claims against MNCs like the pharma company Sanofi, brewer SAB Miller, now owned by AB InBev, among others, according to the Financial Times.

All eyes will therefore be on whether the affected MNCs settle for less than they can receive through damages and interest. They still have the option to continue with arbitration and take it to its logical conclusion, including the possibility of seizure of Indian assets overseas. so the government must be gracious and generous in truly exorcising retrospective taxation in letter and spirit.

In this context, it is not helpful that finance ministry mandarins are speaking very much as Pranab Mukherjee did in emphasizing the sovereign right to taxation; that India’s tax laws cannot be arbitrated and decided upon in foreign jurisdictions.

Fallout on FDI

For these reasons, prospective foreign investors are unlikely to be taken in by the NDA government’s move to remove retrospective taxation. Although the government believes that FDI is coming into the country in record amounts, most of it is through mergers and acquisitions and not green-field investments which entail building factories.

According to the latest United Nations Conference on Trade and Development (UNCTAD) World Investment Report, USD 64 billion entered the economy in 2020, much of it powered by cross border M&As amounting to USD 27 billion in mega-deals in Information and Communication Technology (ICT), health, infrastructure and energy. In contrast, green-field FDI is dropping sharply since 2018.

FDI depends on a more stable policy and taxation regime, including tax certainty than a mere improvement in Doing Business rankings. The larger need is for a non-discriminatory and non-adversarial tax environment. Taking retrospective taxation off the books certainly helps. But it must be properly implemented by the tax authorities to undo the damage done to India’s image as an attractive foreign investment destination.

(The writer is an economics and business commentator based in New Delhi. The views expressed are personal. He can be contacted at nchandramohan@rediffmail.com)