Retrospective taxation – Vodafone case

Source- The Hindu

Syllabus- GS 3- Role of external state and non-state actors in creating challenges to internal security.

Context– The Vodafone Group has won one of the most high-stakes legal battles involving a foreign investor and the Indian state under international law. The retrospective taxation was in violation of the BIT and the United Commission on International Trade Law (UNCITRAL).

What is the case

1. In May 2007, Vodafone bought a 67% stake in Hutchison Whampoa for $11 billion.
2. In September that year, Indian government raised a demand of Rs 7,990 crore in capital gains and withholding tax from Vodafone, saying the company should have deducted the tax at source before making a payment to Hutchison
3. In 2012, the Supreme Court ruled in favour of the Vodafone group.
4. Later, the same year, the then Finance Minister, the late Pranab Mukherjee, circumvented the Supreme Court’s ruling by proposing an amendment to the Finance Act, thereby giving the Income Tax Department the power to retrospectively tax such deals.
5. Vodafone then initiated arbitration in 2014 invoking the Bilateral Investment Treaty signed between India and the Netherlands in 1995.
6. Ruling: It ruled in favour of Vodafone as the taxation was in violation of the BIT.

• The tribunal said that now since it had been established that India had breached the terms of the agreement, it must now stop efforts to recover the said taxes from Vodafone.
• It also directed India to pay £4.3 million ($5.47 million) to the company as compensation for its legal costs.

What is retrospective taxation?

Retrospective taxation allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time behind the date on which the law is passed.

• Countries use this route to correct any anomalies in their taxation policies that have, in the past, allowed companies to take advantage of such loopholes.
• Apart from India, many countries including the USA, the UK, the Netherlands, Canada, Belgium, Australia and Italy have retrospectively taxed companies.

What are the key lessons from Vodafone case?

1. Compensation cost- The tribunal has ordered India to reimburse legal costs to the tune of more than ₹40 crore incurred by Vodafone in fighting this case.

• The taxpayer’s money will be used to pay Vodafone
• Key lesson is that three organs of the Indian state — Parliament, executive, and the judiciary — need to internalize India’s BIT and other international law obligations. These organs need to ensure that they exercise their public powers in a manner consistent with international law, or else their actions could prove costly to the nation.

What option does government has to solve the issue?

1. Challenge the ruling– government might challenge the award at the seat of arbitration or resist the enforceability of this award in Indian courts alleging that it violates public policy.

• The government would be ill-advised to go down this road because it would mean that India does not honour its international law obligation.
• It would send a wrong signal to foreign investors reaffirming the sentiment that doing business in India is indeed excruciating.

2. India is entangled in more than a dozen such cases against companies over retrospective tax claims and cancellation of contracts. The exchequer could end up paying billions of dollars in damages if it loses.

Way forward

Government should immediately comply with the decision to support foreign investment. The decision shows the significance of the ISDS (Investor-state dispute settlement). Regime to hold states accountable under international law when in case of undue expansion of state power. The case is a reminder that the ISDS regime, notwithstanding its weaknesses, can play an important role in fostering international rule of law.