23rd May 2022

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Retrospective taxation

In a unanimous decision, the Permanent Court of Arbitration in the Hague on Friday ruled that India’s retrospective claim for Rs 22,100 crore as a capital gain and withholding tax imposed on the British telecommunications company for a 2007 settlement was “a violation of the fair treatment guarantee.” The court also asked India not to initiate tax proceedings against Vodafone Group.

What is the case?

  • In May 2007, Vodafone bought a 67% stake in Hutchison Whampoa for $ 11 billion. This included Hutchison’s mobile phone business and other assets in India.
  • In September of that year, the Indian government first raised a claim for Rs 7,990 crore in capital gains and withholding tax from Vodafone, claiming that the company should have deducted tax at source before making a payment to Hutchison.
  • Vodafone challenged the notice of prosecution in the Bombay High Court, which ruled in favor of the Income Tax Department.
  • Subsequently, Vodafone challenged the decision of the Superior Court of the Supreme Court, which ruled in 2012 that the Vodafone Group’s interpretation of the Income Tax Act 1961 was correct and that it did not have to pay tax on the purchase of the stock.
  • In the same year, the then finance minister, the late Pranab Mukherjee, circumvented the Supreme Court ruling by proposing an amendment to the finance law, giving the Income Tax Department the power to retroactively tax these agreements.
  • The law was passed by Parliament that year, and the responsibility for paying taxes fell to Vodafone. By this time, the case had become infamous as the “retroactive tax case”.
  • The decision in favor of Vodafone marks a setback for the country’s retrospective tax policies. It also raises the possibility that other cases submitted to arbitration may be resolved in the same way.

What is retrospective taxation?

  • As the name suggests, retrospective taxation allows a country to adopt a rule on the imposition of taxes on certain products, items or services and offers and to invoice companies from a point in time after the date on which the law was passed.
  • Countries use this route to correct anomalies in their tax policies that in the past allowed companies to take advantage of such loopholes. While governments often use retrospective change in tax laws to “clarify” existing laws, it ends up hurting companies who knowingly or unknowingly have interpreted tax rules differently.
  • In addition to India, many countries, including the United States, the United Kingdom, the Netherlands, Canada, Belgium, Australia and Italy, have retroactively taxed companies that have benefited from the loopholes. the previous law.

What Happened After India Passed The Retrospective Tax Law?

After Parliament passed the amendment to the finance law in 2012, the responsibility for paying taxes fell to Vodafone. The amendment was criticized by investors around the world, who said the change in the law was “perverse” in nature.

“The retrospective amendment that overturned the decision of the country’s highest court was poorly worded in its broad generalities and carried a perverse sense of revenge,”

said Nigam Nuggehalli, dean of BML Munjal University law school .
  • Following international criticism, India tried to settle the matter amicably with Vodafone, but was unable to do so. After the new NDA government came to power, he said he would not create new tax obligations for companies that use the retrospective tax route.
  • By 2014, all attempts by the telecommunications company and the finance ministry to resolve the issue had failed. The Vodafone Group then invoked Clause 9 of the Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995.

What is the bilateral investment treaty?

  • On November 6, 1995, India and the Netherlands signed a BIT for the Promotion and Protection of Business Investments of each country in the jurisdiction of the other.
  • Among the various agreements, the treaty had established that the two countries would endeavor to “encourage and promote favorable conditions for investors” of the other country.
  • The two countries, under the BIT, would ensure that businesses in each other’s jurisdictions “receive fair and equitable treatment at all times and enjoy full protection and security in the other’s territory. ”
  • While the treaty was between India and the Netherlands, Vodafone invoked it because its Dutch unit, Vodafone International Holdings BV, had bought the Indian business activities of Hutchinson Telecommunicaton International Ltd., turning it into a transaction. between a Dutch company and an Indian company.
  • The BIT between India and the Netherlands expired on September 22, 2016.

What did the Permanent Court of Arbitration in The Hague say?

  • The violation of the BIT and the United Nations Commission for International Trade Law (UNCITRAL) is one of the main factors that led the Court of Arbitration to rule in favor of Vodafone.
  • In 2014, when the Vodafone Group initiated arbitration against India in the Arbitral Tribunal, it did so in accordance with Article 9 of the India-Netherlands BIT.
  • Article 9 of the BIT establishes that any dispute between “an investor of a contracting party and the other contracting party in relation to an investment in the territory of the other contracting party” will be resolved, as far as possible, amicably through of negotiations.
  • The other was Article 3 of the UNCITRAL Arbitration Rules, which establishes, inter alia, that “the constitution of the arbitral tribunal shall not be hampered by any controversy regarding the sufficiency of the arbitration notice, which shall be definitively resolved by the tribunal arbitration ”.
  • In its decision, the arbitral tribunal also said that now that it had been established that India had violated the terms of the agreement, it must now cease its efforts to recover such taxes from Vodafone.
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