Retrospective taxation: the Vodafone case

ECONOMY/ GOVERNANCE/ INTERNATIONAL

Topic: General Studies 3:

• Indian Economy and issues relating to planning, mobilization, of resources, growth, development.
• Government policies and interventions for development in various sectors and issues arising out of their design and implementation.

Retrospective taxation: the Vodafone case

Context: The Permanent Court of Arbitration at The Hague gave a Unanimous ruling on Vodafone case.

What is the case?

• In May 2007, Vodafone International Holding (Dutch Firm) had bought a 67% stake in Hutchison Whampoa for $11 billion. This included the mobile telephony business and other assets of Hutchison in India
• In September 2007, the India government for the first time raised a demand of Rs 7,990 crore in capital gains and withholding tax from Vodafone
• Government argued that Vodafone should have deducted the tax at source before making a payment to Hutchison.
• Vodafone challenged the demand notice in the Bombay High Court, which ruled in favour of the Income Tax Department. Subsequently, Vodafone challenged the High Court judgment in the Supreme Court
• Supreme Court in 2012 ruled that Vodafone Group’s interpretation of the Income Tax Act of 1961 was correct and that it did not have to pay any taxes for the stake purchase.

How did government tried to overrule Supreme Court Judgement?

• In 2012, the government of the day circumvented the SC’s ruling by proposing an amendment to the Finance Act, thereby giving the Income Tax Department the power to retrospectively tax such deals.
• The case had by then become infamous as the ‘retrospective taxation case’.
• Once Parliament passed the amendment to the Finance Act in 2012, the onus to pay the taxes fell back on Vodafone

What is retrospective taxation?

• As the name suggests, 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.
• Global Norm: Apart from India, many countries including the US, the UK, the Netherlands, Canada, Belgium, Australia and Italy have retrospectively taxed companies, which had taken the benefit of loopholes in the previous law.

Consequence of Retrospective Taxation on Market 

• Hurts Companies: While governments often use a retrospective amendment to taxation laws to “clarify” existing laws, it ends up hurting companies that had knowingly or unknowingly interpreted the tax rules differently.
• Hurts Investor Confidence: The amendment was criticised by investors globally, who said the change in law was “perverse” in nature. This impacted the market sentiment and the flow of foreign funds to India.

How did government tried to handle Vodafone case post global outrage?

• Following international criticism, India tried to settle the matter amicably with Vodafone, but was unable to do so
• By 2014, all attempts by the telco and the Finance Ministry to settle the issue had failed.
• In 2014, the Vodafone Group initiated arbitration against India at the Permanent Court of Arbitration at the Hague, under Article 9 of the Bilateral Investment Treaty (BIT) between India and the Netherlands.
• After the new NDA government came to power, it said it would not create any fresh tax liabilities for companies using the retrospective taxation route. But the provision in Finance Act remained.

What is the Bilateral Investment Treaty?

• In 1995, India and the Netherlands had signed a BIT for promotion and protection of investment by companies of each country in the other’s jurisdiction.
• The two countries would, under the BIT, ensure that companies present in each other’s jurisdictions would be “at all times be accorded fair and equitable treatment and shall enjoy full protection and security in the territory of the other”.
• The BIT between India and the Netherlands expired on September 22, 2016.

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

• The court ruled that India’s retrospective demand of Rs 22,100 crore as capital gains and withholding tax imposed on Vodafone for a 2007 deal was “in breach of the guarantee of fair and equitable treatment”.
• The court ruled that Indian order was in violation of United Nations Commission on International Trade Law (UNCITRAL).
• The court has also asked India not to pursue the tax demand any more against Vodafone Group

Implication of the ruling

• Policy Setback: The ruling in favour of Vodafone signals a setback for the country’s retrospective taxation policies. 
• Sets a precedence: The ruling also raises the possibility of other cases under arbitration being decided on similar lines.

Connecting the dots:

• Protectionism in economically interconnected world
• Bilateral Investment Treaties and Concerns