Capital gains made on transfer of equity or any other asset, which derive its’ value from the underlining business in India were and are capital gains made in India. The Government has every justification to tax such capital gains. To tax something, you need an explicit law authorising it. Unfortunately, when Hutchinson made capital gains by selling its equity in a non-resident company which controlled the Hutchinson-Essar telecom business in India to Vodafone, such capital gains were not specifically taxable in the country.
The Government raised demand on buyer Vodafone for collecting tax on the capital gains which seller Hutchinson made, which got blown up to over Rs 30000 crore later. The Supreme Court struck down this demand in 2012. The Government lost.
To make taxability of such capital gains abundantly clear in law, Government amended the IT law and framed detailed rules to collect this tax. Tax laws usually have prospective effect. In this matter, however, the Government used its sovereign power to make such transactions taxable retrospectively. This raised howls of protests; some called it tax-terrorism.
Cairns and Vodafone Embarrassed Indian Government
The Government raised retrospective tax demands in 17 cases exceeding over a lakh crore but recovered only about Rs 8000 crore, including by seizing and selling shares of an Indian affiliate of Cairns. Two of the largest such affected parties—Vodafone and Cairn—took Government to international arbitration tribunals and won. Cairn obtained orders for seizing assets of Indian state and its instrumentalities like Air India to recover its money.
The Government has filed appeals but chances of its succeeding are very slim. This constantly hanging sword must be causing enormous embarrassment. The situation could not have been allowed to linger on.
There were three ways to put an end to it:
first, implement arbitration tribunal orders,
second, settle it bilaterally with Cairn and others and
third, undo the retrospective taxation law itself.
Though belatedly, Government has rightly chosen the third option. It would allow the Government to neutralise the arbitration awards and frustrate ongoing cases. The cash cost to the Government is not very large- only about Rs 8000 crore. Government’s arrears book will get cleaned up for the rest.
Has Indian Government Done Too Little Too Late?
Introduction and passage of Bill in Lok Sabha, however, is not the end of the matter. There are three big questions still to be settled.
First, will this Bill become law?
Second, will the affected parties—Cairn and Vodafone—accept this legislative settlement?
Third, will it improve investment climate?
P Chidambaram, ex Finance Minister has welcomed it. Opposition leaders have otherwise been silent on it. Rajya Sabha is not functioning- courtesy Pegasus row. With this impasse and monsoon session scheduled to end on 13 August, passing of this law is quite uncertain. If it does not pass, will the Government bring an ordinance? Unless the Bill becomes law, there is no end to the stalemate.
Are Cairns & Vodafone Going to Accept India's Package?
On the question of Cairn and Vodafone accepting the package offered, there are some unknowns. The Bill makes retrospective tax assessment orders deemed as never passed subject to fulfilment of 'specified conditions’. There are three specified conditions- withdraw pending court cases, withdraw pending arbitration and enforcement cases, and give an undertaking not to pursue any remedy in the matter.
Some of these conditions need clarity. The Government can also specify ‘other conditions’. The Government will have to frame rules under the amended law to specify these other conditions.
We don’t know what conditions the Government has in mind. Concerned parties would wait to see the fine print before they act.
Whenever the law is brought into effect, pending proceedings would abate nullifying the penalties as well.
The principal issue remaining will be the refund of Rs 8000 crore recovered, interest thereon, and the cost of litigation incurred by the parties. The government has made it clear that no interest would be paid. There is no specific provision regarding cost of litigation.
It seems if the Government does not specify any other unreasonable conditions, Cairn and Vodafone should be accepting the deal. However, we should not underestimate the potential of ‘other conditions’ to mess-up the deal.
Will Scrapping Retrospective Tax Inspire Investors?
On the question of investor sentiment, best test is whether Vodafone would invest further in Vodafone Idea. Ending of retrospective taxation matter does not bring any material cash or financial relief to VI. Their telecom business is floundering for many policy, regulatory and other reasons. It is unlikely that Vodafone would risk additional USD 5-10 billion more on USD 20 billion already lost.
On wider investment climate, while there was considerable criticism of the retrospective taxation policy of India, it did not impact flow of investment if you look at FDI and portfolio investment numbers. While the noise will stop, there is unlikely to be any significant impact on foreign investment flows.
Government’s decision is courageous which has made a virtue out of necessity. A no-nonsense follow-thorough will be needed to operationalise the decision fully and quickly.
(Subhash Chandra Garg is former Finance Secretary to Government of India. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)
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