The chequered past of retrospective tax: All you need to know

"Retrospective Taxation",  these two words have roiled foreign investors looking at India over the years, and led to multiple disputes between the Indian government and global majors like Vodafone and Cairn. The government on Thursday moved a Bill in Lok Sabha to scrap the controversial tax law.

But why did India bring such a law in the first place?

In May 2007, Vodafone bought majority stake in Hutchison Whampoa for $11 billion. The Indian government has 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.

After losing the challenge in Bombay High Court, Vodafone won the case in Supreme Court, which in 2012 ruled that the 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.

The then Finance Minister Pranab Mukherjee, circumvented the top court’s ruling by proposing an amendment to the Finance Act, thereby giving the IT Dept the power to retrospectively tax, giving the IT dept, powers to go after mergers and acquisitions (M&A) deals all the way back to 1962 if the underlying asset was in India.

Vodafone had invoked Bilateral Investment Treaty (BIT) signed between India and the Netherlands in 1995 and in 2014, initiated arbitration against India at the Court of Arbitration at The Hague. In a unanimous decision, the court ruled that India had breached the terms of the agreement and that it must stop efforts to recover the said taxes.

Similarly, in 2007, Cairn UK transferred shares of Cairn India Holdings to Cairn India on which Income Tax authorities slapped a tax demand of Rs 24,500 crore as it contended that Cairn UK had made capital gains. Cairn refused to pay taxes and challenged India's stand at at an arbitration court.

The court ruled in favour of the UK-listed company and ordered Indian government to pay $1.23 billion in damages to Cairn, plus costs and interest. The company, which previously said the ruling was binding and enforceable under international treaty law, has been since then courting Indian government officials to get the money paid. But the government has not agreed to pay.

Cairn has identified high-value assets of the Indian government in the US, the UK, Canada, Singapore, Mauritius, France, and the Netherlands for enforcing the arbitration award. Recently it won a favourable judicial order for seizing 20 properties of the Indian State in UK. The government, on its part, maintained that it will contest the French court order and will look to fight the arbitration vigourously.

The government has now proposed to refund principal amount in full to the litigants, with certain conditions. The companies will need to withdraw the cases and furnish undertakings that they won't claim cost damages or interest.

"In the past few years, major reforms have been initiated in the financial and infrastructure sector which has created a positive environment for investment in the country. However, this retrospective clarificatory amendment and consequent demand created in a few cases continues to be a sore point with potential investors. The country today stands at a juncture when quick recovery of the economy after the Covid-19 pandemic is the need of the hour and foreign investment has an important role to play in promoting faster economic growth and employment," the government said.

"This decision helps to clarify our position with the investors," Tarun Bajaj, revenue secretary at the finance ministry told a news channel.

Experts say the current move to repeal the retro tax will undo pending litigations and restore India's credibility as an investment friendly decision.