The Shome committee’s report on retrospective taxation of indirect transfers of assets in India is a welcome addition to the reform agenda of the government. It should be helpful in turning around the global sentiment towards India and dissipating the dark clouds of gloom that had gathered after the 2012 Union Budget.
The committee has once again brought out a well-balanced perspective on what constitutes good tax policy. Retrospective taxation is retrograde and contrary to the principles of equity and probity in the formulation and implementation of commonly recognised taxation principles. It should occur in only the rarest of rare cases, and then also to “protect” the tax base, and not to expand it. Moreover, it must be preceded by exhaustive and transparent consultations with the stakeholders.
The committee’s analysis of the taxation of transfer of shares of a foreign company having underlying assets in India is impressive. Capital gains from such shares are generally taxable only in the country of residence of the investor and not in the source country where the assets are located, except where underlying assets constitute real property. Even if the tax were to apply to shares in other situations, it should be limited to shares which derive more than 50 per cent value from assets located in India and then also, on a proportionate basis, i.e., only that portion of the capital gains that relate to assets in India. Furthermore, where tax applies retrospectively, it should do so to the income recipient i.e. the vendor and not the buyer who remits the proceeds to the vendor, and without interest or penalty.
The committee goes on to suggest that tax should not apply to mergers and amalgamations, intra-group transfers, and nor to portfolio investments by foreign institutional investors. It also recommends certain exemptions for private equity investors to address their concerns on taxation of gains arising to them outside India on redemption of their investments.
The introduction of the indirect transfer provisions with retrospective effect was bad politics and bad economics. It was condemned widely by the domestic and foreign investors alike. It did not add to the popularity of the then finance minister, Pranab Mukherjee. It was only because of his stature and goodwill that =Mukherjee was able to push it through the Parliament. Economically too, the provisions resulted in immense uncertainty and loss of confidence among the investors about India as a stable tax jurisdiction. India had to face the consequence of erosion in the foreign direct investment inflows.
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So, what prompted these decisions by the government? Was it just a case of misjudgment of its political and economic consequences? Or, was it the compulsion of keeping the fiscal deficit from escalating at a time when other measures such as cutback in food, rail and diesel subsidies did not find favour with UPA allies. Or, it was a vindictive reaction of the tax bureaucracy who felt insulted and humiliated by the judgement of the Supreme Court in the Vodafone case. It could not have been a misjudgement of the consequences, especially for a Minister of such maturity and stature. The compulsions of fiscal deficit management were also not a factor, since the revenues from these tax provisions did not figure prominently in the overall revenue forecast.
The Budget provisions on indirect transfer are wrong tax policy, wrong interpretation of the law and wrong enforcement and administration of the law. Shome Committee has well articulated that in case of non-resident shareholders, capital gains on shares are generally taxed in the country of residence of the shareholder and not the source country, as evidenced by the international practices in most advanced tax jurisdictions. The provisions are based on wrong interpretation of the law and this is backed by the committee’s observation that the Budget provisions are not clarificatory in nature and, instead, widen the tax base.
That the indirect transfer provisions were applied retrospectively is an example of wrong tax administration. As the committee very aptly points out, any retrospective amendment should be applied in exceptional cases and not for widening the tax base. However, the timing and circumstances of the introduction of the indirect transfer provisions clearly suggest that this guiding principle was ignored. Another instance of wrong administration is that the tax is currently being levied on the buyer as against the vendor. As brought out by the Shome committee, in a transaction of transfer of shares of a foreign company with underlying assets in India, the provisions should apply only to the taxpayers who earn capital gains from the indirect transfer.
Such cases further amplify the need for changing the aggressive mindset of tax administration in India, a concern that was also highlighted by the Shome Committee in its earlier Report on GAAR.
Let’s hope the government accepts the committee’s recommendations and delivers on its promise to provide a fair, rational and certain tax environment for the investors.
The author is tax partner, Ernst & Young. Shalini Mathur, Senior Tax Professional also contributed to the article.
Views expressed are personal.
