Tuesday, March 20, 2012

Taxing foreign investors

(First published in The Pioneer on March 20, 2012)


The Union Budget is generally not used as an instrument to target individuals or institutions that have embarrassed the Government. It is normally not used to propose amendments to laws with retrospective effect so that these individuals or institutions are offered no route to escape the fury of the regime. Unfortunately, the Congress-led UPA Government has done just that in the Budget for 2012-13, while it has failed to apply its mind to tackling many other more important problems confronting the country’s economy. But then, little else can be expected from the Congress which has even had the temerity to amend the Constitution with retrospective effect to nullify orders of the court with the sole objective of saving its leader and maintaining its vice-like grip on the people immediately preceding and during the dark days of the Emergency.

The sly manner in which the Government has gone about fixing Vodafone, without naming the firm, by seeking to amend with retrospective effect a slew of provisions in the Income Tax Act, 1961, to make the telecom major cough up Rs 11,000 crore by way of capital gains tax, is eerily similar to what the Congress had done in August 1975 when it amended Article 329 as well as Schedule 9 to negate a judgement of the Allahabad High Court which had invalidated Mrs Indira Gandhi’s election to Parliament. The judgement followed Raj Narain’s petition accusing her of electoral malpractice. The Constitution (39th Amendment) Act was passed, under which a new provision, Article 329A, was added. According to this Article, election to either House of Parliament of a person who holds the office of Prime Minister at the time of such election shall not be called in question. Any pending election petition would abate. This Article was repealed through the Constitution (Forty-fourth Amendment) Act, 1978, after Mrs Gandhi was defeated and the Congress lost power in 1977.

Although the Supreme Court set aside the judgment of the Allahabad High Court in November 1975, the Congress Government decided to take no chances, and a year later brought the Constitution (42nd Amendment) Bill which provided for the amendment of Article 368 dealing with the power of Parliament to amend the Constitution. The new provision removed all restrictions on Parliament’s power to amend, thus subverting the Supreme Court’s landmark verdict in the Kesavananda Bharati case in 1973. The Bill later became law which was subsequently repealed by the Janata Party Government through the 43rd and the 44th Amendments that largely reinstituted the position that prevailed before the 39th Amendment came into being.

The UPA Government’s response through the provisions in the Budget for 2012-13 aimed at cutting Vodafone to size has come after the Government received a setback in the Supreme Court. The court had in January set aside a Bombay High Court order which had directed Vodafone International Holdings to pay the Income Tax Department Rs 11,000 crore as tax after the telecom major had acquired a majority stake in Hutch Essar and entered the Indian telecommunication market. The Supreme Court made two important observations in arriving at the verdict: First, since the acquisition was conducted through an agreement that was finalised offshore, the Indian tax authorities had by law no jurisdiction over the transaction. Second, there was nothing to suggest that Vodafone had entered into the offshore transaction with the purpose to avoid being taxed in India where it launched operations subsequent to the finalisation of the deal.

If the Government believed that the existing laws contained loopholes which allowed companies with assets and business interests in India to escape from paying capital gains tax because the acquisitions had been done offshore, it could have amended those provisions and brought such deals under the tax laws with prospective effect. No eyebrows would have been raised and the Government would have sounded credible in saying that it could not allow the country to become a tax haven. Even the Supreme Court had said that the Vodafone case was an “eye-opener” for the Indian legislature to take measures to meet situations that arise due to “what we lack in our regulatory laws”. The Government did open its eye after the verdict, but only to seek a negation of the verdict.

Of course, even after the Government gets the Finance Bill passed with these provisions, it will not be the end of the story. It could herald the beginning of another battle in the courts, because many experts believe that the proposal to amend the tax laws with retrospective effect (ridiculously with effect from 1962) is bad in law and may be challenged. It is certain that after the Budget is adopted, the Government will re-open the case against Vodafone, triggering perhaps a fresh round of litigation.

The constitutional validity of a retrospective amendment may not be in doubt, but what is equally unambiguous is that the right of the legislature to amend laws with retrospective effect is not unfettered. For instance, the Supreme Court had in the case of Sri Prithvi Cotton Mills versus Broach Borough Municipality, analysed the validity of the retrospective amendment of a statute. It said, “In testing whether a retrospective imposition of a tax operates so harshly as to violate fundamental rights under article 19(1)(g), the factors considered relevant include the context in which retroactivity was contemplated such as whether the law is one of validation of taxing statute struck-down by courts for certain defects; the period of such retroactivity, and the decree and extent of any unforeseen or unforeseenable financial burden imposed for the past period etc.”

The Government’s desire to tax companies with retrospective effect — and that too through a mere ‘clarification’ to the Income Tax Act — is bad politics and worse economics. The issue is not limited to Vodafone any more, since it impacts the image of India among foreign investors as a country worth investing in.

The statement of an official of the Union Ministry of Finance that foreign direct investment is not “primarily dependent upon tax, but is more governed by aspects like huge domestic market, low cost of operation, low labour cost and huge skilled manpower”, ignores the basic fact that, all of the factors which he has listed are irrelevant if there is no transparency and stability in the laws that govern such investment.

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