While presenting the Union Budget 2012-13, Finance Minister Pranab Mukherjee proposed to retrospectively amend the Income Tax Act with effect from April 1962 in order to levy tax on cross-border deals involving overseas companies for assets based in India.

Though retrospective legal amendments have been undertaken several times in the past, this proposed revision is being seen as aimed at Vodafone India. In fact, it could overturn the January 2012 Supreme Court’s ruling which exempted Vodafone from paying $2.3 billion as capital gains tax on a transaction in 2007. Through this deal, which was signed outside the country, Vodafone acquired 67 per cent stake in Indian telecom company Hutchison Essar from Hong Kong-based Hutchison Whampoa.

The proposed move has stirred a hornets’ nest and led to a global chorus of dissent as it could reopen a number of cases and have huge tax liability implications. International investors, global trade bodies, foreign leaders, business lobbies, etc. have sought a review of the proposal.

Global trade associations including Canadian Manufacturers and Exporters, the Confederation of British Industry, the Japan Foreign Trade Council, the Capital Markets Tax Committee of Asia, the National Foreign Trade Council and the United States Council for International Business have expressed their concern to Prime Minister Dr Manmohan Singh. Global pressure has been mounted through subtle suggestions that the amendment would have adverse implications for India and force international companies to review their engagement with the country.

In a letter to Dr Singh in early April 2012, Vittorio Colao, chief executive officer, Vodafone Group, said that the arbitrary and punitive retrospective treatment would tarnish India’s image as an investment destination. According to the UK-India Business Council, governments are entitled to pass legislations to correct anomalies in laws, but this should happen prospectively so that entities can take planned decisions on investment. The uncertainty created by retrospective measures is a bigger issue than the quantum of tax payable.

George Osborne, British Chancellor of the Exchequer, expressed his concern not only for a particular British company but also for the damage the amendment could cause to India’s image for foreign investors.

Recently, the France-based International Chamber of Commerce, and the Business and Industry Advisory Committee to the OECD wrote to the finance ministry saying that the proposal could have negative implications for the country. “We are concerned that the recent introduction of retroactivity is not only unwelcome for the future of India’s investment climate, it will also send a signal to other countries that retroactivity is an acceptable route,” notes the letter addressed to Mukherjee.

The concern of international bodies is understandable. Retrospective taxation could impact the profitability of several global firms as they will be forced to make provisions for any negative impact in case laws are modified suddenly.

However, the government has defended its budget proposal. As a senior finance ministry official points out, “Retrospective taxation is not new to India or countries like the UK.  The latter recently amended its income tax law on a retrospective basis in its budget. The country blocked a scheme used by Barclays, which resulted in a tax liability of £500 million.”

According to the finance minister, the legislative intent of this clause is to widen the application of the Income Tax Act as it covers income which accrued directly or indirectly.

In the midst of all the petitioning and lobbying, the finance ministry is making it clear that India is firm on amending the law retrospectively to tax overseas transactions that involve assets based in the country. It is also sticking to its stand that the country does not have a “no tax” or “low tax” regime nor is it a “tax haven”. The ministry is within its rights to clarify legislation to remove doubts on tax liabilities.

“India is a country where tax laws are such that if you pay tax in one country, you need not pay tax in another country of your business operation, which is covered by the double taxation avoidance agreement. But there cannot be a case where you pay no tax at all,” Mukherjee stated in Parliament.

He added, “We are only explaining our stand in the Vodafone case. The intention of the legislature will have to be clarified from the time when the legislation came into effect. However, it does not mean that all tax cases will be reopened.”