Retrospective taxation- Overhang removed

“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.

Going back in history, in May 2007, Vodafone bought majority stake in Hutchison Whampoa for $11 bn. The Indian government has raised a demand of Rs 7,990 cr 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.

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 cr as it contended that Cairn UK had made capital gains. Cairn refused to pay taxes and challenged India’s stand at an international arbitration court. The court ruled in favour of the UK-listed company and ordered Indian government to pay $1.23 bn in damages to Cairn, plus costs and interest. But the government did not agree to pay.

Cairn 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 favorable judicial order for seizing 20 properties of the Indian State in UK. The government, on its part, had said that it would contest the French court order.

India is scrapping the controversial law, and international litigation hangover. The retrospective taxation of 2012, pursued hitherto by the government, is being set aside. 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.

The government will nullify claims (primarily Cairn plc, Vodafone UK), and refund about Rs.8100 cr. This should end international litigation that has exposed India to asset freezes. The amendment has got a go-ahead from parliament, and must be accepted by litigants (Cairn needs to give up its claims damages). We believe these pieces would fall in place. Cairn is a direct beneficiary, Vodafone UK would likely see a contingent liability removed, and Vedanta extinguishes a contingent liability.

India has been caught in more than a dozen such cases against companies over retrospective tax claims.  The controversial retrospective law was introduced by the previous Congress-led UPA government, but the tax cases that were filed by it were pursued by the BJP government. We see it as a positive at a broader government policy approach, for businesses, particularly global ones.

We feel it could be the beginning of a more corporate and business supportive policy framework. It is a positive development in itself, clears some decks for divestments (Air India), and comes on the back of tailwinds: corporate tax cuts, and wooing of investments and business. Even so, while taxes are simplified, India’s tax authorities have tended to be a bit aggressive in their tax collections efforts. Is this a policy reversal that ushers in a change in ‘on the ground’ approach. Too early to make that call, but it could well be a game changer. We do see this positive for the India investment paradigm.

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Indian Railway and Tourism Corporation Limited – Connecting online

Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 14 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.