By K P C Rao., LLB., FCMA., FCS
“Certainty is integral to Rule of Law. Certainty and Stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner”.
- Justice S.H. Kapadia, CJI
The trend of introducing retrospective amendments continues...as many as 24 proposals this year! There is a significant increase in the number compared to the last two budgets. Finance Bill, 2011 had proposed 5 retrospective amendments whereas 12 amendments were proposed in the Finance Bill, 2010.
The notable ones this year include amendment dating back to year 1962, seeking to tax ‘offshore indirect share transfers’. Another significant proposal amending the law since 1976 relates to the change in the definition of 'royalty' to bring to tax, software and satellite income.
Over the last five years, the Government has undertaken about 150 odd retrospective amendments to direct taxes. While, in the initial years, the amendments were aimed at overcoming the judicial pronouncements of the Apex Court, the trend now seems to scuttle the decisions of the High Courts.
The Cardinal Principle of construction of a statute is that every statute was prima facie a prospective “unless it is expressly or by necessary implication made to have retrospective operation”. When a procedural law is considered it is always retroactive i.e. came into effect from past date so the question of retrospective operation shall arise in substantive laws only. Also a criminal law shall always have retroactive operation whereas the civil law may have retrospective or retroactive operation. Therefore, only substantive civil laws can be operated retrospectively if the statute specifically prescribes it or there exists large interest of the public as whole otherwise all statutes shall be operated retroactively.
Examples of retrospective tax law amendments, particularly if they are anti-avoidance, are not uncommon. In fact, the famous Westminster principle is the supremacy of the Parliament—the right to enact a law includes the right to enact a law retrospectively or retroactively.
Position in UK
In the UK, Section 58 of UK Finance Act, 2008, was changed retrospectively to affect the residential status of foreign partnerships and trusts. The amendment was challenged in R v. HMRC, where the question pertained to the residential status of Isle of Man trusts which, with a negligible contribution of capital from UK resident, was allegedly use to escape tax otherwise taxable in the UK. The Court of Appeal held: “If Section 58 were not made retrospective, the claimants would obtain a windfall at the expense of the general body of taxpayers. It would be unfair to the general body of resident taxpayers not to have given Section 58 retrospective effect. The claimants entered into schemes with the intention of deliberately avoiding UK Tax. HMRC never accepted that the schemes worked and the tax liabilities were not settled before the legislation was applied to them”.
Position in Australia
Australia has also enacted retrospective laws, including those to overcome adverse rulings of courts. Australian Parliament’s Legislation Handbook, which provides recommendations for legislative procedure, suggests the following with regard to retrospective legislation:
“Provisions that have a retrospective operation adversely affecting rights or imposing liabilities are to be included only in exceptional circumstances and on explicit policy authority.”
Position in USA
By contrast, the US Constitution provides that both the Federal government and the State governments are prohibited from passing ex post facto laws (Article I, section 9 and section 10 respectively). However, substance due process amendments in taxation laws have been made retrospectively in certain cases. Notably, these are procedural issues—not issue of imposing a tax retrospectively.
Position in India
Article 20(1) of the Indian constitution provides necessary protection against ex post facto law. Art. 20(1) has two parts. Under the first part, no person is to be convicted of an offence except for violating ‘a law in force’ at the time of the commission of the of the act charged as an offence. A person is to be convicted for violating a law in force when the act charged is committed. A law enacted later, making an act done earlier (not an offence when done) as an offence, will not make the person liable for being convicted under it.The second part of Art. 20(1) immunizes a person from a penalty greater than what he might have incurred at the time of his committing the offence. Thus, a person cannot be made to suffer more by an ex-post-facto law than what he would be subjected to at the time he committed the offence. What is prohibited under Art. 20(1) is only conviction or sentence, but not trial, under an ex-post-facto law. The objection does not apply to a change of procedure or of court. A trial under a procedure different from what obtained at the time of the commission of the offence or by a court different from that which had competence ate then time cannot ipso facto be held unconstitutional. A person being accused of having committed an offence has no fundamental right of being tried by a particular court or procedure, except in so far as any constitutional objection by way of discrimination or violation of any other fundamental right may be involved.
Therefore, in India the legislature surely has the power to amend laws retrospectively. There is a plethora of case laws that recognize this power of the legislature to retrospectively amend a statute. However, as stated above:
a) A legislature can by a retrospective amendment in law, validate such law which has been declared by court to be invalid provided the infirmities and vitiating factors noticed in the declaratory-judgment are removed or cured.
b) If by such validating and curative exercise made by the legislature, the earlier judgment becomes irrelevant and unenforceable, that cannot be called an impermissible legislative overruling of the judicial decision.
Though an amendment presumes the constitutional validity of a statue, constitutional validity of a retrospective amendment may not be free from doubt. The Supreme Court, in case of Sri Prithvi Cotton Mills Vs Broach Borough Municipality, analyzed the validity of the retrospective amendment of a statute in light of Article 19(1)(g) of the Constitution of India, i.e. a fundamental right to practice any profession, or to carry on any occupation, trade or business. The court 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 unforeseeable financial burden imposed for the past period etc.”
The demand for tax in the Vodafone case was a result of failing to understand the difference between the sale of shares in a company and the sale of assets of that company. The ownership of shares in a company does not mean ownership of the assets of the company. The assets belong to that company which is a separate legal entity. In the Vodafone case, 51 per cent of Hutchison Essar Ltd. (HEL) was directly owned by the Hutchison group of Hong Kong through a multiple layer of companies and ultimately by a company incorporated in the Cayman Islands. This was not the result of any devious tax planning scheme but the consequences of the growth of Hutchison Essar Ltd. by acquiring several telecom companies over the years. Hutchison International decided to exit its Indian operations and a public announcement was made to this effect.
Vodafone was the successful buyer of the share of the Cayman Island Company for $11 Billion. Consequently, by purchasing one share of the Cayman Island company, Vodafone came to own 51 per cent of share capital of HEL. The transfer of shares of one non-resident company (Hutchison) to another non-resident company (Vodafone) did not result in the transfer of any asset of HEL in India. All the telecom licenses and assets continued to belong to HEL or its subsidiaries.
The shares owned by Hutchison were sold to Vodafone indirectly purchasing 51 per cent of the share capital of Hutchison Essar Ltd., a company registered in Mumbai. Not a single asset of this Mumbai based company was transferred either in India or abroad. Indeed, there would be no transfer of any asset in India.
This is also exactly how several international transactions are concluded. Vodafone was not the first case where transfer of shares between non-resident overseas company resulted in a change in control of an Indian company. But controlling interest is not a capital asset; it is the consequence of the transfer of shares. The demand made by the Income Tax Department in the Vodafone case was thus contrary to elementary principles of company and tax law.
There has been severe criticism of the India-Mauritius Treaty and it has been accused of depriving the Indian government of crores of rupees of tax revenue. If there is a policy decision to permit tax exemption for investments through Mauritus, one cannot blame the courts for any potential loss of revenue. The government is fully conscious of the so-called loss of direct tax revenue but these incentives are essential to foreign direct investments.
In the end, the Supreme Court's decision on 20th January, 2012 is absolutely correct and adheres to the fundamental principles of company and tax laws. In the Vodafone case the demand was for capital gains tax which never arose in India. Once the hollowness of the department's claim was exposed, the absence of any liability became clear.
The courts merely interpret the law and if a transaction is not liable to Indian income tax, one must graciously accept the result.
RULE OF LAW
According to Lord Bingham the ‘rule of law’ means –
“All persons and authorities within the state, whether public or private should be bound by and entitled to the benefit of laws publicly made taking effect (generally) in the future and publicly administered in the courts.”
Arthur Chaskalson, the first President of the Constitutional Court and former Chief Justice of South Africa in an address said:
“Courts cannot be expected to carry the full burden of what might be required. In a democracy, parliament and civil society are also defenders of the ‘rule of law’ and it is essential that they should play their part in its protection.”
In the celebrated Minerva Mills case in the Supreme Court of India Bhagwati J. said that if there was one feature of the Indian Constitution which more than any other was fundamental to democracy and the ‘rule of law’ it was the power of judicial review.
Therefore, the courts’ inherent power of judicial review was the “fundamental mechanism for upholding the rule of law.”
AMENDMENT TO SECTION 9(1)(VI)
In fact, the amendment made by the Finance Act, 2008, of the UK was very similar to the proposed amendment to Section 9 of the Indian I-T Act by Budget 2012. The amendment was to change the residential status of foreign partnerships which had UK partners. The amendment was done to override the Court rulings.
In India the amendment to Section 9(1)(vi), for instance, is aimed at scuttling the unfavourable decisions of the Delhi High Court in the EricssonAB case and Dynamic Vertical Software case, wherein, it had been held that payments for import of shrink wrapped software cannot be treated as ‘royalty' taxable in the hands of the non-resident. Of course, in terms of the taxability of payments for import of packaged/shrink wrapped software, there have been conflicting decisions from the High Courts (including the decision of the Karnataka High Court in the Samsung and certain unreported decisions).
In Ishikawajma Harima Heavy Industries case the Supreme Court held that, for the non-resident to be taxable in India in terms of the fees paid for technical services, under Section 9(1)(vii), the technical services should have been rendered and utilized in India. Many High Courts had delivered similar decisions, based on this decision. The Government, upset with this development, came out with a retrospective amendment to Section 9(1) by the insertion of a badly worded Explanation, in the Finance Act, 2007 with effect from June 1, 1976, which read as under:
“Explanation:- For the removal of doubts, it is hereby declared that for the purposes of this section, where income is deemed to accrue or arise in India under clauses (v), (vi) and (vii) of sub-section (1), such income shall be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India.”
That this badly worded Explanation was not enough to unsettle the Apex Court's decision in the Ishikawajma Heavy Industries case became clear when the Bombay High Court, in the Clifford Chance case and the Karnataka High Court, in the Jindal Thermal Power case, held that, the law laid down by the Apex Court was still good law even after the 2007 amendment.
Not one to give up, the Government came out with another retrospective amendment in the Finance Act, 2010, by inserting the following Explanation, in place of the Explanation inserted by the Finance Act, 2007:
[Explanation.- For the removal of doubts, it is hereby declared that for the purposes of this section, income of a non-resident shall be deemed to accrue or arise in India under clause (v) or clause (vi) or clause (vii) of sub-section (1) and shall be included in the total income of the non-resident, whether or not:-
(i) the non-resident has a residence or place of business or business connection in India; or
(ii) the non-resident has rendered services in India.]
This then, is a case of re-retrospective amendment, overcoming the effects arising out of a badly drafted law with an equally badly drafted amendment. That the Government would not hesitate going in for another re-retrospective amendment, if the earlier retrospective amendment is struck down by the Courts, should perhaps, come as warning signal for tax payers and other stakeholders who might want to contest the latest round of retrospective amendments.
One popular and unconvincing argument that the Government gives is that, these explanations are inserted in order to ‘remove the doubts”. Doubts, in whose mind, one wonders. Clearly, the taxpayer and the Judiciary would seem to have no doubts about these provisions. And look at this irony the law related to the taxation of payments towards software imports is being retrospectively amended from 1976…. How can somebody justify that the Legislature, in its wisdom, had thought of taxing software payments to non-residents in 1976 when computers were largely unknown in those days…..
Take the case of the retrospective amendments aimed at overcoming the Vodafone decision…. That these retrospective amendments take effect from April 1, 1962, when the concept of tax havens was unknown, is rather unfortunate. One essential test of a retrospective law is that, the law should have and be seen to have the same validity as on the date from which it is retrospectively applicable. This test would completely fail in the case of these retrospective amendments.
The policy of the current day tax administration seems to be, sadly, one of “Heads I Win… Tails you lose” and this view is getting reinforced through the recent retrospective amendments. The tax payer, who has run his business and taken investment and business decisions based on the existing law for several years, is made to pay a heavy price even after spending considerable time, effort and money in pursuing litigation, even up to the High Courts and the Supreme Court. If the Government has been lax in terms of unclear statutory provisions and Rules, who is to be blamed? The executives who draft the laws and the rules or the tax payers who depend on the statutory provisions for running their businesses?
Legal doctrines like “Limitation of Benefits” and “look through” are matters of policy. It is for the Government of the day to have them incorporated in the Treaties and in the laws so as to avoid conflicting views. Investors should know where they stand. It also helps the tax administration in enforcing the provisions of the taxing laws.
Nothing prevents the Government from changing the law on a prospective basis, if it feels strongly that the legislative intent has not been well appreciated by the Judiciary. But, to unsettle the law by putting the clock back by 50 years in unheard of, in any legal system, in any part of the world.
At this rate, India would not need Courts and Tribunals to decide on tax matters. The Government would do well to take away the provisions related to appellate remedies. This would, at least, save the tax payers from spending effort and money on litigation. If this trend goes on, there would be no point in the Courts trying to interpret the law, as any decision which is not to the liking of the Government, could easily get retrospectively amended.
One fails to understand the so called ‘legislative intent' getting reinforced through these retrospective amendments? All that one can see is the reinforcement of the ‘Executive Will' rather than the ‘Legislative Will', in as much as, it seems that the ‘Executive Action’ is prevailing over the ‘Rule of Law'.
The most undesirable outcome of a retrospective amendment is that, it would affect all the concluded transactions which have attained finality. In the instant case, not only would Vodafone get affected but also a lot of other concluded transactions would also get affected, which seems rather unfair.
Let us not going into the merits of the Vodafone case and whether the facts contained in this case would promote to advance the case of ‘tax avoidance'. But, once the Supreme Court had decided that this is a case of tax avoidance rather than tax evasion, all of us including the Government should respect it.
Retrospective amendment to the law may be cheap, quick and certain way of closing a tax loophole and the governments may find itself irresistibly tempting to use this remedy. India is one example where governments have gone overboard to use the power to undo court rulings with retrospective amendments.
The Apex Court still may or may not uphold the constitutional validity of all these retrospective amendments. But, as a nation, we would do well to remember and recollect what the great Nani Palkhivala has repeatedly said:
“Taxes are the lifeblood of the government, but it cannot be over-emphasized that the blood is taken from the arteries of the taxpayers and, therefore, the transfusion has to be accomplished in accordance with the principles of justice and fair play.”
Published in ' The Management Accountant' a monthly Journal of ICAI [June 2012; Vol.47 no 6]
[This material is put online to further the educational goals of ‘Study in Law’. This material may be used freely for educational and academic purposes. It may not be used in any way for profit.]
 R v. HMRC,  EWCA Civ 890
 An ex post facto law or retroactive law is a law that retroactively changes the legal consequences (or status) of actions committed or relationships that existed prior to the enactment of the law.
 Kanaiyalal v. Indumati, AIR 1958 SC 444: 1958 SCR 1394
 Wealth Tax Commr. Amritsar v. Suresh Seth, AIR 1981SC 1106
 Sri Prithvi Cotton Mills Vs Broach Borough Municipality;  79 ITR 136 (SC) ;  1 SCR 388
 Minerva Mills v. Union of India; AIR 1980 SC 1789
 Ericsson AB(2012) 204 Taxman 192 (Delhi)
 Dynamic Vertical Software India Pvt. Ltd. (2011-. TII-08) (Del HC).
 [Karnataka High Court (HC) [ITA No. 2808 of 2005]
 Ishikawajima Harima Heavy Industries Ltd Vs DIT;  288 ITR 408 ( 2007-TIOL-03-SC-IT )
Clifford Chance v. DCIT; (2008-TIOL-650-HC-MUM-IT)
 Jindal Thermal Power Company Ltd. v. DCIT; ( 2009-TIOL-302-HC-KAR-IT)