TAX
LAWS - RETROSPECTIVE LEGISLATION & THE RULE OF LAW
By K P C Rao., LLB.,
FCMA., FCS
kpcrao.india@gmail.com
“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
BACKGROUND
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.
RETROSPECTIVE
TAXATION
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.
Global Scenario
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[1], 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[2]. 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[3].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[4].
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[5],
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.”
Vodafone Case
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.
India-Mauritius
treaty
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[6]
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[7]
and Dynamic Vertical Software case[8],
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[9]
and certain unreported decisions).
In Ishikawajma Harima Heavy Industries case[10]
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[11] and
the Karnataka High Court, in the Jindal
Thermal Power case[12],
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?
CONCLUSION
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.”
-Nani
Palkhivala
[Published in Management Accountant, a Monthly magazine of ICAI]
[1] R v. HMRC,
[2011] EWCA Civ 890
[2] 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.
[3] Kanaiyalal v. Indumati, AIR 1958 SC 444: 1958 SCR
1394
[4] Wealth Tax Commr. Amritsar v. Suresh Seth, AIR
1981SC 1106
[5] Sri Prithvi Cotton Mills Vs Broach Borough
Municipality; [1971] 79 ITR 136 (SC) ; [1970] 1 SCR 388
[6] Minerva Mills
v. Union of India; AIR 1980 SC 1789
[7] Ericsson AB(2012) 204 Taxman 192 (Delhi)
[8] Dynamic Vertical Software India Pvt. Ltd. (2011-.
TII-08) (Del HC).
[9] [Karnataka High Court (HC) [ITA No. 2808 of 2005]
[10] Ishikawajima
Harima Heavy Industries Ltd Vs DIT; [2007] 288 ITR 408 ( 2007-TIOL-03-SC-IT )
[12] Jindal Thermal Power Company Ltd. v. DCIT; (
2009-TIOL-302-HC-KAR-IT)
