I blogged here yesterday about the 'retrospective taxation case of Vodafone'. This post elaborates on the same.
There was an overseas transfer of ownership of the Indian telecoms company Hutch Essar from Hutchison Whampoa to Vodafone Netherlands for a consideration of $11 bn. Indian tax authorities levied a tax on Hutchison for capital gains on the shares of the company sold to Vodafone and directed the latter to remit the amount. Vodafone approached the courts. The Bombay High Court upheld the tax, while the Supreme Court overturned the same.
The Supreme Court took the very narrow legal/technical view that the Income Tax Act 1961 did not allow for taxing indirect financial transactions through foreign channels. Its interpretation was based on making a legal distinction between a company and its shareholders, and the capital gains not vesting on the company but its shareholders who were not located in India. It also ruled that since all the entities were established long before the transaction it did not find any evidence of attempts at tax avoidance. This interview with Surajit Mazumdar clarifies further on the judgement.
In an age where foreign investments, even inter-corporate transfers, are shrouded in several layers of cross-holdings involving entities based out of tax havens, the Supreme Court's interpretation that formed the basis for its judgement was striking. It will be interesting to know how many of the commentators who have lost no opportunity to roast successive governments on this issue have ventured into critiquing the strange judgement of the Supreme Court.
The amendment to the Income Tax Act 1961 made in 2012 was merely clarificatory in nature to a technical contingency not covered by the old legislation. The clarification was to clear all ambiguities about the undisputed sovereign right to tax the gain from an economic activity undertaken in India, irrespective of the location of the associated financial transaction, and thereby prevent any circumvention of the country's tax laws.
The excessive focus on the retrospective part of the clarification in public commentaries on the issue is misleading since what was being done through the legislation was to make the sovereign right to tax unambiguously clear. In other words, it was a case of stating the obvious.
There are no innocent investors here. The duty to pay tax capital gains on any asset is enshrined in the law. It is a bit rich to claim that Hutchison and Vodafone were unaware of it. Indeed it is now known that the financial advisors pointed this out to Hutchison in course of the purchase. But all tis is beside the point.
There appears to be a case that the government over-reached in the sweeping and ambiguous nature of the classificatory amendments themselves. Further, the government made the mistake of agreeing to the arbitration proceedings. Now having agreed to it, there is a case that it should now accept the verdict. That's a fair point and perhaps the only reason for the government to consider not appealing and closing the issue.
It is one thing to critique the government for now not accepting the judgement. But in reality successive governments have faced uniform criticism from commentators right from the levy of the tax itself, even before the retrospective amendments were introduced.
Substantively, apart from the mistake of agreeing to the arbitration, what else could the government have done on this in the litigation till Supreme Court. That it placed its case with clarity is borne out by both the High Court judgement in its favour as well as the egregiously strange nature of the Supreme Court judgement.
Foreign investors and commentators will be happy if the government does not appeal. But, as mentioned in the previous post, it will set precedents. It opens the doors for abusing the channel of indirect foreign transfers on closed or pending or future cases. Besides, the precedent is one more point in favour of businesses in a future international arbitration proceeding.
There is a larger point about the perceptions and attitudes around issues involving foreign companies engagement with domestic laws. The playing field is tilted heavily against governments and in favour of corporations. The Vodafone case is one more example of how corporations, foreign and domestic, interpret domestic laws as suits them and blame governments for ambiguities when the reckoning comes.
As another illustration, consider the example of foreign e-commerce firms accusing the Government of India of whismiscally changing the rules of the game on marketplaces. The original e-commerce policy while allowing e-commerce companies to run virtual "marketplaces" that connect independent sellers to consumers, had explicitly barred them from selling goods themselves and being online supermarkets. Nobody can dispute the intent behind the relevant provisions of the original e-commerce policy.
But market participants choose to overlook it. The foreign firms gamed the rules by establishing local partnerships and creating new on-seller companies. One of the most reputed names of corporate India owned one such partnership with a leading e-commerce company.
But it was only a matter of time before the matters came to a head (for whatever reason) and the government was forced to take action. That this reckoning would inevitably come was all along clear to everyone involved. When it came, the new rules stipulated that no seller on online marketplaces can source more than a quarter of its inventory from a wholesaler linked to the marketplace, and barred sales on the marketplace by any entity owned by the marketplace or any of the its group companies. The restrictions on foreign firms were stricter still.
This reminds of Indian infrastructure companies who routinely bid aggressively, overlooking explicit provisions that would have made their sustainability unviable, in an attempt to bag the contract and get back to renegotiate the terms later. Companies like Amazon did exactly the same thing, accepting the GoI's e-commerce policy and entering the market, in the hope that they would be able to either continue gaming the extant rules or be able to lobby and change the policy itself.
The takeaway from all this is simple. If companies use loopholes in legislations to their advantage, and even if the interpretation is evidently specious and the advantages run into billions of dollars, that's all fine. However, if governments dispute the same, then they are excoriated and accused of damaging investor confidence.
Irrespective of whether the government appeals against this or not, this is a teachable moment about how mainstream commentariat view such issues. If governments, and not just in India, are not to shy away from firmly enforcing regulations on issues of tax avoidance, then there is a need for balanced commentary on such issues.
Rahul Varman makes the point brilliantly,
Thus it is interesting that while such mergers are done in the name of market, efficiency and public welfare, their tax liabilities are also discounted in the name of public welfare, this time for investments and economic growth! And all this can always be justified by asserting that corporations are a legal fiction and cannot be said to have any purposive intent, as in the present judgment. And yet when it is convenient corporations can take the form of a natural person and acquire basic human rights like free speech and due process too!
Heads I win, tails you lose!