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Retrospective Tax:

Retrospective Taxation is a plain English. This means nothing but the old
proceedings are being taxed as per the new rules.
For eg. Lets say that the current tax rates x% for the current assessment year
the previous assessment year was (x-2) %. Because of some reason the IT
department has arrived at a conclusion that previous assessment year also
should be taxed at x% only not (x-2) %. This is called retrospective taxation.
Reasons why India introduced retrospective tax laws:
It has been usual to resort to indirect ownership structures when making
investments in India, particularly those based in Mauritius. Out of the total of
USD 243,055 million that was invested into India between April 2000 and
January 2012, 40 percent was invested through Mauritius.
Indian businesses have often exchanged hands offshore through transfers of
intermediate holding companies. Although the Indian Revenue intended to tax
the gain on such sales, the Supreme Court of India declared that such
transactions could not be taxed in the absence of specific legal provisions
allowing to do so.
It is due to this judicial resort that the Indian Government intends to include in
the statute a provision allowing it to tax indirect transfers. Furthermore,
unwilling to accept judicial defeat in Vodafone, the Indian Revenue authorities
proposed such new provisions to have retrospective effect so as to bring past
indirect transfers within the tax net.
Background:
The main companies involved were:
HTIL
Hutchison Telecommunications International Ltd. a company
incorporated in Cayman Island in 2004. It was listed on Hong Kong and
New York Stock Exchanges. It was the seller and earner of Capital Gain.

VIH Vodafone International Holdings BV a company incorporated in
Netherlands. It was the purchaser of one share of CGP.

CGP CGP Investments (Holdings) Ltd. (CI) a company incorporated in
Cayman Islands in 1998. It is the company whose share has been
transferred.

HEL Hutchison Essar Ltd. a company incorporated in India. It is the main
business company. Controlling share holding in the same has
been transferred by virtue of Share Purchase Agreement and several
related documents. Transfer of CGP share was one of several documents.


In February 2007, Vodafone International Holdings B.V (Vodafone or VIH), a
Dutch entity, had acquired 100 percent shares in CGP (Holdings) Limited
(CGP), a Cayman Islands company for USD 11.1 billion from Hutchinson
Telecommunications International Limited (HTIL). CGP, through various
intermediate companies/ contractual arrangements controlled 67 percent of
Hutchison Essar Limited (HEL), an Indian company. The acquisition resulted in
Vodafone acquiring control over CGP and its downstream subsidiaries
including, ultimately, HEL. HEL was a joint venture between the Hutchinson
group and the Essar group. It had obtained telecom licences to provide cellular
telephony in different circles in India from November 1994

Controversy
In September 2007, the tax department issued a show-cause notice to
Vodafone to explain why tax was not withheld on payments made to HTIL in
relation to the above transaction. The tax department contended that the
transaction of transfer of shares in CGP had the effect of indirect transfer of
assets situated in India.
Vodafone filed a writ petition in the Bombay High Court, inter alia,
challenging the jurisdiction of the tax authorities in the matter. By its order
dated 3 December 2008, the Bombay High Court held that the tax authorities
had made out a prima facie case that the transaction was one of transfer of a
capital asset situate in India, and accordingly, the Indian income-tax authorities
had jurisdiction over the matter.
Vodafone challenged the order of the Bombay High Court before the Supreme
Court. In its ruling, dated 23 January 2009, the Supreme Court directed the tax
authorities to first determine the jurisdictional challenge raised by Vodafone. It
also permitted Vodafone to challenge the decision of the tax authorities on the
preliminary issue of jurisdiction before the High Court.
In May 2010, the tax authorities held that they had jurisdiction to proceed
against Vodafone for their alleged failure to withhold tax from payments made
under Section 201 of the Income-tax Act, 1961 (the Act). This order of the tax
authorities was challenged by Vodafone before the Bombay High Court.
By its order dated 8 September 2010, the Bombay High Court dismissed
Vodafones challenge to the order passed by the tax authorities. Vodafone filed
a Special Leave Petition (SLP) against the High Court order before the Supreme
Court. On 26 November 2010, SLP was admitted and the Supreme Court
directed Vodafone to deposit a sum of INR 25000 million within three weeks
and provide a bank guarantee of INR 85000 million within eight weeks from the
date of its order.
Vodafone International Holdings B V served an arbitration notice under the
Bilateral Investment Protection and Promotion Agreement between India and
the Netherlands for resolving its tax dispute.

Interpretation of Section 9(1)(i) of the Act
At the heart of the controversy was the interpretation of Section 9(1)(i) of the
Act. As per the said section, inter alia, income accruing or arising directly or
indirectly from the transfer of a capital asset situated in India is deemed to
accrue/ arise in India in the hands of a non-resident.
In connection with the above, the Supreme Court observed that:
o Charge to capital gains under Section 9(1)(i) of the Act arises on
existence of three elements, viz, transfer, existence of a capital asset and
situation of such asset in India.
o The legislature has not used the words indirect transfer in Section
9(1)(i) of the Act. If the word indirect is read into Section 9(1)(i) of the
Act, then the phrase capital asset situate in India would be rendered
nugatory (of no value or importance) .
o Section 9(1)(i) of the Act does not have look through provisions, and it
cannot be extended to cover indirect transfers of capital assets/ property
situated in India.
o The proposals contained in the Direct Taxes Code Bill, 2010, on taxation
of off-shore share transactions indicate that indirect transfers are not
covered by Section 9(1)(i) of the Act.
o A legal fiction has a limited scope and it cannot be expanded by giving
purposive interpretation, particularly if the result of such interpretation is
to transform the concept of chargeability which is also there in Section
9(1)(i) of the Act.
o Accordingly, the Supreme Court concluded that the transfer of the share
in CGP did not result in the transfer of a capital asset situated in India,
and gains from such transfer could not be subject to Indian tax.


Role of CGP in the transaction
In dealing with the tax authorities contention that CGP was interposed at a late
stage in the transaction in order to bring in a tax-free entity and thereby avoid
capital gains in India, the Supreme Court observed as follows:
Two routes were available, namely, the CGP route and the Mauritius route. It
was open to the parties to opt for any of the two routes. The transaction of sale
was structured at an appropriate tier (i.e. the CGP route), so that the buyer
acquired the same degree of control as was hitherto exercised by HTIL.
Under the Indian Companies Act, 1956, the situs of the shares would be where
the company is incorporated and where its shares can be transferred. In the
present case, it was asserted that transfer of CGP shares were recorded in
Cayman Island and this was not disputed by the tax authorities.
Considering the entirety of the facts of the case, the Supreme Court held that the
sole purpose of CGP was not only to hold shares in subsidiary companies but
also to enable a smooth transition of business. Therefore, it could not be said
that CGP had no business or commercial substance.
Additionally, the Supreme Court also rejected the argument of the Revenue that
since CGP was a mere holding company, the situs of its share was situated in
India where its underlying assets were located.

Rights and entitlements:
The tax authorities had contended that the transfer of the CGP share was
not adequate in itself to achieve the object of consummating the
transaction between HTIL and VIH and that intrinsic to the transaction
was a transfer of other rights and entitlements. It was further contended
that such rights and entitlements constituted capital assets, gains from
the transfer of which were liable to tax in India. On this issue, the
Supreme Court concluded
As a general rule, in a case where a transaction involves transfer of
shares, such a transaction cannot be broken up into separate individual
components, assets or rights. The present transaction was a share sale
and not an asset sale and concerned sale of an entire investment.
A controlling interest is an incident of ownership of shares in a company,
which flows out of the holding of shares and hence is not an identifiable
or distinct capital asset independent of the holding of shares.
In essence, the Supreme Court concluded that the character of the
transaction was an alienation of shares, and that when parties had agreed
on a lump sum consideration, there was no question of allocation of such
consideration for transfer of any other rights or entitlements.





IT ACT:
As per the ITL, transfer of a capital asset is deemed to be taxable in India if it is
situated inIndia. Vodafone argued that a 'share' is situated where the registered
office of a company islocated and, in the instance case, the shares were situated
in Cayman Islands and consequently, the situs was wholly outside India.
Vodafone also argued that valuation mechanism adopted to ascertain the value
of a share of CGP (based on the underlying assets in the Indian company)
should not determine the situs to be in India. Vodafone reiterated that tax can
be levied on gains arising out of a transfer of a capital asset situated in India, not
a capital asset, the transfer of which has some nexus with India. Mere nexus
with India cannot notionally shift the situs.The SC questioned whether a
transaction can constitute source of income and whether the
rights/entitlements in India can be said to have a situs in India for which it was
submitted that as the transfer was of CGP shares which were situated outside
India. Though a transaction can be a source of income, in Vodafones case,
the transaction was carried outside India and, hence, not taxable in India.
_ The Tax Authority argued that the source rule provisions in the ITL are
extremely wide. This
provision was, in itself, a look through one and, hence, should be interpreted
purposively. If undue importance is given to the phrase situated in India, the
objective of the provision would be defeated. Therefore, the Tax Authority had
the jurisdiction to tax if the source was in India.Furthermore, it was argued
that as the term transfer (for taxing a capital asset) was defined in an inclusive
manner and was meant to expand the scope, it should cover indirect transfers as
well. Alternatively, it was also argued that situs of shares was in India for the
reason that the purpose was to obtain control over the Indian entity. The SC
suggested that recent amendments to the ITLs source rule suggested a shift
from the situs test to a nexus principle. To this, Vodafone replied that tax
could only be imposed on situs and not on nexus.
Vodafone argued that acquisition of controlling interest, which is held by the
Tax Authority, as a taxable transaction, is, in fact, a commercial concept. To
support this, it was stated that tax
implications should remain the same whether 5% shares in a company are
transferred or 90%shares (where even the control in a company is transferred).
Furthermore, one may not be able to transfer controlling interest independent
from transfer of shares. Even assuming that control had been transferred
independent of shares, the control over Indian company was always exercised
by its shareholders (being Mauritius companies) and there was no act of transfer
of such a right. Therefore, the Tax Authority was wrong in submitting that
Hutch transferred controllinginterest situated in India.
The SC also enquired whether any other rights in India (other than shares) were
transferred for which, Vodafone, without referring to the present controversy,
submitted that through a single agreement, multiple assets in various
jurisdictions can be transferred. The Tax Authority opposed this argument and
submitted that controlling interest, being a capital asset, wastaxable in India.

Under the ITL, any person responsible for makinga payment to a non-resident
(NR) is required to withhold tax on the quantum of sum which is chargeable to
tax in India. Vodafone argued that the provision should be read down in case
of payments not having any nexus with India or the said person not having a
presence in India.Furthermore, compliance with such provisionwould result in
breach of the commercial contract between Hutch and Vodafone (which is
governed by the UK commercial laws). Vodafone suggested that the provisions
could apply in case the corporate veil is pierced and not otherwise. The SC
enquired whether acquiring controlling interest would result in creating a
presence in India for which Vodafone submitted that merely because the
recipient has a tax presence or income chargeable to tax in India, an obligation
to withhold tax cannot be cast on a payer who has no presence in India. On the
contrary, the Tax Authority contended that the withholding tax provision
referred to the term person (widely defined and also includes a foreign
company) and, is therefore, applicable to any taxable remittance to an NR. Even
otherwise, Vodafone had a presence in India on account of its shareholding and
JV with an Indian company and, thus, the withholding tax provision stood
attracted.


The Tax Authority summarized its arguments into four alternative parts:
Construing the SPA as it stands and keeping in mind the
facts/circumstances, one could easily discern that transfer of CGP share
was merely a mode to transfer the capital assets situated in India; or
Look at the structure as an artificial tax avoidance scheme; or
Adopt the approach taken by the HC that even though CGPs share was
transferred outside India, there were other valuable rights in India which
were also transferred and, hence, it should be taxed in India; or
Share transfer falls within the widest net cast by the deeming fiction
under the ITL and, therefore, the transaction is taxable.










Retospective ammendments as per Finance Act 2012
Sections
amended
Amendment done Co relating with the case
Section 9(1)(i):
Income
deemed to
accrued or
arise in India
All incomes accrued or arise,
whether directly or indirectly:
Through transfer of a capital
asset situated in India.
Explanation for capital assets:
Any entity (whether registered
outside India) deemed to be
situated in India, If the share of
that entity derived from the value
of asset located in India.
Explanation on Capital assets
provides that:
Shares of CGP investments
(Registered outside India) but value
of shares are derived from the value
of asset located in India.
Section 2(14):
Definition of
capital assets
Property includes:
Any rights in an Indian company
Any rights in relation to an
Indian Co.
Hutchison Hong Kong having rights
in Indian Co.
Examples: Right to appoint directors
right to use hutch brand etc.
Section 2(47):
Definition of
Transfer
The term transfer includes:
Creation of any interest in any
asset in any manner whether
indirectly or otherwise by way of
an agreement (whether entered
inside or outside of India) or
otherwise through transfer of
shares outside India which
affects the transfer of rights in
Indian Company.
Hutchison Hong Kong transferred
rights in Indian Co. (CGP) to
Vodafone created interest of
Vodafone in an Indian company by
Indirect means by way of an
agreement entered outside India
through transfer of shares in Cayman
Island, Mauritius which affects the
transfer of rights from HTIL to
Vodafone.
Section 195(1) As capital assets are not taxable
in India no question to deduct
Tax at Source U/S 195(1)
Section 195(1) for the removal of
doubts to clarify that obligation to
deduct tax at source shall be deemed
to have always extended to all
persons. Whether resident or
nonresident has:
A residence or place of business or
business connection in India or any
other presence in any manner
whatsoever in India



Government stance on retrospective tax case
The budgetary proposal to amend the Income Tax Act with retrospective effect
from 1962 to assert the government's right to levy tax on merger and acquisition
(M&A) deals involving overseas companies with business assets in India is not
Vodafone case specific, but an enabling provision to protect the fiscal
interests of the country and avert the chances of a crisis.
India is a not a no tax' or low tax' or even a tax haven.' India is a country
where all taxpayers, whether resident or non-resident, will be treated on a par.
Secondly, India is a country where tax laws are that if you pay tax in one
country, you need not pay tax in the other country of your business operation
which is covered by the DTAA. But it cannot be a case that you pay no tax at all
Government said the intention was clear: where assets are created in one
country, it will have to be taxed by that country unless it is covered by the
DTAA. The government sought to argue that the decision to amend the I-T Act
with retrospective effect would not impact foreign investment flows.
The apprehension that the retrospective amendments would create negative
sentiment for FDI is not correct. FDI comes when there is profitability. FDI
does not come only on account of zero tax To make the intent of the
legislature clear, clarificatory amendments have been proposed. This will bring
tax certainty and would also make it clear that India has a right to tax similar
transactions. It did not mean that the government would start re-examining tax
cases from 1962 onwards.
In effect, since the Vodafone transaction was not taxed in either of the
countries, it was susceptible to 10 per cent tax in India


Retrospective tax law in China related to indirect transfer of assets
In China, indirect transfer of assets situated in China is taxable under its
general anti avoidance rules. The Circular No 698 dated 10 Dec 2009
was issued by the Chinese authorities with retrospective effect from 1 Jan
2008.
The circular requires that when a foreign investor transfers a Chinese resident
enterprise indirectly, if the actual tax rate margin is lower than 12.5% in the
country of transferor or that country does not levy income tax to its residents on
overseas income, then the enterprise needs to provide detailed information to
tax administration. The circular further provides that if a foreign investor
(actual controlling party) transfers the equity in a Chinese resident enterprise
indirectly via arrangements such as through the misuse of the corporate form
without a reasonable business purpose to avoid corporate income tax liability,
the relevant tax authority holds the right to recharacterise the equity transfer
deal according to the economic substance and ignore the existence of the
offshore holding company used for the tax arrangement.
Retrospective tax in UK
In the March 2008 Budget, the Chancellor announced a crackdown on the
abuse of loopholes in the double taxation treaties which exist between the UK
and other countries.
Prior to 2008, a number of tax avoidance schemes had been established to
enable contractors, and other UK workers to pay income tax in the Isle of Man
(and other locations), whilst working and living in the UK.
Robert Huitson was a client of Montpellier whose own particular scheme
involved a partnership and a trust located in the Isle of Man. Mr Huitson
provided IT consultancy services via the Allenby Partnership with whom he
entered into a consultancy agreement. The partnership paid Mr Huitson 15,000
or less p.a which was subject to UK tax. The Allenby Partnership consisted of
five Isle of Man companies and each partner was a trustee of a Isle of Man
Interest in Possession Trust. Robert Huitson was the settlor and life tenant of
one of these trusts into which he paid 1,000.
The majority of Mr Huitson's fee income was channelled through his trust
which was in excess of 15,000 p.a. The Allenby Partnership would pay profits
to the trustee who, in turn, would pay this to Robert Huitson. Mr Huitson
claimed this income was neither taxable in the Isle of Man, because of
concessions made by the islands fiscal authorities, nor in the UK, by virtue of
Article 3 of the UK-Isle of Man Double Taxation Agreement.

Mr Huitson claimed double taxation relief for the trust income in his 2002 self
assessment tax returns and subsequent returns and HMRC did not challenge this
until June 2004, although they gave no reasons for such until February 2006. At
this point, the Revenue advised the taxpayer to make a payment on account so
as to mitigate potential tax, interest and penalties. In May 2007, HMRC advised
that they were preparing a number of cases for hearing by the Special
Commissioners that challenged the validity of the double tax relief claims.
Before these cases were listed for hearing the March 2008 Budget announced
the introduction of legislation that would render the tax avoidance scheme
ineffective beyond doubt, ie, S.58 Finance Act 2008.

After failing in the High Court to force a judicial review on the grounds that the
legislation was incompatible with the Human Rights Act 1998, Mr Huitson was
again unsuccessful in the Court of Appeal as it ruled that the retrospective
legislation was proportionate and thus compatible with the Human Rights Act.
The court said that in this issue in this case was whether the retrospective law
achieved, a fair balance between the interests of the community and the rights
of the individual, and the balance lay with the community.

In a landmark hearing at the High Court on January 28th 2010, it was ruled that
HMRC could legally claim for backdated taxes retrospectively, following a
claim by IT contractor Robert Huitson
For seven years, Huitson had used a complicated Isle of Man offshore tax
vehicle, run by Montpelier Tax Consultants. He saved himself around 85,000
in taxes over the period, reducing his effective income tax rate to just 3.5%.
Huitson claimed that HMRC could not retrospectively tax him for income
received before the 2008 Finance Act became law, however Mr Justice Kenneth
Parker disagreed, which means that an estimated 2 to 3,000 people who have
used such schemes in the past may be pursued for significant sums of backdated
tax, interest, and penalties.
A the hearing, the judge pointed out that HMRC had already warned
participants in offshore schemes that they may be liable to further taxation, and
that the backdating of tax demands did not breach human rights as it was in the
relevant circumstances proportionate.
Huitson Appeal July 2011
In November 2010, offshore scheme provider Montpelier were granted a Court
of Appeal hearing to contest Justice Parkers original findings.
However, in the judgement which was handeddowninJuly2011, Lord Justices
Mummery, Sullivan and Tomlinson found no reason to overturn the original
ruling


Conclusion:
Terming retrospective taxation a significant disincentive for entities wishing
to do business in India, a government-appointed panel has suggested a string of
legal, administrative and regulatory reforms to make the country a better and
easier place for doing business.
The panel has also suggested simpler drafting of rules to avoid leaving room for
interpretations, while recommending greater autonomy to regulators,
transparency in selection of heads for regulatory bodies, incentives for states
undertaking key reforms and faster resolution of disputes through arbitration
mechanism and consent settlements.
In its 77-page report for reforming the regulatory environment for doing
business in India, former SEBI Chairman M. Damodaran-headed expert panel
said that death and taxes are equally undesirable aspects of human life, but
even death is never retrospective.
Retrospective taxation has the undesirable effect of creating major uncertainties
in the business environment and constituting a significant disincentive for
persons wishing to do business in India.
While the legal powers of a Government extend to giving retrospective effect to
taxation proposals, it might not pass the test of certainty and continuity.
This is a major area where improvements should be attempted sooner rather
than later since business cannot take corrective action retrospectively.