India Moves to Resolve Tax Disputes

It requires a radical overhaul to reorient a system once described as based on “tax terrorism.” This statement perhaps best describes the decade-long changes in the Indian tax administration’s approach and tax policy, seeking to relieve courts clogged with tax disputes. India has been able to make a course correction with a slew of reforms and structural changes.

Most recently the Government of India (GoI) proposed to limit the retrospective application of amendments introduced in 2012 that sought to nullify judicial pronouncements. Acknowledging that the underlying retrospectivity invited criticism from stakeholders and adversely affected India’s international competitiveness, the GoI also proposed the refund of taxes collected under these retrospective amendments.

The Indian parliament has approved the proposals and with the President’s assent, they have become law (the Taxation Laws (Amendment) Act, 2021).

This article contextualizes recent events against the wider backdrop of India’s measures to avert tax disputes.

Retrospective Tax on Indirect Transfers: A Timeline

In March 2012, the GoI proposed wide-ranging amendments to the corporate income tax law. Defended as essential for resolving anomalies, some of these amendments sought to overcome judicial pronouncements and were applied with retrospective effect. In some cases, the retrospectivity went back decades, from the day the income tax law became effective from 1962.

The amendments included an indirect transfer tax imposed on offshore reorganizations which involved transfer of underlying Indian assets.

We describe below the events that led to these proposals.

Vodafone and Cairn

The tale began in 2006 with Vodafone’s decision to enter the Indian telecommunications business sector. Instead of directly applying for a telecoms license in India, Vodafone chose to acquire the license of an existing Indian entity, Hutchison, through a series of complex offshore transactions. The transaction was effected through purchase of shares of a Cayman Islands company—which controlled the license—by Vodafone, a nonresident, from another nonresident, a Hong Kong-based entity.

Since the Cayman Islands company held substantial assets in India, the Indian tax authorities contended that the underlying assets were transferred, thereby granting India the right to tax the gains arising on such transfer. Despite acknowledging that the substantive tax liability was the seller’s, the authorities chose to proceed against Vodafone on the premise that it failed to deduct tax on gains arising to the seller from the transaction. Understandably, Vodafone contested the tax demands, but lost before the High Court of Bombay in 2010.

This shifted the focus to the Supreme Court, which had to consider, inter alia, the following questions:

• Was the capital gain to the seller taxable in India?
• Were the Indian authorities correct to assert that the situs of the shares in the Cayman Islands company was traceable to India and/or the transaction resulted in the transfer of Indian assets?
• Was Vodafone obliged to withhold tax in the transaction?

Disagreeing with the High Court, the Supreme Court of India in January 2012 upheld Vodafone’s stand, to declare that gains arising from indirect transfer of Indian assets were not taxable under the income tax law ([2012] 1 S.C.R 573). The Supreme Court also emphasized the need to observe “certainty” in tax laws, to disregard their innovative interpretation which unduly repressed foreign investors.

Disagreeing with the verdict, the GoI proposed changes to the tax laws which were then approved by the Indian parliament, retrospectively amending the tax provisions and overriding the Supreme Court’s judgment. These amendments “clarified” India’s entitlement to levy capital gains tax on offshore transactions involving Indian assets.

In other words, profits of earlier years, starting from 1962, could be taxed even though they were not taxable at that time given the Supreme Court’s declaration. This amendment was accompanied by a “validation” clause, a provision that validates laws annulled by courts. (Even though such clauses interfere with the notion of separation of powers, a concept recognized in the Indian Constitution, they are accepted as the legislature is considered the best reflector of public opinion.) The validation clause implied that tax could be recovered from Vodafone, notwithstanding the Supreme Court judgment.

It is understood that these amendments were applied in 17 instances. Among these, besides Vodafone, the case of Cairn stands out: This was assessed in 2014 for tax liability arising on offshore reorganization undertaken in 2006. In fact, the shares of the Cairn entity were attached and sold by the Indian tax authorities towards meeting the outstanding amount arising out of the retrospective amendments.

Unlike the Vodafone case, which achieved a final outcome in the Indian courts, the Cairn case is still before the Delhi High Court.

While some of the 17 entities approached Indian courts for relief, with mixed results, both Vodafone and Cairn sought refuge under India’s Bilateral Investment Treaties (BITs) with the Netherlands and the U.K., respectively. Arbitration awards have been announced recently in favor of both Vodafone and Cairn.

Both BITs included a clause of fair and equitable treatment (FET), which provided that if any action of the GoI caused loss to the investors, the GoI shall be liable to “make good” such loss. Vodafone and Cairn argued that the amendments with retrospective effect were a violation of the FET clause, and this was decided in their favor in the arbitration awards.

While the Vodafone award (PCA Case No. 2016-35) is not in the public domain, for reasons of confidentiality (a copy of the operative part of the award is available), the Cairn award reveals the Tribunal calling for fairness and certainty in tax policy, echoing the Supreme Court decision.

The GoI promptly challenged these awards in appeal before the foreign jurisdictional courts in Singapore (for Vodafone) and the Netherlands (for Cairn), claiming lack of jurisdiction of the BIT Tribunals in a sovereign tax policy space. In parallel, even while the BIT claims were pending, India repudiated all existing BITs and proposed a revised BIT model that categorically excluded tax from its coverage.

It is against this backdrop that the recent amendment (which has been introduced even while India’s appeals against the BIT awards are pending) needs to be viewed. It removes the much-criticized retrospectivity by providing for withdrawal of tax demands on the 17 entities, subject to fulfillment of certain conditions.

The amendment nullifies existing demands and provides for the refund of tax (not interest or penalties) already collected, if the entity concerned withdraws pending litigation and undertakes not to pursue and claim in future, whether domestically or abroad. While it can be claimed that the withdrawal of retrospective amendment is not unconditional, that the GoI has hedged its position, or that the provisions are unfair as they deny recouping of lost interest, etc., it is the change of position (and in turn the revisiting of tax policy) which is significant. The change may have been delayed but it is in line with the declared policy of the incumbent GoI that retrospectivity is not a feature of the tax laws.

As at the date of writing, draft rules to effectuate the 2021 Amendments have been issued for public consultation and the final rules are expected to be released shortly. These set out the conditions to be fulfilled and the process to be followed by taxpayers seeking refund and withdrawing ongoing litigation.

Schemes to Reduce Tax Litigation

In addition to the aims of simplifying tax administration and easing compliance, reduction of tax litigation has been a high priority for the GoI. Hence, the withdrawal of the retrospective amendment is another step in the GoI’s long-term agenda of reducing tax disputes. The nature of such schemes and their contribution to reducing tax litigation is explained below.

Income Declaration Scheme 2016

The Income Declaration Scheme (a form of amnesty) envisaged a one-time window for all citizens who have not declared income correctly in earlier years to come forward, declare it, and pay a tax (including surcharge, penalty and interest) of 45% on such undisclosed income. From data the GoI provided, around 64,275 taxpayers disclosed $8.87 billion, of which $3.98 billion was tax and penalty to be paid to the GoI. The move towards liquidating pending tax disputes has continued since.

“Vivad se Vishwas” Scheme 2020

This scheme, which translates as “From Dispute to Trust,” gave taxpayers an opportunity to settle longstanding income tax disputes and be relieved of further strain on their time and resources. The major difference between this scheme and the 2016 scheme described above was a lower tax rate. Further, the Indian Tax Department also waived the levy of interest and penalties and only demanded tax on the disclosed income. The scheme became operational on March 17, 2020 and according to the Finance Ministry of India press release dated August 9, 2021, around 146,701 cases have been addressed so far with a settlement of $13.57 billion under dispute, and $7.31 billion paid against the disputed tax, which has helped to substantially reduce tax litigation.

Reforming the Advance Ruling Mechanism

The advance ruling mechanism was introduced with the intention of providing early tax certainty with respect to transactions of nonresident taxpayers, and avoid future tax disputes. Considering the difficulties faced under the former Authority for Advance Rulings, such as delays and protracted and adversarial inquiries, the mechanism was revamped and the Board for Advance Rulings was introduced in early 2021. This change is expected to reduce pending income tax litigation in the country by guaranteeing the speedy disposal of advance ruling applications.

Dispute Resolution Committee

The Dispute Resolution Committee (DRC) was also introduced in early 2021 to grant early tax certainty to small and medium taxpayers, by preventing new disputes and resolving issues at the outset. According to the figures from the income tax department, roughly 99.3% of all tax returns filed could possibly be covered by the scheme’s financial threshold. With features such as a low threshold for eligible assessment and broad powers to reduce or waive penalties and grant immunity from prosecution, the newly constituted DRC is expected to provide an impetus to expedite dispute resolution.

Fast Tracking Mutual Agreement Procedure Settlements

India published detailed guidance on May 6 and August 7, 2020 on all aspects of the mutual agreement procedure (MAP), such as access to and denial of MAP, technical issues, implementation of MAP, while conforming to the minimum standard under the OECD BEPS Action Plan 14 and as a reaction to recommendations made under the Peer Review Report.

Indian tax rules now provide clear time lines for the taxpayer and tax authorities in India to implement a MAP that has been resolved by the competent authorities of both treaty partners.

Faceless Assessment/Appeal Scheme

Launched in 2020, the Faceless Assessment and Appeal Scheme is one of the largest tax reform measures adopted by the GoI, introduced with a view to minimizing the physical interface, promoting efficiency and effectiveness in tax administration, introducing team-based assessment and increasing accountability. The intention is to deploy technological solutions at assessment and appellate levels, where locational constraints are avoided and instead direct interaction with experts takes place in a timely and efficient manner. More crucially, by limiting interaction with tax officers, this mechanism also seeks to avoid selective indulgence and allegations of undue lenience.

Enforcing Financial Thresholds for Departmental Appeals

The Central Board of Direct Taxes, the chief authority responsible for framing the rules and regulations under Indian income tax law, has repeatedly increased the financial threshold of the tax amount on the basis of which the revenue authorities can lodge statutory appeals before relevant judicial forums, or mandate withdrawal of such appeals. In the last decade, these thresholds have been revised and increased five times, which has resulted in substantial reduction of litigation across different appellate forums. Currently, the threshold for appeals before a tribunal is $67,000, before the High Court, $130,000 and before the Supreme Court, $260,000. As a result, the judicial system is saved from scores of tax department appeals.

Taxpayer Charter

After obtaining its statutory recognition, in 2020 the GoI announced the Taxpayer Charter, which encapsulates the rights and obligations of taxpayers. It is intended to build a relationship of trust between the tax authorities and the taxpayer. The Charter seeks to implement the theme of “Transparent Taxation: Honoring the Honest” and lists a 20-point commitment of the tax department to respect the privacy of the taxpayer, maintain confidentiality, provide timely decisions, ensure a fair and just system, and reduce compliance costs, among other aims.

With this, India has joined select nations which enforce such charters in their tax legislation. It is expected that this move will reduce avenues for friction and also bring about a mindset change to further reduce tax litigation.

Way Forward for Taxpayers

The recent amendment and withdrawal of retrospectivity is in line with the stated objective of the GoI to instill fairness in the tax system, in addition to undertaking measures to prevent disputes. Removal of retrospectivity has a two-fold objective of legal course correction and judicial closure, as well as (subject to the parties concerned consenting) discontinuation of the BIT disputes and various legal challenges.

As regards the tax litigation landscape in India, the GoI may consider implementing other policy solutions, including accelerating the entering into of bilateral advance pricing agreements to reduce transfer pricing disputes, and further enhancing tax certainty by expanding the scope of arbitration and other tax dispute resolution methods, including fast-tracking trial process at lower appellate levels, and avoiding repetitive appeals by zeroing in on main areas of contention.

As a way forward, taxpayers who do not achieve a timely result, even in the improved environment, can consider making formal representations to senior tax officers by invoking the provisions of the Taxpayer Charter, or go to the GoI requesting course correction reforms. Given the sensitivities exhibited over the years by the GoI in addressing pain points, and its pro-reform approach, such requests are responded to promptly, positively, and with enthusiasm.

The withdrawal of retrospectivity is a vivid illustration that the GoI will not hesitate to seek even parliamentary sanction to overcome obstacles in revamping the Indian tax system.

This column does not necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Tarun Jain is a Partner and Divyasha Mathur is a Senior Associate with BMR Legal.

The authors may be contacted at: tarun.jain@bmrlegal.in; divyasha.mathur@bmrlegal.in