What is retro tax all about?

Retrospective taxation was introduced by finance minister, Pranab Mukherjee in the 2012 budget. It gives the CBDT the right to open old cases of taxation where it suspects that legitimate tax was not paid. While the Congress party had then put the retro tax on hold, the NDA government revived the retro tax amendment in 2014 to send a huge tax bill to Cairn UK and also to Vodafone UK. That became the bone of contention for foreign investors investing in India. 

Form versus substance

Both Cairn and Vodafone were a debate of form versus substance. The allegation of CBDT was that the asset sale was put through using a structure which avoided tax deliberately. The contention of the Indian government was that the Indo-UK bilateral trade treaty was for genuine transactions and not for tax avoidance. Based on this logic, the CBDT had put up a huge tax bill for Cairn / Vodafone. In the case of Cairn, the government even held back their tax refund and sold shares of Vedanta in Vodafone’s demat account to recover the dues. That was the bone of contention with Cairn UK. 

Cairn and Vodafone tangle

In a way, the government got into a fix in both these cases. Cairn threatened to confiscate the global assets of Air India, being a proxy for the Indian state. This was to be done on the basis of an order from the appellate tribunal, allowing for such confiscation. This would have been an embarrassment for India and also it would have put a spoke in the Air India disinvestment program. The main issue was Vodafone. With Vodafone India on the brink of collapse, the government is looking to intervene and take over the company to protect jobs. While they have control over adjusting the AGR dues, they cannot take over Vodafone India with the specter of retro tax. 

Step in the right direction

At the end of the day, India may be right about Cairn and Vodafone actually using smart structures to avoid tax. But that is the nature of international tax treaties. You have to go by the rule book and that favors Cairn in this case. For India, there are 2 lessons at this point of time. Firstly, it needs to tighten its rules and contracts to reflect the rising complexity of global business and capital flows. Secondly, the primary focus must be foreign investments into India. That is the only way the “Make in India” program can succeed and the PLI scheme can really make a difference. That calls for a consistent tax regime. Retro tax had to go and is well timed!