Reshaping Tax Laws: Stigma of Retrospective Tax Amendments Amidst Supreme Court's Landmark Ruling
[Ananya and Astha are students at National Law University Odisha.]
The Supreme Court made a significant judgement in April 2023 regarding taxation law, stating that the amendment to Section 153C of the Income Tax Act 1961, introduced by the Finance Act 2015, will apply retrospectively to searches conducted before June 2015.
Section 153C grants the revenue department 'the authority to take action against a party other than the individual being searched if any incriminating articles pertaining to the other person are discovered during the search'. Originally, the provision included the phrase 'belong/belongs to', which was replaced by 'pertain/pertains' by the 2015 amendment that offered a broader scope of interpretation to the courts in proceeding against such third parties. The present case revolved around determining the applicability of the 2015 amendment in light of its legislative intent.
This article focuses on the concept of retrospective amendments in the field of taxation laws and the development of the same in the Indian scenario. It further studies the reasoning of the apex court in the recent judgement and how it strives to strike a balance between taxpayers’ interests and the legislative intent of the 2015 amendment.
The Ministry of Finance presents its finance budget before the start of each financial year. This budget encompasses an evaluation of the previous year’s performance and outlines proposals and plans for the upcoming year, including revenue allocation to different sectors and changes in tax laws (both direct and indirect taxes). These changes, commonly known as ‘amendments’, are introduced with considerations for ongoing developments, taxpayer welfare, addressing previously unresolved loopholes, and taking into account feedback from stakeholders.
There are two types of amendments based on their specified application date: prospective amendments, and retrospective amendments.
Prospective amendments are relatively straightforward to handle and are generally accepted due to their nature of application. On the other hand, retrospective amendments introduce significant confusion and complexity and are not readily accepted. As a result, the effective date of the law’s application plays a crucial role in determining its impact on taxpayers, allowing them to prepare and plan their next steps accordingly.
A retrospective tax is a levy imposed on transactions that occurred in the distant past. Thus, it can entail a new or additional charge on past transactions. In 2012, the Indian government introduced a retrospective tax amendment in the Finance Bill. The purpose of retrospective tax is to make adjustments when there is a significant disparity between past and present policies, resulting in potentially lower taxes paid under the previous policy. By applying taxes under the current policy, retrospective tax seeks to rectify such situations. Many countries employ this form of taxation to address deviations in past tax policies that allowed companies to exploit loopholes for their benefit. Retrospective tax affects companies that may have unknowingly or knowingly taken advantage of different tax rules. Not only India but several other countries, including the US, the UK, Australia, Netherlands, Belgium, Canada, and Italy, have imposed retrospective taxes on companies.
Judicial Role in Shaping Retrospective Amendments of Tax Laws
Retrospective taxation has created significant turmoil in the recent past among foreign investors, resulting in numerous conflicts between the Indian government and major international companies such as Vodafone and Cairn. One of the most significant and contentious retrospective amendments was the inclusion of income generated from the indirect transfer of shares within the tax framework through the Finance Act of 2012.
In the Vodafone case, the Supreme Court ruled against the tax authorities to claim tax on capital gains obtained from the indirect transfer of shares of an Indian company when the primary transaction occurs between two foreign companies acquiring a foreign company that holds a majority stake in the Indian company. A huge magnitude of tax revenue was lost by the tax department as a result of the ruling. To claim its lost revenue back, the Government decided to amend Section 9 of the Income Tax Act, 1961 while presenting the financial budget for 2012. According to the amendment, 'shares or interests in any foreign company or entity would be considered situated in India if their substantial value is derived from assets located in India. Consequently, any capital gains arising from the transfer of such shares or interests in a foreign company, which derive substantial value from Indian assets, were subjected to taxation'. The government made this amendment applicable retrospectively from 1962. This meant that the Vodafone case, where the transactions had already taken place and a ruling had been issued by the Supreme Court, could be subjected to taxation with the application of this retrospective amendment.
Another landmark tussle involved the IT Department claiming a capital gains tax from Cairn UK Holdings Limited. This tax was imposed due to the internal corporate restructuring of Cairn UK in 2006, where the company transferred its entire stake in a subsidiary to Cairn India. Subsequently, Cairn India carried out an Initial Public Offering, selling approximately 30% of its shares to the mining conglomerate Vedanta PLC. Cairn Energy challenged the legitimacy of the imposed tax and initiated an international arbitration process to contest retrospective taxation. In 2020, the arbitration tribunal in The Hague ruled that the Indian government was required to pay over USD 1.2 billion in taxes to Cairn Energy, in addition to other amounts. Notably, Cairn also secured a verdict allowing the seizure of 20 assets owned by the Indian state in the United Kingdom.
Approach of Supreme Court in Present Case
In the recent case before the Supreme Court, the matter in issue was the scope of interpretation of Section 153C in holding third parties accountable against whom incriminating material is found during an independent search. The assesses heavily relied on the Delhi High Court judgement of 2014 which interpreted the provision in a narrow manner, thereby protecting the interests of such third parties. However, the Supreme Court highlighted that this narrow interpretation was rectified by the 2015 amendment to Section 153C giving it the broader meaning which was initially intended by the legislation.
The main issue before the apex court in the current case was regarding the applicability of the 2015 amendment. The court traced down the legislative intent of the amendment and determined that the amendment was brought to empower the tax authorities to take action against third parties against whom incriminating material is found in an independent search. The intent of the amendment can be fully satisfied only if the amendment is applied retrospectively, thus enabling it to rectify the errors made by previous judgements.
Challenges and Rectifications
In general, a taxing statute is usually preferred to be prospective. The simple reason for that is that while paying the tax, the taxpayer must have knowledge of the expenditure to be made. They can thereby, carry out a cost-benefit analysis of the proposed transaction and ascertain whether or not to deal in such a transaction. Such retrospective tax amendment may affect a current agreement, may lead to the reopening of a completed transaction, disturb the tax planning of corporations, variation in accrued rights and remedies of the parties involved, and even at times affect the whole of the procedure involved.
The retrospective application of tax statutes by the legislature is allowed but the same is subject to constitutional limitations. However, in reality, it is often utilized by the legislature with the intent to supersede the effect of judicial decisions. The constitutional limitation implies that tax laws can be struck down if found violative of Article 19. That is if they are discriminatory and put unreasonable restrictions on one’s freedom to carry out their profession making it unduly burdensome and harsh.
The question of the constitutionality of retrospective tax amendments also came up in the case of Electronics Corporation of India Limited v. CIT, where the presumption of constitutionality of such retrospective amendment was contested upon being discriminatory and violative of Article 14 of the Indian Constitution to the extent that it treated un-equals as equals.
Therefore, it can be said that retrospective amendments in taxation laws should not be treated as a general practice but only a rare occurrence in case urgent intervention is required to prevent revenue loss. Although the government stood strong against Cairn Energy, the mounting pressure led to another amendment in the tax laws by the Indian government. On 5 August 2021, the Taxation Laws (Amendment) Bill 2021 was proposed to completely eliminate the provisions of retrospective taxation. This amendment thus rectified the anomaly created by the 2012 amendment.
Conclusion and Suggestions
The recent ruling by the Supreme Court in respect of the retrospective application of the Section 153C amendment has sparked discussions on the concept of retrospective amendments in taxation laws in India. Retrospective taxes have been a contentious issue globally, and India’s experience has been no different. The 2012 amendment caused significant turmoil, leading to legal battles and revenue losses for the tax department.
The government’s introduction of the Taxation Laws (Amendment) Bill in 2021, eliminating the provisions of retrospective taxation, was a significant step towards resolving the issue and creating an investment-friendly environment. The Supreme Court also recognized the interests of taxpayers regarding retrospective tax amendments while protecting the legislative intent of tax statutes in its recent ruling. The government should also acknowledge that maintaining a stable and predictable tax system is essential for fostering private-sector investment. With the elimination of the unreasonable retrospective tax regime, India is anticipated to inspire trust in the country’s regulatory and tax framework among private investors.