Fundamental principles for retrospective amendments to tax laws (especially direct taxes) are that such amendments should be made in exceptional cases and should be constitutionally valid. India has witnessed a series of retrospective amendments in its Income-tax law in the past decade. Most or a majority of them are to subvert the decisions of Judicial Authorities in favour of the tax payers resulting into uncertainty, distrust and ambiguity in tax laws. This article throws light on retrospective amendments in Indian Tax Law, their impact and resulting issues, primarily in the arena of taxation pertaining to non-residents.
1.0 Introduction“Government should collect taxes from citizens the way a bee collects honey from the flowers – quietly without inflicting pain.” –
Chanakya.
There are three pillars of Tax System in India- namely, Legislature, Execution/Administration and the Judiciary. The Parliament has the sovereign right to legislate tax laws, which are executed or administered by the tax department and the judiciary keeps watch, vigil and resolves disputes through just and proper interpretation of the law. All the three pillars derive their powers and limitations from the Indian Constitution.
Entry 82 of the List I to the Seventh Schedule, referred to in Article 246 of the Constitution of India, gives power to the Union Government to levy “Taxes on income other than agricultural income” and Entry 85 of the same Schedule gives power to levy “Corporation tax”.
2.0 Constitutional Validity of Retrospective Amendments
A question arises whether enactment of retrospective legislation is within the powers conferred by the Constitution?
The Parliament has the sovereign power to legislate and this includes prospective as well as retrospective legislations. Where the legislature can make a valid law, it may provide not only for the prospective operation of the material provisions of the said law, but it can also provide for the retrospective operation of the said provisions1.
In the undernoted cases, the Supreme Court examined the validity of retrospective amendments to laws and accorded them Constitutional validity.
(i) Chhotabhai Jethabhai Patel and Co. vs. UOI and another 2
(ii) Rai Ramakrishna vs. State of Bihar1
(iii) I. N. Saksena vs. State of M.P.3
(iv) National Agricultural vs. UOI4
To be constitutionally valid, any retrospective amendment has to broadly satisfy the following tests:
i) T he retrospective operation of the Act should not alter the character of the tax imposed by it so as to make the state incompetent to legislate5;
ii) R estrictions imposed by the Act should not be so unreasonable that they contravene the fundamental rights of the tax payer granted by the Constitution of India under Article 19(1)(g)6;
iii) R etrospective legislation should not be violative of a constitutional provision.
In Kesavananda Bharati’s case, the Supreme Court held that any legislation which has an impact of amending the basic structure of the Constitution or denying the fundamental rights, is considered as unconstitutional.
3.0 I mpact of Retrospective Amendments
3.1 Can the payer be held in default for failure to deduct tax at source u/s. 201 of the Income-tax Act, 1961?
Deduction of tax at source is a machinery provision. Section 195 of the Act casts obligation on every payer to deduct tax at source from the payment made to a nonresident. There is no threshold for the same. In case a payer fails to deduct tax at source, he will be held as an assessee in default u/s. 201 of the Act and shall be liable to pay the amount of tax together with interest thereon.
Therefore, in case of Vodafone International Holdings’ case where it acquired the shares of a Non-Resident (NR) company from the Hutch Group, which through its step down subsidiaries ultimately held the Indian telecommunication business of the erstwhile Hutch in India; it was held to be assessee in default u/s. 201 of the Act for failure to deduct tax at source while making payment to the NR company of Hutch Group. Vodafone contended that no tax was required to be deducted as shares were located outside India and the income of the NR Company was not taxable in India u/s. 9 of the Act. Vodafone won the case in the Supreme Court of India where the Apex Court held that the present provisions do not cover a situation of indirect transfer to the Indian tax net by adopting “look at” approach.
Subsequently, section 9 of the Act was amended vide the Finance Act, 2012 with retrospective effect from 01-04- 1962 to bring indirect transfer of shares within the ambit of deemed income in India by providing for “look through” approach whereby corporate veil of intermediary companies can be lifted to determine whether the substantial value of the transfer is attributed to assets located in India.
Since the amendment is made retrospective, it has an impact of nullifying the Supreme Court decision in favour of Vodafone, subject to the outcome of the writ petitions challenging constitutional validity of such retrospective amendment
The Expert Committee in its draft report on Retrospective Amendments Relating to Indirect Transfer has recommended that “no person should be treated as an assessee in default u/s. 201 of the Act read with section 9(1)(i) of the Act as amended by the Finance Act, 2012, or as a representative assessee of a non-resident, in respect of a transaction of transfer of shares of a foreign company having underlying assets in India as this would amount to the imposition of a burden of impossibility of performance.”
The recommendation of the Expert Committee is justified in the sense that how can one deduct tax at source when the income is brought to tax by retrospective amendments. The only argument in favour of revenue could be that it claims that these amendments were only clarificatory in nature. Courts have upheld retrospective application of amendments where they were found to be in the nature of explanatory, declaratory, curative or clarificatory nature.10
3.2 Can the expenses be disallowed u/s 40(a)(i) in the hands of the payer for failure to deduct tax at source?
In the case Metro and Metro vs. Additional Commissioner of Income-tax11, the Agra bench of the ITAT held that testing fees paid by the Indian company without deduction of tax at source to the TUV Product Und Umwelt GmbH – a tax resident of Germany, cannot be disallowed u/s. 40(a)(i) of the Act on the ground that the payer failed to deduct tax at source. In the instant case such fees became taxable in India only as a result of the amendment in section 9(1), by virtue of the Finance Act, 2010. The assessee relied on the decision of the Supreme Court in the case of Ishikawajimaharima Heavy Industries Ltd. vs. DIT12 to conclude that fees paid by it were not taxable as services were rendered outside India.
The ITAT ruled in favour of the assessee and held that no disallowance can be made in view of the decision of the coordinate bench in the case of Channel Guide India Ltd vs. ACIT13 wherein, following the views expressed by the Ahmedabad bench in the case of Sterling Abrasives Ltd. vs. ITO (ITA No. 2234 and 2244/Ahd/2008; order dated 2008), it is held that law cannot cast the burden of performing the impossible task of tax withholding with retrospective effect, and, accordingly, the disallowance u/s. 40(a)(i) cannot be made in a situation in which taxability is confirmed only as a result of retrospective amendment of law.
The Cochin Bench of the income-tax appellate tribunal14 [ITAT] in case of Kerala Vision Ltd. vs. ACIT held that the payment made for pay channel charges is taxable as royalty with the introduction of retrospective amendments in the act, but the same could not be disallowed u/s. 40(a)(i)Of the act, as it was not taxable before the introduction of the amendment.
3.3 Can Assessee be asked to pay interest and penalty for shortfall in payment of Tax?
Article 20 (1) of the indian Constitution provides that (i) no person shall be convicted of any offence except for violation of a law in force at the time of the commission of the act charged as an offence and (ii) he shall not be subjected to a penalty greater than that which might have been inflicted under the law in force at the time of the commission of the offence. thus, penal laws generally, cannot have retrospective operation.15
Expert Committee headed by dr. P. shome recommended that no penalty should be levied in respect of the income brought to tax on application of retrospective amendments u/s. 271(1)(c) (for concealment of income) and 271C (for failure to deduct tax at source) of the act.
Similarly, the expert Committee also recommended that in all cases where demand of tax is raised on account of the retrospective amendment relating to indirect transfer u/s. 9(1)(i) of the act, no interest u/s. 234a, 234B, 234C and 201(1a) of the act should be charged in respect of that demand, so that there is no undue hardship caused to the taxpayer.
3.4 Reopening of Assessments:
In Babu Ram vs. C. C. Jacob and others16 the supreme Court held that the retrospective amendment is not applicable to the matter which has already attained finality before introduction of the amendment. The apex Court further observed that the prospective declaration of law is a devise innovated by the apex Court to avoid reopening of settled issues and to prevent multiplicity of proceedings. It is also a device adopted to avoid uncertainty and litigation. By the very object of prospective declaration of law, it is deemed that all actions taken contrary to the declaration of law, prior to its date of declaration are validated. This is done in the larger public interest. in matters, where decisions opposed to the said principle have been taken prior to such declaration of law, cannot be interfered with on the basis of such declaration of law.17
It would be interesting to note here that where the supreme Court has expressly made its ratio prospective, the high Court cannot give it retrospective effect. By implication, all contrary actions taken prior to such declaration stand validated.18
Post retrospective amendments to section 9 vide the finance act, 2012, for taxing indirect transfer to tax in india, CBdt has issued a letter to CCits and dgits19 stating that the amended laws would not be applicable to assessments that are already completed. the letter states that “in case where assessment proceedings have been completed u/s. 143(3) of the act, before 1st april, 2012 and no notice for reassessment has been issued prior to that date; such cases shall not be re-opened u/s. 147/148 of the act on account of the above mentioned clarificatory amendments introduced by the Finance Act, 2012.” It further clarifies that “assessment or any other order which stand validated due to the said clarificatory amendments in the Finance Act, 2012 would of course be enforced.” this will have an impact on all cases which are pending at different stages of appeal.
Thus, the letter seem to be providing relief to only those tax payers whose assessments have been completed and no appeals are pending at any level.
4.0 Retrospective Amendments and Tax Treaties
Tax treaties, being bilateral agreements, signed by two sovereign states, would prevail over domestic tax laws wherever there are conflicting provisions. Section 90 (2) provides that between provisions of the act and a tax Treaty, whichever is more beneficial to the tax payer shall apply. Various terms are defined in Article 3 of a Tax Treaty or certain articles dealing with different types of income, for example, dividend, interest, royalty, fees for technical services (fts) etc.
Wherever, any particular term is defined in the tax treaty, and if there is a retrospective amendment to the definition of that term in the act, then such amendment will have no impact on provisions of tax treaty. For example, in CIT vs. Siemens Aktiengesellschaft20 the Bombay high Court held that the amendment in the definition of the “Royalty” with retrospective date will have no impact on interpretation of tax treaty. Payments made by the indian Company (BHEL) were held to be in the nature of “commercial profits” under the india-germany tax treaty (old) and were held not to be taxable in india in absence of Pe. The income-tax department’s argument of applying ambulatory approach for interpretation of the term “royalty” in view of its amendment under the income-tax act, was overruled by the high Court stating that, assessee has right to opt for provisions of the tax treaty u/s. 90(2) read with CBdt Circular 333 dated 2nd April, 1982 as they are more beneficial to him.
In B4U International Holdings Ltd. vs. DCIT21, the mumbai tribunal held that hire charges for transponder satellite would not constitute “royalty” applying provisions of india- usa dtaa, notwithstanding retrospective amendments in the definition of “Royalty” u/s. 9(1)(vi) of the Act by the finance act, 2012.
In Sanofi Pasteur Holding SA vs. Dept. of Revenue22 the A. P. high Court held that “the retrospective amendment to section 9(1) so as to supersede the verdict in Vodafone international and to tax off-shore transfers does not impact the provisions of the india-france dtaa because the dtaa overrides the act.” the Court also rejected the revenue’s contention that as the “alienation” is not defined in the dtaa, it should have the meaning of the term “transfer” in section 2(47) as retrospectively amended. The Court ruled that as per article 31 of the Vienna Convention, a treaty has to be interpreted in good faith and in accordance with the ordinary meaning. it further held that, though article 3(2) provides that a term not defined in the treaty may be given the meaning in the act, this is not applicable because the term “alienation” is not defined in the Act.
In Director of Income-tax vs. Nokia Networks OY23, it was held that the assessee had opted to be governed by the dtaa and the language of the dtaa differed from the amended section 9 of the act. The amendment cannot be read into the DTAA. On the wording of the dtaa, a copyrighted article does not fall within the purview of royalty.
Article 3 of the un model Convention (MC) and the OECD MC as well as almost all indian tax treaties provide that any term not defined in the tax treaty shall have the meaning that it has at that time under the laws of that state, for the purpose of taxes to which the treaty applies. In other words, the meaning of a particular term is not defined in the treaty, then tax laws of the state which applies provisions of a tax treaty (i.e., state of source generally for determining taxability of income) would be applicable. for example, the term “FTS” is not defined in India’s tax treaties with mauritius and uae. In such a scenario amendments made to the term fts in the act with retrospective effect would be applicable to any entity earning such income from india who is resident of these countries.
Article 7 in certain tax treaties (for example, dtaa with usa and uK) provide that deductibility of expenses of the Permanent establishment (Pe) shall be subject to the provisions of the domestic tax laws. In such a scenario, if there is a retrospective amendment in the act, concerning computation of business profits of a PE, then such revised provisions would be applicable.
5.0 Expert Committee on Retrospective Amendments to section 9 relating to indirect Transfer of Shares
Retrospective amendments are supposed to cure the unintended defect or lacuna in the legislations and/ or to bring clarity in law. However, the recent trend of retrospective amendments is very disturbing, which is to overrule or nullify the effect of favourable decisions of the Courts and tribunals in favour of the tax payer, albeit, the Government has inherent right to correct infirmities in the law which may have been surfaced in a decision of a Court or tribunal resulting in a favourable decision to the tax payer. Thus, any retrospective amendment which may have an effect of neutralizing a Court ruling, by itself, would not render it unconstitutional unless, it alters the character of the tax imposed by the state so much, that it renders the state incompetent to legislate and/or its operation is so unreasonable that it results in to contravention of the fundamental rights of tax payers guaranteed by indian Constitution. At the same time, where the retrospective legislation is introduced to overcome a judicial decision, the power cannot be used to subvert the decision without removing the statutory basis of the decision.24 further, such amendment cannot be made retrospectively only for the purpose of nullifying a judgment where there was no lacuna or defect in the original law.25
In 2012, the then Prime minister constituted an expert Committee on general anti avoidance rules (gaar), to undertake stakeholder consultations and finalise the guidelines for gaar after far more widespread consultations so that there is a greater clarity on many fronts26.
In the meantime the finance act, 2012, inserted following two explanations to section 9(1)(i) of the act with retrospective effect from 01-04-1962.
“Explanation 4.—for the removal of doubts, it is hereby clarified that the expression “through” shall mean and include and shall be deemed to have always meant and included “by means of,” “in consequence of” or “by reason of.”
Explanation 5.—for the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside india shall be deemed to be and shall always be deemed to have been situated in india, if the share or interest derives, directly or indirectly, its value substantially from the assets located in india.”
The above explanations were inserted to nullify the effect of the land mark decision of the supreme Court in case of Vodafone International Holdings BV vs. Union of India27 where in the apex Court held that indirect transfer of asset (in this case it was “shares”) by one non-resident to another non-resident of a foreign company which owned an indian company through various intermediary companies, was not covered by section 9 of the act and hence not taxable in india. as the stake involved was very high (about rs. 14,200 crore), government amended section 9 of the income-tax act with retrospective effect. However, it resulted in lot of opposition, criticism and negative impact about stability and reliability of indian tax laws in the minds of foreign investors, thus impacting flow of foreign investments. At that time the expert Committee headed by dr. Parthasarathy shome was already examining gaar provisions. So, the government expanded the scope of the expert Committee on gaar to include the examination of the applicability of the amendment on taxation of non-resident transferring assets, where the underlying asset is in india.
The said expert Committee submitted its draft report in 2012 titled “draft report on retrospective amendments relating to indirect transfer”, wherein it concluded that “retrospective application of tax law should occur in exceptional or rarest of rare cases, and with particular objectives:
(i) to correct apparent mistakes/anomalies in the statute;
(ii) to apply to matters that are genuinely clarificatory in nature, i.e., to remove technical defects, particularly in procedure, which have vitiated the substantive law; or,
(iii) to “protect” the tax base from highly abusive tax planning schemes that have the main purpose of avoiding tax, without economic substance, but not to “expand” the tax base.
Moreover, retrospective application of a tax law should occur only after exhaustive and transparent consultations with stakeholders who would be affected.”
The “Tax Administration Reform Commission” (TARC) headed by Dr. Parthasarathy shome harshly criticised “Retrospective Amendments.” TARC submitted its first report on 30th may, 2014. the report28 states that: “retrospective amendments have further undermined the trust between taxpayers and the tax administration. Many seem to feel that it has become the order of the day. Many of the retrospective amendments have been introduced to counter interpretation in favour of the taxpayer upheld earlier by the judiciary. the most famous is the introduction of provisions for taxation of ‘indirect transfer’ with effect from 1st april, 1962, to overrule a supreme Court judgment which held that indian tax authorities did not have territorial jurisdiction to tax offshore transactions, and therefore, the taxpayer was not liable to withhold the taxes29. An overnight change in the interpretation of a provision, which earlier held ground for decades, provides scope for tax officials to rake up settled positions. This approach to retrospective amendments has resulted in protracted disputes, apart from having deeply harmful effects on investment sentiment and the macro economy.
6.0 Some Typical Retrospective Amendments pertaining to Non-residents have been tabulated in the table on the following page:
