Bye, Bye Retro Tax: Why, How, When

In a move that will help boost India's image as an investment destination, the Finance Ministry has proposed to nullify the tax on indirect transfers introduced in 2012 and levied retrospectively over five decades.

According to a new bill introduced to amend the income tax law, the tax on indirect transfers will hereon apply only prospectively to transactions undertaken after May 28, 2012. As for tax demands made on transactions before that date, they will be nullified subject to certain conditions and any tax collected will be refunded, according to the bill.

In the statement of objects and reasons accompanying the bill, the ministry has explained how the retrospective tax came to be and why it has moved to make it prospective hereon, as well as the implications for ongoing cases.

(This has been reproduced from the The Taxation Laws (Amendment) Bill, 2021.)

STATEMENT OF OBJECTS AND REASONS

1. The issue of taxability of gains arising from the transfer of assets located in India through the transfer of the shares of a foreign company (hereinafter referred to as "indirect transfer of Indian assets") was a subject matter of protracted litigation.

Finally, the Supreme Court in 2012 had given a verdict that gains arising from indirect transfer of Indian assets are not taxable under the extant provisions of the Act.

2. As the verdict of the Supreme Court was inconsistent with the legislative intent, the provisions of the Income-tax Act, 1961 were amended by the Finance Act, 2012 with retrospective effect, to clarify that gains arising from sale of share of a foreign company is taxable in India if such share, directly or indirectly, derives its value substantially from the assets located in India. The Finance Act, 2012 also provided for validation of demand, etc., under the Income-tax Act, 1961 for cases relating to indirect transfer of Indian assets.

3. Pursuant thereto, income-tax demand had been raised in seventeen cases. In two cases assessments are pending due to stay granted by High Court. Out of the said seventeen cases, arbitration under Bilateral Investment Protection Treaty with United Kingdom and Netherlands had been invoked in four cases. In two cases, the Arbitration Tribunal ruled in favour of taxpayer and against the Income Tax Department.

4. The said clarificatory amendments made by the Finance Act, 2012 invited criticism from stakeholders mainly with respect to retrospective effect given to the amendments. It is argued that such retrospective amendments militate against the principle of tax certainty and damage India's reputation as an attractive destination. In the past few years, major reforms have been initiated in the financial and infrastructure sector which has created a positive environment for investment in the country. However, this retrospective clarificatory amendment and consequent demand created in a few cases continues to be a sore point with potential investors. The country today stands at a juncture when quick recovery of the economy after the COVID-19 pandemic is the need of the hour and foreign investment has an important role to play in promoting faster economic growth and employment.

5. The Bill proposes to amend the Income-tax Act, 1961 so as to provide that no tax demand shall be raised in future on the basis of the said retrospective amendment for any indirect transfer of Indian assets if the transaction was undertaken before 28th May, 2012 (i.e., the date on which the Finance Bill, 2012 received the assent of the President). It is further proposed to provide that the demand raised for indirect transfer of Indian assets made before 28th May, 2012 shall be nullified on fulfilment of specified conditions such as withdrawal or furnishing of undertaking for withdrawal of pending litigation and furnishing of an undertaking to the effect that no claim for cost, damages, interest, etc., shall be filed. It is also proposed to refund the amount paid in these cases without any interest thereon. The Bill also proposes to amend the Finance Act, 2012 so as to provide that the validation of demand, etc., under section 119 of the Finance Act, 2012 shall cease to apply on fulfilment of specified conditions such as withdrawal or furnishing of undertaking for withdrawal of pending litigation and furnishing of an undertaking that no claim for cost, damages, interest, etc., shall be filed.

6. The Bill seeks to achieve the aforesaid objectives.

The bill will have be passed into law and the new provisions notified for the changes to come into effect.