In 2012, as Minister of Finance, Pranab Mukherjee introduced a retrospective amendment to the Income Tax Act in the budget to overturn a ruling by the Supreme Court in favor of telecommunications company Vodafone. The aftereffect can still be felt. Recent reports suggest that in September the government could challenge an international arbitration award in favor of Vodafone that the retrospective amendment is in violation of the investment treaty between India and the Netherlands. Separately, another arbitral tribunal earlier this week concluded that the government's decision to tax Cairn Energy was in violation of the India-UK investment treaty. As a result, Cairn received $ 1.2 billion in damages.
According to Mukherjee, his cabinet colleagues held the retroactive tax poorly. The then oppositional BJP criticized this as a symptom of “tax terrorism”. However, once in office, no party seems willing to refrain from making this harmful decision. After all, the September arbitration gave the government enough time to close the chapter on it. The result of maximum government and unthinkable governance will be reputational damage if there is an opportunity to attract investment from companies looking to relocate production lines out of China.
The story began when Vodafone indirectly acquired its Indian telecommunications assets from Hutchison Telecommunication in 2007. The tax department blamed Vodafone for ensuring that the payment was not withheld. The matter snaked to the Apex court, which ruled in Vodafone's favor. The retrospective change that followed opened a can of worms. During the NDA regime, the tax department tracked Cairn Energy and even sold its related stocks. Consequently, in this case the arbitration tribunal will have a financial impact on the treasury.
It is wrong to view this issue as a challenge to the sovereign power of the Indian Parliament. Instead, companies investing in India are trying to enforce their rights as they believe the goal post was changed after the fact. Loopholes in tax law that allowed indirect transfers of Indian assets have been closed. Therefore, any decision the government makes today on issues dating back over a decade can only undermine investment and tax revenues. It is in India's best interest that the government make a clean break with retroactive laws. They only add to regulatory turmoil and political unpredictability. A stable tax and regulatory environment is essential for sustained high economic growth.
This piece appeared as an editorial statement in the print edition of The Times of India.