Dear Vodafone, Government, Get Ready For Part II

The author compliments Finance Minister Pranab Mukherjee for his deft handling of the Vodafone crises despite relentless pressure from all sides. However, now that the stage has shifted from the political arena to the legal arena, it is time to take stock of the options available to the warring parties, says the author as he evaluates the alternatives and identifies their pros and cons in a succinct manner

Vodafone, to its credit, tried very hard but, in the end, all its machinations were to no avail against Finance Minister Pranab Mukherjee’s steely resolve. Vodafone got people in very high places to put enormous pressure on the Indian government to scrap the retrospective amendments. On the political front, international heavy weights like Tom Geitherner, US Secretary of State, Gordon Brown, Finance Minister of UK and David Gauke, Chancellor of the Exchequer, expressed their strong disapproval of the amendments. On the commercial front, leading industrialists from Adi Godrej to Narayan Murthy and everyone else in between spoke out against the amendments. Even on the legal front, eminent senior counsel Soli Dastur and Dinesh Vyas expressed grave doubt about the constitutional validity of the amendments. Celebrated Senior Advocate Harish Salve lashed out at the Government in public and sent out the dire warning that the retrospective amendments would “ruin” India. Even noted economist Bibek Debroy jumped on the bandwagon and demanded that Pranab Mukherjee should “honourably” withdraw the amendments before it was too late. Pranab Mukherjee was attacked in Parliament as well by the members of the opposition.

In an attempt to shame the government, Vodafone even flashed Prime Minister Manmohan Singh’s letter dated 5.2.2010 addressed to Gordon Brown where he had assured the latter that there was “no question” of a retrospective amendment to tax Vodafone. “Are a few billions worth more that the solemn promise made by our PM?” Vodafone’s counsel Harish Salve asked emotionally at a public meeting.

Ordinarily, against such sustained & relentless onslaught of pressure from all fronts, one would have helplessly buckled and given up. Here, one must compliment Pranab Mukherjee for his steely determination in refusing to give in.

In fact, Pranab Mukherjee gave a text book demonstration of how to handle a crises situation of this magnitude without letting things go out of hand. He never appeared flustered, never lost his temper and always had a gentle smile playing on his lips. Also, his answers were very diplomatic. When asked about the PM’s letter, he maintained a studied silence. He used persuasion (if you earned profits here, you must pay tax here), subtle deception (the Supreme Court directed us to amend the law), threats (if we don’t do this, the consequences would be draconian for the country), tact (every FM has done retrospective amendments), national pride (if the UK can do retrospective law, are we inferior to them) & diplomacy (I respect you; so I am stalling GAAR to address your concerns).

There were three master strokes in Pranabda’s campaign. The first was to paint the entire picture as an “Aam Aadmi vs. tax-avoiding MNCs”. That ensured that anyone who supported Vodafone was self-conscious of being viewed suspiciously as an anti-nationalist. The second was to discredit Vodafone’s stance that it was an “innocent babe in the woods” caught in the cross fire by fishing out old letters that the department had written to Vodafone warning it of its obligation to deduct TDS. And the third was fishing out the retrospective amendments that the UK Govt. had carried out in similar circumstances. The fact that the UK Govt. had also done retrospective amendments somehow added legitimacy to the entire retrospective exercise.

Anyway, now that the Finance Act 2012 has become law, the stage will move to the legal arena and it is time to evaluate Vodafone and the Government’s options. Lets’ first take a quick look at the amendments that will affect Vodafone:

(i) Explanation to s. 2 (14) which defines “capital asset”:

‘Explanation: For the removal of doubts, it is hereby clarified that “property” includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever

(ii) Explanation 2 to s. 2 (47) which defines “transfer”:

‘Explanation 2: For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India

(iii) Explanations 4 & 5 to section 9 which defines “income deemed to accrue or arise in India”:

‘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.

(iv) Validation clause in s. 119 of the Finance Act 2012

119. Notwithstanding anything contained in any judgment, decree or order of any Court or Tribunal or any authority, all notices sent or purporting to have been sent, or taxes levied, demanded, assessed, imposed, collected or recovered or purporting to have been levied, demanded, assessed, imposed, collected or recovered under the provisions of Income-tax Act, 1961 (43 of 1961), in respect of income accruing or arising through or from the transfer of a capital asset situate in India in consequence of the transfer of a share or shares of a company registered or incorporated outside India or in consequence of an agreement, or otherwise, outside India, shall be deemed to have been validly made, and the notice, levy, demand, assessment, imposition, collection or recovery of tax shall be valid and shall be deemed always to have been valid and shall not be called in question on the ground that the tax was not chargeable or any ground including that it is a tax on capital gains arising out of transactions which have taken place outside India, and accordingly, any tax levied, demanded, assessed, imposed or deposited before the commencement of this Act and chargeable for a period prior to such commencement but not collected or recovered before such commencement, may be collected or recovered and appropriated in accordance with the provisions of the Income-tax Act, 1961 as amended by this Act, and the rules made thereunder and there shall be no liability or obligation to make any refund whatsoever.

Vodafone’s Options:

(I) Challenge the retrospective amendments

Vodafone has the option of challenging the retrospective amendments either in the High Court under Article 226 of the Constitution or in the Supreme Court under Article 32 of the Constitution (see Rupa Ashok Hurra vs Ashok Hurra 2002 AIR 1771.

From a tactical and commonsense point of view, it would be better for Vodafone to directly approach the Supreme Court because if the matter comes up before the same bench which passed the verdict, it is such an advantage for obvious reasons. If possible, the Petition should be brought up for hearing before the present judges retire though that may be difficult from a logistical point of view.

There is no dearth of legal precedents on the issue of validity or otherwise of a retrospective amendment but the question is how to apply it. The leading judgement on the topic is Rai Ramkrishna vs. State of Bihar 50 ITR 171 (SC) where it was held that a retrospective amendment could be challenged on the ground that it was “arbitrary or burdensome” or “so unreasonable that it contravened the fundamental rights guaranteed under Article 19(1)(f) & (g)”. This was reiterated in Lohia Machines vs. UOI 152 ITR 308 (SC) where it was held that for retrospective amendment to be valid, it must not be “unreasonable or arbitrary”. In National Agricultural Co-op Marketing Federation vs. UOI 260 ITR 548 (SC), it was held that a “new levy and an unforeseen financial burden” with “excessive and unreasonable retrospective effect” could (in principle) “violate the assessee’s fundamental rights under Articles 14 & 19(1)(g) of the Constitution”.

Of course, one must bear in mind that whilst courts made all the right noises, in the end they upheld the retrospective amendments in most of the cases. Mico Products 187 ITR 517 (Bom) was one of the rare decisions in which the retrospective amendment to s. 35 (scientific research expenditure) to provide that an assessee was not entitled to depreciation if he claimed s. 35 deduction was struck down on the ground that it was “clearly unreasonable” and violated Articles 14 & 19(1)(g) because it imposed an unexpected financial burden on the assessee. However, this was promptly reversed by the Supreme Court in Escorts 199 ITR 43 on the ground that the “legislature could have never envisaged a double deduction” and so there was “nothing unreasonable” in the retrospective amendment.

Now the billion dollar question is: What is “unreasonable” and “arbitrary” in the present case? It is such a subjective concept and depends on the outlook on the person. Let’s look at Vodafone’s possible arguments on why the amendments are “unreasonable and arbitrary”:

(i) The liability is sought to be enforced against a person who did not earn the income but who merely made payment. Vodafone is being treated as the statutory agent of the Government for purposes of TDS. The principal (i.e. the Government) cannot tell the agent that though the agent was right in not deducting tax at source on the basis of the law as it then stood, the agent should now pay up because of a change in law made by the principal. Such a change in the law is harsh, unreasonable and arbitrary;

(ii) The amendment is not to remove any defect in language or lacuna. It is not a case of “small repairs” but one where a fresh liability to tax is imposed/ material changes are made;

(iii) the amendment results in a heavy financial liability which was not foreseen and which will prejudicially affect the assessee’s right to carry on business (in India);

However, the counter view to this is that if billions of dollars are earned from India and tax is sought to be avoided by setting up a shell company in a tax haven, there is nothing unreasonable in amending the law to ask the recipient (or the person who paid it) to disgorge a part of the gains by way of tax. Also, as Vodafone was forewarned by the Government of the impending liability, it has only itself to blame for not deducting TDS. Also, Vodafone is really not out of pocket because it can recover the TDS from the recipient. In fact, when a similar tax-planning scheme (which had been approved by the Courts) in the UK was retrospectively plugged, the Court upheld the validity of the retrospective amendments in Robert Huitson vs. HMRC [2010] STC 715 on the basis that the law which allowed assessees to avoid tax through artificial arrangements was “plainly unacceptable in terms of public policy” and that a “clear signal” was justifiably sent to taxpayers that their attempts to avoid tax would be countered with “effective and decisive steps” of the legislature.

(II) Argue that the amendment cannot overturn the judgement of the Supreme Court inter parties:

Now this is a very delicate issue that needs to be handled with care.

Ordinarily, the law is that a retrospective amendment does not affect the validity of a judgement which has attained finality. Support for this proposition can be drawn from several judgements. In Madan Mohan Pathak vs. UOI AIR 1978 SC 803, a single judge held LIC liable to pay bonus to its employees. LIC filed an appeal before the Division Bench. During the pendency of the appeal, Parliament enacted law which disabled the employees’ right to bonus. LIC’s appeal ought to have been allowed in view of the new law. However, it was dismissed and LIC did not take further steps. The result was that the judgement of the single judge directing LIC to pay bonus became final even though it was contrary to the new law. When the validity of the new law was challenged by the employees, the Supreme Court held that as the order directing LIC to pay bonus had become final, it was binding on LIC despite the law being to the contrary. This judgement was followed in Cauvery Water Disputes Tribunal (1993) Suppl. 1 with the dicta “The principle which emerges from these authorities is that the legislature can change the basis on which a decision is given by the Court and thus change the law in general, which will affect a class of persons and events at large. It cannot, however, set aside an individual decision inter partes and affect their rights and liabilities alone. Such an act on the part of the legislature amounts to exercising the judicial power of the State and to functioning as an appellate court or tribunal”. In S. R. Bhagwat vs. State of Mysore (1995) 6 SCC 16 it was held “It is now well settled by a catena of decisions of this Court that a binding judicial pronouncement between the parties cannot be made ineffective with the aid of any legislative power by enacting a provision which in substance over-rules such judgment and is not in the realm of a legislative enactment which displaces the basis or foundation of the judgment and uniformly applies to a class of persons concerned with the entire subject sought to be covered by such an enactment having retrospective effect”.

The entire law of the subject was succinctly summed up in National Agricultural Co-op Marketing Federation vs. UOI 260 ITR 548 (SC) with the words “The decisions are an authority for the principle that a judicial decision which has become final inter parties cannot be set at naught by legislative action”.

Now, in Vodafone’s case, the Supreme Court held that Vodafone was not liable to deduct tax because the gains did not arise in India. Ordinarily speaking, though the statute has been “cured” so as to tax such transactions, such curative legislation does not touch the validity of a judgement which has attained finality.

However, this is where the magic of the declaration clause in section 119 of the Finance Act 2012 comes in. It declares that “Notwithstanding anything contained in any judgment … all notices sent .. or taxes levied .. in respect of income accruing .. from the transfer of a capital asset situate in India in consequence of the transfer of a share … of a company .. incorporated outside India .. shall be deemed to have been validly made … and shall not be called in question on the ground that the tax was not chargeable on any ground including that it is a tax on capital gains arising out of transactions which have taken place outside India …”

So, the effect is that the verdict of the Supreme Court is nullified.

Interestingly, if it had not been for the declaration clause in s. 119, the Government would have had to get the Supreme Court to set aside its verdict before progress could be made. For this it would have to file a review petition telling the court that as the basis on which the decision was given has changed, the judgement should be recalled. An authority in support of this is Raja Shatrunji Vs. Mohammad Azmat Azim Khan (1971) 2 SCC 200 where it was held that one of the grounds for review is an error apparent on the face of record and where a statute has been amended retrospectively, a judgment applying the unamended law would constitute an error apparent on the face of record.

One difficulty here would have been that the Government had already filed a (premature) review petition which got dismissed. However, there is no bar against the filing of a second review petition as far as I am aware, especially when there are new “circumstances” justifying the second review.

Another point worth noting is that s. 119 on its own would have been void because “such an act on the part of the legislature amounts to exercising the judicial power of the State and to functioning as an appellate court or tribunal”. However, because it is accompanied by a retrospective “curing” of the statute, s. 119 is valid.

(III) Argue that it (the payer) cannot be proceeded against unless the recipient is first proceeded against:

This is supported by Mahindra & Mahindra and Crompton Greaves. In Jagran Prakashan, the Allahabad High Court went to the extent of stating that even if the payee is not traceable, the payer is not liable for the tax, he is only liable for the interest and penalty.

Of course, there is no question of any penalty being imposed given that the Supreme Court had decided in favour of Vodafone. The levy of interest can be resisted by relying on the cases which held that interest u/s 234B & 234C cannot be levied where the liability arises due to a retrospective amendment because the assessee “is not expected to be clairvoyant to foresee the retrospective amendment”.

(IV) Argue that there is discrimination:

In Circular/ Instruction dated 29.5.2012, the CBDT has held that assessments which are completed as of 1.4.2012 will not be reopened pursuant to the retrospective amendment while cases which are pending as of that date will be processed as per the amendment. Of course, whether there are any such “completed” assessments which will be entitled to the benefit of the Instruction or it is a mere eyewash is anybody’s guess but it does give Vodafone the opportunity to raise a challenge that in letting one class of assessees off the hook, the Government is guilty of “discrimination”. There is no sanctity in choosing 1.4.2012 as the cut-off date and the same has been done on the whims of the Government and in an arbitrary manner. Also, there is no intelligible differentia between assessees whose assessments are completed and those which are not so as to justify the differential treatment. It is a fortuitous circumstance that in one case, the assessment order is passed, while in another it is not, as of 1.4.2012, and this cannot be the basis of a reasonable classification.

In Ranka & Ranka, the Karnataka High Court held that the CBDT’s low tax effect circular which said that appeals before a monetary limit would not be filed from 9.2.2011 onwards was discriminatory because “the benefit cannot depend on the date of the decision (of the Tribunal) over which neither the assessee nor revenue has any control” and that all assessees were eligible for the benefit.

Of course, the larger issue is whether the Circular/ Instruction is at all binding on the AO if he decides to defy it. On this, there is a fascinating debate available with a very persuasive view saying that it is not binding and an opposite equally persuasive view saying that it is binding! Fortunately, Vodafone need not get into that arena of dispute!

(V) Argue that there is no “cost of acquisition”:

Explanation to s. 2 (14) defines “capital asset” to mean “any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever”. However, such rights do not have a determinable cost of acquisition and so, following the dicta of B. C. Srinivasa Setty 128 ITR 294 (SC), the capital gains provisions fail.

(VI) Invoke BIPA:

Vodafone’s invocation of the BIPA (“Bilateral Investment Promotion and Protection Agreement”) between India and the Netherlands appears to more a case of saber-rattling by Vodafone rather than anything serious. The Government’s belligerent stand also indicates that they think BIPA is just a bluff by Vodafone.

There are two problems with BIPA. First, the assessee is not a resident of Netherlands. It is a resident of the Cayman Islands. Can a holding company of the assessee be entitled to invoke BIPA is the first hurdle. The second hurdle is that Article 4(4) thereof specifically excludes taxation matter from its ambit with the words:

The provisions of paragraphs 1 and 2 in respect of the grant of national treatment and most favoured nation treatment shall also not apply in respect of any international agreement or arrangement relating wholly or mainly to taxation or any domestic legislation or arrangements consequent to such legislation relating wholly or mainly to taxation.

So, how does the present dispute as to whether the retrospective amendment is proper or not come within the ambit of BIPA? I can’t figure it out.

So, there you have it. A short but succinct analysis of the options available to the warring parties. If you can think of any other options, don’t hesitate to chip in.

Vellalapatti Swaminathan Iyer
Hyderabad