Dear UK Govt, Heal Thyself Before Preaching To India About Vodafone

The UK Govt’s not-so-subtle threats to India over the Vodafone retrospective amendments have irked the author. The author cites two controversial retrospective amendments effected in the UK to supersede well settled judicial precedents and fumes that a Government which itself indulges in questionable legislative practices has no moral right to preach to others.

The question whether the Vodafone retrospective amendment is the right thing or not is one issue. The question whether the UK Government has the moral authority to threaten the Indian Government to withdraw the retrospective amendments is a separate issue.

When UK’s Finance Minister Gordon Brown and Chancellor of the Exchequer George Osborne criticized India over the Vodafone retrospective amendments, a lot of people nodded sagely, agreeing with their dire prognosis that the amendments seeking to nullify the judgement of the Supreme Court were improper and ought to be withdrawn forthwith as it would otherwise “dampen enthusiasm about India’s investment climate“.

However, what is now causing consternation is that the UK Government is also guilty of a similar retrospective amendment to nullify a judgement of the High Court & Court of Appeals.

Lets’ get some background. In Padmore v IRC [1989] STC 493, the question arose whether a UK resident, who was a member of an offshore partnership based in Jersey, could be made liable for UK income tax on earnings received from the partnership. The assessee claimed that under the DTAA between the UK & Jersey, the UK taxpayer was exempt from UK income tax while the Revenue argued that as the assessee was not a resident of Jersey and did no business there, he was not eligible for relief under the DTAA and was thus liable for full UK income tax on earnings from the partnership. However, the High Court and Court of Appeal held that as the partnership was a “body of persons” resident in Jersey its business profits were exempt from UK tax, the share of those profits attributable to UK resident partners was also exempt from UK tax. Such profits were also not taxable in Jersey (and Isle of Man and other tax havens) and so escaped tax-free.

This loophole was plugged by a retrospective amendment in 1987. Thereafter, another tax avoidance scheme involving an off-shore trust was devised. The way this scheme worked was this: A UK resident, say, a self-employed architect, would become a partner of a firm, and beneficiary of a trust, in the Isle of Man. As partner, he would agree to render services for a (nominal) fee/share of profit. The firm would contribute to the trust of which the assessee was the beneficiary. In future, the assessee would not directly render services to his clients in the UK. Instead, the contract would be entered into by the Isle of Man firm with the UK client and the assessee would, as a representative of the firm, perform services, while the bill would be raised by the Firm. His (nominal) share of profits in the firm would be taxable in the UK. However, his interest in the offshore trust was not taxable under the DTAA.

The UK Revenue did not say that the scheme was a “sham”. They accepted that the transaction was “within the four corners of the law” and permissible even if it was “artificial“. In July 2002, the UK Revenue issued a Technical Exchange (Issue 63) in which they stated that “were considering how best to challenge the scheme“. They couldn’t think of anything and so, finally, several years later, to supersede the verdict, section 58 of the UK Finance Act, 2008 was introduced to nullify retrospectively the use of tax avoidance schemes of the type referred to in Padmore vs. IRC.

In Budget Note (BN66), the Government stated that the amendment was “to clarify, retrospectively, legislation introduced in 1987, which itself was retrospective, so that it has effect as intended“.

The validity of the retrospective amendment was challenged (under the Human Rights Act) in Robert Huitson vs. HMRC [2010] STC 715. In rejecting the challenge, the Court made interesting observations on why the retrospective amendments were necessary.

15. The tax avoidance scheme, if it worked, would, therefore, appear to realise every taxpayer’s dream of lawfully avoiding, or at least greatly reducing, income tax in any jurisdiction. By exploiting the arrangements, the Claimant over 7 years avoided income tax of £84,980, and reduced his effective tax rate to an average of 3.5 per cent. On the face of it this would appear to be a rather paradoxical result of a DTA exclusively aimed at avoiding double taxation

26. It does not require great insight to see that this result would not be acceptable in terms of public policy

30. The response in Padmore, in my judgment, is of considerable importance to the present claim. Even assuming that the decision of the High Court in Padmore was correct as a matter of technical interpretation of the DTA, the result of the decision – that a UK resident could avoid UK income tax on the profits of his or her trade or profession – was plainly unacceptable in terms of UK public policy in fiscal affairs. Whatever the true meaning of the DTA, there was a wider rationale in terms of public policy: UK residents should pay UK income tax on the profits of any trade or profession; and a DTA, intended to relieve from double taxation, should not be used as an instrument either to avoid all taxation or to reduce it to well below the level that would be applicable to the relevant income in the country of residence.

33. It seems to me that these two features emphasised the importance that Parliament attached to the public policy to which I have referred. In my view, these events sent out a clear signal to taxpayers and their advisers that the legislature would be very likely to take effective and decisive steps to counter, even with retrospective measures, any attempt, through artificial arrangements, to take advantage of a double taxation arrangement, in particular, Article 3(2) of the double taxation arrangements with Jersey and the Isle of Man, in such a way that a UK resident would avoid, or very substantially reduce, the UK income tax on the profits of his or her trade or profession that would, in the absence of the artificial arrangements, otherwise have been payable.

So, now the question is what is the difference between the retrospective amendment to supersede the Vodafone judgement and the retrospective amendment to supercede the Padmore judgement. Its hard to find any difference. In both, the amendments are “clarificatory” of the “intention of the legislature“. In both, the amendments are to counter artificial tax avoidance arrangements (which were legally valid and not a “sham”). In both, the transactions were opposed to “public policy” (as perceived by the respective governments). In both, the amendments are to supersede judicial precedents. In both, the message intended to be sent was: “Don’t mess with the law. Pay your taxes and sit quietly“. In both, the amendments go back several years.

The only difference, if at all, is that while the Indian amendments will hit multi-billion dollar global conglomerates for whom the tax bill will be just a flea bite, the UK amendments will hit thousands of self-employed citizens who can ill-afford to pay the back taxes. So, why the holier-than-thou attitude?

The second retrospective amendment carried out by the UK government in the Finance Bill 2012 was with respect to certain tax avoidance schemes devised and implemented by Barclays which enabled it to save 500M pounds. Exchequer Secretary to the Treasury, David Gauke, defended the retrospective amendment by stating “We do not take today’s action lightly, but the potential tax loss from this scheme and the history of previous abuse in this area mean that this is a circumstance where the decision to change the law with full retrospective effect is justified“.

So, what is the moral authority that the UK Government has to criticize the Indian Government over the Vodafone retrospective amendments? If “tax loss” and “public policy” justifies the retrospective amendment in the UK, why is it not justified in India? It is a case of the Pot calling the Kettle black! What is sause for the goose has to be sause for the gander!

Vellalapatti Swaminathan Iyer
Hyderabad