On August 5, 2021, the government proposed the Taxation Laws (Amendment) Bill, 2021 to amend Section 9 of the Income Tax Act, 1961 (ITA). It was notified as an Act on August 13 after being passed by both houses of the Parliament and upon receiving Presidential assent. 

Section 9 provides for taxation of income considered to have been derived from India under strict nexus rules. 

This part of the statute came under controversy in 2012 when the then government retrospectively amended it to include within its scope offshore indirect transfer of shares that derive substantial value from assets in India. 

This was in response to the Supreme Court’s judgment in Vodafone where the apex court held that capital gains from offshore indirect share transfer do not fall within the scope of the Indian law, particularly in absence of a clear statutory mandate or like under General Anti-Avoidance Rules (GAAR) in other jurisdictions. 

The government disagreed with the judgment and found it inconsistent with the legislative intent. Post the 2012 amendment, several investors approached international investment tribunals to seek redressal and two of these disputes, Vodafone, and Cairn were decided in favour of the investors.  

1. Dissecting The Taxation Laws (Amendment) Act, 2021 

With the outcome of awards emerged a belief that India’s taxation policies are not investor-friendly and are negatively impacting the current and potential investment environment. 

Hence, the 2021 Act is as an attempt to regain the investors’ trust and avoid India from getting locked in international disputes, including its assets getting attached as a result of enforcement of awards.  

The 2021 Act proposes to nullify the tax demands made due to the retrospective amendment of 2012 and refund taxes collected so far. 

The proposal is contingent on respective parties withdrawing their claims before domestic or international dispute forums and desisting from any future claim. 

It also states that the refund is only limited to the tax collected, hence, discharging the government from any liability towards interest, costs, or damages. 

While the discussions between the Centre and the affected investors are ongoing, it is essential to understand what the recent measure means for the foreign investors.   

2. Has retrospectivity been given a complete farewell?  

On many occasions, the incumbent government had disassociated itself from the retrospective amendment and opposed it by labelling it as ‘tax terrorism’ even before it assumed power in 2014. 

The Statement of Objects categorically states that the retrospective amendment had become a ‘sore point with potential investors’. 

Nonetheless, it took nine years to undo the retrospective amendment. It retains the retrospective application but carves out an exemption for the specified (17) investors who fulfil certain conditions. 

This is to avoid any future litigation and also vindicates the government’s view to restrain from retrospective amendments.  
To settle the ongoing disputes, the Centre may be required to refund in excess of Rs 8,000 crore it had collected from the investors. This is in addition to substantial costs it has incurred while contesting the matters before international forums.  

3. How tax dispute settlement is going to shape up 

This policy change has implications for the future which needs to be specifically adverted. 

a. Domestic settlement mechanism 

What comes out as a clear message is the government’s reluctance to litigate taxation matters, as well as their desire to bury past cases. 

The proposal itself comes as a form of a settlement. The Centre had initiated several schemes in the past to ensure that tax matters are prevented and settled in a timely and cost-efficient manner. 

For instance, restructuring the Authority for Advance Ruling (as the Board of Advance ruling), introducing the Dispute Resolution Committee, the 2020 Vivad se Vishwas scheme for tax disputes, and issuing guidelines for pursuing Mutual Agreement Procedure (MAP). 

The revamp of MAP falls in line with the peer review process proposed under OECD BEPS to strengthen dispute resolution under tax treaties (Action 14). We are yet to witness how these mechanisms will reduce the burden of disputes cruising in treaty cases, nonetheless, the positive intent is laudable.  

b. International tax settlement mechanism 

Though India is a signatory and a party to the OECD’s Multilateral Instrument (MLI), it has refrained from adopting the mandatory binding arbitration on grounds of sovereignty.

However, with the country supporting the Pillar One and Pillar Two proposals of the OECD, it is expected to be part of the international tax community in setting up a Review Panel recommended under Pillar One. 

The panel was proposed with an aim to provide greater certainty by establishing a mechanism that will allow accurate application of sourcing rules on profits of multinational enterprises to be allocated to market jurisdiction. 

India’s acceptance of adjudication by the review panel is viewed as a welcome step towards embracing arbitration on digital tax.  
c. International Investment Arbitration 

A key concern for the government caused by the retrospective controversy was investors approaching international forums under bilateral investment treaties (BIT) for disputing tax measures. 

On the grounds of the ‘fair and equitable treatment’ principle, Vodafone and Cairn achieved awards in their favour that held the Centre liable, rejecting its stand that the claim interferes with its sovereign rights to frame and enforce tax laws. The 2021 Act requires the investors to withdraw any such proceedings initiated at international forums. 

The Revised Model Bilateral Investment Treaty, based on which India is currently negotiating its BITs, consists of tax carve-out under its scope. If the clause survives the negotiations, it will restrict a foreign investor from seeking recourse to investment treaty for a tax measure in the future. In other words, the 2021 Act marks the closure of tax disputes being litigated in BIT space. 

4. Conclusion: Imagining the future of India’s tax policy 

The tax landscape in India is undergoing crucial changes with the lawmakers consistently emphasising on the need for investor certainty and trust. 

For instance, the 2020 introduction of the Taxpayers’ Charter that enlists the rights and obligations of a taxpayer, aims to build trust between the taxpayer and revenue. 

The retrospective amendment stood out as a roadblock for achieving these objectives. Building upon the 2021 Act, apart from settling the current disputes, the government must ensure that the revamped, domestic and international approaches to mitigate tax controversies and resolve disputes are implemented effectively and are accessible by current and potential investors. 

Incorporation of international best practices in tax law and administration can help place India at the peak of foreign investments, giving a further boost to the aspirations to the 1.2 billion strong nation.  

(Mukesh Butani, Managing Partner at BMR Legal. Assisted by Akshara Rao, Associate at BMR Legal.)