[Vidhispeaks] Certainty of Tax Legislation in India

By Aashima Sawhney

Tax policy plays an instrumental role in the commercial decision-making process of potential investors and accordingly has a direct impact on the economic growth of a nation. Over the past decade, tax legislations have generally been amended with a view to enhance transparency and develop efficient legal systems that facilitate global trade.

However, as Adam Smith elucidated in his renowned work ‘An Inquiry into the Nature and Causes of the Wealth of Nations’, a good tax system comprises of not just efficiency but also fairness, certainty, and convenience. He argued that taxpayers should be made aware about why and how taxes are to be levied in order to enable them to make informed choices. Despite this, multiple jurisdictions fall short in the area of tax certainty. Majority of the tax systems call upon taxpayers to self-assess their liability to tax, yet the legislation may make it impossible for them to establish such liability accurately leading to disputes and an unsteady environment for carrying out commercial activities.

International Development

Realising the importance of stable tax policies, the G20 members called on the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD) in 2016 to develop practices that would enhance certainty of tax laws.

As a result, IMF and OECD released a report in 2017 that recommended steps to ensure consistency in tax administration practices, mitigating ambiguity in legislations and building robust dispute resolution mechanisms. The initial report was followed by progress reports in 2018 and 2019, respectively. Notably, while the original report only focused on improving tax systems of the G20 and OECD countries, the update reports emphasised on improving tax systems of developing countries as well.

At the domestic front

In India, fiscal policy has often been recognised as stimulus for attracting investments. For instance, while announcing the corporate tax cuts in 2019, Finance Minister Nirmala Sitharaman credited the decision as a step towards promoting growth and investment. However, despite such efforts, India has not yet been able to establish itself as a leading investment hub as per World Bank’s latest ease of doing business (EDB) index.

According to a study, while India’s position in the EDB index has improved in the last few years, it’s overall ranking drops due to a low score under the head ‘paying taxes’.

As per the Indian Private Equity and Venture Capital Association, uncertainty in tax administration is one of the key threats to private investments in the country. This can be evidenced by the infamous disputes between multinational investors like Vodafone Plc and Cairn Energy Plc (herein referred to as ‘Companies’) and the Government of India due to the retrospective tax amendment introduced in Finance Act, 2012 that allowed Indian revenue authorities to levy tax on the gains arising from the sale of a foreign company's share if such a share, directly or indirectly, derives its value substantially from the assets located in India.

The retrospective nature of amendment led to significant international disquiet as it was in gross violation of the principles of certainty and stability. As a consequence to the tax demands raised under the amended provision, the companies initiated international arbitration proceedings against the Indian government under their respective Bilateral Investment Treaties (BITs). The companies claimed that India breached the guarantee of fair and equitable treatment laid under the BITs.

After years of prolonged battle, the Arbitration Tribunals in both cases ruled in favor of the companies based on the rationale that by retroactively introducing a tax burden, without a specific justification, on a transaction that was not taxable at the time it was carried out, India deprived the investors of their ability to plan their activities in line with the legal consequences of their conduct.

According to the bench, the retroactive amendment was a violation of the principle of legal certainty, which the Arbitration Tribunals considers to be one of the core elements of the Fair and Equitable Treatment standard, and of the rule of law more generally.

Given the unfavorable decisions of the Arbitration Tribunals and larger outcry of the international community against the retrospective nature of amendment, the government last month passed the Taxation Laws (Amendment) Bill, 2021 through which this controversial provision has been withdrawn to the extent that no retrospective tax demand shall be raised on any indirect transfer of Indian assets provided the transaction was undertaken before 28 May 2012.

The way ahead

While the decision of the government to course correct is a welcome step and should help in portraying India as a stable and tax friendly jurisdiction, there is still a long way to go.

Going forward, it may be worthwhile for the government to consider implementing the changes set out below to enhance certainty and further build the trust of the taxpayers in the system.

(a) Robust dispute resolution process: In order to provide greater transparency and efficiency in tax assessments, the Central Government introduced the Faceless Assessment Scheme, 2019 (Scheme). The Scheme completely overhauled the existing dispute resolution process and is based on eliminating the interface between an Assessing Officer and the taxpayer during the course of proceedings, to the extent that is technologically feasible.

While the intention of the government is appreciable, there are certain aspects of the Scheme that require clarity particularly Section 144B(7)(vii) of the Income-tax Act, 1961 (IT Act) that allows taxpayers to request for a personal hearing as opposed to being granted a hearing as a matter of right. The request for personal hearing will be granted at the discretion of the Chief Commissioner or Director General in charge of the Regional Faceless Assessment Centre. Right to be heard is a fundamental principle of natural justice and accordingly given the way this provision has been worded, doubts have been raised about whether a taxpayer can be denied a personal hearing if the request is not granted. While the Delhi High Court has recently clarified in a landmark ruling that the usage of word ‘may’ under Section 144B(7)(vii) of the IT Act would not absolve the tax authorities from the obligation of granting a personal hearing, yet it is essential for the legislature to release a clarification in this regard to ensure that there is no ambiguity.

(b) Uniform judicial decisions: The Indian judiciary has contributed significantly over the years towards the interpretation of tax laws. However, there have been instances where the interpretation of a provision of law by a court has been in contradiction to the interpretation laid down by another court under same material facts.

For instance, while interpreting whether deferred capital gains should taxable in the year of transfer or not, on one hand the Delhi High Court held in the case of Ajay Guliya v Assistant Commissioner of Income Tax that the total consideration would be taxable in the year of transfer and on another hand the Bombay High Court held in the case of Commissioner of Income Tax v Hemel Raju Shete that the consideration would not be taxable in the year of transfer. Identical factual scenarios should result in identical outcomes. Hence, it is important to formulate a mechanism that ensures that taxpayers are certain about the interpretation of a legal provision and can accordingly plan their activities.

(c) Efficient administration: Businesses are presently dealing with a great deal of economic instability as a repercussion of the pandemic. In such times, it is crucial for tax administrations across jurisdictions to instill faith in the investors. The Indian government announced various measures to provide relief to the taxpayers over the past two years including extension of timelines for tax compliance and filing requirements.

However, the reliefs were generally granted for a short period of time and new notifications had to be released from time-to-time to further extend the due dates. This resulted in a situation of uncertainty for taxpayers. For instance, on several occasions taxpayers had to approach courts and request them to direct the tax authorities to take appropriate actions. Even though the pandemic was an unprecedented situation, going forward measures taken by the tax authorities will be more helpful where they are efficiently implemented and not just announced in a timely manner.

Conclusion

Fiscal legislation is experimental and dynamic, even more so in new areas which are evolving to keep pace with the changing face of global businesses. However, policymakers should attempt as far as possible to balance the requirement of introducing new policies in the name of transparency and efficiency with the principles of certainty and stability to inculcate public faith in the legal system and tax administration. Certainty is undoubtedly a desirable feature of tax systems, and indeed for economies generally, both for governments and taxpayers and taking mindful steps in this direction is key to maintaining a steady financial system.

Aashima Sawhney is a Research Fellow at Vidhi Centre for Legal Policy.

Vidhispeaks is a fortnightly column on law and policy curated by Vidhi. The views expressed are of the fellow and do not reflect the views of Vidhi or Bar & Bench.