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The Taxation Law (Amendment Bill), 2021

13 min read

By: Arryan Mohanty

Published on: May 17, 2022 at 08:24 IST


Famous Economist Adam Smith stated in his book The Wealth of Nations that an ideal taxation system should be founded on the principles of equality, clarity, convenience, and efficiency.

Time of payment, procedural formalities, and payment amount should not be subject to arbitrary decisions and should be obvious to the taxpayer and everyone else.

While taxes may appear to be an unavoidable economic obligation to fund government services, the concept of tax is based on the social contract idea of governance.

Taxes are remuneration paid by individuals in exchange for the government’s and society’s economic advantages, as well as a tool for wealth redistribution between the rich and the poor.

As a result, a fair and just taxation system is essential to the smooth functioning of a democratic society. The addition of retrospective modifications to tax laws creates a legal obligation in the past, even if the statute did not exist at the time.

The Indian government has used retrospective modifications to overturn judicial decisions and impose unjust tax demands on many businesses.

By repealing the retrospective tax laws, the Taxation Laws (Amendment) Bill, 2021 marks the end of the period of ‘Tax Terrorism’ and offers a favorable environment for foreign investment.

Ms. Nirmala Sitharaman, Minister of Finance, introduced the Taxation Laws (Amendment) Bill, 2021, in the Lok Sabha on August 5, 2021. The Income Tax Act of 1961 (IT Act) and the Finance Act of 2012 are both amended by the Bill.

The IT Act was revised in 2012 to impose a retrospective tax liability on income derived from the sale of shares in a foreign corporation (i.e., also applicable to the transactions done before May 28, 2012). This retroactive basis for taxes is proposed to be repealed by the bill.

Challenges to the Constitutionality of Retrospective Taxation Laws

The words “Retro” and “Specere” stem from the Latin words “retro” for “backwards” and “specere” for “to look at.”

Thus, retrospective laws are concerned with events that occurred in the past. This is in direct opposition to the legal rule “Lex prospicit non respicit,” or the future principle guiding legislation that is effective immediately.

People may be disadvantaged by laws that were not there when they were breaking them, hence retrospective laws are generally thought to be unjust and oppressive. It appears to be at odds with the concepts of equity, fairness, and natural justice.

As a result, retrospective legislation must be utilized with caution and only on rare occasions to avoid a serious miscarriage of justice. However, in the area of taxation, Indian legislators have often enacted retrospective legislation.

The legislative propensity to reverse certain judgements and correct certain ambiguities or inconsistencies in existing laws has affected this trend. While enacting retrospective law, the government has taken use of the premise of presumption of constitutionality.

To dispute this presumption of constitutionality, the law imposes a high burden of proof. The reason-ability test, on the other hand, has been used by the courts to overturn any laws that appear to be illogical.

In the case of Retrospective Taxation Laws, the Supreme Court held that imposing an unreasonable tax burden would deter people from practicing their profession, which could be interpreted as a violation of Article 19(1)(g) of the Indian Constitution, which guarantees the right to practice any legitimate profession or trade.

One of the most important judicial decisions on retrospective taxation laws came in the case of Chhotabhai Jethabhai Patel & Co v. Union of India (1961).

The administration declared that the duty on manufactured tobacco would take effect from the day the law was introduced in Parliament, not the day it was passed. The petitioners asked the Supreme Court to overturn the retroactive law.

To establish whether the retrospective law was legitimate and if it violated Part III of the Constitution, the Court relied on international judgements.

While there was no clear constitutional restriction on retrospective laws, the Apex Court concluded that Part III of the Constitution applied to taxation laws because there was no explicit constitutional restriction on such laws.

The application of a tax retroactively, on the other hand, does not automatically render a statute capricious and illegal.

This legal precedent led to the abuse of legislative power, prompting the government to move from correcting minor flaws in its legislation to retroactively enacting large modifications.

Only in 1978, the Supreme Court of India, in the case of Maneka Gandhi v. Union of India, clarified that when enacting a retrospective statute, the legislature is bound by fundamental rights limits.

The courts have authorized retrospective modifications to existing laws to correct flaws and help them achieve their goals.

Even if the amendment is not expressly made retrospective, the law requires that the clarifying or explanatory nature of the amendment be reviewed to see if it is retrospective.

In the case of Lohia Machines Ltd and Anr. v. Union of India (1985), the Parliament added a retrospective rule to the Income Tax Act, 1961.

While it was argued that the newly added regulation was incompatible with the remainder of the Act and so defeated the Act’s intended impact, the Supreme Court ruled that the retrospective modification was only clarifying and thus legitimate.

Even a planned revision may be deemed retrospective in application in certain circumstances. This is frequently the situation when a statute has omissions that later changes must be understood to be retrospective in character in order to achieve the desired application of the statute.

In Commr. of Income Tax v. Alom Extrusion Ltd. (2009), an alteration to a legislation led in some tax-payers losing the benefit of receiving deductions on their taxable income due to the statute’s projected application.

The Supreme Court ruled that persons should not be denied the advantages of a statute because of a legislative error. The judiciary has always upheld retrospective revisions to tax rules that are solely declaratory or curative in nature.

A fundamental change in the law that creates a whole new responsibility retroactively, on the other hand, would be contrary to the spirit of the Constitution.

In the case of Union of India v. M/S Martin Lottery Agencies Limited (2009), the Supreme Court declared that existing laws cannot be amended under the guise of clarification unless there is a good reason.

The imposition of additional tax responsibilities that are retrospective in nature violates Article 19(1)(g) and Article 14 of the Constitution’s fundamental rights.

Even when declaratory or curative amendments are made, the law requires that contradictions be addressed in the public’s favor.

The High Court of Delhi found in Ansal Housing and Construction Ltd. v. ACIT (2017) that a tax statute reform must be aimed to remove any hurdles experienced by taxpayers, not the tax authorities.

The lack of clarity in the rules and regulations imposed by the retrospective modification could cause ambiguity in the act, perhaps making it invalid.

In the case of Commr. of Income Tax v. NGC Networks India Pvt. Limited (2019), the High Court of Bombay applied the maxim “Lex non-cogit ad impossibilia” to determine that a party could not be expected to perform the impossible task of foreseeing the future and complying with a law that would be enacted at a later date.

This stops legislators from abusing their position and taxpayers from bearing the brunt of an irrational tax.

Recent Controversies regarding Retrospective Taxes

Vodafone International Holdings BV v. Union of India

In the case of Vodafone International Holdings BV v. Union of India (2012), the plaintiff is a firm incorporated in the United Kingdom.

In 2007, the UK-based corporation that had recently joined the Indian telecom industry was sent with a show cause notice for failing to pay tax on the indirect transfer of assets in India.

In the same year, Vodafone paid USD 11 billion for the rights to a Cayman Islands-based business called CGP Investments (Holding) Ltd. CGP was a subsidiary of Hutchison Telecommunications International Ltd, a Cayman Islands-based company owned by Hong Kong businessman Li ka Shing.

Hutchison Essar Limited, an Indian company, was owned by CGP to the tune of 67 percent. Since acquiring CGP, Vodafone has also acquired Hutchison Essar Limited, which is a subsidiary of CGP. Before the Supreme Court of India, a dispute arose over the payment of tax on stock transfers.

The Court looked at the nature and purpose of the transaction between the two foreign firms and determined that the main goal of the transaction was to transfer GCP’s shares, not Hutchison Essar Limited’s.

Furthermore, the Apex Court stated that tax liabilities emerge when there is a direct or indirect income rather than a transfer of capital assets while reading Section 9(1)(i) of the Income Tax Act, 1961.

It was a non-taxable transaction under Section 2(14) of the Income Tax Act, 1961, because it was a sale of shares rather than capital assets. The tax must be levied at the source, that is, at the location where the transaction took place, rather than at the point where the value of the items was derived.

After the Supreme Court’s decision in this issue, the Indian legislature approved the Finance Act of 2012 to circumvent the legal decision.

Non-residents and corporations incorporated outside India’s territorial jurisdiction now face tax liabilities if they are involved in the transfer of shares whose values are derived from assets in India, according to a retrospective change to Section 9(1)(i) of the Income Tax Act.

Vodafone has petitioned the Permanent Court of Arbitration in The Hague for redress due to the deliberate change of legislation to impose tax liability.

The arbitral tribunal ruled in the company’s favour, finding that the retrospective amendment of the taxation law is in violation of the Indian government’s commitment to fair and equitable treatment under the India-Netherlands Bilateral Investment Treaty and the India-United Kingdom Bilateral Investment Treaty.

Cairn UK Holding Limited case

The Income Tax Department of India slapped a capital gain tax on Cairn UK Holdings Limited on account of the internal corporate reorganization of the business in 2006, following the Supreme Court’s ruling in the Vodafone case.

Cairn UK had transferred to Cairn India its whole ownership in one of its subsidiaries in Jersey, Channel Islands. Later, the Indian subsidiary conducted an Initial Public Offering, selling around 30% of its stock to Vedanta PLC, a mining company. Cairn was served with a tax demand of Rs 22,100.

In deciding this case, the Permanent Court of Arbitration in The Hague decided that the retrospective alteration to the statute could not be called a clarificatory amendment. The domestic legislation change went against the Bilateral Investment Treaty between India and the United Kingdom.

As a result, levying tax on the firm would be illegal under international law. A tax penalty of USD 1.2 billion was also levied on the Indian government as a way of repaying Cairn for its losses. Following that, the Indian government engaged into talks with the prospect of waiving half of the tax liability.

Cairn, on the other hand, tried to have the arbitral judgement enforced in the United States by seizing Air India’s assets. The corporation claims that the government-owned enterprise represents the Indian government and is hence obligated to pay the government’s debts.

It aims to break through the corporate veil and acquire Indian assets all around the world. Several lawsuits have been filed around the world to get the arbitral award enforced. A French court recently granted the UK-based corporation permission to freeze over 20 Indian assets valued about 20 million Euros in Paris.

Salient Features of the Bill

Non-residents are obligated to pay tax on income derived from any business link, property, asset, or source of income located in India under the IT Act.

The 2012 Act clarified that if a company is formed or incorporated outside of India, its shares are presumed to be or have always been located in India if they derive a significant portion of their value from assets located in India.

As a result, anyone who sold such foreign company shares before to the Act’s implementation (i.e., before May 28, 2012) became subject to pay tax on the profit earned from the sale.

The bill intends to eliminate the tax duty imposed on such individuals if they meet specific criteria. These are the conditions:

  • If the person has filed an appeal or petition in this regard, the appeal or petition must be withdrawn or the person must provide an undertaking to withdraw the appeal or petition;
  • If the person has started or given notice of any arbitration, conciliation, or mediation procedures in this regard, the notices or claims must be withdrawn or the person must make an undertaking to remove them,
  • The person must sign a waiver agreeing to forego any right to seek or pursue any remedy or claim in this matter that would otherwise be available under applicable law or a bilateral agreement, and
  • Any additional conditions that may be imposed.

All assessment or reassessment orders made in connection to such tax liability shall be deemed to have never been issued if a concerned individual meets the foregoing conditions, according to the Bill.

Furthermore, if a person meets these requirements and is qualified for a refund, the cash will be reimbursed to him without interest.

Impact on investors and stakeholders

Even though the tax policy restructure has been delayed, it has sent a clear message to all investors who have already invested in India’s economy, and especially to those who will invest in the future, that India will correct its course and is even willing to bite the bullet even if the circumstances are not ideal.

This action has clarified the government’s position on tax policy fundamentals.

Despite the fact that this restructure in tax policy has been delayed, it has sent a clear message to all investors who have already invested and especially those who will now invest in India’s economy that India will go to any length to fulfill its responsibilities and do what needs to be done, and despite being criticized, this step has clarified the government’s position on tax policy principles.

This decision by the government has caught the attention of international investors as one of the administration’s “Boldest” and “Brave” moves.

Many industrialists applauded this move, and many international investors’ faith in India’s laws appears to have been restored. Some opposition leaders have praised the decision as well.

All of the cases that were brought following the retrospective tax have now been resolved. There will be no such demand from the government, and any money collected will be returned to them.

As a result, the entities should logically abandon their cases against the government, as there is no purpose in pursuing them now that their claim has been waived.

Experts also believe that by removing the retrospective tax, there is now more clarity for deals between nations that are not covered by any tax treaty benefits, and that this has helped India’s stance in terms of ease of doing business in India.

Stakeholders will now have faith in Indian laws, knowing that they will receive everything they require to work in an optimal atmosphere. It has now transformed India’s taxes system into one that is transparent, unequivocal, straightforward, and equitable.

This is a far better option for the parties to settle their issue outside of court, and it is much better if it is done amicably and without the intervention of a third party.

It is more of an unspoken law of the arbitration process that if one side is willing to negotiate a reasonable settlement that is equally acceptable to the other, the other party must try to settle rather than continuing with the arbitration and the dispute.

This change in law does not change existing laws; the law governing the indirect transfer of Indian assets remains unchanged, and tax authorities will continue to impose tax liabilities on entities involved in such transactions.

All that has been accomplished is to provide an easy way out for those who have been caught up in the law’s retrospective application; if we look at it from this perspective, only those 17 companies against whom such cases have been brought will be affected.

The government hopes that by correcting the problem, it will attract more foreign investment and portray India as an investor-friendly country.

Effect of International Relations

India is a signatory to various trade and investor protection treaties, and the 2012 modifications were in violation of these agreements. As a result, these accords were cited by parties in front of arbitration tribunals.

Furthermore, it would have negatively impacted potential foreign investors’ willingness to invest in the country, as well as the country’s ranking in the Ease of Doing Business Index. Hence, it was critical to eliminate the retroactive impact of laws.

Road Ahead

Though the 2021 Act removed retrospective taxation, it will be interesting to see how investors react to this change under “The required conditions.”

Companies like Vodafone and Cairn, which have suffered treaty breaches and significant litigation damages as a result of the government, may not be satisfied with receiving the principal amount without interest in exchange for waiving all available remedies and giving the government the option to prescribe any other condition in the future.


The government has begun a process of making long-awaited revisions in response to the international tribunals’ opinions on India’s retrospective tax structure.

The Permanent Court of Arbitration’s decision in favor of tax-payers and against the Indian Income Tax Department has culminated in the introduction of the Taxation Laws (Amendment) Bill, 2021, despite India’s efforts to establish that domestic taxation laws fall within the scope of its sovereign right.

The government wants to halt the seventeen arbitration cases brought against it by the United Kingdom and the Netherlands under the Bilateral Investment Protection Treaty.

The incapacity of Indian law to adapt to changing requirements of society is exemplified by the consumer protection legislation that jeopardize the business model of Walmart-owned Indian e-commerce behemoth Flipkart, as well as the controversy over Facebook Inc.’s WhatsApp’s end-to-end encryption feature.

Scrapping the retroactive rules could help India attract more foreign investment and provide a clear and dependable tax framework for international companies.

The enactment of the Taxation Laws (Amendment) Act, 2021, was a wise move by Parliament in negating the 2012 Finance Act’s retrospective impact. Retrospective taxation plainly violates the principle of certainty and, as a result, should not be practiced in India’s tax system.

Furthermore, nullifying this retrospective application will undoubtedly benefit the economy by assisting in the re-establishment of foreign investor confidence.

Today, the country is at a crossroads where rapid economic recovery from the COVID-19 pandemic is critical, and foreign investment plays a critical role in supporting faster economic growth and employment.

Edited by: Tanvee Jain, Publisher, Law Insider