The recommendation of the Parthasarathy Shome Committee that tax laws should be applied prospectively — and retrospectively only in the rarest of cases — is the right approach. It also raises an important question that officials in the finance ministry should introspect over: doesn’t retrospective legislation violate the principle of legal certainty? Companies have reasonable expectations that the tax benefits of a course of action will not be changed. There is no question that double taxation treaties cannot be used for tax avoidance; Mauritius had the right under its treaty to tax the transaction, but chose not to do it.
But the incident creates another conundrum. Companies use many exemptions within the Income Tax Act for tax planning purposes, like investment allowances that permit them to take on capital expenditure. Those exemptions are not treated as tax avoidance measures, but could they in future? The government is expected to take a final decision on the recommendations by November 15, so companies affected by the retrospective changes in the Finance Bill 2012 — mainly Vodafone, which was hit by a very large withholding tax bill ($2 billion plus penalties and interest) after its acquisition of the Essar Group’s stake in their then joint venture, based on the treaty with Mauritius — may be able to breathe a little easier, but they are not out of the woods yet. The finance minister, Palaniappan Chidambaram, may be progressive, but it’s not clear that all the considerable political capital invested in changing the rules retrospectively will be written off so easily.
India is not the first country to try and use retrospective provisions in amending tax legislation; the United Kingdom did it by introducing changes in its Finance Act 2008 for similar reasons; the legality of retrospective legislation was decided in two cases before a court of appeal after the two parties who sought the court’s intervention filed suit. In both cases, the court of appeal ruled that a retrospective provision in the Finance Act 2008 was not illegal. In one case, it decided that the policy stating double taxation treaties are not to be used for tax avoidance should be strictly applied. The court also held that in balancing the community’s interest (of all other taxpayers) against that of an individual, retrospective legislation did achieve fairness. Despite the seemingly worrying conclusions that this may lead to, there are still lessons from the UK cases that we could take away. The UK government has chosen to introduce specific anti-avoidance regulations in the form of Disclosure of Tax Avoidance Schemes that apply prospectively, not retrospectively. In all likelihood, when the General Anti-Avoidance Rules become law, they would be clear and unambiguous.