January 28, 2013

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Conclusion or Reasoning: What Matters

- Aseem Chawla, Partner [ MPC Legal ]
- Vibhooti Malhotra, Associate [ MPC Legal ]


Do means justify the end or is the end that counts. The recommendations of the Empowered Committee, headed by noted economist Dr. Parthasarthi Shome, inter alia, to examine the ramifications of introducing an amendment in Section 9 of the Income Tax Act, 1961 (‘the Act’) to tax indirect transfer of assets are being widely hailed as somewhat of a saviour for foreign investments into the country.

The amendment in Section 9 was introduced vide tax proposals enunciated in Budget - 2012 after the Supreme Court’s decision in the celebrated Vodafone decision. Taking a very progressive view, Former Hon’ble Chief Justice Kapadia, the then presiding Judge of the Hon’ble Bench, had held that, “FDI flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works”1. However, very recently, former Hon’ble Chief Justice J. S. Verma had remarked that the decision in Vodafone completed the trinity of infamous Supreme Court judgements, which should be soon forgotten or overcome.2 Justice Verma opined that the Apex Court must be guided by only the economic philosophy contained in Articles 38 and 39 of the Constitution of India, not any other extraneous considerations.

If one were to draw, from Justice Verma’s admonition, it can probably be said that the Expert Committee, headed by Dr. Shome should be governed by the mandate contained in its terms of reference. The report acknowledges the fact that commenting on the constitutionality of this amendment is beyond its competence, however the same goes on to term the enactment as not “genuinely clarificatory” and should be applied only prospectively. However, in the event the amendments were to be applied retrospectively: a) any tax on capital gains found leviable should be imposed directly rather than representative assessees or assessees in default and b) no interest or penalty should be charged on the amount of tax liability. Therefore, despite suggesting its inability, the Shome Committee Report ventures into the Constitutional sphere. Be that as it may, it shall be interesting to understand the legal meaning attributable to the phrase “genuinely clarificatory”. Also, the Committee advises the Government to resort to retrospective legislation only in “rarest or rare cases”- coincidentally the legal standard adopted by the Supreme Court to benchmark death sentence cases.

Article 246 of the Constitution, confers nearly plenary powers to the Parliament of India, subject to the limitations contained in fundamental rights, the entries contained in State Lists, public policy or as prescribed in the Constitutional machinery at large. The legislative power to make law with retrospective effect is well recognised. The Supreme Court has held that a power to legislate includes the power to legislate with retrospective or prospective effect.3 Retrospective application of clarificatory amendments is rarely struck down, since they are assumed to be part of the statute book since inception. However, as the Report also highlights, the challenge lies in understanding what constitutes “clarificatory amendment” per se.

However, if a clarificatory explanation seeking to get over prior rendered decisions is seen to be amounting to a ‘new’ levy or is in substance a change in law, the retrospective amendment will then be rendered unconstitutional, as was laid out by the Supreme Court in the case of National Agricultural Co-operative Marketing Federation of India vs. Union of India.4 From a purely legal standpoint, an argumentative endeavour can be made out for suggesting that amendment to Section 9 of the Act being held unconstitutional. Notably with respect to the vagueness associated with the phrase “substantially derives value”. There are no guidelines which can assist in outlining the provision or quantifying the extent of “substantial value” – leaving room for arbitrary application of the law.5 The fate of retrospective amendment may soon be judicially scrutinised. Petitions have been filed before the Calcutta High Court and Bombay High Court by McLeod Russel and SAB Miller respectively, challenging the said retrospective amendment against the fairness principles enshrined in the Constitution of India.

It is noteworthy that Shome Committee was originally constituted to vet and rework the GAAR guidelines. And the mandate to examine the implications of amendment made to the Income Tax Act, 1961 relating to the taxation of non-resident transfer of assets where the underlying asset is in India, particularly in the context of the tax liability of portfolio investors and Foreign Institutional Investors (FIIs) was introduced later. This enhancement in the terms of reference happened in the month of September in the wake of declining FII6 and FDI flows after the Vodafone decision. It is pertinent to note that when the Amendment was tabled in the Parliament, the then Finance Minister had exuded confidence that India isn’t desperate for foreign investment.7

Though the recommendations of the Report may not come under criticism from a tax policy angle – since the same are grounded in preserving certainty, reducing undue burden and retaining buoyancy of foreign investment, however doubting the legislative power of the Parliament to arrive at the same conclusion may not have been the best strategy. Interestingly very recently, the Solicitor General has requested the Chief Justice to refer the Vodafone decision to a larger bench since the principles in the main judgment can be misunderstood by various High Courts of the country.8

The final call on the status of Section 9 and the Vodafone tax matter shall have to be taken by the Government, which is now being formally advised by Dr. Parthasarthi Shome.9 Philosophers have been struggling with the dichotomy of means and ends for centuries now. Indian Government which is keen to restore its position as favourable investment destination, perhaps needs to indulge in a similar introspection.

1 Vodafone International Holdings B.V. v. Union of India (UOI) and Anr. (2012) 341 ITR 1 (SC) 2 C.f. “ infamous-sc-judgments/1031582/0”, 3 Income-tax Officer, Alleppey v. Ponnoose and Ors. AIR1970SC385, 4 (2003) 260 ITR 54, 5State of West Bengal v. Anwar Ali Sarkar AIR 1952 SC 75, 6C.f. “”, 7C.f. “”, 8See “ 1043478”, 9C.f. “”

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