Retrospective tax: Keep Vodafone pragmatism pragmatic

The removal of the legal basis for the demand for a capital gains tax that, together with penalty and interest, has grown to more than ₹20,000 crore on Vodafone’s acquisition of Hutch-Essar in 2007 will not immediately or directly benefit troubled Vodafone-Idea (Vi). But we should recognise the amendment to the tax law as a peace offering to Vodafone. It comes nine years after BJP leaders used the term ‘tax terror’ to refer to the retrospective clarification, brought in by Pranab Mukherjee in 2012, to the effect that indirect transfers of Indian assets were liable to capital gains tax in India.

Cairn Energy and Vodafone had each won international arbitration awards against the claims of capital gains tax on its operations in India. Cairn had initiated action to realise the arbitration award of $1.2 billion plus interest and cost amounting to at least $500 million, by taking over Indian government-owned assets abroad. This could prove mighty embarrassing for the government, and stymie disinvestment of Air India, which does own assets abroad vulnerable to legal takeover by Cairn.

The government’s decision to cut its losses and amend the 2012 amendment to rid it of retrospective effect sends the message that it is moving away from tax arbitrariness, at least towards foreign investors. Tax terror these days is reserved for opposition politicians and owners of newspapers that diligently expose false claims on ‘unparalleled’ management of COVID-19.

Also read: Centre’s ‘burial’ of retro tax a last-ditch attempt to lift sagging economy

Vi needs upwards of ₹20,000 crore in the next couple of months to survive. Its owners Vodafone and Kumar Mangalam Birla have publicly washed their hands of the company. Of the company’s total debt of around ₹180,000 crore, about five-sixths is owed to the government. That does not include the capital gains tax claim. The government would be the biggest loser, apart from 28 crore Vi subscribers, were the company to go under. The massive delay in porting that large subscriber base to other operators and the remaining two large operators’ own reflexes on the scope to raise tariffs when the third player has disappeared are huge potential sources of public anger that could be directed at the government. The government would not want to face this.

So, the government is reportedly contemplating some concessions: lower levies by way of spectrum usage charges and licence fees and more time to pay outstanding dues. In no other country is spectrum auctioned off at fancy prices and still 10 per cent of revenue collected by the government as licence fees. Once companies have obtained their lease on spectrum, paying the price discovered in an auction, their tax obligation is like that of normal businesses: you pay tax on the profits you make. As regulated entities, they do cough up, in addition, a fraction of 1 per cent of revenue, to cover regulatory expenses. In India, on top of the licence fees, which are 10 per cent, 8 per cent and 6 per cent of the adjusted gross revenues (AGR) in A, B and C category circles, the government also collects up to 6 per cent of revenue as spectrum usage charge. Indian telecom operators lease spectrum from the government paying lakhs of crores and then still pay extra as spectrum usage charge as a share of revenue every year. The move to do away with or slash these charges is entirely rational and welcome.

These measures are prospective. Even if the government announces them, it would not reduce the outstanding AGR dues of telcos, in which penalty and interest far outweigh the original dues demanded by the government. Penalty and interest accumulated because telcos disputed inclusion of non-telecom components of their revenue that the Department of Telecom included in AGR to be shared with the government. Of the over ₹92,000 crore the government claims telcos, including those that no longer operate, owe as unpaid licence fees, the original figure is a little over ₹22,000 crore — 74 per cent is a combination of interest and penalty.

Also read: Pranab proposes, Nirmala disposes retro tax after 9 years

After the Supreme Court’s order justifying the AGR dues, the government cannot reduce the total dues, including on spectrum usage charge, of ₹1.47 lakh crore. What it can do is to convert what the telcos owe it into equity.

That would amount to nationalisation of Vi and, if Bharti and Jio also take up the government’s offer, a significant state ownership in these carriers as well. But the latter two, who stand to form a cosy duopoly if Vi were allowed to sink, might not want government busybodies on their boards and are likely to decline the bailout. Vi is in no position to.

When the financial crisis of 2007-09 felled entire industries in the US, the Obama administration nationalised General Motors and Chrysler, while Ford chose not to take state funding and survived the crisis on its own. The government later sold its stakes in the auto giants and made a decent profit. There is no reason to believe that a similar scenario would not play out in Indian telecom as well.

How much of its outstanding exposure to Vi the government would need to convert into equity depends on whether any strategic investor is around to invest in Vi. The sacrifice of its ‘retrospective tax demand’, it hopes, would propitiate Vodafone’s global leadership to reconsider its decision to pour no more funds into its Indian operation. It remains to be seen how Vi would respond to this climbdown from the withering disapproval delivered by Ravishankar Prasad in 2019 of the Vodafone suggestion that the government’s policies were driving its India operation into liquidation, forcing the company’s CEO to offer a lame, we-didn’t-mean-that apology.

While the government will now abandon its tax demand on Vodafone, it would have to refund to Cairn the capital gains tax it forcibly collected from its Indian operation for its consolidation of several subsidiaries into Cairn India in 2006. Cairn India Holding owned 26 Cairn operating arms across India’s hydrocarbon industry, sprawling across exploration and development and India’s geography. Prior to its initial public offering of early 2007, Cairn brought all the subsidiaries, including Cairn India Holding and its operating arms, under Cairn India. In 2014, the government decided that the internal reorganisation was liable to capital gains tax and issued a demand for ₹24,500 crore. The government forcibly sold Cairn’s shares to realise its tax claims and withheld dividend payments to the parent, as well. This tax demand relied on the retrospective clarification used to raise the tax demand on Vodafone.

That clarification was, in a minority view that the present writer strongly endorses, wholly appropriate in Vodafone’s case but misplaced in Cairn’s.

Also read: Should govt offer a lifeline to embattled Vodafone Idea?

In Vodafone’s case, the transaction that transferred control of telecom operator Hutch-Essar in India, in 2007, to Vodafone, a British telecom major (What-a-phone!), took place outside India. A Dutch subsidiary of Vodafone bought from Hutchison, a Hong Kong industrial group, a company in the Cayman Islands called CGP Investments. The whole business of CGP Investments was to own 67 per cent in Hutch-Essar. The question was when a foreign company was sold by one foreign company to another foreign company, did the Government of India have any right to tax that transaction? At first blush, no. But first blushes can be deceptive, whether in tax or in matters less prosaic.

Why does the government have any right to tax any economic activity? The conditions that allow economic activity to take place are not a force of nature. These conditions are created, maintained and constantly refined by the state, on behalf of society. The cost involved has to be recovered as tax from the economic activity itself. This is the simple rationale for taxation.

CGP Investments had any value at all because of economic activity in India, in which the company CGP owned, Hutch Essar, participated and gained from. So, when CGP’s owners sell the company and make huge capital gains, why should the Government of India not be entitled to a share of the wealth created out of economic activity in India, made possible by GoI? If sale of foreign companies is not liable to taxation in India, what is to prevent all further creations of companies in India to take the form of subsidiaries of Cayman Island tax avoiding entities? Why should anyone pay stamp duty on property sales in India? Say, property Xanadu on Mount Road, Chennai, is owned by Tax Shelter Incorporated, Cayman. When Kublai Khan wants to sell Xanadu to Chalapathy, Kublai simply sells Tax Shelter Inc to a happy Chalapathy, who no longer has to bear any property registration expense: after all, Xanadu’s direct ownership remains unchanged. Similarly, all sale and purchase of companies can be insulated from capital gains tax through the expedient of registering them as subsidiaries of companies in tax havens.

The tax department took the sensible view that Hutch was liable to pay capital gains tax in India on the gains it made on sale of CGP Investments. Vodafone said no. The Bombay High Court upheld the tax claim. Vodafone appealed in the Supreme Court, and won. So, GoI, with Pranab Mukherjee as finance minister, amended the tax law in 2012 to clarify that indirect transfers of Indian assets would be liable to tax. For good measure, the amendment said it has always been the intent of the tax law to subject indirect transfers to tax in India.

This led to an uproar, experts crying themselves hoarse over retrospective tax and tax uncertainty. First principles do not suggest the tax demand was retrospective. The Bombay High Court did not think the tax was retrospective. It was only the Supreme Court’s reading that made it retrospective. In all fairness, the tax department had written to Vodafone before it had made its payment to Hutchison, asking it to withhold the capital tax payment before remitting the payment to Hutchison.

Was India the first country to make retrospective changes to the tax law? No. China has done it. But then, it is China, you might say. But so had Australia as also, Britain.

The claim of tax uncertainty was the most specious. It brought absolute clarity and certainty to the tax law: any transfer, direct or indirect, of Indian assets would be liable to tax in India.

But the government then proceeded to muddy the waters for itself. It raised a tax demand in 2014 on Cairn. It also raised such demands on 16 other companies. Cairn’s case was wholly without basis. Cairn’s reorganisation did not change the ultimate beneficial owner. When Cairn India was sold to Vedanta, the beneficial owner changed. That was the time when the capital gains tax was due.

Now, as a measure of pragmatism, the government has moved to scrap the retrospective nature of the 2018 amendment to clarify that indirect transfers of Indian assets would be liable to tax. The latest amendment will return tax collected retrospectively, but would not pay interest or damages. But why not? Let pragmatism be pragmatic. Dogmatic pragmatism would bring paradox, oxymoron and other bits of Greek, Latin, incomprehension and further litigation to a policy stance that is already more than a bit complex.

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