Retrotax returns: $1.6 billion tax demand on Cairn is likely to be a Vodafone redux

There is a sense of déjà vu in tax and legal circles. Vodafone bought itself into Hutch’s Indian telecom operations by acquiring controlling interest in a Cayman Island company that called the shots in the Indian company hitherto controlled by Hutchison Hong Kong.

The tax authorities slapped a notice on Vodafone India to pay up the tax on capital gains made by Hutchison in its vicarious capacity i.e. in its capacity as representative assessee on the ground that even though the transfer took place abroad relating to shares of a foreign company, it was all about Indian telecom assets.

It was a logical argument but then tax law doesn’t recognise the logic — it recognises the express will of the law. And the law at the relevant point of time, while expressly taxing non-residents on their foreign income emanating out of business connection in India, did not make a similar claim on capital gains. The result was the Supreme Court giving a reprieve to Vodafone on technical grounds.

In 2012, then finance minister Pranab Mukerjee sought to initiate some rearguard action by making a retrospective amendment for which the entire nation is being pilloried and has become a butt of joke among foreign investors. Retrospective amendments smack of pusillanimity even if they are clarificatory in nature.

The Supreme Court is not likely to be impressed by the demand for tax from Vodafone after filling in of the breach pointed out by it by the government. Because retrospective amendments that cast financial liability, not on at the time of assessment, should be anathema to any fair minded tax regime in a civil society.

The facts regarding the latest tax notice slapped on Cairn Energy are eerily similar. The tax demand relates to an alleged Rs 24,500 crore worth capital gains it made in 2006 while transferring all its India assets to a new company, Cairn India, and got it listed on the stock exchanges.

The Income-Tax Department had in a January 22, 2015 order held that the Edinburgh-based firm made capital gains of Rs 24,503.50 crore when it transferred its entire India business from subsidiaries incorporated in places like Jersey, a tax haven, to the newly incorporated Cairn India in 2006.

According to the I-T Department, Cairns received Rs 26,681.87 crore for the asset transfer against its entire investment of Rs 2,178.36 crore in the India business.

There is a crucial difference though between the two transactions. While Vodafone bought from Hutch, an outsider, Cairns was all in the family initially, though later on Vedanta bought controlling interest in Cairn India.
One doesn’t know if the tax authorities took the permission of the government at the highest level before presenting the draft assessment order to Cairn but it is in for the same fate as the Vodafone tax demand.
Should the government proceed against Vodafone emboldened by the retrospective amendment, the Supreme Court is likely to strike it down. So will the demand on Cairn.

To be sure equity in both the deals is on the government’s side but as said earlier equity and tax are aliens. The government ought to leave such past transactions alone and instead concentrate on transfer pricing matters where it has curiously made a tame surrender by accepting the Bombay High Court verdict in Vodafone, preferring not to challenge it.

This is the harbinger of its stand on similar transfer pricing matters, including the one relating to Shell. Both Vodafone and Shell helped themselves to shares of Indian operating companies for a song and got away with the plea that being on capital account they were outside the pale of transfer pricing dispensation.

This disingenuous plea strangely cut ice with the Bombay High Court as well as with the government. Alas we gave up pursuing wrong causes and start pursuing right ones!