New tax philosophy for an emergent economy
Albert Einstein famously said about taxes: “This is too difficult for a mathematician, it needs a philosopher.” One is reminded of these words while considering the actions of the Indian revenue authorities in the case of Vodafone and others related to retrospective taxes. It seems they are determined to extract revenue whatever be the cost in the long run. The cost will be loss of faith by foreign investors in a reliable regulatory and legal system that should make it easier to do business in this country. Giving over-riding importance to short-term gains over long- term opportunities has been the mindset of governments in the past. It was expected the NDA would have a different approach, given Arun Jaitley’s comments in 2016 regarding the retrospective tax laws of the UPA government having hurt the country by scaring investors away. Instead, it has continued to pursue companies with the threat of retrospective tax demands.
The Vodafone saga needs to be recapped to put the issue in perspective. It began in 2007 when the Vodafone’s Dutch affiliate bought over Hutchison’s shareholding in Hutchison-Essar Limited. The 11 billion dollar transaction was carried out in the Cayman Islands. Indian tax authorities subsequently sought 2.2 billion dollars as capital gains tax, a levy disputed by Vodafone. The case went up to the Supreme Court which in 2012 ruled in favour of the telecom company. The matter did not rest as the UPA government amended the law and made it effective retrospectively since it was enacted in 1961. Vodafone invoked arbitration proceedings under the bilateral investment treaty with the Netherlands in 2014. By 2016, the income tax department’s original demand of Rs 7,990 crore had risen to Rs 22,100 crore, including interest and penalty.
To be fair to the tax mandarins, India is not the only country to have used retrospective tax amendments to curb legal loopholes. The US, UK, the Netherlands and Canada are among the countries which have also carried out such retrospective taxation. India has also not been alone in chasing Vodafone to pay dues on transactions in tax havens. The telecom major ended up paying 1.95 billion dollars in 2010 to the UK government for diverting funds to subsidiaries in low tax countries like Luxembourg. This is the same disturbing trend noticed in the Hutchison deal where the transaction was carried out in the Cayman Islands. One of the key arguments in favour of an appeal is that it will deter international companies from opting for tax havens to avoid domestic levies. The difference, however, is that in the UK, for instance, the company lost the court case and paid the taxes. In this case, the apex court ruled in favour of the company and the government then went ahead with retrospective amendments to sidestep the ruling.
The net result is that the government is currently embroiled in several similar arbitration cases including a high profile one with Cairn Energy. Even in the Vodafone case, media reports indicate revenue officials are veering towards taking the fight to Indian courts on the basis that the bilateral investment treaty does not cover tax issues. The stance will be particularly appealing right now when the exchequer’s resources are stretched beyond its limits owing to the pandemic. But accepting this viewpoint would be a short-sighted approach. And past history on tax issues in this country has shown that a narrow focus on revenue has ended up being counter-productive.
The case of the Nokia plant in Tamil Nadu is a sad illustration of this attitude. The handset manufacturing plant along with ancillary units employed about 35,000 workers in its heyday. The crackdown by the tax authorities on Nokia for a demand of about Rs 7,000 crore in 2013 left most of these people jobless as the plant was shut down. The tax disputes resulted in it being left out of Microsoft’s takeover of Nokia’s global assets. The operations of the plant are reported to have been shifted to Vietnam. There is a finally a chance of reviving the fortunes of those living nearby since a Finnish equipment supplier to Apple has recently acquired the plant. But in another development, the equipment firm has now been acquired by a Chinese company.
The disastrous long-term economic impact of a wholly revenue-oriented approach in the case of Nokia should have been a lesson for policymakers. Apparently, it has not. The relentless pursuit of taxes without considering a wider economic perspective seems to continue in this regime as it did in the previous one. This approach may find even more favour nowadays owing to the need to shore up resources following collapse in growth and resulting decline in revenue collection.
Even in this pandemic-ridden scenario, however, the government must take a more holistic approach to taxation issues. The question of whether to continue appealing court and arbitration decisions ad infinitum needs to be examined taking into account the overall economic outlook. For instance, the Nokia case shows that a wider viewpoint is imperative as protecting jobs became irrelevant in the process of revenue collection. Besides, pursuing cases of retrospective taxation even after rulings by the highest court is bound to deter potential investors. It had been expected that the Modi government would bring in a radically different approach given the initial drive to improve the ease of doing business. But the situation has not changed till now and arbitration proceedings are continuing in other cases related to retrospective taxation.
In referring to other countries that have resorted to retrospective taxes, it needs to be examined whether the situation is at all comparable. India, unlike many others, is in dire need of both domestic and foreign investments to kickstart its economy. Besides, the question is, does the country benefit more from gaining a huge sum of money in a single year or from opting for investments that could provide revenue for decades, and also much-needed employment? All these issues need to be considered in a more thoughtful manner than has been done till now. A long-term perspective needs to be taken not just on the Vodafone tax issue but on the philosophy of taxation in an emerging economy.
