Listen Vodafone: Heads We Win, Tails You Lose

Image: Corbis

If Yashwant Sinha was the master of the rollback Budget, Pranab Mukherjee could well be named the impresario of the retrospective Budget. In this Union Budget the finance minister has introduced three tax measures with retrospective effect. One is regarding the sale of assets with control outside India. The second measure is the government’s treatment of software sales by a multinational as royalty income rather than business income.

And the third is that the transfer pricing norms between a foreign subsidiary and its parent have been clarified on the higher side.

The message is quite clear: Don’t fight with the government because it can change the laws any time and give you a bloody nose. The biggest fallout of all the three retrospective steps is expected to be felt on Vodafone, the $67-billion telecommunications giant.

On January 20, the Supreme Court of India brought down the curtain on one of the most bitterly contested tax cases of modern India. It ruled that the Government of India had no jurisdiction to tax the share sale done by Hutchison Essar to Vodafone. Had the case gone the government’s way, Vodafone would have had to pay Rs 11,000 crore to it. But Vodafone’s feeling of happiness, as Buddha once said, has been rather fleeting.

“This is a lot of heartburn,” says Dinesh Kanabar, deputy chief executive officer and chairman tax, KPMG (India), who was one of the key people who had advised Vodafone on the tax case. Kanabar’s point is rather simple. He says that one of the reasons that the Supreme Court cited while dismissing the government claim was the adverse effect on FDI. “But what stability does this move convey? This means there is no point in appealing against a government law because the law itself can be changed!”

Harish Salve, who won the case for Vodafone in the Supreme Court, is simply livid at this sneaky step. “This is insane. I don’t know who has advised him [the finance minister]. They are calling it clarificatory and at the same time they are also making it retrospective. This is sending a very bad message across that in India you cannot trust anybody. It is not a question of who won or lost. We want to show that our institutions work,” he says.

The next few weeks could see the tax department issue a fresh notice to Vodafone and the company challenging that notice. “We are examining this proposed decision with our lawyers, but we do not believe this retrospective change in tax law should have any impact on the final judgement handed down by the Supreme Court in our tax case. We continue to have faith in the Indian judicial system,” said a spokesperson for Vodafone Plc.

But it may not be a matter as unequivocal as Vodafone thinks. After all, the legislature does have the power to make laws and therefore nullify a judgement, but that has it own risks. In an interview to CNBC TV18 after the Budget, Finance Minister Pranab Mukherjee said that retrospective taxation is not a violation of the Supreme Court judgement. Maintaining that the government had the power to enact laws with retrospective effect, Mukherjee said the Court had asked the government to clarify on the law and he had done just that. “We have complied with whatever the Supreme Court has stated,” he said.

What Mukherjee, however, fails to realise is that international investors look for stability and predictability in a country’s actions. There will remain no difference between a banana republic where laws can change at the whim of the rulers and a functioning democracy like India which is reputed for its judicial system and respect for contracts. “Any move by the Indian government to nullify the Vodafone judgement through the finance bill in the guise of a clarificatory amendment will irreparably impact India vis- à-vis foreign investment,” says Fereshte Sethna, the Mumbai-based partner at Dutt Menon Dunmorrsett. Sethna represented Vodafone.

Legal experts predict some uncertainty for Vodafone. In the past, the courts have upheld retrospective amendments except in cases where the change is of a charging provision that has been specifically struck down by the courts. “Amendments with retrospective effect can be justified only in exceptional circumstances and then only when something which is really axiomatic needs to be clarified. Legislative amendments which have far-reaching implications ought not to be made with retrospective effect,” says Percy Billimoria, Senior Partner, AZB & Partners.

Legal minds believe that the government’s stand could be mere posturing to get something out of Vodafone. Case in point: ITC, where an ordinance was introduced to nullify a Supreme Court judgement. In exchange, ITC did not apply for a refund of Rs 350 crore that it had deposited with the government pending resolution of the case. Remember that Vodafone has Rs 2,500 crore deposited with the Income Tax department.  

In general, a step that reverses an earlier verdict of the Supreme Court seems like a retrograde step. And not just Vodafone, but even other large acquisitions of Indian assets might be up for review. For instance, GE’s sale of Genpact or Mitsui’s sale of a stake in Sesa Goa could be reviewed.

And not just the transaction, even the favoured route to come into India—Mauritius—may be seriously affected. If the Government of India is going to tax it even after you locate the holding company in a tax haven, then that route isn’t going to be of much use, is it?

For now, even Salve is stumped. “We can challenge the validity of the law but that’s difficult. You [the government] have changed the ground rules. This subject was not mentioned in the finance minister’s speech which was supposedly aimed at being pro-investor. All I can say is that the less said about this government the better.”

“But what stability does this move convey? This means there is no point in appealing against a government law because the law itself can be changed!”