The government seems hell-bent on scoring a self-goal. Having presented a mediocre budget in response to tough challenges, it wants to make the tax environment all the more uncertain. Having lost a court case, it wants to subvert the judgment. Having brought investment to a trickle, it wants to scare away investors—domestic and foreign. All in pursuit of a treasure trove that seems more elusive by the day.

Mr. Mukherjee’s budget, singularly short on new ideas to generate additional resources, proposes to let the taxman dig up cases as old as 16 years where individuals acquired foreign assets to ensure they were indeed assessed. The immediate target is the $11.076-billion Vodafone-Hutch transaction of February 2007. But the finance ministry officials say the move will allow them to zero in on 35-40 other similar deals to raise a total of $10 billion or Rs. 50,000 crore, roughly equal to the bill for the job guarantee scheme for one year. What that will do to business confidence or investment sentiment is another matter.

To recapitulate, Vodafone, a British company acquired Indian telecom assets of Hutchison in February 2007 for $11.2 billion. In a carefully structured deal, Vodafone International Holdings (a company incorporated in The Netherlands) acquired shares of CGP (a company incorporated in Cayman Islands, which owned Hutchison’s Indian telecom assets) from Hutchison Telecommunications International Ltd (another Cayman Islands company).

The income tax department raised a demand of $2.6 billion (Rs. 11,297 crore) on Vodafone, saying it was supposed to withhold capital gains tax from Hutchison and pay it to the government. The dispute went to the court. The Bombay High Court ruled in the I-T Department’s favour. Vodafone then moved the Supreme Court against this order denying any tax liability.

In a landmark judgment two months back, the Supreme Court held that Vodafone was not liable to be taxed on the deal, since the country’s laws did not provide for taxing mergers and acquisitions done offshore, even if those business deals were implemented in India. The government filed a review petition which was dismissed this week by the court which found no merit in it.  

Even before the Supreme Court had decided on the review petition, Mr. Mukherjee thumbed his nose at the court and proposed amendments to the Income Tax Act (and that too retrospectively from April 1962) to bring the Vodafone-Hutch type deals into the tax net. Clause F in the Explanatory Memorandum on direct taxes that talks of the amendment going all the way back to 1962, also has a ‘validation clause’ which confers justification on actions of the tax officials “notwithstanding anything contained in any judgment, decree or order of any Court or Tribunal or any Authority”.

Supporters of the amendments argue that it is the country’s legitimate right to collect tax from any international transaction associated with Indian assets, irrespective of the country where the transaction takes place or the residency of the companies associated in the transaction. If you earn income because of your business in India, you have to pay income tax in India. There is no ambiguity and no uncertainty in that respect. However, some people think they can create special purpose vehicles (SPVs) in any tax haven just by doing some paperwork, and shift Indian capital gains to those havens. Is it fair that someone earns trillions of rupees and walks away without paying any tax at all — just because he has created tax haven SPVs?

These are valid arguments, but they do not justify the retrospective nature of the amendments. That is because the government does not tax everyone in the same manner, and the tax treatment is certainly not uniform over a period of time. For instance, the statute on SEZs specifically says they are not to be taxed, but last year the finance minister brought in a minimum tax on SEZs.

Should the tax be dismissed on grounds that it violates the “intention of the legislature”? You and I pay capital gains taxes if we sell our house, but those investing in the stock market get away with paying just 0.125% as securities and transaction taxes if they have held the shares for more than a year. FII investments coming in from Mauritius are allowed to get away with no taxes, while direct foreign investment in industries is asked to bear taxes, although the latter is supposed to be creating jobs and productive capacity while the former is not.

That being the case, the only thing that matters is what the government’s tax law is at any particular point in time; there’s no point bringing in morality or fair play or level playing field. That is why the court was right in saying that it had to “look at the deal through the Income-Tax Act as it stands today” and not “look through” the deal to reflect the “intentions of the legislature.” It also noted that the acquisition was neither a preordained one nor a sham transaction and the taxman cannot deny strategic tax planning by a company.

Mr. Mukherjee has claimed that the proposed amendments were meant only to “make the intention of the legislature clear”. He has pointed out that government is empowered to legislate and there is a history of such retrospective changes.

These are specious arguments that will not stand scrutiny. The number and nature of the amendment make it clear that their objective is not just to make clear the intention of the legislature but to legislate the new thinking on the issue.

Apart from all this, the Vodafone-Hutchison deal also needs to be viewed from a larger perspective of attracting foreign direct investment (FDI). Both the original investor (Hutchison) and the one that bought its business in India (Vodafone) have demonstrated their commitment in terms of building assets and generating employment. While clarity in tax laws and plugging loopholes to prevent round-tripping of investments is welcome, it should not be at the expense of promoting legitimate FDI activity, especially in core infrastructure sectors.

The issues involved go beyond a tax dispute between the government and a telecom firm. Many companies in several sectors, IT for example, will bear the brunt of the Budget proposal to amend tax laws with retrospective effect. The Budget proposal to retrospectively amend the definition of ‘royalty’ from 1976 will force many Indian companies to pay tax on past purchases of computer software. Any payment towards packaged software would amount to royalty, according to the amendment. To begin with, this means a massive additional tax burden for firms such as Tata Consultancy Services (TCS), Sonata Software, GE, Wipro, Microsoft and others.

Indian corporate houses as well as foreign investors are keenly watching the government’s moves. Going by what the law says is one thing, trying to figure out what was in the minds of lawmakers makes investing a whole lot more risky.

While no one can possibly have any quarrel with the government’s right to make amendments to the law, these should ideally be prospective and not retrospective. If the law could be changed today to suit the government, it could be done anytime and any number of times in future. What is commercially sound and lawful today may no longer be so if laws are changed in future with retrospective effect. This possibility creates an air of uncertainty about business decisions which is not conducive to risk bearing and enterprise.

Once the Budget for 2012-13 — in which the proposed amendments have been suggested — is adopted by Parliament, the tax officers can (and probably will) have another go at Vodafone. This can trigger another round of litigation. That will hardly be an advertisement for India as an investment destination.