With the Lok Sabha passing The Taxation Laws (Amendment) Bill, 2021 on August 8, a sordid chapter in our taxation history is finally getting closed.

Coming after the international arbitration awards in favour of Vodafone and Cairn, the bill seeks to refund the dues to these and 15 other companies without any interest, subject to the withdrawal of all pending litigation and promise of no future claims by the companies. Though much delayed, the measure would help restore some of the lost reputation of India as a predictable tax regime and a good investment destination, particularly at a time when global supply chains are relocating away from China.

The NDA Government deserves credit for reversing a dubious policy introduced by Mr Pranab Mukherjee in 2012 that had not only attracted international indignation, but hugely decelerated FDI inflows into India. Way back in 1819, the US Chief Justice John Marshall had famously warned: “That the power to tax involves the power to destroy; that the power to destroy may defeat and render useless the power to create.” The retrospective taxation legislation had indeed destroyed our once vibrant telecom sector.

The Government move came more than a month after Mr Kumar Mangalam Birla, the non-executive chairman and director of Vodafone-Idea Ltd (VIL) resigned after his pleas to the government to buy his entire 27 per cent stake in the company to save it from an “irretrievable point of collapse” had fallen on deaf ears. With a subscriber base of 268 million and a market share of 23.5 per cent, VIL is one of the only three private-sector competitors left standing in a field that was once vibrant with a dozen national and international players.

VIL now is on the verge of collapsing under the weight of its nearly Rs 1.8 lakh crore liability, which includes Rs 96,270 crore in deferred spectrum obligations, Rs 23,000 crore due to banks and financial institutions, besides Rs 60,000 crore dues to government on account of Adjusted Gross Revenue (AGR), the revenuesharing mechanism between the government and the telecom companies since 1999 in lieu of the earlier ‘Fixed License Fee’ model.

The company is also facing a huge cash crunch of about Rs 25,000 crore. VIL’s collapse would mean the Indian market would be a duopoly of Reliance Jio and Airtel to serve a billion people’s telecommunication needs. In July, the Supreme Court had refused to recompute the AGR dues of the three telecom companies (total about Rs 1 lakh crore). Vodafone shares had predictably plunged by nearly 19 per cent after Mr Birla’s resignation on August 4, investors having lost a whooping Rs 22000 crore since January 2021.

The telecom sector was India’s success story. The vibrant sector had attracted multiple national and international giants as well as small operators. The global giant Hutchison was one of the first telecom companies to enter India. Collaborating with its Indian partner Essar, HutchisonEssar expanded its operations pan-India and became a leading market player. Like other operators, it got new licenses for some telecom circles and operated in other circles by acquiring smaller telecom entities with licenses for those circles.

This led to a very complex, though not unusual, ownership pattern for large multinational companies. The Hong-Kong based Hutchison Whampoa held shares in downstream companies in the Cayman Islands like CGP Investments, which in turn held shares in downstream companies based in Mauritius which in their turn held shares in an Indian holding company that controlled Hutchinson’s subsidiaries in India. Through the CGP, Hutchinson held 67 per cent stake in Hutchison-Essar. Cayman Islands and Mauritius, being tax havens, attracted multinationals with the operational flexibility of relocating their units to avoid taxes; this too is not unusual.

Only now, the major economies have agreed to cooperate to prevent such tax avoidance by applying a minimum 15 per cent global corporate tax rate on multinationals operating in different countries. In December 2006, Hutchison decided to exit India. In May 2007, it sold its Indian operations to the Netherlands-based Vodafone at $10.8 billion, which then acquired CGP Investments whose acquisition gave it control over all downstream companies and hence control over its Indian operations. Taking advantage of the loopholes in Indian tax laws which did not make such transactions taxable even though the assets were located in India, the entire deal and payments were transacted outside India.

Hutchison-Essar thus became Vodafone-Essar. The capital gains that accrued upon the acquisition of the Cayman Islands-based CGP was shown in Hutchinson’s accounts as ‘profit from discontinued operations’ which was not taxable in India under the extant laws; besides, it was also not the first time that such transactions were executed without attracting tax liabilities. But this time, under Mr Mukherjee’s directions, the Income Tax Department reckoned the capital gains as taxable and in September 2007 raised a demand of Rs 7,990 crore on Vodafone.

The Department later admitted that it was a “test case” to make such transactions taxable. Vodafone duly challenged it before the Bombay High Court on the ground that Hutchison had sold a foreign company, CGP Investments, to another foreign entity, Vodafone, and a transaction between two foreign entities concluded outside India cannot be taxable in India as it would amount to applying Indian law to a commercial tranaction outside India between two non-Indians. In December 2008, the High Court ruled in favour of revenue which was overturned by the Supreme Court in January 2012 which absolved Vodafone of all tax liability, holding that the sale did not amount to tax avoidance.

That should have closed the matter permanently, with the legal loophole being plugged by a prospective legislation. Instead, Mr Mukherjee introduced retrospective taxation by amending the Income Tax Act in the 2012-13 budget to override the Supreme Court judgement ~ against the counsel of PM Manmohan Singh and other colleagues who feared, rightly, that it would adversely impact the FDIs that India needed so much. The FDI inflow indeed nosedived as a fallout of the amendment. Reversing a growth rate of 64 per cent registered in 2010-11, it fell from $37 billion in 2011-12 to a trickle of $24 billion in 2012- 13.

It would take another three years to reach the 2011-12 level – in 2018-19, FDIs increased to $51 billion, or only 1.8 per cent of GDP as against 2 per cent in 2011-12. India’s position in the World Bank’s ‘Index of Investment Friendliness’ fell from 131 in 2011 to 134 in 2013, below Uganda, Ethiopia and Yemen. Mr Mukherjee’s only defence, a weak one, as articulated in his autobiography “The Coalition Years 1996-2012”, was: “Despite the angst that my proposal generated at that time, and even now, both from within my party and outside, I wonder why every succeeding finance minister in the past five years has maintained the same stance.”

The amendment forced Vodafone to approach the Permanent Court of Arbitration (PCA) at The Hague, under provisions of the Bilateral Investment Treaty (BIT) between India and Netherlands signed in 1995. Under Article 9 of this treaty (which lapsed in 2016), both countries guaranteed each other fair and equitable treatment requiring any dispute to be settled amicably through arbitration, for which a mechanism was also suggested.

In September 2020, the PCA ruled that the Indian government’s retrospective demand of $2.7 billion on Vodafone was “in breach of the guarantee of fair and equitable treatment” under the BIT, warning that enforcing the tax demand would be a violation of India’s international obligations. India should have gracefully accepted the verdict and moved on, earning the goodwill and confidence of foreign countries and investors. Instead, it went on to appeal.

It was a similar story with the UK based Cairn Energy and another Indian entity, Cairn India, where the Government’s coercive power was even more starkly evident as it slapped a tax demand of Rs 10247 crore ($1.2 billion) on Cairn India in January 2014, then went on to seize its financial assets, besides freezing payment of dividend by it to Cairn Energy. Cairns Energy too approached the PCA and won a Rs 8842 crore ($1.2 billion) award in December 2020. Here again the government went on to appeal, forcing Cairn Energy to approach foreign courts to recover the money from India’s foreign assets. Vodafone and Cairn may have taken advantage of tax loopholes by using tax havens like all multinationals, but applying a coercive instrument like retrospective tax only ends up in destroying companies and eroding investor confidence in the stability and predictability of a tax regime.

The country has paid dearly for this blunder, which has also left a once-vibrant sector now gasping for breath. One does not know if the new bill will be enough to revive Vodafone-Idea Ltd., but at least it has given it a ray of hope and confidence to investors, as reflected by a 19 per cent rise in its share price on August 6, subsequent to the introduction of the bill.

(The writer is a commentator, author and academic)