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Understanding the PCA's ruling on 'Retrospective Taxation'

The Permanent Court of Arbitration at The Hague has ruled that the Indian government was wrong in applying the retrospective tax on Cairn. The dispute between the Indian government and Cairn relates to retrospective taxation and the ruling is the second arbitral setback to India over its position on retrospective taxation.

The disputes became a 'retrospective taxation case' when in 2012 Finance Minister Late Pranab Mukherjee proposed an amendment to the Finance Act, which gave the Income Tax Department the power to retrospectively tax companies on certain products and items or services which previously companies have taken advantage of. Using that backdate, India demanded taxation from Vodafone and Cairn Energy, retrospectively.

Retrospective tax is a combination of two words “retrospective” and “tax” where “retrospective” means taking effect from a date in the past and “tax” refers to a new or additional levy of tax on a specified transaction. It allows a country to pass a rule on taxing certain products, items or services and deals and charge companies from a time behind the date on which the law is passed.

In the Cairn Energy case, India lost because it had a bilateral investment treaty with Britain, under which the two nations committed to giving each other fair and equitable treatment and in case a dispute arose, it would have to be resolved by an amicable settlement, meaning arbitration. Thus, the Permanent Court of Arbitration said it saw these tax demands as a violation of the bilateral treaties.

The judgment delivered by PCA will definitely have a material bearing on similar cases wherein such issues are involved and taxation of foreign institutional investors (FII) will be impacted as a result of the two recent verdicts. Also, the Shome Committee had recommended that any taxation involving the indirect transfer of assets located in India should be prospective and not retrospective. The Committee concluded that retrospective application of tax law should occur in exceptional or rarest of rare cases, and with particular objectives. Moreover, the retrospective application of tax law should occur only after exhaustive and transparent consultations with stakeholders who would be affected.

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