To start with, it would be very cliché to say that failing to plan is planning to fail but then cliché is a cliché because it’s true. We cannot overlook it as, over the decades, our politicians and policy makers have religiously ignored it and toed the country to a directionless state of affairs. Whether they lack vision or succumb to Indian regulatory labyrinth we don’t know, all we are aware of is for more than 60 years our elected representatives have constantly doled out policies that either lack clarity or get subjected to multiple amendments post execution.
The latest targets of their master class indecisiveness include SEZ and foreign investment policies coupled with ongoing Vodafone tax liability case. The Special Economic Zones Act, 2005, Economic Zone Rules, 2006, enacted SEZ Policy. The underlying objective of forming SEZs was to provide developers and entrepreneurs a competitive and hassle-free set up in order to boost manufacturing and exports. Keeping in mind that India’s secondary sector has always lagged behind, this looked like a reasonable move for channelizing investment and creating jobs. Additionally, financial environment and economic indicators were in total support. To attract investments, the government decided to give certain tax breaks. It was decided that businesses that have SEZ Units and developers would be exempted from Minimum Alternative Tax (MAT) and Dividend Distribution Tax (DDT). To enforce the prior, s.115JB (6) was enacted wherein the entrepreneur or developer carrying on business or rendering any service would not be liable to pay MAT on their income.
Further, the developer and receiver were relieved from DDT by virtue of s.115-O (6) which expressly states that no tax on distributed profits shall be chargeable in respect of the total income of the undertaking or enterprise engaged in developing or developing and operating or developing, operating and maintaining a SEZ for any assessment year or any amount declared, distributed or paid by the way of dividends on or after 1st April, 2005. The policy was appealing and major industrial houses along with talented entrepreneurs started putting in their money that they raised through borrowings.
It was the government Finance Bill, 2011 proposal that eventually resulted in amendments to Income Tax Act due to which s.115JB (6) and s.115-O (6) were made inoperative with effect from 1.4.2012 and 1.06.2011. Including cess, MAT and DDT were to be taxed at rates 20.1% on book profits and 16.22% on dividends distributed.
While section 10 AA of Income Tax Act 1961, exempts profits of SEZs to the extent of 100 % in first five years, 50% in next five years and 50% of plough back of export profits for the following five years, there are now in place MAT and DDT, which are also taxes on income.
It is no rocket science that developers and business houses invested their money keeping in mind these incentives. These tax breaks were in one way promises made by the govt. and denial of the same is not only retrograde but will also lead significant liquidity crunch and fall in profitability of businesses operating in SEZs. Simply put, the govt. had earlier made a promise on the basis of which developers and entrepreneurs changed their positions and by imposing taxes now it is going back on its word.
The law was pretty much successful from foreign direct investment (FDI) and employment generation point of view but failed on land acquisition front. The prime reason given by govt. to impose these taxes now is to bring tax liability of businesses related to SEZs with non-SEZ entities. Now, if the core idea was that all entities have to be treated at par and pay same taxes then what’s so special about SEZs? Why pass legislation, make rules, provide incentives and make people specially invest their money?
Until recently, most SEZ developers and business were hoping that Judiciary would strike off the 2011 amendment on the basis of principles of promissory estoppel and legitimate expectation. Mindtree Ltd., challenging the constitutionality of said amendment filed a writ before Karnataka High Court only for Justice H.N. Nagamohan Das to dismiss it and validate the imposition of taxes. Other interested companies include Biocon Ltd., Piramal Projects Ltd. etc. This is not surprising as it is a well-settled principle of law that promissory estoppel cannot prevent the application of a statutory rule. Since it is an equitable doctrine, it must yield when equity so requires. The courts refuse to enforce this doctrine if it results in great hardship to government and would be prejudicial to the public interest. The govt. justified its act by claiming that there was erosion of tax base.
Firstly, it’s a settled principle of law that every tax exemption should have a sunset clause and our legislators while framing the SEZ policy failed to ascribe one to the exemptions u/s 115JB (6) and 115-O (6) of the Income Tax Act. The fundamental objective of 2011 amendment was to remove this very flaw. So, the govt. While formulating the policy didn’t have a clear idea and did not decide upon as to when these exemptions would be withdrawn. Moreover, when it is mandatory to declare the particular time after which the policy would cease to operate (if not extended by legislative action), it is a major failure on part of our lawmakers to leave it unaddressed. Secondly, the Ministry of Commerce and Industries and Ministry of Finance have always had differences with respect to fiscal bargains given under this policy. Their powers under this framework were not clearly defined and ultimately led to vagueness and overlapping. Ideally, the ministries should have outlined their powers well before implementing the policy. Thirdly, the govt. has asserted that with 2011 amendment it aimed to eliminate the inequality between SEZ and non-SEZ businesses. Now, if there wasn’t supposed to be any difference in taxation policies of these two classes, why sugarcoat and float this policy in first place?
In 2009, the Ministry of Finance had set up a Working Group on Foreign Investment (WGFI) headed by UK Sinha to streamline multiple foreign portfolio investment routes and minimize regulatory norms. In 2010, the WGFI suggested introducing a single qualified financial investor route and doing away with classes like Foreign Institutional Investors, their sub-accounts (FII), Nonresident Investors (NRI) and Foreign Venture Capital Investors (FVCI).
Few months later, in his budget speech, the finance minister Pranab Mukherjee announced that only FIIs, their subaccounts and NRIs were permitted to invest in Indian mutual fund schemes. As per the guidelines that followed later, a new investor class was to be created known as Qualified Financial Investor (QFI). QFI was then defined as a person resident in a country compliant with Financial Action Task Force (FATF) norms and a signatory to International Organization of Securities Commissions (IOSCO) Multilateral Memorandum of Understanding. This person could not be a resident of India or SEBI registered FII or its sub-account. Qualified Depository Participants (QDPs) were charged with responsibility of deducting tax and taking care of KYC norms. The new QFI route did not do well, prime cause of which could be attributed to ambiguity in tax treatment. According to figures put forth by bankers as of now there are less than 50 QFIs with their investments in equity pegged below Rupees 800 crore.
Then SEBI in December 2012 appointed a committee on rationalization of investment routes, under the chairmanship of former Cabinet Secretary KM Chandrasekhar. This committee proposed that the FII, their subaccounts and QFI routes be blended to create Foreign Portfolio Investor (FPI). The committee suggested that the FVCI and NRI routes be retained as distinct investor classes as they serve different purposes. The FPI definition is akin to QFI, but instead of QDPs the Chandrasekhar committee has suggested introduction of Designated Depositary Participants (DDP) with different eligibility criteria than QDPs. However, other aspects are considerably similar.
It would be pertinent to note that as of now there are less than 50 QFIs and more than 1700 FIIs. Simply put, FPI is mostly FII who, if Chandrasekhar Committee report is accepted, will be exempted from registration with SEBI and will be subjected to KYC by DDPs. Additionally; a different qualification criterion will render the existing QDPs of no use. Further, tax treatment of FPI is still not clarified and is entirely upon Central Board of Direct Taxes to decide.
Our policymakers (WGFI) first suggested doing away with FIIs, FVCI and NRI and rooted for a single class. Then QFI was introduced which kept FIIs and their subaccounts out of its domain. Then came FPI, which consisted of QFI and brought within its ambit FIIs, with the latter having a dominating share. In other terms FPI to be more or less FIIs only. Here again, the proposal is to maintain FVCI and NRI as separate investment routes. Now if FPI is mainly FII and FVCI and NRI remain different categories, we’ve reached the situation that existed prior to WGFI’s recommendations. Irrespective of what steps are taken next, the very fact that these events took place and govt. considered them all gives a good depiction of the lack of foresight and planning on part of our officials, including the ability to select the right set of recommendations.
When uncertainty is discussed, one just can’t afford to skip Vodafone’s case. Vodafone is facing a tax liability of over Rs 11,217 crore for purchase of Hutchison Whampoa’s stake in Indian telecom business Hutchison Essar back in 2007. The tax department contended that as the transaction amounted to indirect transfer of business assets located in India from Hutchison to Vodafone there was a case of capital gains tax. However, the apex court ruled that sale of shares having situs outside India by one foreign company to another foreign company was not within the scope of taxation in India as the law imposed capital gains tax on direct transfer of shares only. Even when the telecom giant had won its case before Supreme Court, the govt. didn’t budge from its stand and passed an amendment to the Income Tax Act with retrospective effect to undo the ruling.
Our lawmakers need to understand that corporations invest their money keeping in mind current and future policy outlook, which they expect to be stable. If at the time of investing there are no proposals to change the policy or law in near term, investors cannot be blamed for the acts they carryout legally. If there is flouting of laws then govt. could always take them to court, which the tax department eventually did. Now when the apex court declared that Vodafone carried out the transaction well within the policy framework, just because the govt. was dissatisfied for having missed an opportunity to collect considerable amount of tax and not putting in place a policy to keep a check on such transactions earlier, it should not have, later on, brought in an amendment with retrospective effect.
For foreign investors such a step is nothing less than traumatizing. Amending the law with prospective effect is justified, but retrospective application is beyond comprehension. The government is bound by rules it passes beforehand and which enable the investors to foresee with adequate certainty as to how the authority will behave in a particular set of circumstances, logic being that one should be able to plan their actions on the basis of the system in place.
Ex post facto law or passing a law with retrospective effect is not considered judicious and is contrary to the rule that every person must be aware of what his obligations are. A law that creates duties dating back in the past subjects people to a cost they could not have been aware of. While the legislature has constitutional backing to pass such an amendment in certain situations, it must keep in mind the reasonability and practicality of the same.
By upturning the Supreme Court judgment it has sent jitters across the investor community. Message is out that Indian policy is never stable and govt.’s representations can never be relied upon. Rather than putting in place a sound economic model and providing legal stability for the same, the govt. has always resorted to knee-jerk reactions. Lack of planning on part of our legislators always results in missed opportunities and then to capitalize on the latter they introduce investor-averse regulations and clarifications.
Regard could be had to the latest set of rules delineating FDI in multi-brand retail trade policy. While the first impression of FDI policy in this sector delighted the investors, clarifications issued later on damped the effect and again subjected them to frustration. Majority of them annoyed with the fact that even after a series of clarifications and notifications the govt. is yet to make clear whether 50% of the investment in back-end infrastructure is one time or continuous in nature.
To conclude with, whether lack of planning prowess is a problem with only our policymaking class or Indians in general we don’t know. After all, our town planning methods are also something we cannot be proud of. It is needless to say that the best examples of planning by Indians include Gurgaon, Jaipur etc. which, at the very outset, are nowhere near Lutyens’ Delhi and Le Corbusier’s Chandigarh. All we know is that our policymakers have to develop a vision and make sure that each and every aspect of a policy is defined and discussed upon, including taking feedback from interested sectors, before they go ahead with its implementation. Initial absence of thought and gut reactions that follow only end in uncertainly that undoubtedly lead to bad financial health of the economy and sends out an impression of uncertainity.
www.grandmasters.in | 8 Years & Counting
www.rcls.in | 8 Years & Counting
www.itlegalsummit.com | 8 Years & Counting
www.bfls.in | 8 Years & Counting
www.maels.in | 8 Years & Counting
www.plcs.co.in | 8 Years & Counting
Copyright © 2020 Lex Witness - India's 1st Magazine on Legal & Corporate Affairs Rights of Admission Reserved
