“Banks had virtually stopped funding following the developments in Andhra Pradesh. But now, as a result of the clarity on the regulatory front, I am sure bank funding will resume,” chief financial officer of the country’s only listed microlender SKS Microfinance, Dilli Raj told reporters
Mumbai: The crisis-ridden microfinance sector has welcomed the budgetary proposal to table the new MFI Bill, saying the regulatory clarity will help in the resumption of bank funding, reports PTI.
“Banks had virtually stopped funding following the developments in Andhra Pradesh. But now, as a result of the clarity on the regulatory front, I am sure bank funding will resume,” chief financial officer of the country’s only listed microlender SKS Microfinance, Dilli Raj, told PTI.
Finance minister Pranab Mukherjee said in Budget speech that he will be tabling the Micro Finance Institutions (Development and Regulation) Bill in the current session of Parliament.
At present, the microfinance sector is governed by state laws in Andhra as well as the Reserve Bank of India (RBI) regulations.
Mr Raj said that coming from the Centre, the Bill will override the AP law, which has hurt the sector badly, and hence bring in regulatory clarity.
“The Bill will also prevent regulatory arbitrage and promote healthy development of this industry,” the chief executive of the sectoral umbrella body MFIN, Alok Prasad, said.
Mr Raj said the legislation will also help the sector recover its dues from Andhra Pradesh, its biggest market, and added that SKS alone has been forced to write off loans of over Rs9,000 crore in the state.
Problems for the sector started in October 2010, following a spate of suicides by borrowers in Andhra due to alleged pressure from recovery agents appointed by MFIs (microfinance institutions). The AP government then passed a law which gave overarching powers to the state and imposed a slew of measures to control MFIs’ activities, including capping their lending rates.
“The Bill is likely to rectify the lack of uniformity in regulation, eliminate state level interventions and enable closer monitoring of this ailing sector,” consultancy firm Ernst & Young India partner Viren H Mehta said.
The ease with which the ruling of the Supreme Court has been upturned, and the fact that the DTAAs are to give way to the long arms of the I-T Act stretching back to 16 years, would make any foreign investor think thrice before investing in India
Taxes are said to be the price we pay for being civilised; taxmen may, however, choose to charge this price in most uncivil ways. Legislating with retrospective effect (also known as ex post facto law) is surely not civil as it goes against the generic rule that every man must be aware of what his obligations are, and a law that creates obligations dating back in the past exposes men to a price that he could not have been aware of. This may be constitutionally good, but surely not civil. FA Hayek is credited with oft-cited passage: “Stripped of all technicalities [the rule of law] means the government in all its actions is bound by rules fixed and announced beforehand—rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances, and to plan one’s affairs on the basis of this knowledge” . Political theorist Joseph Raz says: “A person cannot be guided by a law which did not exist at the time when the action occurred. It is fundamentally unfair to hold a person to be in contravention of the law when that law did not exist when the alleged contravention occurred” 2.
Despite what political theoreticians might have advised over centuries, parliamentarians care least for equity and justice when it comes to enacting retrospective laws. This action becomes highly contemptuous when the Parliament re-enacts a rule to override a ruling of the court, where the government was a party. This essentially means the rule of law has no meaning—if the highest judicial forum of the land gives a ruling interpreting a law as it was, and the parliament then rewrites a law as it wants it to be, retrospectively, there are two big casualties—one, respect for the judiciary, and second, certainty of law.
Retrospective taxation across the World
Examples of retrospective tax law amendments, particularly if they are anti-avoidance, are not uncommon. In fact, the famous Westminster principle is the supremacy of the Parliament—the right to enact a law includes the right to enact a law retrospectively or retroactively.
In the UK, Section 58 of UK Finance Act, 2008, was changed retrospectively to affect the residential status of foreign partnerships and trusts. The amendment was challenged in R v. HMRC,  EWCA Civ 89, where the question pertained to the residential status of Isle of Man trusts which, with a negligible contribution of capital from UK resident, was allegedly use to escape tax otherwise taxable in the UK. The Court of Appeal held: “If Section 58 were not made retrospective, the claimants would obtain a windfall at the expense of the general body of taxpayers. It would be unfair to the general body of resident taxpayers not to have given Section 58 retrospective effect. The claimants entered into schemes with the intention of deliberately avoiding UK tax. HMRC never accepted that the schemes worked and the tax liabilities were not settled before the legislation was applied to them”.
1Road to Serfdom, 1944
2The Rule of Law and its Virtue’ (1977) 93 LQR 195
Prior to this, in Robert Huitson Vs HMRC3 , courts had approved retrospective anti-avoidance legislation. To this, the comment of an academic, on the BBC, was: “Is it the thin end of a very dangerous wedge, allowing HMRC to get its own way without bothering to argue its case in the courts? Or will retrospection be used only exceptionally, most commonly in response to artificial tax planning schemes? What is certain is that backdating legislation is a cheap, quick and certain way of closing a tax loophole, and it may be irresistibly tempting for the government to use the same method again.4 ”
In fact, the amendment made by the Finance Act, 2008, of the UK was very similar to the proposed amendment to Section 9 of the Indian I-T Act by Budget 2012. The amendment was to change the residential status of foreign partnerships which had UK partners. The amendment was done to override the rulings in the Padmore Vs IRC5 .
Australia has also enacted retrospective laws, including those to overcome adverse rulings of courts. Australian Parliament’s Legislation Handbook, which provides recommendations for legislative procedure, suggests the following with regard to retrospective legislation: “Provisions that have a retrospective operation adversely affecting rights or imposing liabilities are to be included only in exceptional circumstances and on explicit policy authority.”
In the US, though there is a constitutional prohibition against passing ex post facto laws by Clause 3 of Article I, Section 9 of the US Constitution. However, substance due process amendments in taxation laws have been made retrospectively in certain cases. Notably, these are procedural issues—not issue of imposing a tax retrospectively.
Proposed amendments to Section 9 of the I-T Act
The Finance Bill 2012 has proposed several retrospective amendments in certain key provisions of the I-T Act, with retrospective effect (i.e. from the date of coming into force of the I-T Act, which are likely to have far reaching effects on the foreign direct investments in India.
Key amendments affecting the tax liability of the foreign direct investment in India are summarized hereunder:
(a) Section 2(14) – definition of capital asset: Definition of property has been amended to include shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.
3 EWHC 97 (Admin)
5(1987) STC 36 affirmed by the Court of Appeal (1989) STC 493
(b) Section 9(1) – income deemed to accrue or arise in India: The following explanations have been added:
(i) the expression through shall mean and include and shall be deemed to have always meant and included by means of, in consequence of or by reason of; and
(ii) an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.
(c) Section 149(1)(c) – time limit for notice: A reassessment can be done if four years, but not more than sixteen years, have elapsed from the end of the relevant assessment year unless the income in relation to any asset (including financial interest in any entity) located outside India, chargeable to tax, has escaped assessment.
Precedents of retrospective amendments in India:
The legislature surely has the power to amend laws retrospectively. There is a plethora of case laws that recognize this power of the legislature to retrospectively amend a statute when6 :
(a) A legislature can by a retrospective amendment in law, validate such law which has been declared by court to be invalid provided the infirmities and vitiating factors noticed in the declaratory-judgment are removed or cured.
(b) If by such validating and curative exercise made by the legislature, the earlier judgment becomes irrelevant and unenforceable, that cannot be called an impermissible legislative overruling of the judicial decision.
Though an amendment presumes the constitutional validity of a statue, constitutional validity of a retrospective amendment may not be free from doubt. The Supreme Court, in case of Sri Prithvi Cotton Mills Vs Broach Borough Municipality7 , analyzed the validity of the retrospective amendment of a statute in light of Article 19(1)(g) of the Constitution of India, i.e. a fundamental right to practise any profession, or to carry on any occupation, trade or business. The court said:
“In testing whether a retrospective imposition of a tax operates so harshly as to violate fundamental rights under article 19(1)(g), the factors considered relevant include the context in which retroactivity was contemplated such as whether the law is one of validation of taxing statute struck-down by courts for certain defects; the period of such retroactivity, and the decree and extent of any unforeseen or unforeseenable financial burden imposed for the past period etc.”
The BBC note cited above which says retrospective amendment to the law is cheap, quick and certain way of closing a tax loophole, and that governments may find itself irresistibly tempting to use this remedy. India is one example where governments have gone overboard to use the power to undo court rulings with retrospective amendments.
6See, Rai Ramanakrishna v. State of Bihar (1963 50 ITR 171), Assistant Collector of Central Excise, Calcutta Division v. National Tobacco Co. of India Ltd.,  1 S.C.R. 822; Ujagar Prints v. Union of India  179 ITR 317 /  3 SCC 488  1 S.C.R. 388
One such famous example is the amendments in the Finance Act, 2007, and subsequent amendment in Finance Act 2010 to nullify the effect and tests laid down in the Ishikawajima case, which also dealt with amendment in Section 9 of the I-T Act.
The Supreme Court, in this case, laid down the tests for applicability of Section 9(1)(vii) of the I-T Act, (dealing with income by way of fee for technical services) to be applicable, it is necessary that:
(a) services provided by a non-resident assessee under a contract should be utilized within India; and
(b) such services should be rendered in India or should have a link with India that entire income from fees, etc., becomes taxable in India.
Thus, for a non-resident to be taxed on income for services, such a service must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax.
The principle of this territorial nexus was outdone by a retrospective amendment in the Finance Act, 2007, (valid with effect from 1 June 1976) which provided that the income will be included in the total income of the non-resident, whether or not the non-resident has a residence or place of business or business connection in India. This amendment by the Finance Act, 2007, did not affect the principles of the Ishikawajima case as it did not address the criteria of utilization and rendering of services in India. Therefore, the said principles of the Supreme Court still held good post the amendment brought forth by the Finance Act, 2007. This was upheld and also followed in the Clifford Chance case9 .
Consequently, the legislature further retrospectively amended Section 9 (valid with effect from 1 June 1976) and provided that the income from technical services shall be included in total incomes of the non-resident whether or not (i) the non-resident has a residence or place of business or busi¬ness connection in India; or (ii) the non-resident has rendered services in India. Thus, it was recognized by the Mumbai Bench of the Income Tax Appellate Tribunal in case of Ashapura Minichem Vs ADIT10 that the principles set out by the Supreme Court are no longer valid.
Lohia Machines case11
Years ago, there was an amendment in Section 80J of the I-T Act whereby the definition of “capital employed” was retrospectively amended to remove debentures and long-term borrowings from the scope of the term. In this particular case, Nani Palkhivala and other senior counsels argued at length against retrospective legislation.
8Ishikawajima Harima Heavy Industries Ltd. v. Director of Income Tax, Mumbai (2007) 3 SCC 481
9Clifford Chance v. DCIT (2009) 318 ITR 237 (Bom)
10(2010) 5 Taxman 57 (Bom)
11Lohia Machines Ltd vs Union of India AIR 1985 SC 421
The ruling makes references to several previous decisions of courts on the power of retrospective legislation. Judge AN Sen, in his dissenting judgment, remarked: “The mere fact that any statutory provision has been amended with retrospective effect does not by itself make the amendment unreasonable. Unreasonableness or arbitrariness of any such amendment with retrospective effect has necessarily to be judged on the merits of the amendment in the light of the facts and circumstances under which such amendment is made”. The withdrawal of a benefit unequivocally available from the past will amount to imposition of a new tax, and this was considered by justice Sen as unreasonable and arbitrary. Several court rulings have relied upon the reasonableness test to uphold or overthrow retrospective amendments.
Impact of retrospective amendment of Section 9 of I-T Act
The possible impact the proposed amendment may have could be:
(a) Reopening of cases assessed on the basis of decisions favouring taxpayer and recovery of taxes with interest. The cases, in light of amendment make in Section 149(1)(c) could be opened for a span of the preceding 16 years (being the new limitation period), which could be detrimental to the taxpayers.
(b) The non-residents who have already liquidated their investments in India, and have mitigated tax liability under the beneficial provisions of the I-T Act, will now also be subject to a fresh look at tax liability arising in the preceding 16 years.
(c) Conflict with the provisions of the Double Tax Avoidance Agreements (DTAA), between India and various countries, as the amendment is against the true spirit, nature and scope of the DTAA. This impact is further aggravated by virtue of amendment in Section 90 of the I-T Act (relation to the DTAA), proposed to be applicable from 1 April 2012, which now provides that the provisions of the I-T Act shall be applicable even if they are less beneficial than the DTAA to the taxpayer. Before the Finance Bill 2012, Section 90 provided that between the DTAA and the I-T Act, benefit of the provisions which more beneficial to a taxpayer could be availed.
(d) Furthermore, insertion of a fresh Chapter X-A on the General Anti-Avoidance Rule, which may apply to any step or part of the arrangement, puts the onus on the taxpayer to establish the bona fide purpose of an arrangement.
Summary and concluding remarks
The key question, for the proposed amendment to Section 9 of the I-T Act, is:
(a) whether the amendment is merely clarificatory in nature? and
(b) does it amount to imposing a new tax?
If there is a new tax which in substance never existed, the proposed amendment amounts to imposition of a new tax, which may be taken to be arbitrary or unreasonable.
The proposed amendment is preceded by the words “For the removal of doubts, it is hereby clarified that...” However, the amendment that follows is far from either clarificatory, or for removal of doubt. What the amendment does, in substance, is to change the situs of an income from the place of legal domicile of the entity to the place where effective assets are based. It cannot be said that the tax rule was always based on effective situs of the asset, rather than legal situs. If this was merely a case for removal of doubts, other than the Vodafone case, has the CBDT ever chased takeovers of Indian companies that have happened outside India? It cannot be that the tax officers also had a doubt on the territorial sweep of Indian tax laws.
In fact, it would be logical to contend that the proposed amendments have caused a substance shift of tax base, and therefore, amount to a retrospective new tax rather than a clarificatory amendment. If that was not the case, there was little reason for the accompanying amendments that allow the taxmen a long rope to go 16 years to catch what might be taxable under the new law and was not taxable under the existing law. If all that was lacking in Section 9 was clarity, the government did not need 16 years to respond.
In the opinion of the authors, the ease with which the ruling of the Supreme Court has been upturned, and the fact that the DTAAs are to give way to the long arms of the I-T Act stretching back to 16 years, would make any foreign investor think thrice before investing in India. The finance minister’s proposal puts the very credibility of India as an investment destination at stake, as the government’s action shows that it is not the rule of law that prevails in India – it is the rule of the executive.
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