Retrospective taxation is distasteful. It undermines the government’s credibility and the rule of law, and introduces unpredictability into the tax system. The poor taxpayer is left floundering because she cannot predict the consequences of entering into a business transaction!
Unfortunately, in India, of late, this is precisely what we see happening. First, the previous government overruled the Supreme Court judgment in Vodafone International Holdings BV vs Union of India & Anr, and retrospectively amended the law relating to the taxation of capital gains from April 1, 1962—this was 60 years back in time when many of the present day actors in the saga had not even been born. The cause for this elaborate exercise was an international transaction which took place abroad and involved two foreign companies, none of whom was resident in India. Second, even more recently, the present government, shortly after coming to power, seized upon a solitary judgment coming from the Authority for Advance Rulings in the case of Castleton Investments Ltd and began issuing notices for the levy of minimum alternate tax (MAT) on incomes alleged to have escaped assessment in earlier years. These two separate developments have made both Indian and foreign taxpayers alike ask if there are any limits at all on the powers of the government to shift the goal-posts and change tax laws with retrospective effect. Fortunately, three Supreme Court judgments have shed considerable light on such powers. But, ultimately, we will have to recognise that such powers are enormous, and constraints that do exist are mostly judge-made.
The vast powers vested in the government to legislate with retrospective effect were reiterated in March this year in the case of Netley ‘B’ Estate. In this case, the Karnataka government tried to remove the lacuna in its Agricultural Income-tax Act by adding section 26(4). This new provision stipulated that even though the firm was actually no longer in existence, it was by a legal fiction still deemed to be alive for tax purposes and persons who constituted it would still have pay tax on its income even after it had been dissolved. This law was made in 1997 but was made effective from April 1, 1975, i.e. 22 years earlier. The amendment specifically sought to change the conditions in which the Supreme Court’s own judgment in LP Cardoza and others vs Agricultural Income Tax Officer and others was rendered. While upholding this amendment, the Supreme Court ruled that the Legislature is competent to amend a law retrospectively so as to remove the lacuna pointed out by the Court and render an earlier decision of the Court ineffective. The legislature cannot, however, directly enact a law with the express object of overriding or revising the judgment of the Court or nullifying its directions to the parties. Also, the amendment must fall within the framework of the Constitution. The Court agreed with its earlier decisions to the effect that a liability cannot be created retrospectively for the first time, nor can a vested statutory right or relief be withdrawn from a back date, unless there are strong and exceptional circumstances for doing so (Tata Motors vs State of Maharashtra).
The nature of these constraints has been discussed in other cases as well. In the Commissioner of Income-tax vs Vatika Township, the Supreme Court ruled on the date from which a certain surcharge on search assessments was to take effect. This law came into force with effect from June 1, 2002, but the rate at which it was to be levied related to that prescribed for the assessment year, relevant to the previous year (that is the financial year), in which the search the took place. The Revenue argued that the provision was only clarificatory and desired that it should apply to all pending assessments—i.e. assessment year starting April 1, 2002 (AY 2002-03) and earlier assessment years, if need be. The court did not accept this plea and held instead that the law would apply only to searches which took place on or after June 1, 2002. It pointed out that the nature of, and the extent to which, legislative power can be exercised retrospectively has never really been codified, and most of the principles have to be gleaned from judge-made law.
When such a law is enacted, the courts will insist that the intention to effect a retrospective amendment should be explicit and unambiguous. The normal presumption is that the law enacted will take prospective effect. The rules of legal interpretation in India respect the Latin maxim lex prospicit, non respicit—the law looks forward and not backwards. When it does look backwards, it should not seek to change the character of a transaction that has already occurred; impose a fresh obligation that did not exist earlier; or modify an accrued right.
These principles were also applied by the Supreme Court in the case of Sarkar Builders. Certain commercial area restrictions were introduced as a condition for claiming a tax concession applicable to certain industrial undertakings and housing projects under section 80-IB of the Income-tax Act. These took effect from April 1, 2005.
Ordinarily, this new law would have been applicable to assessment year 2005-06, because direct taxation in India is based on the principle that the law applicable is the law as it stood on the first day of the assessment year. This is what the Revenue pleaded for. The Court held otherwise because following this time-honoured principle would have been extremely unfair to the assessees who had obtained approvals for their projects from local authorities on the basis of the unamended law in force prior to April 1, 2005. The assessees concerned could not have anticipated the change in law, and could not be expected to demolish buildings already constructed, so as to bring the project specifications within the ambit of the new law. It, therefore, ruled that the amendment would apply only to cases where local authority approvals had been obtained on or after April 1, 2005, after the amendment to the section had already been announced.
These three rulings of the Supreme Court appear to indicate that even with judicial constraints, the power to legislate retrospectively on tax matters is very vast indeed, almost draconian in nature. But merely because a power exists does not mean that it has to be exercised. Restraint, more than legislative action, is a much better strategy for building up faith in the tax system and encouraging voluntary compliance with the law. The government must realise that taxpayers have to often spend large sums of money on tax litigation. For the most part, the issues involved in such litigation seldom require a court judgment, and should ordinarily be settled at a lower level. A taxpayer understandably feels doubly frustrated when, after having spent large sums of money to vindicate her stand, she finds the government stepping in to amend the law from a back date. This is nothing short of a player changing the rules of the game, just because she is losing!
Padmini Khare Kaicker is managing partner of BK Khare & Co. Hardayal Singh was formerly chief commissioner of income-tax and ombudsman to the income-tax department, Mumbai