Thursday, February 24, 2011

Why retrospective tax amendments are beneficial in the long run?

As a future chartered accountant(with an interest in taxation), I'm probably biting the hand that feeds many of my co-professionals. But the rationale for retrospective tax amendments should be understood before complaining about it(like the ICAI has done in its Pre Budget Memorandum here).

Like any human activity(and more so typical of a social science like law), tax law is imperfect. In this rapidly changing economic/technological environment, even the best trained policy makers cannot anticipate all the consequences of their laws. This gives rise to unintended consequences as the below examples show;-

  1. In the early 1990's, GE Shipping(of the Sheths) made a virtue of issuing rights shares at par, often at a substantial discount to market value. The conventional explanations of rights issue discount, ownership base not changing etc do not account for it. ProfSidharth Sinha(IIM-A Prof) postulated a probable explanation that for creating tax deductible reserves under Section 33AC of the IT Act 1961(linked to par value of share capital), GE Shipping issued rights issue at par to maximize the par value(depressing share premium to zero!). This fine example of transaction structuring was a perfectly legal way to minimize taxes(even if if went against financial markets canons)
  2. India's tax treaties with Marutitius, Cyprus and other tax havens lead to the incongruousness of Indian assets being transferred without capital gains being paid to India(via source rule). The tax authorities then tried to characterize the  sale of shares as being 'substantially the sale of underlying assets'
In perfectly legal cases like (1), courts may frown upon the morals but no court will uphold the tax demands. But in case (2) where the taxman can build a plausibly arguable case, he may win the battle in court as the present Vodafone tax tussle shows.

Also, as the Statement of Revenue foregone shows, smaller firms pay more tax reflecting that they are not 'optimizing tax as conventionally thought. It is the big fish who pay less tax. So even from an equity standpoint, retrospective amendments level the playing field for big and small players. 

 Moral:- As a famed jurist said, when people play with fire(transaction structuring without an economic rationale save tax saving), they should not complain when they get burned. So if people devise strategies which bend the letter of the law, they should not complain when the spirit is applied via retrospective amendments. 

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