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  • 7/30/2019 Article_Does retro_Mukesh_Indian law news_Apr1366714025.pdf

    1/5India Law News 1 Winter/Spring Issue 2013

    IndiaLawNewsA quarterly newsletter of the India Committee

    VOLUME 4, ISSUE 1, WINTER/SPRING ISSUE 2013

    n the Indian Finance Act of 2012, Parliament

    made several amendments to the income taxlaws, with retrospective effect. The express purpose of

    the legislation was to overrule the January 2012

    judgment of the Supreme Court of India in the Vodafone

    case. This article discusses whether the retroactive

    aspect of the legislation undermines the doctrine of

    separation of powers or compromises judicial

    independence to the extent of making the retroactive

    law unconstitutional.

    The Vodafone case involved a sale of shares from

    Hutchison Telecom International Ltd. (HTIL), aCayman Islands entity owned by the Hutchison group,

    to Vodafone International Holdings BV, a company

    incorporated in the Netherlands. HTIL owned

    Hutchison's operations in India though a series of

    companies incorporated in Mauritius. The Indian

    Revenue authorities contended that as the transaction

    resulted in the sale of business assets located in India

    from Hutchison to Vodafone, Vodafone was liable to

    pay tax on the transaction even though the shares were

    purchased from HTIL and not Hutchinson. Vodafone

    challenged the decision. The Supreme Court of India

    ruled that the wording of section 9 of the Income Tax

    Act does not permit a look through(piercing thecorporate veil). Hence, the sale of shares of a foreign

    company by a foreign company to another foreign

    company could not be brought within the scope of

    taxation in India.

    The Indian Parliament, to counter the Supreme

    Court judgment, introduced retroactive substantive

    amendments to sections 9 and 2(47) of the Income Tax

    Act in the form of clarifying explanations to amend the

    scope of section 9, so as to bring within the ambit o

    Indian taxation the sale of shares of a foreign companyif such shares have derived substantial value from

    Indian assets. The legislation had the effect o

    retroactively making the Vodafone transaction taxable

    in India. Many have argued that overruling the

    Supreme Court by retroactively effective legislation

    undermines the rule of law and the separation o

    powers.

    continued on page 6

    DOES RETROACTIVE LEGISLATION COMPROMISE JUDICIAL INDEPENDENCE? THECONSTITUTIONALITY OF THEVODAFONE LEGISLATION

    B Mukesh Butani and Rahul Yadav

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    continued frompage 1

    Parts I, II and III of the Constitution of India

    provide for separation of powers among the Executive,

    Parliament and Judiciary. Indian courts have

    consistently upheld the doctrine of separation of

    powers, and that each branch of the government must

    operate within the limits set forth in the Constitution.

    There must be no transgression or attempt by onebranch to supplant, derogate or encroach upon the

    designated space of the other branches.

    THE CONSTITUTIONALITY OF RETROACTIVELEGISLATION

    The power to enact laws lies within the exclusive

    domain of the legislature. The power to legislate

    includes the power to legislate retroactively (also

    referred to by the courts as retrospective legislation),

    including within the field of taxation:

    Legislative power conferred on the appropriate

    legislature to enact laws in respect of topics covered by

    several entries in the three lists can be exercised both

    prospectively and retrospectively. Where the

    legislature can make a valid law, it may provide not

    only for the prospective operation of the material

    provisions of the said law, but it can also provide for

    the retrospective operation of the said provisions. Rai

    Ramkrishna v. State of Bihar (1963) 50 ITR 171 (SC).

    While legislative power to introduce amendments

    for the first time or to amend an enacted law with

    retrospective effect is recognized, it is nevertheless

    subject to constitutional limitations. Judicial principles

    require that amendments made retroactive (a) should

    use words expressly providing for or clearly implying

    retroactive operation; (b) must be reasonable and not

    excessive or harsh, otherwise they run the risk of being

    struck down as unconstitutional; and (c) where the

    legislation is introduced to overcome a judicia

    decision, the power cannot be used to subvert the

    decision without removing the statutory basis of the

    decision.

    It is also a settled principle that legislative actions

    are subject to judicial review by the Indian High Courtsand Supreme Court. There is no doubt that the

    legislature is empowered to enact laws retrospectively

    as well as prospectively. No such enactment, however

    should result in an alteration of the basic structure of

    the Constitution. Kesavananda Bharti v. State of Kerala

    AIR 1973 SC 1461). The general rule is that any

    amendment or enactment that violates fundamenta

    rights may be struck down by the courts as

    unconstitutional.

    Accordingly, pursuant to the writ jurisdictionconferred upon under Articles 226 and 32 of the

    Constitution, the High Courts and Supreme Court act

    as watchdogs to safeguard fundamental rights. Such

    powers have been exercised with great caution by

    Indian courts. On numerous occasions, when the courts

    have been called upon to consider the validity of

    legislation, the courts have shown great restraint

    Unless the legislation patently violates fundamenta

    rights and there is no recourse to prevent such a

    violation but to declare the law unconstitutional and

    strike it down, the courts will find the legislationconstitutional.

    LIMITS ON RETROSPECTIVE LEGISLATION

    The power to legislate includes the power to

    validate a law which has been held invalid by the

    courts by making retrospective amendments. This can

    be done by removing the infirmities in the law or by

    filling the lacuna therein. The obvious question is

    DOES RETROACTIVE LEGISLATION COMPROMISE JUDICIAL INDEPENDENCE? THECONSTITUTIONALITY OF THE VODAFONE LEGISLATION

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    whether by exercising such power the legislature

    violates separation of powers by limiting the power of

    judicial review.

    A retrospective amendment to overcome a

    judgment does not, by itself, render the amendment

    invalid or unconstitutional, even if it has the effect of

    neutralizing the judgment of a court, making the

    judgment virtually ineffective. Such amendments do

    not amount to the statutory overruling of judicial

    decisions. I.N. Saksena v. State of M.P (1976) IILLJ 154

    SC.

    "A competent legislature can always validate a lawwhich has been declared by courts to be invalid,

    provided the infirmities and vitiating factors noticed in

    the declaratory judgment are removed or cured. Such a

    validating law can also be made retrospective. If, in the

    light of such validating and curative exercise made by

    the legislature granting legislative competence the

    earlier judgment becomes irrelevant and unenforceable,

    that cannot be called an impermissible legislative

    overruling of the judicial decision. All that the

    legislature does is to usher in a valid law with

    retrospective effect in the light of which the earlierjudgment becomes irrelevant." Ujagar Prints v. Union of

    India [1989] 179 ITR 317 (SC)

    Accordingly, the judiciary accepts that the

    legislature is competent to render a judgment

    ineffective, provided that the legislature removes the

    statutory basis of the judgment with retrospective

    effect. However, such retrospective amendment must

    satisfy the test of constitutional validity, including inter

    alia, the test of reasonableness. Taxing statutes, like any

    other statutes, are subject to amendment withretrospective effect.

    THE DOCTRINE OF SMALL REPAIRS

    Legislative power to enact retroactive legislation

    has to adhere to constitutional limitations, of which the

    most important is the principle of small repairs,

    which is an index of whether the law is harsh and

    oppressive, or a valid exercise of the power to enact

    retrospectively. The principle of small repairs, is an

    expression that originated in an article in the Harvard

    Law Review where it was observed that it is necessary

    that the legislature should be able to cure inadvertent

    defects in statutes or their administration by making

    what has been aptly called small repairs. This

    principle was subsequently adopted by the Indian

    Supreme Court (Assistant Commissioner of Urban Land

    Tax v Buckingham and Carnatics Co Ltd 75 ITR 603 (SC)

    Virender Singh Hooda and Ors v State of Haryana AIR

    2005 SC 137), and has been applied by Courts in

    determining the constitutional validity of retrospective

    legislation. The doctrine seeks to provide a touchstone

    by which the limits of legislative power to enacretrospective legislation, including tax legislation, may

    be tested.

    A close analysis of the relevant jurisprudence

    specifically in relation to tax legislation, demonstrates

    that retrospective legislation has been upheld by courts

    principally in two situations, cumulatively reflecting

    what amounts to small repairs: (a) the imposition of a

    tax, where the intention to impose the tax was always

    clear but such imposition failed due to a formal defect

    or (b) the imposition of a tax, where the intention toimpose the tax was always clear, but the imposition

    originally failed due to sheer inadvertence.

    The doctrine of small repairs also assumes

    importance against the backdrop of the legitimate

    expectations of the taxpayers. Lord Scarman in R v

    Inland Revenue Commissioners ex p. Preston (1985) AC 835

    (House of Lords, England) laid down emphatically tha

    unfairness in the purported exercise of power can

    amount to an abuse or excess of power. Thus the

    doctrine of legitimate expectations is applied in thecontexts of reasonableness and natural justice.

    The doctrine of small repairs permits retrospective

    amendment where the aim of such amendment is to

    convey the meaning or to clarify the intent of the

    provision as it was always meant to be; to remove a

    patent defect which, but for the modification, would

    have absurd results; to supply an obvious omission in a

    former statute; or to explain a formal statute. Therefore

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    retrospective legislation which does not satisfy the

    requirement of small repairs but in fact leads to

    substantive amendments which are neither clarificatory

    nor declaratory in nature, may be struck down by the

    Courts as ultra vires and unconstitutional on the

    grounds that it is unreasonable, harsh or oppressive.

    THE QUESTIONABLE CONSTITUTIONALITYOF THE RETROACTIVE LEGISLATIONINVODAFONE

    The amendments made to section 9 of the Income

    Tax Act by the Finance Act of 2012, which outlines the

    deemed source rule of taxation, cannot be said to

    have been made to rectify a formal defect or aninadvertent error. Further, the severity and magnitude

    of these amendments does not appear to be

    clarificatory even though they have been introduced in

    the statute under the garb of clarificatory explanations.

    They clearly seem to fall outside the four corners of the

    doctrine of small repairs.

    The constitutional validity of these amendments

    has yet to be tested in a court of law. Nevertheless, we

    are of the opinion that the amendments cannot

    rationally be held to be clarifying the intent of the

    Income Tax Act so as to include the offshore sale of

    shares by one foreign company to another foreign

    company (such as Vodafone) within the ambit of

    section 9 of that statute. This does not seem to be a

    valid exercise of legislative power, as it amounts to a

    substantive amendment levying a fresh charge, which

    cannot be given retrospective operation as per settled

    legal principles. Not only are these amendments

    unreasonable, they fasten substantive liability insofar

    as their retrospective operation is concerned, and theyare also harsh and oppressive. While the amendments

    may stand the test of constitutional validity insofar as

    their prospective operation is concerned, whether or

    not Courts uphold their retrospective operation

    remains to be seen (writ petitions have been filed

    challenging the constitutional validity of section 9 by

    McLeod Russel (India) Limited (an Indian company) in

    the Calcutta High Court and SABMiller Limited (an

    Australian Company) before the Bombay High Court).

    To conclude, while the legislature has the power to

    render a courts verdict ineffective by removing the

    statutory basis of its judgment, the exercise of such

    power has to conform to constitutional requirements

    and the limitations are even more rigorous in the case

    of a retrospective enactment. A practice whereby the

    legislature, in an attempt to remove the basis of the

    judgment, ushers in substantive amendments

    retrospectively (which do not qualify as smal

    repairs) in the garb of clarificatory or declaratory

    amendments is not a valid exercise of legislative power

    Such an attempt by the legislature not only undermines

    the independence of the judiciary but also disturbs the

    critical balance between the three branches ofgovernment.

    Judgments and decisions of the Supreme Court

    being the highest court in India, are the law of the

    land as expressly provided for under Article 141 of the

    Constitution of India. Thus, it remains to be seen

    whether the retroactivity of section 9 will stand up to

    judicial scrutiny if and when the McLeod Russell and

    SABMiller cases wind their way to the Supreme Court.

    Every democracy aspires to achieve the goal ogood governance in accordance with the Rule of

    Law. For the Rule of Law to prevail it is imperative

    that there exists a sense of responsibility and mutua

    respect among the three branches of government

    Therefore, no branch should be surprised when its

    attempt to usurp the power of another in derogation of

    the constitution is challenged until defeated.

    Mukesh Butani is the Managing Partner of BMR

    Legal and specializes in International Tax and

    Transfer pricing with over 25 years experience in

    advising Fortune 500 multinationals and Indian

    business houses on a wide range of matters. He is a

    member of the Advisory Group on International Tax

    and Transfer Pricing constituted by the Indian

    Ministry of Finance. He is also a member of the

    OECD Business Restructuring Advisory Group, the

    International Fiscal Associations Permanent

    Scientific Committee and the OECD-BIAC

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    committee. Mukesh can be reached at

    [email protected].

    Rahul Yadav is an Advocate and international tax

    dispute expert at BMR Legal and has worked

    extensively on several cross border transactions.

    Rahul can be reached [email protected].

    mailto:[email protected]:[email protected]:[email protected]:[email protected]