article_does retro_mukesh_indian law news_apr1366714025.pdf

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



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



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



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



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]

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