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Need for business certainty: Crucial takeaway from SC
January, 30th 2012

The Indian tax and corporate advisory ecosystem is in a flurry of intense activity. The Supreme Court has decisively and emphatically rejected the claim of the income-tax department that a transfer of a foreign holding company indirectly holding Indian shares is necessarily subject to taxation as if it were a transfer of Indian shares (in the Vodafone litigation). Every tax advisory firm on the street is busy arranging webinars and conference calls to showcase expertise in analyzing the decision of the Supreme Court.

Even without getting into abstruse analysis of taxation concepts (that is not the remit of this column), it would however be critical to take note of one clear signal that India's highest court has given: that the rule of law has to be certain, and it is critical that the consequences of one's business conduct are clear, specific and predictable.

We live in an environment where every regulator in India seems to be taking pride in how creative and combative it can get in scoring victory in litigation, rather than in providing a certain and predictable environment in the regulatory space it administers. Against this backdrop, such an emphatic signal from no less than the Chief Justice of India is a welcome respite and a stark reminder to arms of the Indian states that the institution of the judiciary will not hesitate to uphold the rule of law.

For the cynics, the Supreme Court's decision is a welcome surprise. The stakes were sizeable - an estimated Rs 11,500 crores could have been collected by the revenue authorities. The revenue authorities had had a victory from an excellent bench of the Bombay High Court. Judicial attitude was expected to be an uphill task to overcome, particularly after the Supreme Court asked for a sum of Rs 2,500 crores to be deposited with the revenue authorities. And now that the last word is out, the Supreme Court has underlined that one Constitutional institution is indeed functioning with clarity in the rule of law as a clearly stated canon.

The Supreme Court has noted: FDI flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law. Certainty and stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner.

The tax department is notorious for being combative and creative in litigation rather than being predictable and clear in what it would precisely like. For example, till date, there is litigation all across the nation about whether import of software in a DVD would mean the importer has to pay duty on the DVD, although software imports are duty-free. Whether shrink-wrap software contracts are products or services is another such controversy. These are areas where it is completely open to the revenue authorities to legislate and provide specific clarity, but the business community is at the risk of spending enormous time and energy, apart from expenses, on litigation, instead of doing more business by operating in an assured certain environment and thereby paying more taxes.

Some editorials have criticized the Supreme Court's opinion as exceedingly mindful of form over substance. However, it is in this critique that another noteworthy principle is underlined: that courts should not legislate, and should focus on enforcing the applicable law as it stands. It is indeed true that the Direct Tax Code, which would be the new income-tax law, has proposals to cover indirect transfers of Indian shares as taxable events. Predictability and clarity is what is needed, whether to legislate or not, is purely a prerogative of the State.

When the new takeover regulations were being drafted, one question keenly debated was whether incidental and indirect acquisitions of Indian listed companies, without such acquisition being the intent of the overseas transaction, should at all trigger an open offer for shares in India. Detailed and clear legislation has now been provided to deal with when an indirect acquisition is deemed to take place, at what thresholds would the indirect acquisition be deemed to be an intended acquisition, at what thresholds would it be deemed to be a material component of the indirect acquisition, and what are the consequences of the indirect acquisition being incidental and inconsequential.

It has been legislated that an open offer would be triggered in every instance, but the rules of the game would vary depending on what type of indirect acquisition it turns out to be. The idea again is to provide specific clarity on the rules of the game.

It is not just tax policy certainty but any regulatory policy certainty that is critical for making rational investment decisions.

Our regulators should take this decision of the Supreme Court as a trigger to introspect on how best they could aid and abet predictable rule-compliant activity in their sectors and shed the attitude of being the smarter litigator in a duel. Their arena of comfort should be their own field of regulation, and not the court room.

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