Tax laws

Clarifying amendments to Indian tax laws: back taxes in disguise?

Every year, the announcement of the Union budget is eagerly awaited as one of the key tax policy events in India. This year was no different.

The 2022 Union budget saw a series of proposed amendments aimed at ending ongoing litigation on certain issues in the courts. Most of these amendments favor the taxman and not the taxpayers. Interestingly, such amendments have been proposed even in cases where the Supreme Court of India has already decided the issue in favor of the taxpayers.

A question that many taxpayers and tax professionals grapple with is whether these changes will even apply to pending litigation for the past period.

In the aftermath of the infamous 2012 retrospective amendment to overturn the Vodafone ruling, the current policy provision had pledged not to introduce liability retroactively (see Finance Minister’s Budget Speech 2014). However, the current changes seem to break that promise.

“Clarifying” Amendments in Budget 2022

It is proposed that all such amendments be incorporated prospectively into the statute book with effect from April 1, 2022. However, the use of phrases such as “for the avoidance of doubt” or “will apply and be deemed to have always been applied”. indicate that the changes are for clarification only and may potentially apply even for the past period. Some of these modifications have been discussed briefly in the following paragraphs.

Refusal of expenses even where there is no exempt income (Section 14A of the Income Tax Act)

Section 14A provides that no deduction is allowed for expenses incurred in connection with income exempt from tax in India. The Supreme Court has ruled that the said denial will not apply in cases where no exempt income is actually earned by the taxpayer in a particular financial year (see PCIT v. GVK Project and Technical Services Ltd [2019] 106 181 (CS)).

With the 2022 budget, an amendment has been proposed to clarify that the disallowance of expenditures under said section will apply and be deemed to have always applied even where the exempt income has not accrued or has not accrued. been generated or has not been received in a given year. .

No deduction on interest converted to debentures (Section 43B of the Income Tax Act)

In accordance with the existing provisions, certain interest costs can only be deducted on the basis of the actual payment. The provisions also state that the mere conversion of interest into a “loan or borrow” will not be considered an actual payment. The Apex Court, in a recent decision, held that the conversion of interest into “debentures” was an actual payment (see MM Aqua Technologies Ltd [2021] 129 145 (CS)).

Now, an amendment has been proposed to clarify that the conversion of interest into debentures or any other instrument by which the obligation to pay is deferred to a future date, will not be considered a payment of interest.

Ineligibility of certain payments as business expenses (Section 37 of the Income Tax Act)

Under current law, in computing business income, no deduction is allowed for an expense incurred by the taxpayer for a purpose that constitutes an offense or is prohibited by law. There was ambiguity about the application of this provision in certain situations.

For example, the applicability of this prohibition in the event of an infringement of foreign law or the composition of an offense was the subject of the dispute. In addition, the admissibility of expenses incurred by pharmaceutical companies in providing gifts to healthcare professionals has been challenged in numerous cases. Judgments exist both for and against taxpayers on all of these issues.

To remove the above ambiguities, amendments have now been proposed to expressly prohibit such expenditure.

Prospective effect or retroactive effect of modifications

Amendments which are introduced with the use of the words “to clear up doubts”, “shall be deemed to have always meant” or to explain an existing provision, are normally considered to be clarifying or declaratory amendments.

These amendments should provide for an obvious omission or dispel doubts in the interpretation of existing legislation. Generally, these clarifying changes are considered to have retroactive effect. This applies even if such amendments are made applicable from a prospective date in the Finance Bill (see Principles of Statutory Interpretation of Judge GP Singh and CIT v. Vatika Township (P) Ltd [2014] 49 249 (SC)).

The rule is different when it comes to substantial modifications which modify existing rights, or which impose new obligations or impose new duties or attach a new handicap. These amendments are presumed to have prospective effect unless there is an express legislative intent to give retroactive effect.

In addition, in cases where two possible interpretations existed and a modification benefiting the taxpayer is introduced, the modification is considered to have retroactive effect.

Thus, a question arises as to whether the recent amendments are really clarifying?

While the “form” may be that of a clarifying amendment, on the “substance” these seek to undo the legal positions established by case law. Thus, these amendments impose a new responsibility on taxpayers, particularly in the case of Section 14A and Section 43B.

Notably, the Apex Court in the M. M. Aqua case noted that if a provision alters or alters the law to its prior state, it cannot be said to have retroactive effect. This will be the case even if the wording of the provision suggests that it is a simple clarification.

The proposed changes could provide clarity and certainty for the future. However, these amendments will in no way resolve previous disputes.

The tax authorities will undoubtedly rely on these “clarifying” amendments in all ongoing litigation to support their argument. Taxpayers may take a position that these amendments should apply prospectively for the reasons discussed above.

One thing is clear. The proposed changes have raised a serious question about the government’s desire not to introduce retroactive changes to tax laws. It is true that old habits die hard.

S Vasudevan

Executive Partner, Lakshmikumaran & Sridharan

Email: [email protected]

Harshit Khurana

Senior Partner, Lakshmikumaran & Sridharan

Email:[email protected]