In a recent decision[1], the Delhi High Court has held that the Explanations 6 and 7 added to Section 9, IT Act, 1961 via Finance Act, 2015 are retrospective in nature despite the amendment not expressly stating so. A brief recall to the Finance Act, 2012 which inter alia amended Section 9 along with adding Explanation 5 to it, to overcome the effect of Supreme Court’s decision in Vodafone International Holdings.[2] The amendment clearly stated that Explanation 5 would have effect w.e.f. 1.04.1962. However, such an express declaration was missing when Explanations 6 and 7 were added in 2015. Nonetheless, the Delhi High Court held that Explanations were retrospective in nature by referring to their legislative history.
Facts
The respondent, August Capital PTE Ltd, was a company incorporated in Singapore in 2011. Between January 2013 and March 2014 the respondent invested in equity and preference shares of Accelyst Pte Ltd (‘APL’), incorporated in Singapore. In March 2015 the respondent sold its investment to an Indian company. In the return of the income for the particular Assessment Year, i.e, 2015-16, the respondent showed its income as nil. The respondent was issued a showcause notice as to why its income from the sale of shares should not be taxed in India. The respondent’s explanation was that it had only acquired 0.05% of ordinary share capital and 2.93% of preference share capital and had no rights of management and control concerning the affairs of APL and thus the capital gains arising out of the transfer of shares was not taxable in India.
The Assessing Officer, Dispute Resolution Panel decided in favor of the Revenue Department wherein the respondent’s taxable income was pegged at a little more than Rs 36 crores. The tribunal ruled in favor of the respondent and directed deletion of the income and against the tribunal’s decision, the Revenue filed an appeal before the Delhi High Court.
The respondent was sought to be taxed under Explanation 5 that was added to Section 9, IT Act, 1961 via the Finance Act, 2012. Explanation 5 added via Finance Act, 2012 with retrospective effect stated that:
… an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India;
The above Explanation was unambiguously added to tax Vodafone like transactions. However, immediately after its insertion there were specific concerns about the uncertain nature of the terms ‘share and interest’ and ‘substantially’. A Committee chaired by Mr. Parthsarthy Shome recommended that the term ‘substantially’ used in Explanation 5 be defined precisely to avoid interpretive difficulties. The narrow concern was that Explanation 5 may also include within its scope small investors wherein even if a single share of a company is transferred – and such company derived its value substantially from assets located in India – it would result in taxable gains under the Explanation 5.
Explanations 6 and 7 were added to address the above concerns and effectively provided a benefit to small investors. For example, Explanation 6 states that for the purpose of this clause, it is hereby declared that the share of interest, referred to in Explanation 5 shall be deemed to derive its value substantially from the assets (whether tangible or intangible) located in India, if, on the specified date, the value of the assets exceeds the amount of ten crore rupees and represents at least fifty per cent of the value of all the assets owned by the company or entity, as the case may be. A minimum threshold was prescribed to indirectly define the term ‘substantially’ used in Explanation 5.
Similarly, Explanation 7 inter alia states that for the purposes of this clause no income shall be deemed to accrue or arise to a non-resident from transfer, outside India, of any share of, or interest in, a company or an entity, registered or incorporated outside India referred to in Explanation 5 if the such company or entity directly owns the assets situated in India at any time in the twelve months preceding the date of transfer, neither holds the rights of management or control in relation to such company or entity, nor holds voting power or share capital or interest exceeding five per cent of the total voting power.
Arguments and Decision
The respondent in the reply to showcause notice had clearly stated that it had no control and management rights in APL and further argued before the Delhi High Court in the same vein. The respondents argued that the Explanations 6 and 7 should have retrospective effect since Section 9(1)(i) read with Explanations 4,5,6, and 7 form a complete code. They referred to the context and reason for introductions of Explanations 6 and 7 and argued that the reason for introduction of these Explanations was to cure the unintended effect of Explanation 5 and given this context, Explanations 6 and 7 should also be given a retrospective effect even if Finance Act, 2015 did not expressly state that these Explanations would have retrospective effect.
The Revenue, on the other hand, argued that Explanations 6 and 7 brought a substantial change in the law and were not merely clarificatory amendments. And added that even a clarificatory amendment need not necessarily have a retrospective effect.
The Delhi High Court cited the Shome Committee recommendations and the text of Finance Minister’s speech while explaining the introduction of Explanations 6 and 7. Both these sources led to the straightforward conclusion that the Explanations 6 and 7 were added to cure the limitations of Explanation 5, and thus the Delhi High Court concluded that the insertion of Explanations 6 and 7 was a curative step to cure the vague expressions used in Explanation 5. The High Court noted that:
The argument advanced on behalf of the appellant/revenue, shorn of gloss, boils down to the fact that the insertion of Explanations 6 and 7 via FA 2015 was to take effect from 01.04.2016 and could only be treated as a prospective amendment. The argument advanced in support of this plea was that Explanations 6 and 7 brought about a substantive amendment in Section 9(1)(i) of the Act. In our view, this submission is misconceived because Explanations 6 and 7 alone would have no meaning if they were not read along with Explanation 5. Therefore, if Explanations 6 and 7 have to be read along with Explanation 5, which concededly operates from 01.04.1962, they would have to be construed as clarificatory and curative. (para 20)
The Delhi High Court reasoned that the legislature took recourse to the mischief rule else Explanation 5 offered no legislative guidance to the assessing officer and was in danger of being struck down as arbitrary. The High Court concluded that though the Finance Act, 2016 stated that the Explanations 6 and 7 were to take effect from 01.04.2016, the legislative history provides authority to conclude that they could be treated as retrospective.
Conclusion The Delhi High Court relied almost solely on legislative history and context of the introduction of Explanations 6 and 7 to Section 9 to hold that the Explanations had a retrospective effect. This is novel territory because the Finance Act, 2015 clearly does not state that the Explanations 6 and 7 will have retrospective effect. Alternately, one could also argue that the Delhi High Court adopted holistic approach in interpreting the effect of Explanations 6 and 7. It is undoubtedly true from the legislative history, as the High Court cited, that the Explanations 6 and 7 were intended to overcome the shortcomings of Explanation 5. And as standalone, Explanations 6 and 7 do not contain much substance. Thus, if Explanations 6 and 7 are to be read in tandem with Explanation 5, there is little reason to suggest that only Explanation 5 should have a retrospective effect while Explanations 6 and 7 operate prospectively.
[1] The Commissioner of Income Tax, International Taxation-I v Augustus Capital Pte Ltd 2023:DHC:8521-DB.
[2] Vodafone International Holdings B.V. v Union of India & Anr (2012) 1 SCR 573.