Taxation is contentious irrespective of the geography it is imposed. Tax disputes are routine and no government is prepared to let go the alleged ‘tax-evaders’ to use their terms. Legitimate models of tax avoidance too are brought under dispute to extract that marginal tax which government feels it is being denied. Any instance of deviation in terms of non-payment of taxes even when legitimate is frowned as challenged to the sovereignty. There are instances when current tax laws do not permit taxation on certain transactions or activities yet the government would feel going after those who have leveraged these laws to their benefit. Any corporate or an individual is entitled to leverage the laws to their benefit. If loopholes exists, those can be curbed through legislation. There is an omnipresent hide and seek game between the taxpayers and the government over payment or non-payment of taxes. Those who can afford to hire accountants and lawyers to prepare their tax claims to minimize the taxes would do so. In their pursuit, they are perhaps well prepared to run a long period of litigation. The common tax payer however does not have the luxury given the transaction costs entailed in this pursuit.
Recently, the government of India lost an arbitration suit against Cairn India over its alleged non-payment of capital gains tax. The firm had felt that the Indian laws if interpreted correctly would mean that they do not have any tax liability. Yet the government did not feel so. It was certainly not the first time the government felt so. Few years ago, in a similar case against Vodafone, the government had lost. What followed was the retrospective tax legislation not just to curb the loophole but to extract the taxes from Voda. It was more of a prestige battle, more a game of chicken that laid the foundations for the regressive piece of legislation. This has once raised the spectre of the retrospective tax and the tax litigation of the government. There is of course a debate on should government go in for appeal against the arbitration verdict or should the government continue with the measures to extract the tax dues which it feels is legitimate.
There is no second thought per se that the sovereign is well within its rights to impose retrospective taxation. It is different matter however, should such a tax be imposed. The government erred in economic terms when it came up with the idea in 2012. While it might have earned few political brownie points, what it did however do was to vitiate the investor climate. The effect on investor withdrawals was pronounced. The perceived dysfunctionality of the government apart from the growing climate of political instability and change made the investors wait for the regime change which happened in 2014. The investor memory too is short and given the attractive opportunities in India, they did come back. The government currently would obviously be in a political dilemma on the future of the case. In pure theoretic terms, the choice is very evident. The government would accept defeat and proceed further with life. Yet such an action while sound in theory might not sit well with the bureaucrats and tax mandarins sitting in the corridors of power. The reasons are not located in the arrogance of the bureaucracy nor in the inability to exercise political or bureaucratic will. The problem lies in the risk transfer and mitigation of risk consequences.
Apparently, Vodafone had asked for advice on taxation before the deal and was indicated that it would have to pay taxes. It is possible Cairn too would have received a similar advice if they had approached the tax authorities which in all probability they would have beforehand. Yet these would be essentially informal advice but would have sufficient indicators to the firms on the likely trajectory of the future direction of the litigation. The government has the luxury of running a near infinite period of litigations. It does have the luxury of legislative approach to secure the taxes which in all probability would be embroiled yet again in another round of litigation, so on and so forth. The decision to wind up the litigation can emerge only through a government decision of acceptance of arbitration verdict or for that matter any judicial verdict. Alternatively, government can resolve through negotiations. In all probability, there are negotiations currently underway between the government and Cairn. Yet negotiated settlements too would take their own time with any immediate resolution unlikely. In the absence of any high profile retrospective taxation moves, the investor climate too might not suffer any vitiation. The reasons for prolonged litigation and reluctance to close the case lies in the an unintended application of the skin in the game.
The bureaucrats are unlikely to take a decision on closing the case, since they feel they might be hauled by the Comptroller and Auditor General (CAG). As with any auditors, CAG too would flag certain things which would be right on paper yet very different is available in practice. The practical considerations are given go by most of the times. This is critical. The bureaucracy does not apparently want to be dragged years after retirement into the judiciary answering questions on the deal. Herein they have the skin in the game but the auditors do not have. The bureaucrats would perhaps prefer to leave the decision in the hands of the political bosses. To the political leaders, it is the electoral consideration and the optics that matter. The opposition would leave no stone unturned to cast aspersions on the decision to accept defeat or close the case through negotiations. This means endless rounds of political communications might have to be centred on addressing these allegations however unfounded they might be rather than any achievements they have to demonstrate. This would mean the prolonged litigation away from the glare would be the low hanging fruit and a better option for the government.
Ironically, contrary to popular perception, continued litigation might be a rational option for the tax authorities given the cost benefit analysis. Dropping the litigation might send numerous positive signals at the collective level, yet at the individual level, they are likely to create problems in terms of having to explain and defend their actions at various judicial and political forums for years to come. The risk averse bureaucrat or for that matter the politician would seek to wear down the firms through a prolonged attrition before some compromise is reached. The skin in the games differentials between different actors does provide different motivations and thus different decision outcomes at various levels. The case studies of both Cairn and Vodafone are a testimony to the same.
Thoughts on Theory and Practice 