The Problem of Retroactive Taxes - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 21 April 2012
The Problem of Retroactive Taxes A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
Imagine that you are earning a salary and paying 25% income tax on it. Five years later, the government raises the income tax rate to 30%. Naturally you will be unhappy at the prospect of paying more taxes, and ending up with a lower disposable income. In the end, you'll likely accept that there is little you can do about it, and hope that the greater tax revenue generated will result in improvements for the country as a whole.

But now, imagine that the government says to you that you not only have to pay income tax at 30% from now on, but also on your earnings in the last five years. For the last five years, you've been paying 25% income tax thinking that this is what was required of you. But now, you have a large bill for unpaid taxes over the last five years that you never thought you had to pay. You would undoubtedly be outraged.

This is what is known as a retroactive tax. A retroactive tax is one that is imposed on previous financial activity. Why am I talking about this now? As many of you are probably aware, the Indian government in its recent budget has gone after some multinational companies to try and extract taxes on previous deals done. In particular, they are going after Vodafone, and imposing a tax on a deal it did 5 years ago. This is likely to apply to many multinational companies.

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In the beginning of the article, if I had replaced an individual earning a salary with a multinational corporation earning vast sums, we may not feel that a retroactive tax is that unfair. After all, they are earning so much money, so surely the Indian government has a right to tax it and use it to benefit the country.

This is actually true. Closing tax loopholes is a good thing, and should be encouraged. It is fair for a large company to pay its share of taxes, just like the salaried individual. However, a retroactive tax is a big mistake. The right policy would be to introduce the tax on future transactions, not on past ones. But why is exactly is a retroactive tax so bad?

The answer is trust. When a government imposes a retroactive tax, it is breaking the trust between the society and itself. It is breaking a contract, and this type of behavior would be illegal in any private party transaction. If the government cannot be trusted, then this will surely be a detriment to future investment. If I can't be sure that today's profits will remain profits (and not taxes), then I will have a lower incentive to invest in the first place. A strong economy requires that contracts are honored and trust exists between market participants. Otherwise these retroactive taxes may have terrible unintended consequences.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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17 Responses to "The Problem of Retroactive Taxes"

Dr Anil K Kothari

Oct 10, 2012

It appears that the basic purpose of Shome committe was to give recommendations which our FII likes. The retrospective tax was levied because some corporates were smart enough to manipulate the fine print of earlier tax rules. Companies like Vodofone which were ready to pay 50% of the demand in compromise will be very pleased from the recommendations. I am really surprised that all recent rules and policies are being framed to attract capital inflow from abroad. Why not give tax concessions to Indian savers and discourage gold investments which will automatically improve the situation on Forex front.
As a economist i am in favour of promoting indian investors.



Apr 24, 2012

This single element of uncertainty can affect any future investments in the country negatively.Government being penny wise and by all means have not studied implications in depth. In spite of keep moving the goal posts, the government is good at scoring self goals.In its enthusiasm to plug the revenue deficits, resorting to unethical means is short sightedness.All these show the government in poor light and lack of a political visionary at the helm of affairs.


Vinod Sahni

Apr 23, 2012

It is unfair to term what is proposed in the finance bill (presented by FM in March 2012) as RETROSPECTIVE TAX because THESE ARE CLARIFICATIONS & became necessary when some corporates were found to avoid paying any tax any where! As FM has rightly mentioned, NOT paying tax anywhere is UNFAIR, especially when someone making some gain is just trying to play with words. In a country like India where even the poorest pay (indirect) taxes in the form of excise tax while, say, buying a match box, a smart person or corporate should not be allowed to get away paying nothing!!


Krishnan Bheemanad

Apr 23, 2012

Yes I fully agree that retro taxing is draconian and illegal. The Supreme Court has not finnaly disposed of the case: I am hoping they will axe this proposal as vindictive. FM and his officials are still saying that they are not proposing retrospective taxation, but only stating the "intention" of the 1962 Income Tax law. This is just hogwash and nobody is going to be fooled. It is plain fact that the FM is going after Vodofone in this case. 11,000 crores is too huge to miss out. Afterall where will he go for funding huge unproductive expenses of the fat govt which even the other day announced an uncalled for bail out of the white-elephant Air India!!



Apr 22, 2012

yes .retroactive taxes are bad and then nobody can believe this govt.I am surprised how Dr MMS allowed this to be even discussed.In short you are penalizing somebody else for your own shortcomings.Even Supreme court in my opinion is not right in 2 major decisions.One is cancelling licenses because a minister did not follow procedures or took bribes or whatever.the second is forcing schools to accept poorer students because the govt is failing to do so in spite of spending huge amounts.



Apr 22, 2012

Its not reasonable and/or desirable.



Apr 22, 2012

When I first read about this I didn't know whether to laugh or cry? I laugh when I think it's God's lila and cry when I think of fellow Indians. To keep the Maharaja flying just rob Peter and Paul.


Jeevan Shetty

Apr 22, 2012

Mr. Assad Dossani's analysis is usually correct. This time however he has gone off mark. This is because, the subject has been misrepresented by him. First the assumption of individual paying 25% tax is incorrect. It should be the individual has not been paying taxes where as he has been cleverly misusing loop holes to avoid tax. Second the govt. has not increase any rate of tax on the individual but only made a claim on the tax which the govt. is due. The individual has been hiding his income abroad being a resident in India. These should be the assumption for the write up. Please do not misrepresent fact and put at stake the credibility and reputation of your letter and equity master portal at stake. Please publish this comment.
Jeevan Shetty


sujatha kumar

Apr 22, 2012

I love the way Assad Dossani is able to break up complex tax laws into simple equations which a non technical person can understand and identify with so easily. He is a natural. I am grateful to equitymaster for bringing him into this weekend edition and to derivantage and making the complex game of derivatives sound so easy and practical. Thank you equitymaster and Assad Dossani!



Apr 22, 2012

The Vodafone deal was designed to evade tax and escaped in courts due to tax loop hole. There is nothing wrong in plugging the loop hole and demanding tax from an MNC, however mighty it must be. Any number of motivated articles to condemn the retroactive measure, will not justify the tax dodge intentions of Vodafone and Essar groups. While government bashing is a popular past time for all, in this instance, the Govt acted as it should

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