Retrospective tax is one of the dishonest forms of amendments made to the existing law. When the government makes changes to a particular law which come into an effect from the date prior to the date of making such changes is called the retrospective tax.
This means that suppose the government passes an amendment in the tax law on the budget day that the money spent on your child now, shall be treated as income for the child, then this change becomes effective from the date income tax came into force. So, the consequence of this, any amount spent now with your child will be taxable. The application of the law enacted on the later date, but have supposed to come into effect from some prior date is an example of Retrospective law.
Reason for taxation
This came into the picture during 2007 from the Vodafone Hutchison tax case, Vodafone agreed to acquire controlling interest of 67% in Hutch-Essar group for $11.1 billion. This led to the violation of tax law as alleged by income tax authorities as the transaction involved the purchase of asset of an Indian company and, therefore the transaction is liable to be taxed, but Vodafone disagreed to the allegation which resulted in a $2.5 billion tax dispute and the case went to the Supreme court. In 2012, the Indian Supreme Court passed the judgment in favor of Vodafone saying that the Indian tax department has no jurisdiction to levy the tax on an overseas transaction between two companies incorporated outside India.
However, the Government of India was against the judgment of the Supreme Court and believes that if an Indian company, i.e. Hutchison India Ltd. conducts a financial transaction; they are liable to pay tax to the government. Therefore, the government changes the income tax law retroactively and made sure that any company under similar situation will not be able to avoid tax by operating out of tax havens like the Cayman Islands. The Cayman Islands are one of those tax havens areas, where levied tax is very low and in most situations no corporate tax and no income tax are also implied. Instead of taxes, the corporation pays a licensing fee to the government. This is based on the share capital possessed by the company. This gives various multinational companies to conduct their business free of transaction costs at these places.
So, based on this retrospective tax that displeased various multinational companies as it would affect their business, resulted in a setback in the foreign direct investment. Since this tax law amendment came into existence when the previous party was in power i.e. Congress. The Expectation was made that during this budget some reforms will be taken against this retrospective tax, but no such steps have been taken as of now, but it is still expected that some action will be taken against this tax law in near future.