What is the Sovereign Right to Taxation?

India Sep 27, 2021

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Finance Minister Nirmala Sitharaman, in the monsoon session of the Parliament, introduced The Taxation Laws (Amendment) Bill, 2021. The amendment seeks to withdraw the tax demands made using the retrospective legislation passed in 2012 to tax the indirect transfer of Indian assets. With the scrapping of the retrospective levy of tax, major ambiguity in taxation laws has been removed, thus providing clarity to foreign investors.The government has put special emphasis on its “sovereign right to taxation” in India.

What is the definition of a Tax?

As per a document on the website of the Ministry of Statistics and Programme Implementation, tax is a pecuniary burden upon individuals and owners of property to support the government. It is not a voluntary payment or donation but a contribution commanded by legislative authority.

Taxation in India

The tax structure in India is a three-tier system based on the Central, State and local governments. The Seventh Schedule of the Constitution categorises tax under the separate heads of Union List and the State list. The Union and States do not have any concurrent power of taxation.

What is the Sovereign right to taxation in India?

An act of sovereign power cannot be prevented by any other power recognised by the constitution of India. The Indian Constitution grants the government the sovereign right to levy taxes on individuals and organisations. It specifies that no one has the right to charge taxes, save by the authority of law. Any tax charged should be backed by a law passed by the legislature or Parliament as per Article 265 of the constitution.

However, an important point to be noted in the sovereign right to taxation is that it is not absolute. The two provisions of the Bilateral Investment Treaties (BIT) are used to challenge the taxation measures.

Limits to the sovereign right to taxation

The two provisions used to limit the power of taxation of a country under the BIT are- Expropriation and fair and equitable treatment. The expropriation provisions state that the tax levied by the government of a state should not be discriminatory or confiscatory, implying it should not be unreasonable in any way. Fair and equitable treatment holds that states must carry out legal changes in their tax laws in a reasonable manner. There have been many instances where foreign investors have challenged the taxation measures citing breach of legal certainty. The most recent cases are the Cairn energy and Vodafone dispute. The international arbitration court declared India's claims unjustified due to the retrospective feature in the Indian tax laws. The retrospective taxation has now been done away with by the government.


The scrapping of the retrospective taxation law after nine years is a welcome step. India has, however, emphasised its right to taxation as a sovereign power. What is needed now is that India should exercise this right while keeping in mind international law obligations and act in good faith to attract and enable the growth of the much needed foreign investment in India.

This article has been written by Khanak Sharma for the Paradigm.

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