Govt's proposed new tax rules reopen raw wounds

MUMBAI Mon Mar 19, 2012 3:29pm IST

1 of 2. An employee uses an electronic machine to check an Indian currency note inside a bank in Allahabad December 16, 2011.

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MUMBAI (Reuters) - India's proposal to back-date tax claims on overseas deals involving local assets throws foreign investment into fresh uncertainty, experts and industry figures said, potentially reopening old legal battles and clouding business sentiment.

Vodafone (VOD.L) prevailed in a January Supreme Court ruling that found it did not have to pay tax in India on its $11 billion deal to enter the country.

Business groups hailed the decision as bringing clarity to the country's investment climate after a year of government scandals, slumping economic growth and policy paralysis eroded investor confidence.

But in his budget on Friday, Finance Minister Pranab Mukherjee sought to bypass that ruling with a retrospective amendment to 50-year-old tax laws, stirring a legal hornets nest and resurrecting a dispute that many hoped had been put to bed.

"People are indeed very, very worried about the tendency for India to make retrospective amendments," said Dinesh Kanabar, chief executive officer and chairman, tax, at KPMG India.

"You litigate for years, go all the way to the highest court for clarification, only for the government to say: 'This is what we meant'...The finance minister ought to be far more pragmatic than look for a few billion dollars here or there," he said.

India had sought $2.2 billion from London-listed Vodafone in tax after its purchase of Indian assets from Hong Kong-listed Hutchinson Whampoa Ltd (0013.HK). Vodafone said the deal was between two overseas entities, and India had no right. The Supreme Court agreed.

Mukherjee had other plans.

On Friday, the union budget included a proposal that, if passed by parliament, will allow the country to retrospectively tax cross-border transactions in which the underlying assets are located in India.

The amendment would change India's 1962 Income Tax Act, but will only seek to investigate deals done in the past six years, Finance Minister Pranab Mukherjee was quoted by local media as saying at an industry event on Sunday.

"Retrospective fiscal legislation should normally not be done...(but) every finance minister will have to protect the interests of the government from a revenue point of view," Mukherjee was quoted as saying by the Financial Express.

"MUDDIED WATER"

Vodafone is the largest overseas corporate investor in India, but its long-running dispute has come to symbolise the perils foreign firms face doing business in the country.

Clarity on its tax liability was applauded by investors, who saw it as a rare piece of sunshine in a clouded climate that had reduced investments in India to a five-year low in 2011, according to the Centre for Monitoring Indian Economy.

Business figures have criticized the amendment, which the head of the Confederation of Indian Industries said would "create an impression of India being an investor unfriendly country especially at a time when we need urgent investment."

"This is most retrograde. Our policymakers should realize we do not live in isolation. We need FDI, foreign technology and capital," said Deepak Parekh, chairman of Housing Development Finance Corp (HDFC.NS), India's biggest mortgage lender.

Mukherjee has sought to allay industry worries by asserting that the new amendment would not duplicate tax paid in other jurisdictions, and only seeks to ensure tax is paid on deals involving the transfer of Indian assets.

Even the head of the planning commission, Montek Singh Ahluwalia, a powerful policymaker outside of the finance ministry with close links to the prime minister, said he was uncomfortable with the proposal.

"I am personally uncomfortable with retrospective things," Ahluwalia told CNN-IBN news channel. "Now you know when ministries do that they usually have some very good reason and I just don't know enough what the reasoning is."

Vodafone's deal is not unique. Various other acquisitions involving overseas deals that appeared closed after the Supreme Court ruling could be affected by the proposal.

Kraft Foods Inc's KFT.N 2010 acquisition of Cadbury's Indian business and deals involving Indian assets sold by AT&T Inc (T.N) and SABMiller Plc's (SAB.L) purchase of Fosters would be at risk under the new amendment.

"The proposal...raises a question as to whether foreign investments are protected in India," wrote Nitish Desai Associates, a legal and tax advisory firm, in a research report.

Legal and tax experts say that while the amendment will see foreign investors act more cautiously in future deals involving Indian assets, the government's decision to throw past deals back into turmoil will only sour overseas investment appetite.

"The government is saying it is clarifying its position," said Amrish Shah, national leader, transaction tax, Ernst & Young India. "But on past deals, it has muddied the water."

(Editing by Tony Munroe)

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