BREAKINGVIEWS: India's tax grab threat could backfire badly

MUMBAI Thu Mar 29, 2012 3:31pm IST

An employee uses an electronic machine to check an Indian currency note inside a bank in Allahabad December 16, 2011. REUTERS/Jitendra Prakash/Files

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

Credit: Reuters/Jitendra Prakash/Files

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MUMBAI (Reuters Breakingviews) - Investors fear that New Delhi will use tax law changes that could trap Vodafone to snare offshore institutions. If that's not what the government intends, it should say so. If it is, the value of nearly all investment assets is endangered. Capital inflows could slow to a trickle.

Vodafone is the largest foreign direct investor in India. It has invested $26 billion since 2007. But that's small beer compared to the $200 billion foreign investors hold in India's equity market, according to data from the Securities and Exchange Board of India. Together, they hold 17 percent of the total.

Investors have two concerns. First, they fear the retrospective taxation of capital gains made over the past six years. Worries abound, and are deepened, because past investment had been made with presumed certainty. Investors seemed to have a government assurance, and a Supreme Court judgment, which indicated that they would not be subject to any such taxation.

Investors are also worried about New Delhi's prospective tax plans, and especially proposals designed to target tax evasion. Legitimate tax exemptions may be recast as illicit loopholes. Investors who currently don't pay any capital gains tax may have to cough up 15 percent on future profits.

If the government moves are being misinterpreted, New Delhi needs to act swiftly to erase the doubts before the fears become any more entrenched. The smart thing to do would be to clarify policy now before new laws are passed. Ambiguities could debilitate for an extended period if new legislation has to be tested in court and driven by the establishment of precedent.

New Delhi may be quite justified in pursuing reform of its investment tax regime. Investors may be obliged to contribute more and enjoy fewer exemptions. But retrospective orders, though they may be designed to correct past mismoves, create problems that can stretch far into the future. And even while uncertainty reigns, investors are freezing up.

CONTEXT NEWS

- Foreign brokerages are worried about recent provisions, designed to tax indirect investments and combat tax evasion in India. They say the provisions are couched in ambiguous language and could also be used to target overseas market investors. That, in turn, could risk a sell-off in markets, Reuters reported on March 28.

- The Asia Securities Industry and Financial Markets Association, a lobby group, published a letter to Finance Minister Pranab Mukherjee on March 28, expressing "deep concern," and asking for the government to clarify its stance.

- At the heart of its concerns are two provisions announced this month. The first gives India power to retroactively tax the indirect transfer of assets, which was widely seen as targeting Vodafone's $11 billion purchase of Hutchison Whampoa's Indian assets. The second targets tax evaders via the General Anti-Avoidance Rule (GAAR), putting the onus on investors registered in countries with special tax exemptions with India to prove they do not intend to explicitly avoid taxes.

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own)

(Editing by Robert Cole and David Evans)

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