BREAKINGVIEWS: Govt sensibly considers GAAR U-turn

Prime Minister Manmohan Singh (R) speaks with Palaniappan Chidambaram during a seminar at the Asian Development Bank annual meeting in Hyderabad May 5, 2006.

MUMBAI (Reuters Breakingviews) - The Indian economy needs reform urgently but fractious politics are holding back the nation. Under the circumstances, an expert panel's recommendation to reverse investors' tax uncertainly after this year's budget is quite good news. The government should quickly accept the advice.

Back in March, the then finance minister, Pranab Mukherjee, spooked overseas investors with two announcements: a decision to override a Supreme Court ruling on a tax case in favour of UK-based telecom operator Vodafone and a punitive set of laws that would raise taxes on investments in the name of reducing tax avoidance. The fickle and hostile policy risked making India a no-go zone for all but the most intrepid foreign capitalists.

Since then, Mukherjee has been kicked upstairs to the ceremonial role of President and both the new Finance Minister, P. Chidambaram and the prime minister, Manmohan Singh, have made no secret of their desire to overturn Mukherjee's mess.

New Delhi has a habit of over-promising on reforms, but so far so good. A panel of experts was set up following Mukherjee's promotion which has come back in unusually quick time with recommendations that would delay implementation of the General Anti Avoidance Rules (GAAR) for another three years - and when they are implemented excluding foreign investors in securities from the short-term capital gains tax of 15 percent on overseas investments.

The government now needs to act with even more speed and accept the proposals. The finance minister might even go the whole hog and call off the Vodafone case too. These steps would make the route for foreign investors into India less rocky, but ultimately investors want returns as well as tax certainty.

That will be harder. While the government's political opponents don't care much either way about Mukherjee's tax mess, fixing the mess he made of the public finances and pushing forward with the economic reforms he failed to champion will take more political capital than Singh and Chidambaram appear to have right now.

CONTEXT NEWS

- A controversial set of laws to stop tax avoidance in India should be deferred until 2016, an advisory panel, set up by Prime Minister Manmohan Singh to examine the rules, said on September 1 the general anti-avoidance rules (GAAR) target firms and investors routing money through tax havens.

- A committee set up to review the rules for portfolio investors coming into India through the foreign institutional investor (FIIs) route has recommended that all kinds of non-resident investors through FIIs, either direct or indirect, be spared from GAAR so far as transactions in listed securities are concerned. FIIs who do not seek benefits of tax treaties would also not come under GAAR, the panel said in its draft recommendations.

- Analysts said this provides clarity to those investing through FIIs in India, using instruments such as participatory notes. However, the panel clarified that all these exemptions to non-resident investors through FIIs be restricted to only transactions in listed securities.

- The committee has also suggested removing short-term capital gains tax, 15 percent at present, and increasing the securities transaction tax to make it tax-neutral for the government. At present, stock market investors don't pay any tax if they hold shares for over a year. However, if they sell shares within a year, they have to pay 15 percent tax on gains made through such transactions.

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

(Editing by Edward Hadas and Sarah Bailey)