Interestingly, the current finance minister who is trying his best to undo the damage done to foreign investor sentiment by one of his predecessors resorted to similar expressions as the latter. “India is not so vulnerable that every legitimate tax demand is considered as tax terrorism… we are not a tax haven and we don’t intend to be one,” stated Arun Jaitley at the AGM of CII. The author of the controversial retrospective tax amendments similarly argued that a 1.2 billion nation cannot be allowed to be a tax haven; that India was not a banana republic in which any one can escape without paying the country’s taxes!
In one case, the tough talk was to dismiss demands from FIIs for retrospective exemption from tax notices sent to them by revenue authorities to pay Minimum Alternate Tax for earlier years. In his budget 2015 speech, Jaitley proposed to scrap MAT on capital gains by FIIs prospectively.
The other case was a strong defence of retrospective taxation. A strong message was being sent to MNCs that taxmen have been given powers to reopen tax cases going back to 1962, particularly to target telecom giant Vodafone, which refused to pay tax on its offshore acquisition of a mobile telephone asset located in India.
Foreign investors can’t have it both ways on retrospective taxation! But there is no doubt that this amendment to the Income Tax Act was a transformational moment when investor sentiment turned adverse during the last years of the UPA regime. Tackling this legacy issue remains a top priority of the NDA government. An emerging economy like India expects huge amounts of FDI to help build its roads, ports, high speed railways and airports. Obviously, it cannot indulge in what has been termed tax terrorism or very aggressive tax laws, as the current finance minister rightly emphasised.
The converse of this is not a tax haven, but a stable tax regime which has greater clarity on laws; a non-adversarial administration and a fair mechanism for resolving disputes. India, however, cannot push too strongly that it is not a tax haven to fend off pressure from FIIs who seek retrospective tax exemptions. The reality is otherwise. For example, 10-year tax holidays have been introduced in the tax law precisely to attract foreign investment, and this has worked very well. It was certainly successful in attracting a lot of investment in telecom that is the poster child of reforms.
A lot of the so-called “foreign investment” into India is, in fact, money laundered out of country and is now being routed back through tax havens like Mauritius. Singapore is fast catching up. In fact, as much as 36 per cent of the FDI that has come into the country from April 2000 to January 2015 is from Mauritius alone. This route has not been plugged to this day. The Indian Government has two options before it — to either amend its tax treaty with Mauritius, or indeed terminate it. Indonesia took the drastic latter option, as it was unhappy with the use of the Mauritius route by foreign investors. But the Indian government, no doubt for its own strategic reasons, has not taken such a step, including the fact that there has been considerable resistance to change from Mauritius itself.
Besides Mauritius, FDI to the country comes from other tax havens like Singapore, Cayman Islands, British Virginia, Bermuda, Virgin Islands, Malta, Bahamas and the Isle of Man – all of which amount to more than half of India’s FDI equity inflows of $243 billion from April 2000 to January 2015! So much for the tax haven argument! Most of India’s outbound FDI, too, is routed through tax havens like Singapore. Jaitley, for his part, has only partially succeeded in making the tax regime non-adversarial and conducive for investors. If foreign investors secured relief from the lower courts in transfer pricing disputes, the tax authorities have been urged to desist from appealing in the Supreme Court. But the spectre of retrospective taxation still has not been exorcised from the books. In Budget 2015, he only reaffirmed what he stated in his interim Budget last year that retrospective tax provisions adversely impact the stability and predictability of the taxation regime and resort to such provisions shall be avoided. To make good on his assurance, the finance minister has deferred the implementation of a General Anti-Avoidance Rule (GAAR) – which already exists in China, Canada, Australia and soon in the UK — to counter aggressive tax avoidance in two years. It has also been decided that when implemented, GAAR would apply prospectively to investments made on or after 01.04.2017.
GAAR was sought to be introduced in Budget 2013 to prevent tax evaders from routing their investments through tax havens like Mauritius, Luxembourg and Switzerland, but has been postponed since then.
Budget 2015, however, sought to provide greater clarity on the taxation regime for offshore mergers and acquisitions, like Vodafone’s acquisition of Hutchison Whampoa’s stake in 2007 to enter the domestic mobile telecom space. Capital gains tax will be applied to all transactions involving indirect transfer of a foreign company’s assets if 50 per cent or more of the company’s assets are based in India. However, these provisions will not apply if the value of Indian assets does not exceed $1.6 million. Only the income pertaining to Indian operations will be taxed on a pro rata basis.
Despite these measures, however, foreign investor apprehensions still linger. The reason why retrospective taxation still remains in law is simple. As the government has not got its fiscal house in order, it is loath to forgo the huge revenues that can be tapped through taxing foreign M&A transactions. A ballpark estimate is that revenues of around Rs 40,000 crore are at stake!
But the truth is that taxing global M&As and slapping massive transfer pricing demands is no substitute for setting right finances. Furiously arguing that we are not a tax haven is no substitute either.
(N Chandra Mohan is an economics and business commentator based in New Delhi)
N Chandra Mohan
