For corporate taxpayers in India, promises from the recently elected BJP Government that it will put a stop to retrospective law making must have felt like a breath of fresh air. However, with trust between investors and the Government at a low ebb, and a mounting pile of legal issues to resolve, especially in the area of taxation, Prime Minister Nahrendra Modi’s new administration has little time to lose.
On June 6, 2014, India's Finance Minister, Arun Jaitley, held a pre-budget consultation meeting with representatives from trade and industry bodies, which urged the Government to introduce predictable tax policies to foster greater confidence in India as a place to invest and do business.
In particular, the industry and trade bodies urged the government to not give retrospective effect to tax laws as it hurts business sentiment and discourages foreign investment. Instead, they called for credible policies, continuity, and clearer laws.
The Confederation for Indian Industry (CII) pressed for an amendment to the Income Tax Act to reverse the retrospective amendment in the dispute with Vodafone, and called for an end to such policies. "A simple, transparent and non-adversarial tax regime bereft of complexities and ambiguities would go a long way to strengthen business sentiment and restore faith of the foreign investor in the India growth story," the Confederation stated.
Ajay Shriram, the CII's President, said at the meeting that: "At a time when the Indian economy is struggling to regain its growth momentum and investment sentiment is weak, frequent and retrospective changes in tax laws, which are ambiguous and open to wide interpretation, should be avoided to restore investor confidence."
"A pro-growth budget which makes a bold statement on reforms would go a long way to effect a turnaround in sentiment and mark a return to growth. The economy is at an inflexion point and is awaiting remedial action. CII is looking for Credibility, Continuity, and Clarity from the Budget," he said.
The New Government
The good news is that the new Government seems to be on the same page as the CII and other representatives of domestic and foreign businesses, at least judging by recent statements from senior BJP figures and from Modi himself.
On the first day of the new government, Ravi Shankar Prasad, India's Minister for Telecommunications, Law, and Information Technology promised foreign investors a stable and transparent investment climate, hinting at the end of controversial retrospective tax policies in India. "The larger view is that retrospectivity [should be] avoided to the maximum. The fiscal regime, the policy regime, taxation regime must be very evident because India needs investment," he told a local press briefing.
The bad news is the amount of work to be done by the new administration to restore the trust and confidence of the business and foreign investor community. These issues are summarised below.
Unresolved Tax Disputes
In May 2014, Vodafone chief Vittorio Colao called on India's Government-elect to make good on its election promises and demonstrate "how open the country is again."
Colao told reporters in London that the introduction of retrospective tax legislation had been "really damaging to the Indian reputation." The changes to the Income Tax Act were implemented as part of Finance Bill 2012. They stipulate that shares in a foreign entity should be treated as being located in India if the foreign entity's profit substantially derives from India-based assets. The provisions were given retroactive effect from 1961.
Colao is optimistic that the Bharatiya Janata Party "will quickly do something to restore confidence in the country." As for Vodafone, its stance is "never adversarial." The company is willing to "engage in any conversation," Colao said.
In April 2014, Vodafone launched international arbitration proceedings in an effort to bring its long running dispute with the Indian tax authorities to a close. The outgoing administration withdrew its offer for non-binding conciliation talks in response.
The Vodafone affair can be traced back to the company's USD11.2bn purchase of a 67 percent stake in India's Hutchison Essar Ltd. The deal was structured as a transaction between Vodafone's Dutch subsidiary and a Cayman Islands-based company that held Hutchison Whampoa's Indian assets, but the Indian Tax Office said that Vodafone was liable to be taxed because the majority of assets were based in India, and that under Indian law, buyers have to withhold capital gains tax. Vodafone, however, contended that as it was the purchaser, not the seller, it made no taxable gain from the transaction. Vodafone went to court in an attempt to overturn the tax office's demand for USD2.2bn in back taxes, and while the courts initially rejected the company's arguments, the Supreme Court ruled in January 2012 that Vodafone had no reason to withhold tax.
It was the Vodafone case above all that prompted the former Government to introduce retrospective tax measures in 2012 Finance Act to the effect that for tax purposes, any entity registered outside of India will be deemed to be resident in India if its value derives substantially from assets located in India. These changes were made effective from April 1, 1961. Since then, Vodafone has been issued with a “reminder” about its previous tax liability, and has been embroiled in separate disputes involving alleged transfer pricing abuses.
When pressed on the Vodafone tax dispute, Prasad said: "We will look into it. Our manifesto has been very specific that we want a stable regime where those who invest in India may not have to face uncertainty," adding that a stable fiscal and legal policies would attract higher foreign investment.
However, there is a growing list of multinationals with a grievance with the Indian tax authorities.
Nokia has followed Vodafone's lead and begun international arbitration proceedings in an attempt to resolve tax disputes with the Indian authorities. The mobile phone manufacturer has invoked the 2003 India-Finland Bilateral Investment Promotion and Protection Agreement, and has written to the Government to explain its actions. A statement said: "Nokia is keen to work with authorities in India to resolve the tax disputes. The letter seeks for amicable resolution of the current tax disputes."
In April 2014, Nokia was forced to leave its Indian factory out of its takeover deal with Microsoft as a result of its ongoing tax problems. The company's Indian assets were seized by the Income Tax Department in 2013 in an attempt to claw back royalties the Indian state says Nokia owes for the period between 2006-07 and 2011-12. Nokia has contested this demand and is also fighting an attempt by the Tamil Nadu tax department to assess sales tax on the export of devices from its Chennai plant.
Cairn Energy said on May 15, 2014, that it is actively seeking the resolution of its dispute with the Indian tax authorities. In an interim management statement from the company, Cairn confirmed that for as long as the row is ongoing it is still unable to sell a residual shareholding in Cairn India Limited, valued at USD1.1bn.
The Indian Income Tax Department is seeking the payment of capital gains tax it says that Cairn's wholly owned UK subsidiary should have withheld when transferring assets to its Indian parent, Cairn Energy PLC, during the Indian fiscal year ending March 31, 2007. Cairn has already filed a nil notice for the period in question, and claims that none of the transactions it undertook then is chargeable to tax in India.
Cairn's recently retired Chairman has also urged the new Modi Government to tackle the problems with the country's tax system head on. Speaking to The Telegraph newspaper, he said that India must try to be more investor-friendly, and pointed out that Cairn was just one of a number of companies with outstanding "tax questions" there.
"I would very much hope that one of the first things the new Government sorts out is that they look at the whole retrospective tax legislation, and the impact it is having on foreign investment," he said.
Direct Taxes Code
Growing uncertainty continues to hang over the much-delayed Direct Taxes Code. The original 2010 DTC Bill was drawn up in 2009 to consolidate and amend the law relating to direct taxes, to bring about an effective and equitable direct tax system in India and was introduced in the lower house of Parliament on August 30, 2010. The Standing Committee on Finance (SCF), after examining the draft 2010 DTC Bill, presented its report on modifications in March 2012. Several of these recommendations have been incorporated into a new version of the legislation, known as the 2013 DTC Bill.
Among the proposed changes, the Code would be amended to modify the treatment of transactions with non-residents, particularly indirect transfers of assets located in India. Income arising from the indirect transfer of assets would be subject to tax in India where 20 percent of the total assets are located in India. The earlier draft provided for a threshold of 50 percent, but the SCF warned that even a threshold of 33.3 percent could be manipulated to the extent that the transfer could avoid tax altogether. Exemption is provided for the transfer of small share holdings (up to 5 percent) outside India, the SCF pointed out. The 20 percent proposal is however widely considered to be impracticable.
The definition of "place of effective management" (POEM) would be modified to the place where key management and commercial decisions necessary for the conduct of business as a whole are made. Earlier, in the draft 2010 DTC Bill, POEM was to be defined as the place where the board of directors made or approved commercial or strategic decisions regarding the company. The SCF had considered that the definition in the draft DTC Bill 2010 was unclear, and could create uncertainty.
Modifications to general anti-avoidance rules (GAAR) are also in the pipeline. The SCF recommendations in this area, agreed by the Government, included that the onus of proof should rest on the tax authority invoking the GAAR. It was also proposed that the constitution of the panel approving the use of the GAAR should be reviewed, and it was advocated that taxpayers should also be permitted to obtain an advance ruling to determine whether a transaction would face the GAAR.
The Income Tax Department has appealed to politicians to enact the 2013 Code in 2014-15, but each successive set of amendments has made the proposals less and less realistic. It now seems unlikely that anything remotely resembling the current draft will ever be enacted.
In June 2014 it was announced that India's new Finance Minister, Arun Jaitley, is to meet with state finance ministers this month to discuss how to overcome the obstacles preventing the adoption of a Goods and Services Tax (GST).
Jaitley made the announcement following a briefing, which was arranged to bring him up to speed on progress towards implementing the new regime. In its pre-election manifesto, the Government committed to discuss with state ministers their concerns and to agree solutions.
Implementation of a nationwide GST would introduce a simple, internationally-accepted tax regime to broaden the tax base and enable the country to lower trade tariffs. GST would replace the central sales tax, the state sales tax, entertainment tax, lottery tax, electricity duty, and value-added tax.
A first step towards GST adoption will be the passage of the Constitution Amendment Bill, which must receive support from two thirds of lawmakers in India's bicameral legislature, majority backing from state authorities, and lastly presidential endorsement before it can take effect.
Work towards a GST for India has been ongoing since 1994, and a new law had been envisaged to be in place by April 2010. Recent issues that have scuppered progress have been the compensation package for states in exchange for the repeal of the Central Sales Tax (CST), proposals for a Dispute Settlement Body, and the issue of whether petroleum products and liquor should be included in the GST base.
Given his pro-business credentials, it will be interesting to see how Modi approaches the long-standing dispute between India and Mauritius over the two countries’ bilateral double tax avoidance agreement (DTA).
Foreign investors have previously preferred to route funds into India via Mauritius because of the tax advantages offered by the Indo-Mauritius DTA, which was signed in 1983. India has long pushed for changes to this agreement. In particular concern has been expressed regarding the capital gains tax (CGT) clauses that permit both resident Indian and foreign investors to route investments into India and take tax-free gains.
The current DTA only provides for CGT in an investor's country of residence, but the Indian Government is said to be seeking the imposition of CGT on any investments re-routed from Mauritius to curb tax avoidance.
Mauritius has proposed to the new Indian Government that it will approve a new stringent limitation of benefits clause in a revised India-Mauritius double tax treaty, and will exchange information on persons applying to be registered in the territory with Indian authorities automatically. Mauritian Prime Minister Navin Ramgoolam made the pledge during his visit to India to attend Modi’s swearing-in ceremony. He said: "There must be a quick resolution to resolve all issues related to the double tax avoidance agreement between the two countries."
Mauritius has pledged to set up a joint authority with India to oversee the automatic sharing of information on entities wishing to register in Mauritius that are seeking to invest in India. In addition, Mauritius has promised to vet companies registering in the territory to ensure that they meet well-defined criteria, in particular that they should be registering the company for a legitimate business purpose, and that there should be commercial value and economic substance linked to the choice of Mauritius as a business location.
In return, Ramgoolam said India should encourage businesses to use the financial sector of Mauritius by mobilizing funds on favourable terms and conditions for financing major infrastructural projects. Ramgoolam said Mauritius will defend the reputation of its financial sector, which he said is on the white list of the Organisation for Economic Cooperation and Development, thus confirming its credibility. Ramgoolam said after the meeting that: "We both agreed that there must be a quick resolution for certainty, clarity, and predictability."
For Modi however, this might not be such a significant issue as it was for previous administration because foreign investors routing investments through Mauritius are said to be concerned about the impact of India's GAAR, which would challenge triangulated investments through tax havens. These Rules are due to come into effect from April 1, 2016.
The meeting occurred within days of the publication of figures compiled by India's Department of Industrial Policy and Promotion that showed that Singapore surpassed Mauritius as the leading source of foreign direct investment (FDI) into India in the 2013/14 financial year (to March 31, 2014), which it attributed to tax considerations.
Out of the total equity inflow to India that year of USD24.3bn, FDI from Singapore rose from only USD2.3bn in 2012/13 to almost USD6bn in 2013/14, while FDI from Mauritius fell from USD9.5bn to USD4.86bn. FDI equity to India from the United Kingdom also increased from only USD1.1bn in the previous year to USD3.2bn in 2013/14.
However, it is still noticeable that, out of the total FDI equity inflows of USD217.6bn into India since April 2000, Mauritius has supplied 36 percent, or USD78.5bn, compared with Singapore's total of USD25.4bn (12 percent), and the UK's total of USD20.8bn (10 percent).
India's DTA with Singapore has adopted a protocol that limits the ability of third-country residents to "treaty shop" to obtain the treaty's CGT benefits, by preventing entitlement to those investments into India, including those by shell and conduit companies, "arranged with the primary purpose to take advantage" of the DTA's provisions. It is thereby seen to afford foreign investors into India a greater surety of satisfying the future GAAR rules.
Special Economic Zones
The removal of tax incentives for companies operating out of India’s special economic zones has been a major source of frustration for the country’s businesses. However, the Indian Ministry of Industry and Commerce is hoping to restore a number of tax concessions for SEZs in the upcoming budget.
The Ministry said it would call on the Government to reintroduce an exemption for developers and business units operating in the special economic zones (SEZs) from the minimum alternate tax (MAT) and dividend distribution tax (DDT). These were introduced on companies based in SEZs in the 2011/12 Budget.
On June 8, 2014, the Associated Chambers of Commerce and Industry of India (ASSOCHAM) called on the Government to support the withdrawal of the two levies to "regain the trust of domestic and global investors."
"If immediate action is taken by implementing these corrective measures it would restore investor confidence and bring back SEZs to the forefront of economic and industrial development," said D S Rawat of ASSOCHAM, while releasing a report entitled Suggestions to Revive Special Economic Zones.
SEZs in India offer a number of tax incentives, including temporary tax holidays and import duty waivers, but uncertainty concerning tax perks for the zones and the current tax burden is said to be stifling investment.
It all sounds rather positive at the moment, although it is still far too early to judge a government that has only just come to power. The budget due to be announced in July 2014 will give us whether the BJP is prepared to back up its fine words with concrete actions.