Should India scrap the Retrospective Tax which is a huge letdown for foreign investors?

Should India Scrap The Retrospective Tax Which Is A Huge Letdown For Foreign Investors?

The case of Retrospective Tax took shape in India when, in January 2012, the Indian government led by United Progressive Alliance (UPA) suffered a major setback after Supreme Court passed its verdict in favor of British Telecom operator Vodafone, affirming that the company has no liability of Rs. 20,000 crore towards the Indian tax officials.

The claim of tax from Vodafone stemmed from its acquisition of India based mobile operator, Hutchison Essar in 2007. The legal defeat prompted the government to bring amendments relating to cross-border transaction in the Income Tax Act of 1961, which were applied retrospectively, allowing a gateway for the Indian tax officials to re-open cases of cross-border deals and claim tax applicability, which earlier were not under the ambit of taxation as per previous provisions.

In Favor:

1) Retrospective Tax could bring revenues to government but at a hefty cost of shooing foreign investors away.

2) While the previous UPA government acted strangely to deal with the issue, the new government, National Democratic Alliance (NDA) headed by Prime Minister Narendra Modi is keen on setting the things right by pulling off the retrospective tax rule altogether.

3) The move could be favourable for India, which has recently recovered from a financial crisis and is overly dependent on foreign institutional investors.

4) India is not the first or only nation to apply the tax retrospectively as countries like U.K. and Australia have also applied such amendments in their taxation policies to curb avoidance of tax by foreign companies.

5) If a law appears to be lacking or provides leeway for foreign companies to avoid tax then the legislature has right to amend and rectify law and tax retrospectively. The curative and validating nature applied by the legislation does not necessary mean overturning of judicial decision. While adopting retrospective taxation in a case, the context, period and the financial burden on the party should be considered and if the applicability of such taxation appears valid then it should be imposed with no difficulty.

Against:

1) The weapon of minting money through taxes is regarded as Tax Terrorism and hampers the growth prospects of India as an investment destination.

2) The case of retrospective tax poses itself as a barrier for the entry of foreign investors, who do not want to be a part of dragging tax disputes. Moreover, the retrospective tax has not only opened up Vodafone case but is a threat to at least 20 more such cases including Royal Dutch Shell Plc, Finnish handset maker Nokia, WNS Holdings and IT firm IBM.

3) Retrospective tax can be mis-used and the same can be used for extorting money from companies.

4) Retrospective tax, if enforced forcefully can lead to legal tangles and result in loss to exchequer.

5) Retrospective tax can also lead to FII’s pulling out their money out of India thinking that the business environment is not friendly or conducive for investment, which would indirectly impact growth.

Conclusion: The Parthasarathi Shome panel, which was entrusted with the work of looking into the controversial retrospective tax issue as well as framing the final roadmap on the General Anti Avoidance Rules (GAAR), expressed that retrospective tax should apply but should be restricted to the rarest of rare cases. Repealing the taxation in totality could encourage foreign investors to indulge in heavy tax avoidance, which in turn will hurt India’s revenues. Thus, it is best to apply the tax rule on a case to case basis rather than scraping it completely.