Modi has failed to end India’s tax terror

Foreign investors want India's tax system to be less capricious and retrospective tax given a formal burial.

A sign outside of the income tax office in Kolkata | Photo: Brent Lewin | Bloomberg

Exit polls are pointing to another term for Narendra Modi in India, but don’t expect overseas investors to be as pumped up by his victory as they were five years ago. Before he offers any new promises, they would like the prime minister to fulfill his pledge to make the tax system less capricious.

In its 2014 election manifesto, Modi’s Bharatiya Janata Party attacked the then Congress Party-led government for unleashing “tax terrorism and uncertainty,” which it argued, “not only creates anxiety among the business class and negatively impacts the investment climate, but also dents the image of the country.”

Team Modi’s promise of a non-adversarial tax environment gave hope to the likes of the U.K.’s Cairn Energy Plc, which earlier that year had landed on the radar of Indian tax authorities for dodging a levy on purported capital gains.

The transaction in question was an eight-year-old reorganization. Cairn Energy transferred ownership of its Indian oil field in 2006 to Cairn India Ltd., to prepare for the local unit’s initial public offering. But in January 2014, the Indian tax department began questioning the internal transfer of shares, weaponizing a 2012 law that allowed for windfall gains to be probed retrospectively, going all the way back to 1962. Cairn has been contesting the government’s right to tax the transaction.

Modi’s party – looking to unseat the Manmohan Singh government on charges of corruption, policy paralysis and economic mismanagement – managed to latch on to the angst caused by retrospective taxation.

It was one of the Singh government’s many blunders, a typical bureaucratic overreaction to a long-running tax dispute with Vodafone Group Plc. Apparently, while buying the Indian mobile-phone business of Hong Kong tycoon Li Ka-shing in 2007, the British telco should have held back a portion of the payment for the taxman. Or so the authorities contended, even though the transaction had occurred entirely outside the country. When Singh’s administration lost its $2.2 billion withholding tax claim in India’s Supreme Court, it changed the law and gave itself power over offshore deals.

Vodafone’s travails made international headlines, and that’s why investors took comfort from the BJP manifesto. To see what happened next, let’s return to Cairn. In March 2015, almost a year after the Modi government won its popular mandate, Cairn Energy received a rude tax bill. In February 2016, a final assessment order pegged the dues, including interest and penalties, at 290 billion rupees, or $4.3 billion at the prevailing exchange rate.

After Cairn disputed the levy, New Delhi expropriated Cairn’s shares in Vedanta Ltd. (into which it had merged its Rajasthan oil field, the country’s biggest onshore discovery in two decades), pocketed the dividends and then sold the stock.

The exploration firm is now awaiting the outcome of international arbitration. Under a U.K.-India bilateral investment treaty, it’s claiming $1.4 billion in compensation. Vodafone, meanwhile, is fighting New Delhi under both the U.K-India accord and a Dutch-India agreement.

To be fair, the Modi administration didn’t abuse the draconian power of retrospective taxation any further. But by asking Vodafone and Cairn to take a “one-time offer” in which the penalty and interest would be dropped if they paid the tax, the BJP government showed no genuine desire to live up to the party’s 2014 manifesto. Given that there was plenty of expert advice within India damning retrospective taxation, the demands ought to have been scrapped.

A protracted U.S.-China trade war might bolster the investment case for India as an alternative to the People’s Republic. Yet the niggling suspicion of global investors that they could lose billions to policy fickleness is far from allayed. India’s official election results are due May 23. If Modi does return as prime minister, the least he can do is to signal an intention to honor international arbitration awards without further legal maneuvers.

The fairness point is already made. For deals getting done now, it’s clear to buyers and sellers that if ownership of offshore financial entities with substantial underlying Indian assets changes, capital gains taxes are payable locally. That was the case with India’s biggest e-commerce website, controlled by Singapore-based Flipkart Online Pvt., which was sold to Walmart Inc. in a $16 billion deal last year. Walmart deducted taxes, and the sellers didn’t complain.

There will be much bigger Indian assets created in the future, and plenty of levies to collect. Let victims of tax terror walk free, and be made whole. The whole idea of raking up the past – all the way back to 1962 – needs a formal burial. – Bloomberg.

1. U.K.-based Vedanta Resources Plc acquired a majority stake in Cairn India in 2010. In return, Cairn Energy got 9.8% of Vedanta’s India unit, which became 5% of the combined entity plus some preference shareswhen the two companies’Indian businesses merged in 2017.
2. New Delhi did try to use the 2012 law to collect taxes from overseas investors in global funds with substantial India exposure, but dropped the plan when fund managers pointed out that it would be impossible to implement. Since then, the tax department has overreached in other ways, such as by its bizarre insistence to treat angel investors’ equity contributions as taxable income of startups.

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.