I will be spending next week in Mumbai and Delhi (with @singarbitration), and in preparation have been contemplating the impact of the recent budget proposals on foreign investment, and in turn the implications for the Indian economy.
Before going on any trip, I like to remind myself of some basic economic facts, so my trusty EIU ‘World in 2012’ guide tells me that India has:
- GDP of $5,083 bn (PPP)
- a population of 1,220 m
- a per capital GDP of $4,170 (PPP)
- GDP growth 7.8%
- inflation 7.7%
Whilst these statistics are impressive, India’s growth rate has persistently been a couple of percentage points lower than that of China. The reasons for this are many, but commentators seem to agree that one factor is the barriers or impediments to foreign investment in many sectors of the Indian economy, which may help to stimulate competition and growth.
Regardless of sector, one key requirement of foreign investors in India is certainty over the rules for investment, and in that context recent attempts by India to levy retrospective tax charges are very (to put it mildly) unhelpful. I’ve blogged before on the Vodafone tax case, but since the helpful supreme court judgment rather unhelpfully the budget proposals published in March 2012 contains proposals that would change significant parts of Indian tax legislation with retrospective effect (back to 1962 in some cases) and reverse decided case law on many provisions.
There are 24 retroactive provisions in the bill designed, in the words of Revenue Secretary R S Gujral, to protect the government of India from returning taxes previously collected which it would otherwise be required to do to comply with Court decisions (in itself an extraordinary statement of disrespect for the Supreme Court of India and its position under the Indian Constitution).
Although presented as mere clarifications, the changes are clearly substantive changes in law and made as a direct reaction and in contradiction to various rulings and judgments of the courts in India. Specifically the changes are reinforced by a provision (s113) which grants the tax department wide ranging powers to demand, and collect and seize tax from taxpayers notwithstanding contrary judicial decisions. The changes go to the very heart of the constitution of India, the rule of law in India, and are likely to impact many Indian as well as international investors and businesses.
Specific international M&A aspects
The most prominent of the judgments proposed to be reversed is the January 2012 Supreme Court ruling relating to the 2007 Vodafone transaction, where it was held that an overseas share transfer cannot be taxed in India even if there is a consequent change in control of a lower tier company in India. The budget now seeks not only to overturn this ruling, which had been hailed both internationally and in India as a sign of the rule of law in India and a positive sign for investor certainty, but also to do so with retrospective effect. Numerous other companies would be affected, including AT&T, General Electric, Fosters, Sanofi-Aventis, Kraft-Cadbury, Cairns, Unilever, Accenture, Mcleod Russel and E-Trade as well as a reported 400 other transactions being investigated by the Indian tax office. As the legislation is retrospective to 1962 there may well be other transactions that can be targeted by the tax authorities which were completed decades ago.
In many of the cases, the targeted companies are purchasers who made no gain, but are being pursued for the tax on a gain realised by sellers. Doing this retrospectively is extraordinary; it is impossible to withhold retrospectively once the purchase price is paid.
In addition, other provisions included in the budget would expand the definition of ‘royalty’ retrospectively to 1 June 1976 aiming to nullify a number of recent rulings and court decisions, including cases involving Asia Satellite Telecommunications, Ericsson AB, Factset Research Systems, Infosys Technologies, Intelsat, ISRO Satellite Centre, Lucent Technologies, Motorola, TV Today Network, and Velankani Mauritius
Impact on Investors in India
The extreme nature of the retrospective changes is a significant departure from international norms and raises major concerns among investors and multinational companies in respect of their investments into India. It undermines public confidence in the judiciary and respect for the rule of law which is one of the fundamental principles of a democratic society. It further creates uncertainty on laws and unpredictability of the cost of doing business in India, and a perception that the revenue authority can act completely unchecked by the judiciary in India. If these proposals are enacted India would distance itself from other countries which are encouraging and bringing favourable reforms to encourage foreign direct investments.
The Watcher needs to make it clear that he has investors in India as clients, and this post should be read in that light.