In the first two-and-a-half weeks of May, foreign investors withdrew over Rs.16,700 crore from Indian equities and debts.

Manish K. Pandey | The Dollar Business

One of the few things that the Modi-led NDA government has been most vocal about, ever since it came to power in New Delhi, is the establishment of a pro-business environment in the country. The government has been trying hard to distinguish itself from its predecessors by chanting words and phrases that portray it as business friendly. “Make in India”, “Ease of Doing Business”, etc., have become the modernly-regarded sacred chants of the entire country. Well, at least practically so! But then, what one does is more important than what one says. And the policymakers at the helm of affairs seem to have forgotten this age-old adage! That’s the message their actions seem to be indicating of late.

Just two months back, in March 2015, Cairn India was slapped a tax notice worth $3.3 billion for transactions dating back to FY2006-07. Reason, as per tax officials, was simple: Cairn did not pay tax on the capital gains arising out of the transfer of shares from its erstwhile UK parent (Cairn Energy PLC) to its Indian subsidiary, Cairn India (now a part of the Vedanta Group).

It was around the same time when foreign institutional investors (FIIs) also started receiving notices from the tax authorities. FIIs were asked to cough up something called the Minimum Alternative Tax (MAT), a 20% levy which traditionally applied to domestic firms that would otherwise pay zero corporate tax because of various exemptions. In fact, till date, tax authorities have issued notices amounting to over Rs.600 crore (in taxes) to a group of about 70 FIIs.

What’s even more shocking is the fact that they are being taxed for the profits made by them in FY2012-13. Result: The wildfire has forced foreign investors to stay away from India. According to the Securities and Exchange Board of India (SEBI) data, foreign investors have reduced their portfolio investments in India from Rs.24,564 crore in February 2015 to Rs.15,266 crore in April 2015. In fact, matters worsened in May. In the first two-and-a-half weeks of the month, foreign investors withdrew over Rs.16,700 crore from Indian equities and debts.

Global rating agency Fitch is of the opinion that the ongoing retrospective tax issue will force foreign investors to think twice before investing in India. [Obviously! I’m not one of those who loves the feeling of pseudo-safety, with my head buried deep in the sand!] In fact, the Vodafone case is a classic example of what such retrospective tax bills can do to financial markets that thrive on foreign money. When, in 2012, Vodafone was asked to pay more than Rs.20,000 crore in back taxes for its purchase of Hutchison Essar Telecom in April 2007, foreign portfolio investments in India dropped from Rs.1,68,000 crore to Rs.51,000 crore the very same year.

Although the Modi wave and pro-business agendas propagated by NDA have been successful in attracting a net investment of Rs.2,80,000 crore into the Indian stock and debt markets (the highest ever annual investment India has seen so far) in FY2014-15, the euphoria won’t last long if the government does not ensure a stable and logical tax regime in the country.

Has the government bowed down to the finance-ministry bureaucrats who are busy bridging the fiscal gap, or are phrases like “Make in India” and “Ease of Doing Business” nothing but balderdash? Whatever the case may be, one thing is sure – the tax authorities have brought a wrecking ball to Mr. Modi’s business-friendly sarkar. And the damage has been done. But time can heal. In this case too. What is needed is a complete overhaul of the Indian tax system as the real problem is that India’s taxation system is adversarial and focuses more on implementation instead of compliance. High rates of corporate taxes (as against its global peers) further complicate the situation. Although the previous governments have tried to compensate it through deductions and exemptions, the moves have only lead to more ambiguity with respect to tax laws, and in turn bigger, darker loopholes.

If the government really wants to make “Make in India” a success and improve the ease of doing business in the country, all it needs to do is stop sending such wrong messages about its taxation policy. And all policymakers will have to do is go back to the drawing board and simplify the system. That’s where they need to invest their time, not in holding up foreign investors for what looks like extortion! 

May 30, 2015 | 11:54 pm IST.