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Proposed Indian tax rule could impact free trade talks with the EU and Canada

Punjab Newsline Network | Tuesday, March 20, 2012

Proposed Indian tax rule could impact free trade talks with the EU and Canada

LONDON: The latest Indian annual budget for 2012-2013, revealed by India’s Finance Minister Pranab Mukherjee last Friday, takes India a step backward toward its previous economic protectionist policies and could derail its discussions for free trade agreements with the European Union as well as Canada.

The government proposed to levy a heavy retrospective tax on some international mergers that would allow it to tax any overseas merger dating back to 1962 when an underlying Indian asset was transferred.

“If passed, this tax legislation will be a shot in the foot of India’s economy,” said Bundeep Singh Rangar, Chairman of London-based advisory firm IndusView UK Ltd. “It sends a message of ever changing goalposts to foreign investors and fund managers and could make India’s risk profile unpalatable to them.”

The announcement in India’s budget comes at a time when India and Canada are in talks to finalize the Comprehensive Economic Partnership Agreement (CEPA) or Free Trade Agreement by 2013. The bilateraltrade is likely to touch $20 billion by 2020. Since 2007, India and the European Union have also been negotiating a free trade agreement, officially known as the Bilateral Trade and Investment Agreement (BTIA), that covers trade in goods and services aside from rules pertaining to cross-border investments, competition policy, government procurement and state aid.

“Free trade agreements are premised on economic openness,” said Mr. Rangar. “The new tax sends a dangerous signal to the contrary and brings back memories of India’s socialist past that made it one of the world’s slowest growing economies,” said Mr. Rangar. “It would not be a surprise if multinationals pressed their governments to bring up this proposed tax in World Trade Organization (WTO) discussions. Or they will simply walkaway from India. In either instance, India stands to damage its international standing.”

The disturbing thing is that the tax is retrospective. The Indian budget stated it would seek to change India’s laws to enable the Indian taxman to tax capital gains made by foreign companies after it lost a $2.2 billion court battle with Britain’s Vodafone Plc in January. The Indian government is currently appealing that Supreme Court decision.

“Foreign investors will seriously and understandably question the stability of the regulatory environment in India,” said Mr. Rangar. “India is entitled to tax local companies for capital gains and corporate income tax. Taxing overseas entities for Indian assets purchased over the past 40 years, however, is a step too far, very impractical to implement and could lead to reciprocal tax treatment for Indian companies that purchased overseas assets. That would be a double blow to India Inc.”

The Indian government’s motivation seems to be to increase its tax collection and reduce its budget deficit to 5.1 percent of gross domestic product next fiscal year, from 5.9 percent this year by capping subsidy spending and raising taxes. India had targeted a budget deficit of 4.6 percent for the current fiscal year ending in March 2012 and will miss that by a wider margin than many economists had expected.

“Increasing tax revenue is a laudable goal for India,” said Mr. Rangar. “That should, however, come from encouraging the number of new financial transactions notsqueezing those that do take place. Besides, India has a dismal income tax base of 2.77%. The government should focus on increasing that tax base rather than punishing corporate buyers of Indian assets.”

The Minister of State for Finance S.S. Palanimanickam said in a written reply to a question posed in India’s Parliament last August that the number of taxpayers was 33.57 million out of a 1.21 billion population. Vodafone’s purchase of Hutchisson Essar, since renamed Vodafone India, was intended toexpand revenue in the face of saturated mobile telecoms markets in Western Europe. India presents itself as one of the world’s fastest growing economies, a position achieved via the opening of its economy and flood of foreign direct investment that totaled $19.43 billion in the year to March 2011 according to India’s Ministry of Commerce and Industry. India’s latest budget, however, threatens to squeeze the tap for overseas funding.

Another clause in the Union Budget 2012, which proposes to taxangel investments, has been termed by more than a dozen industry watchers as “a death blow” which has the “potential to kill entrepreneurial-startup ecosystem” in India. The decision has already created negative feedback among entrepreneurs and might lead to depressed valuations for these companies. Under this proposal, the government will treat all individual investments in a company as “income from other sources” and they will be subject to a tax of 30% at the hands of the companies.

For capital markets, the government announced a number of measures, including tax incentives for small investors in equity savings schemes, reducing taxes on securities transactions, allowing qualified foreign investors in the domestic bond market and easier norms for listing of corporate bond offerings in exchanges.

The budget also sought to restrict subsidies and move to a direct cash transfer system, both seen as positive moves. The government proposes to limit subsidies to 2% of GDP over the next three years and 1.7% thereafter. It also encourages adoption of the Unique Identification (UID) system to provide for direct cash transfers to recipients.

The budget was also positive for investments in infrastructure. More infrastructure sectors were added as eligible for gap funding from the government. The amount of tax free bonds which state-owned infrastructure companies can issue was doubled from $6 billion to $12 billion (from Rs.300 billion to Rs.600 billion); spending on key infra sectors was increased significantly; foreign financing through the External Commercial Borrowing (ECB) guidelines was opened for capital spending on highways, working capital for airlines, low cost affordable housing, among others.


 source: Punjab Newsline Network