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Business News/ Opinion / The spectre of retrospective taxation
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The spectre of retrospective taxation

India must eschew the temptation to find innovative ways to tax investors

Illustration: Jayachandran/Mint Premium
Illustration: Jayachandran/Mint

Few could have imagined that William Faulkner would come to the rescue of India’s taxation system. Yet, that is what Union finance minister Arun Jaitley did in an op-ed in Financial Times on Sunday when he quoted the American novelist, and claimed that, “All of the tax disputes now attracting attention are legacy cases arising from actions that the tax authorities and the judiciary took before we came to power." This is a remarkably weak defence of a taxation situation that threatens to harm India.

In his budget speech earlier this year, Jaitley brought relief to many by assuring that the minimum alternate tax (MAT) will not be applied to foreign institutional investors (FIIs) beginning 1 April 2015. Yet, this did not stop the income tax department in April from sending tax notices to more than a hundred FIIs—with the value of the claims estimated by the finance minister to be over 40,000 crore—for business transactions belonging to previous years. Speaking on the issue, Jaitley backed the actions of the taxman saying that India does not aspire to become a tax haven.

To make matters worse, his junior minister Jayant Sinha quoted a figure of 600 crore for the MAT demand. The variation between 600 crore and 40,000 crore is sure to deter even the hardiest believer in India.

The string of events over the month has spooked foreign investors, with the ensuing outflow of capital supposedly causing greater stock market volatility. The long-standing trouble over retrospective application of taxes has erupted again with foreign investors never missing an opportunity to raise it. It is worth noting in this context that the tax demand slapped on FIIs is only the latest in a slew of tax demands on a number of foreign companies over the last decade beginning with the one on Vodafone.

The culprit behind the growing number of tax-related litigation in recent years has been lack of clarity over the very rules governing taxation. With regards to MAT in particular, this can be traced back to two judgements passed by the Authority for Advanced Rulings (AAR), one in 2010 and another in 2012. While the former exempted foreign investors from MAT, the latter made MAT applicable to both domestic and foreign investors. The government has found reason in the 2012 judgment to go ahead with the current tax demand slapped on foreign investors.

Policy certainty is a crucial ingredient to achieving sustainable economic growth, with stable “rules of the game" assuring safety for investors wanting to engage in productive activity. India, however, has remained a laggard in this regard as various completely arbitrary tax-related actions have shown over the years. Much of the blame regarding retrospective taxation has been pinned on the 10-year rule under the previous United Progressive Alliance government. The current government, on the other hand, has repeatedly assured that it would bring about simplicity and stability to the tax regime.

The real issue, however, lies beyond distinctions along partisan lines. As the controversy over MAT has shown, uncertainty over the interpretation of existing laws remains a huge issue deterring long-term investment in India. In addition, with the absence of any clear signal that retrospective taxation will be illegal, investors are left to the mercy (or sympathy, if you prefer) of the government when making crucial investment decisions.

It is true that successive finance ministers, while refusing to outlaw retrospective taxation, have assured investors that their governments will not resort to the retrospective application of tax laws. The credibility of such assurances has not been worth writing home about as they have been broken during their own tenures. It is important to remember that stability in the rule of law requires its objective application, a feat that becomes possible only when rules are set down in law.

A related issue, and one that is close to MAT, is the predominance of exemptions in the Indian tax system which gives immense scope for both evasion and discretionary action by authorities. In fact, MAT was instituted to compensate for taxes that the government lost out on owing to multiple exemptions granted to various interest groups. The case for simpler tax rules cannot be overemphasized.

It is high time India moves beyond the current fashion of applying simplistic solutions to fix its retrospective taxation woes. Steps must be taken to restore the confidence of investors, which is only possible through a stable rule of law that adds much-needed certainty to policy.

Is uncertainty in tax administration hurting India’s image? Tell us at views@livemint.com

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Published: 28 Apr 2015, 04:31 PM IST
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