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Propelling FDI through tax reforms and exit mechanisms

Propelling FDI through tax reforms and exit mechanisms
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First Published: Fri, Feb 22 2008. 11 52 AM IST

Pallavi J Bakhru, partner- tax and regulatory services, and director-  International Business Centre, Grant Thornton India
Pallavi J Bakhru, partner- tax and regulatory services, and director- International Business Centre, Grant Thornton India
Updated: Fri, Feb 22 2008. 11 52 AM IST
Pallavi J Bakhru, partner- tax and regulatory services, and director- International Business Centre, Grant Thornton India
India has emerged as the most attractive destination for global foreign direct investment (FDI) in 2007 after China, ahead of the United States and Russia, according to the World Investment Report of the UNCTAD. The report states that the sustained growth in income has made the country increasingly attractive to market-seeking FDI.
Foreign investment is important since it supplements domestic sources of funds, which can then be channelized into critical areas such as infrastructure and power. Foreign investment also brings with it new technologies and management techniques that improve productivity and efficiency.
Many countries, including China, with which India has to compete for foreign capital, have been making it more attractive for foreign investors. China has implemented a single window clearance for foreign investors and has reduced its peak tax rate from 33% to 25%. Other countries have followed suit. Singapore, for instance, has reduced its tax rate to 18% and Hong Kong to 15% and both countries are imminently investor-friendly jurisdictions.
In view of this, apart from reducing the overall tax rate to an attractive level, it is critical for India to facilitate overseas investment by making it simpler to set up, carry out and exit from business operations in India. There has also been a growing demand from the investors to rationalize tax laws, increase transparency and stabilize the tax regime. Some of the possible measures that could achieve these objectives are discussed herein.
Advance Price Agreement
In order to provide stability to investors on their tax implications in India, the mechanism of Advanced Price Agreement (APA) needs to be considered.
An APA is an agreement between a potential investor and the revenue authorities, entered into prior to investing in India or undertaking a proposed transaction, which binds both of them to a defined transfer pricing methodology and margin on the proposed operations in India. Apart from providing stability to the investors on tax implications, it also reduces litigation with the revenue authorities with respect to transfer pricing methodologies and margins.
Dividend distribution tax
In addition to corporate tax, Indian tax laws levy a Dividend Distribution Tax (DDT, currently 17%) on the dividends declared. For foreign companies, the issue is compounded by the fact that certain countries do not provide credit for DDT paid by the Indian subsidiaries against the tax liability of dividends received offshore. This is because most treaties that India has entered into with various countries do not specifically deal with credit for DDT against the tax liability in that country. Therefore, apart from a reduction in the rate of DDT, clarity is required on the issue of credit for DDT.
Clarity on continued applicability of DTAAs
With a view to encourage foreign investment in India, treaties with certain countries like Mauritius, Cyprus, Singapore have beneficial clauses on exemption from capital gains in India on sale of shares of an Indian subsidiary. Off late, there have been discussions and deliberations on redrafting or renegotiating of such treaties, whereby such beneficial treatment could be withdrawn. This has resulted in uncertainty in the minds of investors who have already invested through these jurisdictions as well as potential investors. Clarity is needed on continuity of benefits associated with these treaties, one way or the other.
Exit options
Liquidation of an Indian company is an extremely complex and time consuming process with approvals required from various government authorities. There is a need to streamline and draft new laws that would provide a more efficient and expeditious means of exit for foreign companies.
India needs to adapt to the winds of change and it is important for the Finance Ministry to address these issues to make India a more attractive destination for foreign investment.
The author is partner-tax and regulatory services, and director-International Business Centre, Grant Thornton India
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First Published: Fri, Feb 22 2008. 11 52 AM IST