Changing the rules of the game

The executive branch is capricious, arbitrary and incompetent. The legislature is asleep at the wheel and the judiciary seems to be overreaching. Little evidence needs to be presented here to showcase recent executive incompetence—the mishandling of the army, the on-again off-again rule changes on retail foreign direct investment and the recent flip-flop on cotton exports. The legislature has dragged its feet on so many pieces of legislation that it is getting difficult to keep track—the Lokpal Bill, the direct taxes code, goods and services tax, to name only a few. State governments are no better. In rural Tamil Nadu, there is a planned 14 hours of power outage each day. This is the comical state in which businesses conduct their day-to-day lives, dodging deep pits and rapidly moving fireballs.

And to this mess we now add retroactive rule changes. India recently proposed certain legislative amendments to the existing income-tax law. Key amendments include the introduction of general anti-avoidance rules (GAAR) and provisions to retroactively tax indirect transfer of shares of overseas entities with substantial underlying Indian asset value. Even for India, this is a dangerous new direction. A cardinal element of the “social contract" between citizen and government is the exchange of some liberties that results in a fair and objective framework of regulation for the greater good. Retroactive change strikes at the very root of this fairness. Social contract theorists Jean-Jacques Rousseau and John Rawls will be turning in their graves.

Over the years, much has been written about ex post facto (retroactive) laws and some of it has found its way into the constitutions of republics around the world. Article I of the US constitution prohibits the federal and state governments from passing ex post facto laws. There is a rich body of related case precedent. To be fair, even in the US, the explicit prohibition is related to criminal, not civil law. The same underlying principle has been adopted in Article 20 (1) of the Indian Constitution. “No person shall be convicted of any offence except for violation of a law in force at the time of the commission of the act charged as an offence, nor be subjected to a penalty greater than that which have been inflicted under the law in force at the time of commission of the offence."

Much of the expert opinion in India on the recent retroactive income-tax rule changes has focused on the very real implication to foreign investors. Financial Times recently reported that in an unprecedented move, seven business associations from Canada, the US, the UK, Japan and Hong Kong, have written to Prime Minister Manmohan Singh warning him about going against international practice and endorsing retroactive tax rules. They say some companies have already begun to re-evaluate their investments, and others could follow suit in “a widespread reconsideration of the cost and benefits of investing in India".

But these changes have an implication for those of us operating in India as well. It means that we have to be prepared for arbitrary, possibly retroactive changes. Preparation requires not merely business agility, but also deep pockets and an “insurance" reserve that is sure to drive up the systemic cost of capital. Can anything be done? The first thing to do is for the government to rescind the retroactive clause or for Parliament to reject it during this session. The more important thing to do is for citizens to raise their voice against new rules and retroactive rules that are being promulgated simply because governments seem incapable of enforcing existing rules incisively.

Instinctively, our 10-year-old daughter knows that retrospective rule changes are not good. “Unfair" she says of the rule changes in the movie. Is the government listening?

Otherwise, this game will have no winners.

PS: “Know your enemy and know yourself; in a hundred battles, you will never be defeated," said the wise Sun Tzu.

Narayan Ramachandran is an investor and entrepreneur based in Bangalore. He writes on the interaction between society, government and markets. Comments are welcome at narayan@livemint.com

Also Read | Narayan Ramachandran’s previous columns

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