New Delhi: India’s lingering tax disputes with foreign investors, including Vodafone Group Plc, Nokia Oyj and International Business Machines Corp. (IBM), may further tarnish its image as an attractive business destination and increase uncertainity among existing foreign investors in Asia’s third-largest economy.

The finance ministry on Tuesday sought to withdraw from conciliation talks with the world’s largest mobile phone service provider over a 11,200 crore tax dispute over a 2007 transaction. The following day Nokia said it plans to challenge a Delhi high court order that blocked the transfer of its Indian mobile phone factory in Chennai as part of a $7.4 billion handset business sale to Microsoft Corp.

Top global companies including Vodafone, Nokia, IBM and Royal Dutch Shell Plc are facing increasing scrutiny from Indian tax authorities as the government seeks to boost revenue at a time when economic growth has slowed to 4.5% in the year ended 31 March, the slowest in a decade, and officials are grappling to narrow the budget deficit to 4.8% of gross domestic product (GDP) in the current fiscal year. The aggresive tax collection may, however, deter foreign investments that are critical for the country to boost economic growth and cover the nation’s large current account gap.

“India could have done better and taken into consideration the signals this decision sends to foreign investors," said Mukesh Butani, a partner at New Delhi-based BMR Legal, who advises multinational companies on tax disputes. “This isn’t a pragmatic or holistic decision. I don’t think either side has budged since day one of these negotiations."

The 11,200 crore tax demand on Vodafone relates to the withholding tax on the $11 billion transaction by Vodafone Group, in 2007, to acquire a controlling stake in then Hutchison Essar, now known as Vodafone India Ltd. Along with interest and penalties, the total tax demand is around 20,000 crore.

A Vodafone Group spokesman had declined to comment on the latest move by the finance ministry.

Once the cabinet approves the withdrawal proposal, the income-tax department is free to collect the outstanding demand from Vodafone under existing laws.

In case that happens, Vodafone has the option of taking the Indian government to international arbitration under the bilateral investment promotion and protection agreement that the country has with the Netherlands, where Vodafone International Holdings BV is registered. However, government officials disagree about this being an option, as according to them, the treaty does not cover tax disputes.

“Conciliation talks over the tax case is unprecedented. The law was amended after the Supreme Court ruled in favour of Vodafone saying that the liability was with Hutchison to pay the tax, if at all. Now they will have to go back to the interpretation and legal tenability of the amendment," said Sudhir Kapadia, national taxation leader, EY India, a consultancy earlier known as Ernst and Young.

Kapadia was referring to the 2012 Supreme Court decision that came in Vodafone’s favour after which then finance minister Pranab Mukherjee amended the law, where disputes such as Vodafone were liable retrospectively.

In a separate development, Nokia chairman Risto Siilasmaa signaled after meeting commerce minister Anand Sharma on Wednesday that his company was unsure whether it can transfer its Chennai factory to Microsoft because of a tax standoff.

Nokia had agreed in December to place 2,250 crore in an escrow account and pay for any additional tax claims once all legal avenues had been exhausted, but the Delhi high court ruled on 5 February that it must deposit funds to provide for tax demands as these claims are made. Nokia has appealed the decision in the Supreme Court.

Nokia could continue running the Chennai plant as a contract manufacturer for Microsoft if an asset transfer is blocked, but the company wants to quit the mobile phone business to concentrate on selling network equipment.

In the case of Shell, the tax department has added 72,000 crore to its taxable income for fiscal year 2010-11.

Bloomberg and Reuters contributed to this story.

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