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India Signals Tax-Avoidance Clampdown Won’t Be Retrospective

India proposed that a clampdown on tax avoidance due in 2013 won’t apply retrospectively or to cases below a certain monetary threshold, seeking to assuage concern that the plan will deter foreign investment.

The draft guidelines released by the finance ministry in New Delhi late yesterday would also exempt foreign institutional investors if they refrain from routing money to India via tax shelters. The indicative rules are for discussion and feedback and haven’t been seen by Prime Minister Manmohan Singh, who has final approval, the government said today.

Singh, who took charge of the finance ministry earlier this week, has told officials to revive confidence in India after economic growth slowed and proposed tax changes from March’s budget damped investor sentiment, stoking a plunge in the rupee. Yesterday’s draft suggests overseas investors with exposure to Indian stocks through so-called participatory notes won’t be targeted, Deloitte Touche Tohmatsu India Pvt. said.

“Some clarifications are a welcome step,” said N. C. Hegde, a Mumbai-based partner at Deloitte Touche Tohmatsu India. “It remains to be seen how the guidelines are implemented.”

The rupee surged 2.1 percent, the most in more than three years, to 55.6375 per dollar at the 5 p.m. close in Mumbai. The BSE India Sensitive Index jumped 2.6 percent. The currency and stocks were boosted by optimism that European leaders are edging closer toward solving the immediate debt crisis in the euro area.

Net Sellers

The tax guidelines also recommended a monetary threshold for applying the anti-avoidance law to “avoid indiscriminate application,” without specifying its level.

Overseas funds were net sellers of Indian stocks in April and May on concern the planned General Anti-Avoidance Rule, or GAAR, would apply to their holdings.

Pranab Mukherjee, who resigned as finance minister on June 26 to run for the presidency, retreated on the GAAR proposals in May in a bid to salvage investor confidence in Asia’s third-largest economy, delaying their implementation to the fiscal year beginning April 1, 2013.

Mukherjee in the March 16 annual budget said he will also seek clarifications to allow the retrospective taxation of overseas deals in which an Indian asset is transferred.

That announcement followed a ruling in January by India’s Supreme Court that Vodafone Group Plc doesn’t have to pay $2.2 billion in tax on its purchase, conducted offshore, of the local business of Hutchison Whampoa Ltd. in 2007.

International Concerns

U.S. Treasury Secretary Timothy F. Geithner discussed the tax plans with Mukherjee in April after American trade and lobby groups said they may lead to retroactive levies for periods of as much as 50 years and deter foreign investment. U.K. Chancellor of the Exchequer George Osborne has said the proposals could damage India’s investment climate.

Gross domestic product growth in India slowed to 5.3 percent in the three months through March, the least since 2003. The slowdown has sapped tax revenues even as subsidies spur spending, leaving the nation with record borrowing needs to plug the widest budget deficit among the biggest emerging markets.

Fitch Ratings and Standard & Poor’s have said they may strip India of its investment-grade credit rating, citing risks ranging from the fiscal gap to the current-account deficit.

The current-account shortfall swelled to a record $21.7 billion in the three months ended March 2012, the central bank said today.

Record Deficit

For the 12 months ended March, the deficit widened to $78.2 billion, or 4.2 percent of GDP, from $46 billion in 2010-2011, or 2.7 percent of GDP, it said. The full-year figure is also a record, based on central bank data.

Singh said two days ago that India needs to “reverse the climate of pessimism” and that the immediate emphasis of the government is to manage the balance of payments and boost capital inflows into India. His efforts to further liberalize the economy have encountered opposition in the ruling coalition.

Economic reforms in India have slowed due to a lack of political consensus, Kaushik Basu, chief economic adviser in the finance ministry, said in New Delhi today. GDP growth is set to remain subdued for a few months and India will have to live with high inflation until September, he said.

The GAAR guidelines still leave “lots of ifs and buts,” said Nishith Desai, managing partner at law firm Nishith Desai & Associates. “If you look at the fine print, you fall flat. It’s not giving enough comfort to foreign investors. It needs to be completely revisited.”

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