India Proposes Tax-Clampdown Delay as Singh Seeks Investment

Indian President Pranab Mukherjee
Pranab Mukherjee, India's president and former finance minister. Photographer: Andrew Harrer/Bloomberg

A panel set up by India’s prime minister recommended deferring a proposal to crack down on tax avoidance by three years, a move investors said may help boost capital inflows amid the threat of a rating downgrade to junk.

The General Anti-Avoidance Rule, or GAAR, outlined by former finance minister Pranab Mukherjee in his March 16 budget spooked foreign investors and raised concerns that the crackdown with retrospective effect would indiscriminately apply to their holdings of stocks and bonds. A draft report released on Sept. 1 by the four-member committee suggested delaying its implementation to the assessment year 2017-18 on “administrative grounds.”

“It is definitely good news and a sentimental boost,” said Ananth Narayan G., managing director and co-head of wholesale banking at Standard Chartered Plc in Mumbai. “Essentially the proposal will be on hold for the next three years and hopefully will die a natural death, at least the retrospective clause.”

Global funds turned net sellers of Indian stocks in April and May after the proposals, pushing the rupee down to a record low as Prime Minister Manmohan Singh grappled with corruption allegations, a record current-account deficit, and missed budget targets. Singh set up the panel in July to help “reverse the climate of pessimism” after Standard & Poor’s and Fitch Ratings cut the sovereign credit outlook to negative, a step closer to non-investment grade rating.

Vodafone Ruling

The tax panel led by Parthasarthi Shome, a former adviser to the finance minister, also suggested abolishing taxes on proceeds from the transfer of listed securities, whether they are from capital gains or business income, for both Indians and non-residents.

Mukherjee in the annual budget also proposed clarifications to allow the retrospective taxation of overseas deals in which an Indian asset is transferred. The 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 in 2007, conducted offshore, of the local business of Hutchison Whampoa Ltd.

The panel will “look into” the tax treatment of such deals, Finance Minister Palaniappan Chidambaram said at a briefing in New Delhi today. The government is confident of achieving its direct tax collection target of 5.7 trillion rupees ($102.7 billion) for the fiscal year ending March 31, he said.

The rupee gained 0.1 percent to 55.4787 against the dollar as of 3.45 p.m. in Mumbai, while the yield on the 8.15 percent bond due June 2022 declined to 8.22 percent from 8.24 percent on Aug. 31. The BSE India Sensitive Index closed down 0.3 percent.

Tax Mitigation

The committee said tax mitigation using legal means should be distinguished from tax avoidance, and the GAAR rules must be invoked only in cases of “abusive, contrived and artificial arrangements.” The rule must not override an international tax treaty with provisions for anti-avoidance, the panel said.

The recommendations also included a monetary threshold of 30 million rupees per taxpayer in a year under the GAAR rule, according to the report. Singh set up the four member panel, consisting of tax experts and government officials, in July to seek suggestions and submit their final recommendations by the end of September.

Investor concerns that foreign investments will decline prompted Mukherjee to retreat in May and delay the implementation of the rule to April 2013. Standard & Poor’s cut its credit outlook to negative on April 25, citing diminishing growth prospects and slow progress on fiscal reforms. Fitch followed on June 18.

BlackRock’s iShares

Mukherjee resigned as finance minister on June 26 to become the president of India a month later, while Chidambaram took charge from Singh, who held the portfolio until July 31.

The rupee has declined 17.5 percent against the dollar in the past year, and touched an all-time low of 57.3275 on June 22. India attracted $10.1 billion worth of foreign direct investment in the six months to June 30 compared to $15.6 billion in the same period a year ago.

The proposed tax avoidance rules prompted BlackRock Inc., the world’s biggest money manager, to tell investors of its iShares BSE Sensex India Index ETF to “carefully consider their position and seek advice as necessary,” according to the exchange-traded fund’s 2012 semi-annual report on June 30.

Ishares BSE has gained 7.3 percent this year in Hong Kong, compared with a 13 percent increase in the Sensex index.

‘Like a Sword’

“The GAAR issue was hanging like a sword over foreign investors,” Kishor Ostwal, managing director of Mumbai-based equities research provider CNI Research (India) Ltd., said by phone on Sept. 2. “The announcement will clear a lot of doubts and accelerate foreign inflows into the stock market.”

A rebound in purchases of stocks by overseas investors is crucial to reverse the slide in the rupee and fund the current account deficit that widened to a record 4.2 percent of gross domestic product in the financial year ended March 31. The $1.8 trillion economy expanded 5.3 percent in the first quarter of 2012, the slowest pace in three years, and 5.5 percent in the following three months. Growth averaged 7.5 percent in 2011.

Chidambaram on Aug. 7 said he will unveil a plan to contain India’s fiscal deficit and clarify tax laws to “regain” investor confidence.

“Our policy actions should match our long term economic objectives, although in the past year, certain retrograde measures reversed the economic reforms process,” said Nirakar Pradhan, chief investment officer at Future Generali India Life Insurance Co. in a telephone interview. “The government should make more such efforts to attract foreign investments as we are starved of capital. We need policies that deepen our market and encourage overseas investments.”

The chances the panel’s recommendations won’t be implemented in the final report are “fairly” remote, Satya Poddar, a Gurgaon-based tax partner with Ernst & Young said on Sept. 1.

“Essentially what they’re saying is that India is not ready for GAAR and if it is applied, it should be severely constrained,” he said.

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