Bloomberg News

India’s Proposed Change to Tax Law May Slow Foreign Investments

March 17, 2012

Pranab Mukherjee, India's finance minister. Photographer: Simon Dawson/Bloomberg

Pranab Mukherjee, India's finance minister. Photographer: Simon Dawson/Bloomberg

India has proposed changing laws so it can retrospectively tax capital gains by foreign companies, a move industry analysts including Nishith M. Desai say could have a negative impact on investment in the nation.

The government’s had a “knee-jerk reaction” to this year’s loss of a $2.2 billion tax case against Vodafone Group Plc (VOD), said Desai, managing partner at law firm Nishith Desai & Associates in Mumbai. The proposed change in law “will considerably erode India’s standing in the eyes of investors and treaty partners,” he said in an e-mailed statement today.

Finance Minister Pranab Mukherjee, struggling to rein in the widest budget deficit among major emerging economies, wants the change to ensure the government gets as much as 400 billion rupees ($8 billion) of tax payments that officials say is under litigation. The move may slow foreign direct investment into Asia’s third-largest economy, according to KPMG.

India gives foreign investors the guarantee that they will not be taxed doubly, Mukherjee told Bloomberg UTV today. “We do not give them the guarantee that they will not have to pay tax in any country. That way we’ll simply encourage tax evasion and tax avoidance. That is not possible for any government.”

The Supreme Court in January dismissed the government’s demand for 112.2 billion rupees of taxes from Vodafone stemming from its 2007 purchase of Hutchison Whampoa Ltd. (13)’s India mobile- phone operations. The new wording of India’s Income Tax Act will apply retrospectively from 1962, according to Mukherjee’s budget documents presented in parliament yesterday.

Define Intention

Transactions like Vodafone could now be reopened and “assuming that the law holds, the companies will be issued tax notices,” said Uday Ved, a partner at the local unit of KPMG.

“The highest court has given the verdict in favor of them, so naturally that is the highest court of appeal and beyond it cannot go,” Mukherjee said today. “The Supreme Court suggested that you clearly define your position, your intention, that we have done.”

The proposed change will only be applicable to those cases that have already started or are “in the pipeline,” the minister said. The government won’t reopen cases that are more than six years old, he said.

“The budget proposes a number of regressive, retrograde and extraterritorial provisions that would significantly increase tax costs and alter the dynamics of cross-border transactions and M&As,” Desai said.

The government’s budget proposal to introduce general anti- avoidance rules, or GAAR, enabling the taxing of companies it believes are structuring deals in a manner to escape taxes could serve as a roadblock to companies’ investments, he said.

‘A Pandora’s Box’

“The ambiguously worded provisions capture most conventional structures for M&As and investments into India,” said Desai. “If implemented, GAAR will open up a Pandora’s box of uncertainty and litigation, and investors may be forced to think twice,” he said.

While budget amendments to counter Vodafone (VODA) and similar transactions were anticipated, the retrospective aspect of the proposed laws is “surprising,” said Pallavi Bakhru, practice leader for tax and regulatory services at Walker Chandiok & Co.

“We suspect that the constitutional validity of such an amendment will be questioned,” Bakhru said in an e-mail.

The government on Feb. 17 filed a petition to review the Supreme court’s decision on Vodafone, seeking to overturn the ruling. The court had directed the government to return a 25 billion-rupee deposit Vodafone (VODA) made on the contested tax bill, plus 4 percent interest.

‘Have Faith’

“We are examining this proposed decision with our lawyers, but we do not believe this retrospective change in tax law should have any impact on the final judgment handed down,” Vodafone said in an e-mailed statement yesterday. “We continue to have faith in the Indian judicial system.”

Vodafone shares fell 0.3 percent to 166.35 pence at the close of trading in London yesterday. After the court ruling in January, Chief Executive Officer Vittorio Colao said the company would continue to grow its Indian business.

Newbury, England-based Vodafone (VODA) and Hutchison conducted their $10.7 billion transaction offshore, with Vodafone’s Dutch subsidiary, Vodafone International Holdings BV, acquiring CGP Ltd., a Cayman Islands-based holding company controlled by Hong Kong-based Hutchison.

Cyprus, Mauritius

India’s tax department in September 2007 sought 112.2 billion rupees in capital gains tax, saying Vodafone should have withheld that amount from its payment to Hutchison.

The tax law changes are also likely to hit buyout firms, said Anil Singhvi, chairman of Ican Investment Advisors Pvt.

“Private equity owns substantial assets here and they invest through Cyprus and Mauritius,” said Singhvi. “Profits made by them selling Indian companies will now be subject to taxes,” he said.

Vodafone is India’s third-largest wireless operator, with 148 million subscribers and a 17 percent share of the country’s 894 million mobile-phone accounts at the end of December, according to the nation’s telecommunications regulator.

“It is certain that this amendment will be challenged before the Supreme Court by aggrieved parties,” said KPMG’s Ved. However, such petitions haven’t had much success, he said.

To contact the reporters on this story: George Smith Alexander in Mumbai at; Ruth David in Mumbai at

To contact the editor responsible for this story: Paul Tighe at

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