A phrase first used by Prime Minister Narendra Modi while addressing a group of businessmen in the run-up to the elections last year has now come back to haunt his government. Denouncing the UPA government for its adversarial tax policies, Modi promised to end the “tax terrorism” that was unleashed by the previous government on hapless investors. This week these same investors complained that nothing had changed and they still felt terrorised by the taxman.
And so, Finance Minister Arun Jaitley was forced to defend the government pointing out that the opposite of tax terrorism did not mean tax haven. To give credit where it is due, the government has rolled out policies designed to usher in a friendlier tax regime, especially for foreign companies.
The implementation of the much-feared General Anti Avoidance Rules (GAAR), which was to have kicked in from April 1 this year, has been put off by two more years and they will apply only prospectively. Never mind that GAAR is a legitimate tax policy practised by several advanced countries. Second, the Budget amended the Income Tax Act to free FIIs and Foreign Portfolio Investors (FPI) from paying MAT on capital gains from sale of shares. This was to be effective from the 2015-16 financial year. Ironically, it is this concession that has brought trouble for the government as the FIIs now want to be relieved of their liability to pay MAT for earlier years, and this after the Authority of Advance Rulings had held them liable to pay the tax!
Third, the Budget watered down provisions relating to capital gains tax liability for indirect transfers of assets held in India by multinationals by saying that only transactions where a minimum of 50 per cent of the assets are located in India would be liable.
Finally, the most important signal of this government’s commitment to usher in a non-adversarial tax regime was the decision not to contest in the Supreme Court the adverse ruling of the Bombay High Court in the Vodafone transfer pricing case. The government also directed the tax department to apply the principle behind the judgment in the Vodafone case to other similar cases — multinational Shell was a direct beneficiary of this.
The multinationals that are now protesting the supposed return of tax terrorism are known to avoid taxes by leveraging on low-tax countries and jurisdictions such as Ireland, Luxembourg, Mauritius, Singapore and Bermuda Islands. Indeed, Google’s chairman Eric Schmidt once infamously referred to his company’s tax-avoidance practices as “capitalism” and that he was proud of it. Google, Apple and Microsoft are now under the microscope in an Australian parliamentary inquiry over its tax avoidance strategies.
It is common practice for multinationals to house their headquarters in low-tax countries and transfer profits there to avoid tax liability. Starbucks, the US coffee chain, was involved in a famous spat in the UK a couple of years ago for declaring tax losses even while it told its investors in the US that its UK operations were profitable. It was simply repatriating its profits to its European headquarters in the Netherlands in the form of royalty and avoiding taxes in the UK.
The right balance
Indeed, royalty payment is a time-tested method of transferring profits from a high-tax country to a low or zero tax one. The infamous Nokia case in India, which is still unresolved, relates to alleged non-payment of tax on royalties paid by the Indian unit to its parent in Finland. The bottomline is this: tax avoidance using low-tax jurisdictions is a strategy that has been perfected by multinational corporations and it is not just India that has been affected but even the US, UK and other countries.
The difference between India and the rest is that we need foreign investment more than the others do. Therefore, it is not wise to scare off investors through an adversarial tax regime that runs counter to all that Make in India stands for. Yet, giving MNCs a free run with their tax avoidance strategies is not a good idea as it creates an uneven playing field for home-grown businesses. Simply put, foreign players cannot be allowed to gain that extra edge over their domestic competitors by reducing their tax costs.
What we need in our tax policy is the Goldilocks mean, neither adversarial nor accommodative. For a start, Jaitley should advise his tax officers that the glory days of retrospective tax are over and they should stop sending out any more silly notices such as the one they sent to Cairn Energy and Cairn India last month. If there was an opportunity to tax Cairn over asset transfer it was lost back in 2006 when the transfer took place.
The signal that should go out to investors is that they are welcome to participate in India’s growth but their sharp tax practices are not. And that while the government would do all it can to make the environment as tax-friendly as possible it will not tolerate avoidance practices. That would be the Goldilocks mean.