Earlier this week the government introduce an amendment to the income tax act. The amendment was geared towards reversing the draconian provisions that were introduced in 2012 by the then Finance Minister regarding retrospective taxation.
Many had originally expected that these provisions would be reversed in 2014 itself when the NDA government came to power. However, the same did not happen even though the finance minister in 2014 made a statement that no further demands will be made using these provisions by the Income Tax Department going forward. Indeed, since then the tax department have not used these provisions as they refrained from making any demands similar to those in the Vodafone or the Cairn case. Despite this, foreign investors have repeatedly expressed concerns regarding stability of taxation regime due to these provisions.
Let us not go into the merits of the Vodafone or the Cairn tax disputes as judicial authorities have already made it clear that the tax authorities were wrong in raising these demands in the first place. That the then Finance Minister, Pranab Mukherjee went ahead and brought an amendment to justify these demands was a monumental mistake of epic proportions. In an attempt to perhaps bridge a gap in the fiscal deficit largely due to an expansion of subsidies, he damaged medium-term growth prospects of the Indian economy by dampening investor confidence. Lower growth meant lower revenues – and the cycle continues. This is a classic case of apne pair pe khulhadi.
What makes matters worse is the fact that even in 2012 it was clear that such a move will come with serious consequences for investments, job creation and economic growth which in turn would impact tax revenue mobilization.
Numerous Op-Eds were published criticizing these provisions, much like the land acquisition act or the amendments to the companies’ act. However, the government remained undeterred.
Interestingly, several changes were made recently to the companies act thereby cleaning up the mess created by the UPA era amendments. Given that several of the policy errors committed from 2008 onwards have been gradually corrected over the last few years, it was about time that the Indian government recognized the need to reverse the retrospective tax provisions. More so as the country is eying at a greater share of foreign investments which will help expand India’s industrial base, create fresh jobs, and accelerate India’s growth prospects.
The move reiterates the commitment of the government to create an enabling environment, whether through procedural, regulatory, or other reforms. The impact of these reforms has been reflected in India’s ease of doing business rankings and India has consistently been one of the largest recipients of foreign investments be it FIIs or FDIs. But for a large economy such as India, there is still potential for bringing in a larger amount of foreign capital.
Ensuring rule of law and a stable, predictable tax regime are therefore a necessary conditions for India to be able to make the most of the China + 1 approach that most companies are likely to adopt in the post-pandemic world. Therefore, the decision to slay the ghost of the draconian retrospective IT provisions comes at an opportune time as the world is looking at India as a rules-based democracy that can serve as a viable alternative to China.
As is the case, one cannot view the new bill in isolation – more so when China is clamping down on its tech sector. This is why there is an interesting parallel that must be drawn here between the two major large Asian economies – India & China. The first is a democracy that will eventually rectify any mistakes and create a stable policy environment that is compliant with domestic rules & international treaties. The second is a country that has been termed as a currency manipulator, accused of not playing by trade rules & of intellectual property theft and now it seems to be exercising its power to stifle tech and education companies. The latter has also gone ahead and acted against several companies that were listed on foreign exchanges thereby leading to massive erosion of the wealth of foreign investors in a very short span of time.
Global investors must be keenly looking at these developments as they explore the questions regarding capital allocations over the coming years.
The recent bill will also have implications for India’s divestment & privatization plans. Given that the provisions were largely focused on the treatment of sales of Indian assets for taxation purposes, reversal of the provision will ensure certainty of taxation regime if any such asset sale were to take place today. That is, should the government divest some of its PSUs and the stake is obtained by a foreign investor, then in the future, the income tax department cannot raise a fresh demand or raise a dispute regarding the tax liability. Therefore, the reversal of this provision should open the door for a lot of mergers and acquisitions, disinvestment & perhaps even privatization over the coming years. In the process of this churn of assets, a lot of wealth will be unlocked, created and in some cases even redistributed.
India in 2021 is very different from India in the early 2010s. With a stable political regime that provides a predictable business-friendly policy regime, it serves as an ideal investment destination. The proposed changes to the income tax act further reinforce the same as they send a signal to the global investor community that India is open for business.
The author, Karan Bhasin, is a New York-based economist. The views expressed are personal