August 30, 2012 2:06 pm

Doubts remain over India tax proposals

When India announced plans at the end of March to introduce new general anti-avoidance rules for its tax code, it sounded innocuous enough. But angry investors quickly made their views known.

The plan seemed straightforward: companies would no longer be allowed to avoid paying tax by registering their offices abroad, and specifically by using post office box addresses in Mauritius as their corporate headquarters.

As they pored over the details, however, investors discovered rules that were opaque and confusing, and which left India’s famously aggressive tax authorities with plenty of room to tax everything from foreign investment flows to M&A transactions, including those that had been conducted historically.

Taken together with a related set of proposed “retrospective” rule-changes designed to ensnare companies, notably including UK-based telecoms operator Vodafone , for past investments into India, the resulting outcry badly dented India’s business image – just at the moment the nation needed foreign funds to reverse a sharp slowdown in growth.

“There was a huge amount of uproar about how these measures would affect investors,” says Dinesh Kanabar, the Mumbai-based head of KPMG India’s tax practice. “India’s image has been damaged very significantly by the episode.”

It had a more immediate impact too: foreign institutional investment into the country collapsed to virtually nothing in the weeks following the announcement, as worried fund managers lobbied the government to rethink their plans.

Six weeks later they got their wish: in early May India’s then-finance minister Pranab Mukherjee announced a climbdown, delaying the introduction of the rules until April 2013, and setting up various panels to review its implementation.

Anxious investors must now await the draft findings of the most important of these, which is due to report at some point in the next week. But some experts still have doubts that the anti-avoidance measures are the right tool to meet India’s objectives.

“If the government is worried about the Mauritius treaty being abused, it should renegotiate that treaty,” says Mr Kanabar. “It need not set up [the rules] which, if introduced, would have implications well beyond Mauritius, and could create significant uncertainty in the market.”

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