India’s tax laws are deterring investors

In the next three months India will hold a general election. It will be a defining moment for the country at a time of growing economic challenges. The frontrunner in the race to be prime minister is Narendra Modi, the controversial leader of India’s Hindu nationalist opposition. Much of the international discussion about Mr Modi currently focuses on his reputation as a Hindu nationalist and his alleged complicity in past anti-Muslim violence. But if he wins power, the world’s business leaders will be asking another question about him: can he reverse India’s notoriously aggressive tax treatment of foreign companies?

There have been numerous disputes between the Indian taxman and foreign businesses in recent years. None has attracted more attention than that involving British mobile operator Vodafone. Back in 2007 Vodafone took over an Indian mobile outfit that was majority-owned by Hutchison Whampoa, a Hong Kong conglomerate, paying $10.9bn. The Indian government subsequently demanded that Vodafone hand over $2.6bn in capital gains tax for the acquisition, a demand the company refused.

In the ensuing five years Vodafone and the government battled this out in the courts. The Vodafone deal involved a Dutch subsidiary of the British company buying a Cayman entity owned by Hutchison. The Indian government claimed that Vodafone was liable for $2.6bn because it should have withheld the tax from Hutchison on its behalf at the time of the deal. Vodafone argued that, under Indian law, the transfer was not taxable because it took place in a foreign jurisdiction.

Whatever the rights and wrongs, the dispute looked to have been resolved in January 2012 when India’s supreme court issued a judgment in Vodafone’s favour. But India’s government did not leave matters there. It passed legislation allowing it to reopen tax cases retrospectively, thereby taking the Vodafone dispute back to square one. A year ago India indicated it was minded to settle the matter. Now, in another twist, the finance ministry looks set to order that negotiations with Vodafone be scrapped.

India’s government is not alone in worrying about how to recoup tax from foreign companies that operate on its soil but register in offshore tax havens. But India’s problems here go well beyond Vodafone. Many of the takeovers by Indian companies of foreign ones have been routed through tax havens such as Mauritius. The Indian authorities do not seem to show anything like the same zeal in pursuit of their own national champions.

Besides, Vodafone’s tax case is not alone in generating unease abroad. A string of companies – including IBM and the UK’s Cairn Energy – have struggled with India’s revenue services. On Wednesday, Nokia announced that it has in effect been blocked from transferring assets in India to Microsoft as a result of a dispute with the tax authorities. If India wants to send a troubling message to global companies about how unpredictable a tax environment it has, it is certainly getting its timing right.

India today has a reputation for having the world’s most draconian tax regime. What is baffling is whether the country’s authorities have thought through how much self-inflicted damage this is doing. India needs foreign companies to set up shop on its soil. The Indian economy is expected to have grown by about 5 per cent last year compared with 10.5 per cent in 2010. Although its current account deficit has declined in recent times, it remains a matter of concern. It may be that Mr Modi understands this and, if he is elected, will take action.

Meanwhile, any business leader planning to locate in India needs to think hard about the unpredictability of the Indian taxman.

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Letters in response to this editorial:

Brazil’s draconian tax regime is far worse than that of India / From Mr Juan Carlos Hidalgo

India can’t afford to be passive over tax avoidance / From Emeritus Prof Sol Picciotto