Monday, 8 October 2012

Cost of Pranab Mukharjee’s presidency - FDI and Tax Avoidance

The exit of President Pranab Mukharjee from the Finance Ministry had wider implications that just making sure that Congress could get its own candidate installed in the Rashtrapati Bhawan. We have a situation now that government finds itself in a position to bring about a change in several proposal brought about by the Finance Ministry under Mr Mukharjee since he is out of the picture and Mr Chidambaram is on the helm.

The relation between Mr Mukharjee's exit and the push for reforms, and the push to revert some of the Tax Law changes that the same government had introduced in the first place is not lost on anyone. This points to the fact that the economic policies which are made in our country are not made simply based on logic and are not made just with the best interest of the country in mind, but there is a constant tug of war between various lobbies and interests groups which drive their creation and implementation. Is it the case that we are being governed by an immature polity that does not deliberate the implication of any government policy in a non partisan manner without the influence of self interest? Are we not making policies which are the 'common good' of the citizen of this country? That is what a democracy should be about.

One of the changes to Tax Laws which Mr Pranab Mukharjee had introduced was the retrospective amendment to India's Tax Laws to plug a loop hole which had allowed foreign companies avoid paying capital gains tax on sale of Indian assets. This was introduced to ensure that foreign tax havens cannot be used the avoid paying tax in India. A lot of hue and cry was raised by Vodafone, foreign investors, Indian industry and foreign governments. It seems there would be attempts made by the new dispensation in the government to make further amendments in the next parliament session to address the concerns of these bodies.

For me the question is not whether tax laws were amended retrospectively to increase the tax liability of a foreign entity which would be termed unfair and hence 'hurt' the investment sentiment. The question to me is whether loop holes in tax laws were deliberately exploited for tax avoidance in past. Then the question is whether tax laws should have been amended retroactively to correct a past wrong. If a wrong has been committed in the past and parliament has power to correct it then it sends a signal that unintended loop holes should not be exploited to avoid tax. If it leads to discouraging investment from entities which will only invest if such exploitation is possible then so be it. We are not a tax haven. We are a welfare state with duties towards our citizens. We have a policy to tax the rich more than we tax the economically weaker sections of our society. So was a past wrong done, that is the question, not 'sentiment' of investors who want to avoid  tax which is due, a sentiment which is only short term anyway. What is the length to which we are willing to go for FDI?

The second issue is about General Anti Avoidance Rules that were introduced in the Direct Tax Code by Mr Mukharjee. The new dispensation has managed to change that also. A committee was established by Prime Minister Manmohan Singh to look at the GAAR provisions since the investors were not satisfied with it.The committee headed by Mr Pathasarthi Shome has recommended in September this year that GAAR be deferred by 3 years as against the deferment which was already provided by Mr Mukharjee till 2013 to allow for 'training of tax officers'. The fact that GAAR is necessary to weed out the tax evasion which is being perpetrated via Mauritius and other tax havens is not lost on anyone. The tiny country of Mauritius is the single largest investor in India. It has been reported in past that many companies which invest in India from Mauritius have only nominal presence there. Hence the recommendation of the committee to remove the 'genuineness of residency' guideline from GAAR will only lead to continued exploitation of Mauritius root simply for tax avoidance. The committee even recommended abolishing capital gains tax in listed securities and replacing the loss of tax income by increasing STT. In my understanding this will clearly lead to passing the burden to smaller investors and short term traders while providing a great way for existing investors to avoid paying any tax.

Inviting FDI in sectors we need it in is well justified, but encouraging tax havens not only means that foreign investors will avoid tax when it is genuinely due, but in many cases black money earned in India itself would be invested back in India via these havens. At least  that is my understanding about these issues. But then the current dispensation seems to be driven by different motives than the previous dispensation. The policies in our country are personality driven and affected by pressures from self interest groups rather than driven by other nobler motives. I read a scathing criticism of these Shome committee recommendation in the Hindu editorial of 2nd September 2012.

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