The Supreme Court's verdict in the Vodafone case has cleared some of the fog surrounding taxation of cross-border corporate acquisitions. By ruling against the taxman, who was claiming his $2.6 billion of the $11.08 billion purchase of Hutchison's stake in the country's third largest telecom service provider, the court has conceded that Indian law, as it stands today, is incapable of plugging a widely used tax dodge by inbound foreign investment. That's a big plus for India's image as a law-abiding nation. But the government will now have to make the necessary tweaks to curb treaty shopping, the practice of routing investments through letter-box companies in havens like Mauritius to avoid paying taxes in India. The direct tax code, which has just entered the legislative circuit, is clear that local taxes will have to be paid if a large chunk of assets being transferred is Indian no matter which tax haven the money is coming from.
Clarity on this score is welcome. But the delay in arriving at a settled position raised the discomfiting prospect of the taxman turning his gaze on other such acquisitions. Deals originating in mainland America or Europe would have priced local levies into the cost of purchase and corporations that came in through this route had little to be worried about. However, others that chose offshore points of entry into India kept their fingers cros-sed. The sums involved are large: the last decade alone witnessed $116 billion of foreign equity inflow. By targeting the largest deal in this genre - Vodafone's 2007 purchase is by far the biggest acquisition by a foreign company in India - the government is sending out the message that foreign capital is welcome, as long as it comes through regular channels. But as and when the anti-tax avoidance clause is brought in to bear, it should work prospectively.
India is well within its rights to get choosy about in-bound investments. According to a survey of multinational companies conducted by the UN Conference on Trade and Development, India has replaced the US as the most important destination for foreign investment, second only to China. Corporations facing a prolonged slowdown in western markets are planning to shift their capital expenditure to emerging ones like India's as foreign direct investments climb to an estimated $2 trillion in 2012. If the next investment wave is centred on Asia, a frontline emerging economy like India can afford to tone down the welcome it acc-ords foreign capital. China has begun signalling that it intends to cherry-pick foreign investment that fosters high-end manufacturing. India is well within its rights to ensure that the playing rules, once framed, are followed.