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Welcome, but read the rules

India can be choosy about foreign capital and insist that investors go by the book.

india Updated: Apr 06, 2012 22:02 IST

A drumbeat of opinion is swelling over India's move to empower itself to tax cross-border corporate acquisitions in retrospect. The Supreme Court's verdict in the Vodafone case cleared some of the fog surrounding taxation of capital gains in offshore deals over Indian assets. By ruling against the taxman, who was claiming as 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 conceded that Indian law was incapable of plugging a widely used tax dodge by inbound foreign investment. The message for the government in the verdict was that the law needed to be tweaked 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, drafted much before the court ruling and now in the last lap of 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. Till the new law kicks in, the government would have been remiss to allow equivocation in the existing law, the Income Tax Act. And since the law came into force in 1962, the intention of the government to tax all such deals since then had to be clarified.

Finance minister Pranab Mukherjee has emphasised that the legislative intent is not vengeful. The law, in fact, does not allow reopening of corporate tax cases older than six years. Vodafone's nervousness is understandable because its 2007 purchase doesn't enjoy the time-barred immunity. But the high-decibel lobbying against India's rightful duty to address tax avoidance, as many other common law countries have done in retrospect, can be counterproductive. Non-cooperative game theory would suggest the taxman could be forced into prosecuting the Vodafone case if the international chorus does not die down. By targeting the largest deal in this genre, the government is sending out the message that foreign capital is welcome, as long as it comes through regular channels.

India is well within its rights to get choosy about inbound investments without worrying overmuch whether they will dry up if the welcome is not as hearty. Take, for instance, the automobile industry. A fifth of Europe's car-making capacity is idling while sales in India grow in double digits. Corporations facing a prolonged slowdown in western markets plan to shift their capital expenditure to emerging ones 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 insist that foreign capital be subject to a tax regime like that of Britain, which plugged its own tax-haven loophole recently. China has begun 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.