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Economy

The Vodafone Overreach and the Failure of Trust

From my Yahoo Piece:

Vodafone’s Dutch Subsidiary bought a company in the Cayman Islands, in a transaction paid for in foreign currency. Vodafone is a buyer, and not subject to their worry for the last year or so? That the Indian Government wants to tax them.

India has a case. The company being bought controls Vodafone India, one of the largest Telecom operators here. The deal was done abroad purely to avoid Indian capital gains tax that Hutchison would otherwise need to pay, if they sold the Indian company instead. Nearly all of what the Cayman Islands based entity owned was the Indian company’s assets in India. Yes, the tax would apply to Hutchison, but Vodafone should have cut taxes on the purchase and paid that to the Indian government.

Vodafone went to court and after a long battle, won the case. The Court specifically said that the law wasn’t clear on whether such transactions, done abroad, are subject to Indian capital gains tax. The Direct Tax Code (DTC) does clarify, but the bill approving the DTC hasn’t been passed, and in any case, the transaction happened before the DTC applies.

The Finance Ministry, seeing a potential loss of Rs. 10,000 cr. in revenue, has decided to grab money using a retrograde step. In the 2012 budget, Mr. Pranab Mukherjee mentioned what he calls "clarifying the tax position of the government since 1962" — a change in the tax law that includes transactions such as Vodafone’s, retrospectively all the way back fifty years. Such a change would be understandable going forward, but to make a change today that applies back in time is distasteful.

Who will want to trust anything the government says anymore? It said that profits from Special Economic Zones would not be taxed, and then went ahead and introduced a Minimum Alternate Tax that would apply to everyone. It sold shares in ONGC in early March to investors in an open auction, and then introduced an 80% hike in domestic crude oil cess that hurts, most of all, ONGC. It supposedly deregulated petrol prices but seems to have informally told oil companies not to hike prices in a wink-wink-nudge-nudge sort of way, even if they made losses that we, the taxpayers, will eventually pay for.

But these changes might still be acceptable. Overriding of the authority of the Supreme Court should not be. When the Supreme Court has specifically chastised the government for not being clear about something, the correct approach would be to clarify for all cases ahead. But to make that "clarity" retrospective is a sign that they want their way at any cost; they want to win the very decision that they had lost, and effectively telling the court to decide again, under a new law that suddenly applies.

This will create unnecessary tension for foreign investors. Specifically, companies like Genpact, AT&T and SABMiller have cases pending in India, on the same basis. More importantly, the structure of the law says that share sales of any company whose assets are substantially in India will be subject, retrospectively, to Indian taxes.

Does it include, for instance, a Dubai based employee of a Cognizant Technologies (an Indian company listed in the US) who sold some stock options in the US market five years ago? Will it include two Cayman Island based investors who transacted shares of Rediff (another Indian company listed in the US) between each other in 2005? What about the retired pensioner selling shares in his 401K account in the US, of an India-based company? These sound like good questions but the nature of the question is terrible; it has introduced doubt where there should be none, and introduced it going back all the way to 1962.

It is not only for foreign investors to be troubled by the question of retrospective law. It is for all of us; after all, the tax concessions that we assume are given to us today — a tax cut for "infrastructure bonds" for instance — could easily be removed by a retrospective law a few years later, telling us that "Oh, when we said infrastructure, we meant bridges higher than 17 meters, and your company did only 16 meter bridges". Can you imagine having to deal with that?

On one note, the law creates an element of clarity for a few players, who would have otherwise liked to create entities abroad to skirt Indian taxes. They will be disappointed but they won’t have my sympathies.

The matter will go to court, but it has a chance to be changed before that. In parliament, if our dear opposition isn’t sitting there criticizing marginal increases in rail fares after seven years. They are the third arm of our democracy that can effectively end this needless battle between the other two: the executive and the judiciary. Sadly, our elected representatives seem a fragmented lot, and we’ll have to see this play out in court once again. Until there is a decision on the ability of the government to make retrospective law of this nature, we’ll always leave that element of fear in an investor’s mind.

  • prabee says:

    Deepak,
    How will vodafone be responsible for paying tax while its just a buyer. Expecting them to cut taxes from purchase cost and paying to indian govt is not correct isnt it?
    I also dont understand why is hutch not being dragged into court. Who should have actually payed capital gain for the sale of its indian asset.
    one of the worst way is this retrospective law which will make any foreign investor to think over any investment in india. I say we should sack the people who advices pranab of such things and include him in the end 😛