As per his own assessment, one of the biggest challenges that Finance Minister Arun Jaitley faces today is reforming the attitude of the Indian tax authorities. Jaitley spoke about this at a recent summit in Delhi and even went to the extent of suggesting that "unsustainable tax demand" is likely to scare away both foreign and domestic investors.
Jaitley gathered the courage to point to the Shell transfer pricing case which the tax department lost in the Mumbai High Court last week. Some months ago the tax department lost another case of transfer pricing to Vodafone. A few years ago, at an international tax conference, India showed up as an embarrassing outlier among all countries as the worst litigator on transfer pricing.
Simply put, most countries follow established OECD norms when determining the value added and profits made by global companies which operate in several countries depending on cost advantage. Transfer pricing is the value at which companies trade products, services or assets between their own units across borders.
The stability of government standards on transfer pricing is a large part of what makes a country an attractive destination. A country which does not have stable and predictable norms to determine the value added and profits made in its territory will naturally repel global investors. Consequently, this is the single most important condition that India needs to fulfil to ensure that Modi's "Make in India" project takes off.
Jaitley's growing worry over the attitude of the tax department that he supervises derives from the manner in which the government is losing court cases against global companies which could contribute to the "Make in India" project.
A top bureaucrat gave me a very realistic account and said no tax official today will have the courage to drop a case after losing it in the High Court because the national auditor or CAG has raised questions in the past in this regard. Besides, senior officials don't have the earlier protection where the CBI was required to take the relevant minister's permission before probing or questioning an officer of the rank of Joint Secretary and above.
The Supreme Court had issued a directive handing this power to the CBI just before the NDA regime took over. In fact, this was a direct result of the opposition campaign for the CBI to be made autonomous and given more powers. Now that is coming back to haunt this regime!
So the larger question is what sort of assurance will Finance Minister Arun Jaitley be able to give the global business community in regard to the stability of India's tax regime? Both the domestic and foreign investment community were not satisfied with the statement Jaitley made on retrospective tax policy in the NDA's first budget. Will Jaitley be able to do something substantive in the next budget which is just a few months away? The entire business community is focused on this question.
In my view, the debate in India on retrospective tax laws is somewhat misplaced. Retrospective tax legislation by itself is normal. In recent years it has happened in Britain, US and Australia. The business community there did not go up in arms protesting against "tax terror" the way it happened in India. But there are elaborate legal safeguards in the application of these laws in the US and EU. It is how the tax department applies them that makes retrospective tax law clarifications good or bad. Again, it all boils down to the attitude of the tax authorities, which Jaitley is talking about. In Britain, Section 58 of the UK Finance Act 2008 was changed retrospectively to affect the status of tax haven, Isle of Man, which the UK residents were using just to escape tax which was otherwise payable in Britain. The UK court of appeal said, "If Section 58 were not made retrospective, the claimants would obtain a windfall at the expense of the general body of tax payers. It would be unfair to the general body of resident tax payers not to have given Section 58 a retrospective effect".
What the Isle of Man is to the UK, Mauritius has been to India. So in 2012, the UPA government proposed the introduction of what is called General Anti Avoidance Rules(GARR). This would also have retrospectively enabled the tax authorities to probe Mauritius entities which exist purely to avoid paying tax in India. This spooked the stock markets so badly that investors still have nightmares about it. This is because people don't trust the fairness or the reasonableness of Indian tax authorities. This did not happen in other countries where GARR was introduced.
In fact, the principle of GARR is widely accepted and has emerged as a consensus among the G-20 nations to curb the unfair shifting of profits to tax havens and thus denying precious tax revenues to countries. This is very much a component of the black money debate as well. India is part of this new consensus as announced by Modi at the recent G-20 meeting. But India is not sure how it can transform its tax bureaucracy into one that uses such provisions in a manner based on rules and guidelines. This is Finance Minister Arun Jaitley's biggest predicament. He will have to take a call on GARR in his next budget. Given India's G-20 commitments, it will be difficult for him to abolish GARR totally as other countries are using it tactfully, without spooking businesses. Will Jaitley manage to restore confidence on this count?
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