Retrospective tax a nightmare of the past

As India transitions to the Bhartiya Janata Party (“BJP”) government led by Narendra Modi, the international business community will be keeping a close eye on what and how quickly reforms will be introduced. The Budget is due in a few weeks and expectations are high.

Earlier this month Vodafone's CEO, Vittario Colao, told reporters that he is “optimistic that the BJP will quickly do something to restore confidence in the country”. Vodafone has a long running multi-billion dollar Indian tax dispute which stems from its $10.7-billion acquisition of a controlling stake in Hutchison Essar, now Vodafone India. Other international investors are facing litigation too.

As readers will no doubt be aware, the dispute was contested right up to India's Supreme Court and was won by Vodafone, only for New Delhi to retrospectively change the law. The decision to retrospectively change the law caused an international uproar and is widely seen to have acted as a deterrent to foreign investment. The case is now headed for international arbitration.

It is universally acknowledged that the most important feature of a tax system is certainty, perhaps more so than low taxes. Investors base their decisions on laws current at the time of investment and, although they recognise laws can change, they do not expect them to change retrospectively. Indeed in many countries, such as the UK, the ability to pass retrospective legislation is constrained by law. This is not to say that there is never a case for retrospection. It is sometimes necessary to correct anomalies that harm taxpayers but it is generally accepted that retrospection should only be used in the rarest of cases.

It was therefore not unnatural that BJP, the party in Opposition in 2012, referred to the retrospective tax legislation as an example of “Tax Terrorism” and in its election manifesto promised to introduce a non-adversarial tax system. Appealing as the promise is, to both domestic and international investors, it is easier promised than implemented.

The challenge facing the new government is complex. Repealing the legislation introduced to counter the Supreme Court's Vodafone decision is the obvious answer from tax policy perspective. However, India is in need of additional tax revenue and foregoing a sizeable amount of tax is not an easy option. There is great pressure to revive the economy, fund legacy welfare programmes etc.

It is arguable that the repeal of retrospective legislation is a must if the new government is to put up an investor-friendly face and dispel any notion that it might shy away from making tough decisions. It will, however, need to raise funds from other sources. These could include a speedy introduction and implementation of the Goods and Services Tax (GST), introduction of the Direct Taxes Code, better administration of current tax laws and widening the tax base. This will improve investor confidence and will increase foreign investment in the medium to long term.

Overall, Investors will be keen for India to follow other tax regimes and only use retrospective legislation in the rarest of occasions. Business leaders planning to invest in India will want to see the new government demonstrate strong and quick measures to counter the unpredictability of the Indian taxman.

Mukesh Rajani is a partner at PricewaterhouseCoopers (PwC) and has been with PwC for 28 years. He has extensive experience of advising businesses on cross border matters.

The above article was published in India Inc′s print edition of the India Investment Journal launched in June 2014 in conjunction with the India Inc Seminar: A new dawn for India - What does it mean for UK-India Business