Budget misfire has often hit investors where it hurts

India’s Budget plan to levy a surcharge on super-rich, which also engulfed foreign investors, spooked the markets, wiping off over Rs 5 lakh crore from July 5, the day the Union Budget was unveiled, till the end of last week. The Centre’s intention might not have been to scare away foreign investors, but a category of them called foreign portfolio investors or FPIs were hit by the measure. This is not the first time.

Often, in order to ramp up revenues, the governments in India through their Budgets, have introduced measures that have led to tax disagreements, many a time disputes with foreign firms. Be it the transfer pricing regulations of 2001 or retrospective taxation of 2012 or the long term capital gains tax of 2017. Most of them have translated into a significant amount of capital outflows, court cases, the governments issuing clarifications and ending up amending quite a few because the losses emanating from such decisions far outweighed the gains.

But the question is can India, with a fairly large share of current account and fiscal deficits, afford to have such an erosion of foreign investors’ faith in its policies? Foreign investments are needed to plug deficits that run into several lakh crore of rupees. Stable tax policies are needed to keep overseas investors’ faith intact. It did not, however, happen and the Centre indulged into a series of misfires since the beginning of this decade. The important ones include:

Transfer Pricing

Introduced by the then finance minister Yashwant Sinha in the Budget of 2001-02, it aimed at ensuring transactions between related parties are carried out on an arm’s length basis and kept a check on tax leakages in cross border intra-group transactions. Globally, it has helped the governments but it did not work in the case of India and led to disputes over a period of time. The disputes ranged from the arm’s length nature of financial transactions to transfer pricing methodology and so on. Subsequently, in the years that followed, the governments had to introduce laws such as the Advanced Pricing Agreement and Safe Harbour Rules to avoid litigation. The law still has quite a few knots even till date and the Finance Bill of 2019 has tried to address some of them including providing an option to the taxpayers to make one-time payment of tax including surcharge on the amount of transfer pricing adjustment or part thereof, instead of tax on deemed interest every year, in case the taxpayer does not repatriate money from its associated enterprise in India.

GAAR and retrospective tax

In the Union budget of 2012-13, finance minister Pranab Mukherjee introduced a retrospective amendment to the Income Tax Act of 1961. Under the law, the amendments to the Act were to take place retrospectively from 1962. It sought to reopen many closed cases, including that of Vodafone’s, the then-largest foreign investment in India. The idea was to allow the exchequer to earn Rs 35,000-Rs 40,000 crore in back-dated revenues. That never happened but the damage it caused the then government was immense and eventually when Mukherjee became the President of India and P Chidambaram took over as finance minister in 2013, he had to issue a clarification to multinational corporations from a foreign soil that India had postponed the retrograde taxation law for three more years to 2016. The correction took place much after that year’s Budget because investor confidence had suffered a severe jolt and business lobbies from the USA and UK and their governments had written to the then prime minister Manmohan Singh.

Long Term Capital Gains Tax

Finance Minister Arun Jaitley sought to dig out a long-buried tax in 2018 Budget that was not received well at all by the markets and Sensex fell 840 points, the worst fall in two years. It proposed a flat 10% LTCG tax on equities and equity funds above Rs 1 lakh per annum. It also imposed 10% DDT on dividends declared by equity funds. LTCG existed till 2004 but after that, it was replaced by the securities transaction tax (STT) which was levied on all trades made on the stock exchanges. The Budget for 2019-20 adds to the pain. There is an increased surcharge on LTCG for those who fall in the income bracket of Rs 2 to Rs 5 crore and beyond.

Now, Finance Minister Nirmala Sitharaman has said that those FPIs, who wish to avoid the surcharge can register themselves as companies rather than trusts. The problem is over 70% FPIs in India have been registered as non-corporates. The transition from trust to corporate will not be easy and may be subject to the general anti-avoidance rule (GAAR) as the conversion may be perceived as a tax avoidance step by FPIs. In addition, the local law of the land for FPIs may not permit a transition.

Whatever may be the reason, the consequence of the surcharge, which entails a gain of Rs 3000 or thereabouts, could be the opposite of what the government has levied that for. Experts are of the opinion that the move will lead to FPIs shifting their trading to Singapore and Dubai, where Indian equities are traded and tax regime is friendlier.