India’s challenge on corporate taxation
Foreign investors, not to mention the country itself, need a more stable and predictable regime
Foreign companies are depressingly used to run-ins with the Indian taxman. A string of groups, including Vodafone, IBM and Cairn Energy, have been hauled into the dock for not paying their dues in recent years.
Last week another simmering clash returned to the headlines. Nokia announced it was mothballing a mobile handset factory in Chennai. The Finnish company has in effect been blocked from transferring assets in India to Microsoft as a result of a tax dispute. Many believe the facility will close with the loss of more than 6,000 jobs.
India’s government is not alone in worrying about how to tax foreign companies that operate on its soil. Many EU countries fume at the tax arrangements of US technology companies. The OECD has been looking at ways to stop companies from dodging the taxes they should be paying. Finding solutions is not easy.
The structure of India’s economy adds to these tensions. Many Indian-based subsidiaries either perform business services for their foreign parents or assemble products developed abroad – making the system prone to disputes about transfer pricing.
A great deal of foreign and domestic investment is routed through tax havens, notably Mauritius. The Indian government has for years struggled to close this gaping loophole.
New Delhi has set about the task in the wrong way, and a particular bugbear has been unpredictability. India has acquired a reputation for its selective and aggressive application of the rules. Different tax offices interpret the law in diverse ways and many officials seem motivated more by revenue targets than the impartial application of the tax regime.
Cases can also be reopened retrospectively. Tax disputes, such as that involving Vodafone, drag on for years. When it comes to disputes involving offshore tax havens, the authorities do not seem to show anything like the same zeal in pursuit of their own national champions.
What is unclear is whether the authorities have considered how much self-inflicted damage this is doing. India needs foreign companies to set up on its soil. Narendra Modi, the prime minister, has launched a “make in India” campaign to convince manufacturers to set up in Asia’s third-largest economy. Mr Modi wants to increase the manufacturing sector’s share of gross domestic product to 25 per cent from about 15 per cent last year.
But if this is to be anything more than a dream, Mr Modi’s government needs to reassure investors their ventures will not be subject to capricious tax demands. The early indications are that Mr Modi and his ministers have not grasped the significance of this. His first budget, introduced in July by Arun Jaitley, finance minister, failed to end the practice of reopening tax disputes retrospectively. Far from striking this from the statute book, Mr Jaitley affirmed that India was simply exercising its sovereign right.
This issue needs to be revisited again. There are other things the Indian government could do to ease suspicions. One is greater fiscal discipline. A smaller deficit would reduce the pressure on the taxman to milk business. Regional tax offices should abide by the same set of rules and stop operating bespoke local regimes.
Mr Modi has a huge task. He needs to breathe new life into the Indian economy in a period of uncertainty for emerging markets. But there are simple things that this new government can do that would bolster investor confidence. Introducing more moderation and predictability into Indian tax affairs would be an excellent start.
