New Delhi, Sept. 21: After the week-long blizzard of announcements on economic reforms, the finance ministry is turning its attention to another area of foreign investors’ angst: taxes.
On Friday, the revenue department slashed the withholding tax on external commercial borrowings from 20 per cent to 5 per cent, removing a major irritant for companies negotiating loans abroad.
At the same time, there were clear signals that the finance ministry was keen to bury the hatchet over the Vodafone tax case that has wrecked India’s reputation as a viable investment destination, precipitating a 45 per cent decline in foreign direct investment into the country in dollar terms.
The reduction in the withholding tax will apply to funds borrowed between July 2012 and June 2015 - and is seen as a spur to infrastructure projects that have failed to get off the drawing boards because of the lack of funds.
Data sourced from the Reserve Bank of India shows companies borrowed $ 1.07 billion in July this year in the form of external commercial borrowings (ECBs). The outstanding ECB debt stood at $104.4 billion at the end of March 2012. A company can raise ECBs up to a ceiling of $1 billion.
“This is a significant relaxation in terms of administrative compliance. While immediate benefits will flow to the infrastructure sector, it should also help improve the foreign exchange position in the country. Significantly, the concessional tax rate of 5 per cent as per Income-tax Act should find favour with foreign lenders as, generally, the tax treaties prescribe a higher rate of tax on interest income,” said Nikhil Rohera, executive director (direct tax) at PricewaterhouseCoopers India.
The tax cut, coming on the back of a number of reform measures, elevated the mood on India’s bourses. The partially convertible rupee rose to an intra-day high of 53.44, its highest level since May 11 this year.
Vodafone truce talk
But it is the talk of the truce in the Vodafone tax case that is starting to draw the attention of investors.
After a five-year slugfest in courts that produced an adverse verdict for the revenue department, the government tried to undermine the effect of the verdict through a 50-year retrospective amendment of the Income tax Act. The move rattled foreign investors and raised serious questions about the notions of fair play and India’s respect for court verdicts.
The case arose over the revenue department’s move to gouge out $2 billion in taxes from a $11.2 billion deal between two overseas entities – Vodafone International Holdings, a Dutch subsidiary of Vodafone Plc, and Hong Kong-based Hutchison Whampoa and its associate firms.
On Friday, Vodafone India chairman Analjit Singh met finance minister P. Chidambaram, fuelling speculation that a rapprochement was imminent.
The latest initiative from North Block suggests that an old truce offer, which was made about a year ago, has been revived. Under the terms of this offer, Vodafone will have to pay the original tax without any penalties or interest, which the government had threatened to invoke by treating it as an assessee in default. The tax payout could work out to Rs 8,000 crore instead of the Rs 11,000 crore initially demanded, or the Rs 20,000 crore which the government had at one stage threatened to seek.
Chidambaram has asked expenditure secretary Sumit Bose to take over the crucial revenue department to tone down the fulsome rhetoric of its previous secretary who was insisting on the implementation of the general anti-avoidance rule (GAAR). This is a new-age tax measure that developed countries in the west have started to experiment with to stop foreign investors from using elaborate corporate structures and a fund trail passing through a number of tax havens to minimise tax payouts in the country where the income originates. The move to introduce GAAR from April next year had spooked foreign investors who were considering opening ventures in India.
The finance minister told reporters today that the assessing officer in the Vodafone tax case had been asked to consider three aspects before deciding whether or not to serve another notice on the world’s third largest telephony player: the amendment to section 199 of the Income Tax Act, which allows the government to tax an overseas deal if it involves an underlying asset in India; the attorney general’s opinion in the case; and the final report of the Parthasarathi Shome Committee which is examining the GAAR issue.
Meanwhile, Shome told reporters in Mumbai that he would probably submit his final report by the end of the month. In his draft report submitted on September 1, Shome had advised the government to defer GAAR by three years. The scope of Shome panel was expanded recently to examine the issue of taxation of non-resident transfer of assets where the underlying asset is in India – which will have a bearing on the Vodafone case.
Last week, Vodafone Plc’s chief financial officer Andy Halford had told a wire agency in an interview in London that it had started consultations to decide whether it should make a provision for the tax liability in India. A decision would be taken by November, he added. The test on whether to make a provision was “now being applied differently against a recently introduced, albeit retrospective, legislation”.
Sources say revenue officials made a strong case that letting Vodafone off the hook would affect a number of other cases. These include the Idea Cellular-AT&T deal, SABMiller’s buyout of a 100 per cent stake in Foster’s India, and General Electric’s sale of its majority stake in Genpact in a $500 million deal.