The Telegraph
Monday , September 17 , 2012
Since 1st March, 1999
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Slump in FDI flows forces volte-face on rules

Mumbai, Sept. 16: Foreign investors now have a window of opportunity over the next two years to pour money into projects they wish to establish in India using the same elaborate cross-border corporate structures, investment trails and other stratagems they have employed since 1991 to avoid having to pay huge taxes on repatriation of profits, and the payment of royalties and dividends.

It has taken just one fortnight for the pieces of the UPA government’s carefully-crafted strategy to fall into place as it tries hard to reassure foreign investors that they will continue to have an easy ride into India — as long as it is in power.

On September 1, the Parthasarathi Shome committee recommended that the dreaded General Anti-Avoidance Rule (GAAR) should be kept in abeyance for the next three years. The government had earlier planned to kick off GAAR from April 1 next year. But at a time when it wants to soothe foreign investors’ fears, it will readily accept the Shome committee’s recommendations — and that means that the next government, formed after the general elections in 2014, will have to grapple with the intricacies of the contentious tax rule.

The Shome committee has overturned the basic philosophy behind GAAR: revenue generation cannot be its chief motivation, it said. Taxpayers have a legitimate right to arrange their affairs in such a manner as to pay the least possible tax. The use of GAAR must be limited and circumscribed; and India must see the virtue of adopting the guiding principle behind Britain’s use of GAAR which is to attack only “egregious, aggressive, highly abusive, contrived and artificial arrangements” devised by taxpayers to dodge taxes.

Subtle message

The government then sent out a subtle message that it didn’t plan to rip into every proposal made by foreign investors who route their money into India through Mauritius to take advantage of the double taxation agreement between the two countries.

Under the tax treaty, companies do not have to pay a withholding tax on the money that foreign principals legitimately take out of their Indian operations.

The Shome committee added for good measure that the GAAR provisions “shall not apply to examine the genuineness of the residency of an entity set up in Mauritius,” which effectively throws cold water on the taxman’s ardour to crack tax shields and pursue individuals and entities to various corners of the world.

This nixes the intent spelt out in this year’s budget to amend sections 90 and 90A of the IT Act to make the submission of tax residency certificate “as a necessary but not sufficient condition for availing benefits of the (double taxation) agreements (emphasis added).”

Finally, last Friday (September 14), the government scrapped Zara Holdings’ litmus test — a ruse that some clever bureaucrats dreamed up to keep out companies using the much-tramped and rutted Netherlands-Mauritius-India investment trail, which thrives on the back-to-back double tax avoidance agreements between them.

The three decisions, taken together, provide a stable policy environment for foreign investors at least till 2014 when the UPA government’s term runs out.

There is an obvious reason why the government has suddenly decided to bend over backwards to appease foreign investors. Faced with a 45.1 per cent decline in gross foreign direct investments in the first four months of this fiscal (see table), it had no choice but to get off its high horse.

Two aggressive announcements in this year’s budget — the intention to introduce GAAR and the retrospective amendment in the Income Tax Act to force Vodafone to cough up a withholding tax on its $11.2-billion deal in 2007 under which it acquired a 67 per cent stake in India’s third-largest mobile telephony company, overturning a Supreme Court verdict that went in favour of the world’s largest telecom player — had forced investors to turn off the spigots.

The Zara test

On June 29 this year, the Foreign Investment Promotion Board (FIPB) threw out a proposal by Zara Holding BV of the Netherlands to form a joint venture with the Tatas-owned retail arm Trent to market the clothing brand Massimo Dutti.

Zara Holding is a wholly-owned subsidiary owned by Spanish giant Inditex, the holding company that encapsulates the business interests of Amancio Ortega, ranked by the Forbes magazine as the fifth richest man in the world with assets estimated at $37.5 billion.

Ortega was looking to introduce his second clothing brand in India after the hugely popular Zara, rated as the world’s biggest fashion brand. Zara came to India in February 2009 after the FIPB approved Inditex’s single brand retailing venture with Trent in which the Spanish company held a 51 per cent stake.

When Inditex wanted to launch Massimo Dutti, it decided to route the investment through its Dutch subsidiary to make sure it didn’t run foul of India’s tough single brand retailing norms. But Zara’s proposal was rejected because it violated a rule framed by the government in January this year, which said an investor must own the brand it proposed to bring here.

At around the same time that the Zara proposal was rejected, Swedish furniture maker Ikea proposed to invest 1.5 billion euros ($1.96 billion) in India and set up 25 stores. Ikea was worried that the Zara litmus test could scupper its investment proposal. So, the company sent its officials to discuss the issue with the bureaucrats in Delhi.

The substance of those discussions is not known but Ikea was apparently informed that it wouldn’t have to worry. After all, the government would be crazy to place hurdles in the path of an investor ready to stump up close to $2 billion — about a fifth of the gross FDI that came into the country in April-July.

Last month, an intriguing report surfaced in the Wall Street Journal which said Ikea had made “changes in the corporate structure that shuffled ownership of the brand between different parts of the Ikea empire.” Since this happened so soon after the confabulations in Delhi, it must leave everyone guessing whether there was a connection between the two events.

Ikea, owned by Swedish billionaire Ingvaar Kamprad, is closely held and notoriously cagey. The Journal’s report added that Ikea had valued its brand at 9 billion euros ($11.8 billion).

Friday’s announcement may have made that Ikea brand rejig unnecessary. The government now says that it will no longer insist that the foreign entity investing in a single brand retail business — where 100 per cent ownership is allowed — owns the brand.

Making amends

It took the government just nine months — and a roughly $2-billion investment proposal — to unscramble another odious administrative decision.

In the interests of restorative justice, there’s only one thing the government now has to do: admit it made a terrible mistake in trying to get round an adverse Supreme Court verdict in the Vodafone case by seeking to amend the income tax act with retrospective effective from 1962!

Even more egregious was the government’s defence that this wasn’t an amendment but a clarification of legislative intent — which meant that it was able to get into the minds of dead and gone parliamentarians to divine the purpose behind that piece of legislation.

Imaginative as he was even H.G. Wells couldn’t come up with such a nugget in his 1895 science fiction novella, The Time Machine. This is double dealing because the sub-text of the message was that the parliamentarians in 1962 possessed the prescience to anticipate the intricacies of a Vodafone-Hutchison deal in 2007.

A simple — prospective — Mea Culpa will do.



Gross FDI
($ m)
($ m)
Repatriation/Gross FDI
(in %)
2004-05 6,051 65 1.07
2005-06 8,961 61 0.68
2006-07 22,826 87 0.38
2007-08 34,843 116 0.33
2008-09 41,873 166 0.40
2009-10 (P) 37,745 4,637 12.3
2010-11 (P) 34,847 7,018 20.1
2011-12 (P) 46,553 13,598 29.2
FDI turns sticky this year (Comparison of first four months)
2011-12 (P) April-July 18,680 5,273 28.2
2012-13 (P) April-July 10,257 1,881 18.3
Decline (%) 45.1 64.3