Incidentally both are related to the recent budget proposed by the Indian government in the month of March 2012. The Indian government missed the earlier targeted fiscal deficit for the financial year 2011-12, that too by a wide margin. Then, it has projected a higher fiscal deficit for the fiscal year 2012-13. And worse, most of the economists feel that the government would not be able to meet even that target.
But the government seems to find a good plan to generate some tax revenues from other means. In the budget, the government proposed to introduce the General Anti-Avoidance Rule (GAAR). This new rule aims to counter aggressive tax avoidance schemes. And no doubt, in principle the rule is a welcome move by the Indian government. After all, no one, foreign or domestic investors, should be allowed to take any undue benefit of the loopholes in the existing taxation rules.
However, what is hurting the sentiments and confidence in the entire business community, especially foreign investors, is the implementation of the new rules retrospectively. Then, there is no clarity as to how the new rule will be implemented. Who all would be coming into this new tax net? As of now, GAAR is very broad. And it could be interpreted as the taxation on foreign investment in stock and bond markets as well.
Implementation of law retrospectively is seen as changing the goal post by the Indian government. In that scenario, foreign investors would not be able to feel confident while coming to do business on Indian soil. No doubt, making rules is the government's prerogative. But, in the process, the government must not be unfair by changing the rules of the game, already played. Especially, if an entity has done business by following the rules, without any ill intension, it should not be victimised. For example, Vodafone's purchase of Hutchison's stake in its Indian venture. As per the management of the Vodafone Group, at the time of transaction, there was no tax liability since the transaction was conducted by the foreign companies overseas. As a matter of fact, the apex Indian court, the Supreme Court, has already given a decision in favour of Vodafone. Still, the new rule would allow the government to impose a tax of more than US $2 bn on the company. And Vodafone is contemplating all available actions against this.
And many more similar cases would keep arising in the future as well. The most hurting outcome of this would be the loss of credibility of the Indian government. The business environment is already mired by all sorts of corruption scams, policy paralysis and lethargic bureaucracy. The legal battles due to the retrospective implementation of GAAR would add further woes. And in turn, would widen the trust deficit between the policy makers and the investors.
GAAR is a very important step taken by the Indian government. However, first the government must come with all the clarity as to how the rules would be implemented. Then, in the process, the government must ensure that it should not hurt Foreign Direct Investment. After all, India badly needs to grease the wheels of its economic growth to keep it moving at a robust pace.