No, you can't have your cake and eat it too

2 JULY 2011

The Income Tax Department is desperately seeking to increase tax revenue, doubtless under pressure from the Ministry of Finance, in order to reduce the country's fiscal deficit. In its quest, it is taking new and untested stances. Earlier it has slapped a tax bill on Vodafone, for not having deducted tax at source from the capital gains accruing to Hutchison, from whom it acquired a controlling stake in the Indian company, through an offshore transaction. Hitherto, offshore transactions of shares in a company (which is a legal entity) was not subjected to such tax. Vodafone points out that the Department has made no claim on Hutch, which made the gains, as it would perhaps be futile to pursue an entity based in Hong Kong with no assets in India. Far better to pursue Vodafone, which has invested $ 11 b. in India. ----------------------------- A Good Time To Sell Bad Stocks -----------------------------

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Once bitten, twice shy. Last week Vodafone acquired the 33% stake held by Essar, but it is deducting tax at source from a part of that stake bought, similarly, in an offshore transaction, by way of abundant caution.

But every action has an equal and opposite reaction. One such opposite reaction would be a fall in M&A activity, at least until the court gives its judgement on the tax bill on Vedanta.

Another stance taken by the department is in its investigation of onshore services offered by IT companies. These are, rightly, according to this columnist, treated as export of software on which exemption from tax is claimed. The department differs. It claims these to be 'body shopping' and not export of software, thus liable to tax. TCS is the latest to be so investigated, after Infosys and Wipro. Its onshore work accounts for 45% of revenue, and, were this stand of the IT Department to be upheld, there would be equal and opposite reactions.

Export of IT services form a large part of the invisible earnings, whose growth, as per the table below, has helped curtail India's current account deficit in FY 2010-11

Exports55.3 52.0 65.977.2
Imports87.2 89.3 97.4107.1
Trade Deficit(31.9) (37.3) (31.5)(29.9)
Invisibles (net)19.8 20.5 21.524.5
Current acc. Deficit(12.1) (12.1) (10.0)(5.4)
Source: Mint, July 1

Imports, largely of crude oil, are price inelastic and growing. The trade deficit is roughly at $ 30 b. a quarter. Without invisibles, which are growing, the current account deficit would be unmanageable, and would impact the exchange rate.

The Government's stance on the Cairn-Vedanta deal has been correct. The deal was conditionally approved last week, after, basically, endorsing the stand of ONGC which was paying all the royalty whilst holding a 30% share in the block. The Government, which initially proposed the arrangement in order to attract explorers like Cairn plc, had not, hitherto, intervened. The dispute between ONGC and Cairn was the subject of arbitration. One of the conditions is for the arbitration to be withdrawn by Cairn. The other is for the royalty be treated as cost deductible, hence refundable to ONGC for the excess amount. What this means for the deal is that Cairn plc gets less than it had earlier negotiated for, the difference being in the royalty payment agreed on in the initial deal (which was with Cairn not Vedanta) and which the Government got an opportunity to intervene in once ownership changed hands. ONGC has a pre-emption right.

An equal and opposite reaction to the policy flip flops and paralysis of economic decision making is the reduction in investment. Capital expenditure by companies for the Jan-Mar quarter, at Rs 266,000 crores, is the lowest in 7 quarters. Projects worth about Rs 52,000 crores were shelved. This means that economic growth will be impacted.

Labour laws are something that are crying out for debate and reform. Existing laws protect those already employed in the organised sector, even as they give a raw deal to those outside. The $ 73b. auto industry employs some 13 million persons, of whom 70-80% are contract labour. The reason they are on contract is because of the labour laws which make it almost impossible to downsize, or relocate, manufacturing units in the event of a slowdown. Contract labour gets fewer benefits. So what is happening is that, because of rigidity in labour laws, over 70% of those employed in the industry are excluded from benefits whilst 30% are protected. The industry seeks to double revenue in 5 years, but will take the new workforce on contract. It is the same for the textile industry, which also provides high employment.

The reason for the paralysis in moving ahead with economic reform is because the Government seeks to build consensus, to make sure that the reforms are carried through, and last. Given the fact that political expediency ranks higher than patriotism for most of our political leaders, the building of consensus is, basically, a quid pro quo exercise. If one were ever to see them shirtless, one would notice that politicians have clean backs!

One hopes, at least, that the Government can take a tougher line with the NSG (nuclear suppliers group). It had taken a tough line to get the civilian nuclear deal approved by Parliament, and had barely managed to survive a floor test in the effort. The deal, if one recalls, allowed India access to enrichment and processing equipment even though India is not a signatory to the NPT, since our neighbours also aren't. Now, however, the NSG is reneging on the deal! It wants India to sign the NPT to get access to enrichment and processing equipment.

Luckily, developments in solar technology, and the lowering of costs, are making this a viable option. Gamasolar has established a solar plant in Spain to generate 19.9MW of energy. Nuclear power has a huge cost of shut down as is being discovered by Germany, which has decided to shut down its nuclear power plants. This is because the nuclear fuel rods, waste and spent fuel, need to be stored in concrete facilities for several decades after shut down.

Last week the market was up after the Greek Parliament approved an austerity programme enabling it to receive the bailout money. Part of the programme includes spending cuts, including in social spending (healthcare and pension), which is why the Greeks are on the streets in protest. Part of the programme envisages faster privatisation of state assets. The point is that the assets would go far cheaper than they would have fetched a few years ago, something that our policy makers also have to bear in mind when they express reservations, e.g. at the sale of Air India. Air India would need Rs 3,000 crores a year, for ten years, just to keep it afloat and there is no good reason why it should not be privatised, since pouring tax payers money into it is simply an unacceptable waste. (leading to the IT Department scrounging around for additional ways to get revenue). The only ostensible reason for having a national airline is that it comes to the rescue in case of emergencies, such as when Indian's had to be evacuated out of Libya. But surely the Government can hire planes for the job at a lower cost?

The BSE-Sensex added 522 points to close the week at 18767 and the NSE-Nifty gained 156 to end at 5677.

What next?

Well, the Finance Minister, having got feedback during his recent US visit from global investors, may advice the Prime Minister to push the accelerator on economic reforms. On the cards is increasing foreign investment in organised retail. A few such announcements, combined with the greater confidence of global investors after the extension of the Greek party, may help sustain the rally for a wee bit more. Perhaps to 19,500 on the sensex.

The rally ought to be a selling opportunity. The US Congress has about a month to raise the debt ceiling of $ 14.3 trillion, which is being hit. A failure to do so would cause rating agencies to lower the AAA rating of the US Government, which would have negative consequences. It's likely that the Congress will blink. If it doesn't the roller coaster ride would be dangerous, not just thrilling.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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5 Responses to "No, you can't have your cake and eat it too"

Rasesh Shukla

Jul 4, 2011

Hallow everybody

The best way to reduce deficit in trade balance is very strictly restrict import of Nonsense goods like toys small home articles and other Nor Essential items, this is not unbalancing our Trade account but also spoils so many things, just from our employment to GDP, we just cant afford such multiple affecting losses, on the ground of capturing so called “Free Economy” or to meet WTO norms.

Rasesh Shukla


Jack Wilson

Jul 4, 2011

I am quite surprised that nobody -- newspaper, newsletter, magazine, TV channel, website, etc. -- ever talks about reducing the SIZE of the government and the bureaucracy to control the growing deficit. Isn't it high time to have a leaner (not meaner) and more efficient government that refrains from wasting taxpayers money?



Jul 3, 2011



anupam garg

Jul 2, 2011

Decision making of top brass of the country is becoming more and more questionable. Slapping baseless taxes on companies is only going to degrade country's ranking in the list of best places to do business. India's hopes for double digit growth can only b fulfilled by pvt sector. Kill the golden goose & then keep dreaming about shiny eggs.

But its not only Indians who are short term thinkers. The whole world seems to be havin vision problems. Weren't the risks & problems of nuclear reactors known b4hand? this is something which is taught in xth std. & now tht countries hav got themselves engaged, i dont think thr shld b any looking back. There's no point shutting down operational reactors 4 the fear of natuaral disastors. Of course, residential areas should not b constructed nearby but wht's done is done.

In this sensitive issue also, India showed vision problems by making herself dependent on foreign nations. To what extent will the promises b fulfilled is any1's guess. Its about time we figure out our friends and foes & enter into future commitments & engagements accordingly.



Jul 2, 2011

hi,Mr.Mulraj--I think one reason reg delay in AI privatisation is --if privatised, how can all the VVIP's/Union ministers and their retinue continue to enjoy the foreign junkets at the taxpayers' expense? regds

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