Lobbying for a tax-free banana republic: Aditya Velivelli

Guest Post by ADITYA VELIVELLI

POST-BUDGET UPDATE ADDED AT THE END OF THE POST (JULY 12, 2014)

Consider that an individual bought a house in 1992, made a few modifications, added a garden etc. and rented it out for the next 15 years. This would have brought the individual a steady stream of income over that 15 year period.  In 2007, the individual decides to sell the house and it fetches a much larger sum than it was bought for (considering real estate prices went up quite a bit during 1992-2007). The income tax department sends a bill for 20% of the sale price. This is the long term capital gains tax and applies to both residents of India as well as non-residents.

Now consider this.

In 1992 the Hutchison Group of Hong Kong invested in the Indian mobile telecom industry through a joint venture later named Hutchison Essar Ltd or HEL. By 2006, Hutchison expanded its presence into 23 mobile telecom circles.

In 2007, the Hutchison Group’s 67% controlling interest in HEL was indirectly sold to Vodafone for an amount of USD 10.8 billion. This transaction occurred through Vodafone’s purchase of shares in a Cayman Islands (offshore) entity. It was a calculated attempt by Hutchison and Vodafone to avoid paying tax on capital gains.

Economic Times reported on April 3, 2007

The I-T department recently shot off a letter to Hutchison Essar [HEL] asking it to impress upon Hutch Telecom International [HTIL] to pay $1.9 billion by way of capital gains.

“…it has come to our knowledge that HTIL has made substantial gains from their investment in Hutchison Essar [HEL]. You are requested to impress upon HTIL to discharge their tax liabilities on the gains made.”

The Income-Tax department letter stated that according to Section 195 of the Income-Tax Act, Vodafone should deduct income tax when making the payment. However, HEL, HTIL and Vodafone ignored the I-T department and the case went to court.

The Supreme Court ruled in favor of Vodafone in January 2012 because it inferred that the transaction occurred between Vodafone’s Dutch unit and the Cayman Islands company and thereby between two non-India based entities. This meant that Vodafone did not have to pay $2 billion in capital gains taxes on the transaction.

The Indian Government decided not to take this lying down.

If someone offered to invest $200 billion in India only if there is no tax, I will not allow it,” the former finance minister and now President of India, Pranab Mukherjee, told reporters in March 2012. “This is because India is not a tax haven, zero-tax or low-tax country.

President Pranab Mukherjee, a veteran of national politics originally from Bengal, understood that India should not be treated as a banana republic. One can deduce from Vivekananda’s speeches that John Stuart Mill has an audience in Bengal and there is a good probability that Pranab Mukherjee was one of them. With an MA in Political Science and History, Pranab Mukherjee could have noticed Mill’s statement:

A peculiar tax on the income of any class, not balanced by taxes on other classes, is a violation of justice, and amounts to a partial confiscation.

President Mukherjee could have decided that such a violation of justice must not occur. In the March 2012 union budget, Pranab Mukherjee announced plans to change the law to allow the taxation of overseas deals in which an Indian asset is transferred.

Financial Times of the UK was shocked enough to call it a bombshell:

Into a budget generally described as “balanced” or “modest” the Indian government seems to have slipped one bombshell: retrospective taxation of overseas transactions which involve assets primarily in India.

In reaction to this change in laws, immense pressure was exerted for the first time on a sovereign country as large as India. Financial Times reports

In an unprecedented move, seven business associations from the US, the UK, Canada, Japan and Hong Kong, have written to Indian prime minister Manmohan Singh warning him against going against international practice and endorsing “retroactive” tax rules.

They say some companies have already begun to re-evaluate their investments – and others could follow suit in “a widespread reconsideration of the costs and benefits of investing in India”.

That’s pretty much as strong as it gets in global business diplomacy, where companies are generally loathe to blast government policies so publicly. But the stakes have rarely been as high as they now are in India.

But, other commentators pointed out more reasonably

“The government wants to plug as many holes as possible,” said Jagannadham Thunuguntla, head of research at SMC Global. “If your fund actually belongs to the US and just to get a tax advantage, you’ve created an artificial company in Mauritius…Mauritius is not being used as a residence, just as a tax shelter.  [The government’s point is that] the tax-avoidance agreement with Mauritius should not be made a mockery of.”

WSJ reported similarly in Aug 2012

India’s aggressive drive against tax avoidance echoes efforts in other big emerging markets, including China. Having become confident enough of their investment allure, they have begun to emulate tactics long used in the U.S. and Europe to challenge multinationals’ complex tax schemes.

Note what WSJ said. India was simply following in the footsteps of countries such as USA and China to avoid becoming an alluring destination for speculators in banana republics.

Plenty of news articles came out in the aftermath of the bombshell of budget 2012 that tried to play it as being against investors and therefore bad for India. See here and here and here.

However, as a BusinessWeek article pointed out, real investors look for growth and are not concerned with taxation of capital gains

Despite a shifting regulatory environment, India’s relatively fast growth continues to seduce investors.

“This trip reinforced the enormous potential of India and we remain committed to helping our clients grow both inside and outside India,” chief executive Lloyd Blankfein said in a statement Sunday.

“If you do business in the U.S. you are lucky to have 2 to 4 percent growth,” said Gunjan Bagla, MD of a Los Angeles consulting company. “If you want to grow revenue 5 to 10 percent you have no choice but to look at a market like India. You have to take India as it is.”

An example of why investors invest

The sale will allow Soros, T. Rowe Price Group Inc., Citigroup, ICICI Bank Ltd. and the other investors to benefit from an expected $500 billion investment by the Indian government in roads, ports and bridges to reach a 10 percent economic growth rate by 2012.

People like Soros invested because they expected the infra companies to get Govt. projects and thereby make profits. Soros did not invest thinking about the capital gains tax issue which was already out in the open by Dec 2007.

Economic Times reported on December 9, 2011

India Inc fears populist measures and higher fiscal deficit as general elections approach

Ajay Piramal, who sold his pharma business that he built from scratch to Abbott Laboratories for $3.72 billion in May 2010, is biding his time by investing driblets of cash in his tried-and-tested real estate business and also reinvesting cash surpluses in inter-corporate deposits.

Piramal for whatever reason did not mention his Vodafone investments at that time, which might have been funded by the proceeds from his sale to Abbott. Considering the amount of money, about half the money from the Abbott sale went toward buying the stake in Vodafone. And yet in public, Piramal disingenuously mentioned that he was “biding his time”.

These 2 examples of Soros and Piramal are given just to show that investors do not think about the capital gains tax issues when they decide to invest. Put simply, Piramal invested his money as soon as he found an opportunity notwithstanding Govt. tax policies and so-called India Inc fears.

By 2014, Piramal’s Vodafone investment made an absolute gain of more than 51%.  Can you then imagine how much Vodafone itself gained after having bought HEL in 2007?

It is only people dealing in mergers and acquisitions that fear taxation the most. They also happen to be the most unproductive “investors” as they play with money and debt to make profits

Unable to find profitable productive investment opportunities in the face of excess capacity and flagging demand, they have been eager participants in the merger, takeover, and leveraged buyout frenzy that has swept the country in recent years, becoming in the process both lenders and borrowers on an enormous scale.

On the upcoming budget to be presented today, July 10, NDTV said on July 8:

Modi Government May Scrap Law That taxed Vodafone-Like Deals

In a move to signal the new government stands for investor-friendly reforms, Finance Minister Arun Jaitley is likely to announce on Thursday in his maiden budget the scrapping of a recent legislation that allowed India to tax deals that have already been concluded.

However, no analysis was offered on recent news regarding Jaitley’s Vodafone conflict of interest

Jaitley has on file recorded that all issues relating to the Vodafone tax case be referred to Minister of State for Finance Sitharaman or Revenue Secretary Shaktikanta Das, sources said. No reason for Jaitley’s decision was given but it may be linked to the fact he could have been associated with either parties in the case in his capacity as a senior lawyer.

Jaitley had not let this conflict of interest be known when he criticized the retroactive taxation as leader of the opposition in the Rajya Sabha in March 2012. Perhaps this conflict of interest occurred after his Rajya Sabha statement. This should have been confirmed by the newspapers, but again no questions were asked, and the PTI report was simply repeated verbatim. This episode is similar to the manner in which newspapers responded to the Reuters June 4 report on FDI in e-commerce, which all newspapers duly printed verbatim offering no analysis.

With so many shenanigans going on here, instead of addressing them, The Indian Express, the newspaper that claims “journalism of courage” published on July 7 an article by a graduate student of business that demanded annulment of retroactive taxation because it has “perhaps caused incalculable damage to the country”. The graduate student’s article is one of several articles in the last few days urging the government to do away with the retroactive taxation. Here is one from UK’s Financial Times editorial and one from India’s Economic Times. BJP’s backroom economic think-tank director Shaurya Doval expressed similar views “Moves such as retrospective taxation have dented investor confidence. India needs to restore its credibility.” PTI reported that Mr. Jaitley has delegated Vodafone related retroactive taxation issues to minister of state for finance, Ms. Nirmala Sitharaman. It should be noted here that Ms. Sitharaman is a colleague for Mr. Shaurya Doval at the BJP think-tank, India Foundation. To what extent her colleague’s views affect her is not known.

Let readers decide why Indian Express and Economic Times decided to publish such articles while at the same time ignoring the expose published at Kafila on FDI in e-commerce.

Let readers also ponder these words of Noam Chomsky on the Indian media

The media in India is free, the government doesn’t have the power to control it. But what I saw was that it was pretty restricted, very narrow and provincial and not very informative, leaving out lots of things.

POST-BUDGET UPDATE (JULY 12, 2014)

Post-Budget headlines say “Belying Expectations, Finance Minister Doesn’t Scrap Law on Retrospective Taxes”.

BUT NOT SO FAST

Vodafone had initiated arbitration proceedings in January under the India-Netherlands Bilateral Investment Treaty. The previous Government indicated that this was improper because “tax disputes aren’t covered” by the treaty and that it would contest the arbitration notice,

The new commerce minister Nirmala Sitharaman used a vulgar word “tax terrorism” to describe President Pranab Mukherjee’s patriotic initiative on retroactive taxation while the new telecom minister publicly stated “Retrospective taxation is something that needs to be avoided”.

An individual familiar with Vodafone’s affairs said “What we have heard and seen is that voices in the government are supportive of scrapping the retrospective amendment and we feel this is reflective of the government at large”.

The BJP government ignored the previous government’s stand and instead joined the arbitration proceedings in June. Again, newspapers did not analyse why the BJP Govt. decided to go ahead with arbitration even though previous Govt. had decided to defend against the arbitration notice.

The previous government was planning this in early May

According to officials, the government won’t appoint an arbitrator in response to the notice sent by the Dutch arm of the British telecom giant…

Legal experts say unless Indian government gives its consent, the arbitration would be “stillborn”.

Finance ministry officials said that Vodafone was well aware of India’s position that taxation is not covered by the India-Netherlands BIPA and that the question of appointing arbitrators does not arise. 

Despite all these advantages on the government’s side, the BJP government gave in to arbitration because it favored Vodafone’s demands and considered retroactive taxation as “tax terrorism”.

Interestingly, a public interest litigation (PIL) has been filed in the Supreme Court to restrain the government from going ahead with arbitration proceedings. The PIL, filed by former additional solicitor general Biswajit Bhattacharya, states that “allowing arbitration would lead to violation of rule of tax laws”.

13 thoughts on “Lobbying for a tax-free banana republic: Aditya Velivelli”

  1. The author seems to be missing the point. The protest was not on the imposition of Capital Gains Tax but on retrospective taxation.

    The business forums were protesting the imposition of taxes on an event which occurred prior to the law being framed.

    Ex post facto laws are typically forbidden by several legal systems & constitutions.

    It is against the concept of fairness – A person or an organization decides on his actions basis the best understanding of the legal framework at that time.

    Hence, I believe the protests were fair against retrospective taxation and not the taxation of capital gains.

    I hope the readers can spot the difference.

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    1. Shivinder, If big corporations turn out to be tax cheats and humiliate our Government, then the only route left to obtain the money owed is to change the law.

      How can you say it is against the concept of fairness, when a Government has to answer to its own nationals why they have to pay tax on capital gains while foreign corporations get away with it. What President Pranab Mukherjee did in the 2012 budget was a patriotic and courageous initiative.

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      1. Hi,

        There is no concept of tax-cheats. The law did not EXIST at the time of the deal. Which is why the government had to promulgate a retrospective ruling.

        I am not against the concept of capital gains on such a transaction. The government could have simply admitted the loophole and closed it. It would have been the law and all future transactions would have to comply by it. Simple.

        By changing the law and retrospectively penalizing a company, the government achieved nothing but scaring away investment flows. Your interest would dwindle if you believe the government can change the law later and penalize you for your previous actions.

        @Nivedita – i have read the link – In 2012, the Supreme Court ruled that Vodafone was not liable to pay taxes on its acquisition – The addition of another PIL doesn’t change the facts of the case.

        We must all realize that this is a dangerous and shaky ground – When you can change the law later and penalize for activity prior to the enactment of the law, where is the concept of natural justice?

        The law could be changed tomorrow and say that in the interest of public health smoking is outlawed – And anyone who has ever smoked should be put in jail…. It’s an extreme example – of course – but that is the danger of legal precedent.

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      2. Corporates may be (some of them ARE indeed) cheats. It does not mean government should turnout to be one. Vodafone only made use of law of the land at the prevailing point of time. And it is really funny to see patriotism creeping into the comment of the author – reminds me of the saying “patriotism is the last refuge of ………”. And by the way it was not president pranab who did it – it was politician-minister pranab.

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  2. I have demonstrated in the article that investors invest when they see an opportunity to make profits. Government law-making process does not deter them. It is a lie they put out there to blackmail governments.

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  3. Another, germane example of retro tax would be this. The income tax slabs have been enhanced in this budget. So all of us can claim “retro” treatment and ask for IT refunds going back to the full period of our earning years!

    the retro tax law was an act of extreme stupidity and malice. Look at the sequence of events. First, CBDT imposed a tax claim basis a concept (offshore capital gains) that was not present in the statute books. The affected company appealed to the courts, and the Supreme Court ruled in its favour. The govt then went ahead and changed the law retrospectively to effectively overrule the SC judgement!

    Recipe for “cheating” corporates is a cleaner, simpler law, not a muddled attempt at claims. This only enriches lawyers serving both the government and the corporates!

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  4. Rajeev, and rapacious corporate capital is the last resort of the…? Strategically, historically all nation-states have used the idea of national interest against the ravages of unfettered multinational capital. Surely you know that the most striking example of protectionsim in the closing decades of the nineteenth century was the U.S itself? In Europe, nationalists like Friedrich List were urging the boycott of foreign goods and companies to protect the German people. So if patriotism “creeps into” the response of the author, it is hardly a matter of comment. What about a term such as “India Inc”?

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  5. Thanks Sunalini for your comments. Apparently Rajeev did not read the article to take note of this WSJ report:
    “India’s aggressive drive against tax avoidance echoes efforts in other big emerging markets, including China. Having become confident enough of their investment allure, they have begun to emulate tactics long used in the U.S. and Europe to challenge multinationals’ complex tax schemes.”
    http://online.wsj.com/news/articles/SB10000872396390444327204577615924257597492

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  6. Your citation for the BJP government starting arbitration with Vodafone in June 2014 goes to a Hindu BusinessLine article publsihed February 2014 (which BTW refers to arbitartion offers from the UPA government under Indian laws in June 2013, not 2014). Perhaps you would like to correct that.

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