In a recent interaction with Finance Minister Arun Jaitley, former Finance Minister P Chidambaram said that if he had had 282 MPs, he "would have passed a simple legislation that is required to undo" retrospective taxation. But the former minister's actions belie his words. Rather than demonstrate any inclination to repeal the law, as finance minister he had aggressively deployed it. The running joke during his tenure was that the National Advisory Council set the expenditures, the ratings agencies decided upon the fiscal deficit, and the finance ministry unleashed its taxmen to collect enough revenues to satisfy the expenditure and deficit targets.
Using a term popularised by candidate Narendra Modi, this "tax terrorism" was among the root causes of the dip in the growth rate from which the economy is yet to recover. While Mr Jaitley has promised not to open new cases of retrospective taxation, his ministry too has been slow to take actions that would soften the blow from the old cases and end the tax uncertainty that continues to dog future investors. The ultimate victim of the delays on both counts has been the prime minister's Make in India campaign.
The case of the Nokia factory in Chennai, which once manufactured 150 million handsets to become the world's largest handset manufacturer, best illustrates the damage an inadequate response to past cases can inflict on the economy. Established in 2006, the factory once employed 12,000 workers directly and another 25,000 indirectly in factories supplying parts and services to it.
In 2013, Nokia decided to exit mobile and smartphone manufacturing and sold its worldwide operations to Microsoft. Around the same time, the income tax department retrospectively assessed a sum of Rs 15,258 crore in tax liability against Nokia, India and placed a lien on its Chennai operations. The lien led to the exclusion of the factory from the Microsoft deal. Nokia India tried to keep the operations at the factory partially alive by producing handsets on contract for Microsoft, but the latter ended the arrangement in October 2014. Currently, the factory is closed,with the tax authorities holding the lien on it.
The president of Nokia India, whom I recently met, says that ten different international and domestic manufacturers have expressed interest in buying and reviving the Chennai factory. It seems that such revival would be a win-win proposition. For India, it would turn an unproductive asset productive. The factory would also escape technological obsolescence, which occurs rapidly in this sector in the absence of continuous upgrading. Above all, the revival would return tens of thousands of good jobs back to workers in Chennai. Nokia too would gain because the sale would preserve the value of its factory, which is bound to decline rapidly otherwise due to obsolescence. For the tax department, a renewed factory would be a source of tax revenues. The government will, of course, be free to hold the proceeds of the sale of the factory in an escrow account to preserve its collateral.
As regards future investors, the assurance against retrospective taxation remains insufficient, since they must additionally be able to assess with reasonable certainty future tax liabilities. The existence of an unusually large number of tax disputes, which make a non-trivial contribution to the clogging of the judicial system, testifies to the ill-defined nature of tax laws in India.
Once again, the Nokia tax dispute illustrates the point. The dispute involved downloads of software from the parent firm in Finland on handsets manufactured by the Chennai factory. The latter paid the parent firm royalty on these downloads. Indian tax authorities argue that Nokia owes them a tax on those royalty payments. Nokia counters that this is in contradiction of a bilateral treaty between India and Finland, which stipulates that the software business is taxed in Finland. Evidently, such ambiguities need to be cleared if we wish to see the Make in India campaign succeed.
Downloading software on a piece of equipment manufactured in one country from a company located in another country is hardly an unusual activity. China manufactures hundreds of millions of pieces of handsets, tablets, laptops and desktops each year and they all require software owned by companies located in other countries. Why have such disputes not endangered the electronic assembly industry in that country? One suspects that the Chinese understand better that it is unwise to kill the goose that lays the golden egg.
In today's highly globalised world, paper-thin cost differences can lead entire factories to migrate from one country to another. The entry of Nokia in 2006 had offered India the opportunity to set an example that would lead the global electronic industry to migrate to it. But in our zeal to immediately generate a large volume of revenues, we have compromised that prospect. Ironically, in doing so, we may not have added much to our revenue kitty either. Already, the tax authorities have lost a $3 billion tax claim against Shell in the Bombay High Court.
With wages rapidly rising in China, all is still not lost. Wage costs in India are significantly lower and this fact could still help us turn the tide in our favour. But this is only possible if we drop our lackadaisical attitude and rapidly set our house in order. We must urgently end the uncertainty that the current ambiguity in tax laws implies. This is not a terribly complicated task once we recognise that other countries do have well-defined tax regulations that we could adapt to our special circumstances.
While this end in uncertainty will go a long way towards placating investors, we will also need to reform the land acquisition law and labour laws to provide a healthy business environment all around. We ought to remember that no social programme can trump the social security that well-paid steady jobs and a fast-growing economy provide. Even imparting skills is of little value if the economy is held back by a poor business environment and, thus, fails to generate the jobs that are supposed to use those skills.
The writer is professor of economics at Columbia University
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