More than any other single act, the retrospective amendment of tax laws governing transfer pricing in the 2012 Union Budget damaged India's reputation as a destination for investment. The United Progressive Alliance (UPA) government spent years trying to do damage control for that poorly communicated act of lawmaking, and eventually failed. Among the many hopes engendered by the arrival of the National Democratic Alliance (NDA) was that it would help move India beyond this trap. A more business-friendly government would hopefully communicate the government's attempt to levy only fair tax demands in keeping with widely held global principles while not compromising sovereign rights. However, last week when Cairn India was hit by a notice from the tax department demanding Rs 20,495 crore in back taxes consequent on a related-party transfer prior to the company's listing in 2007, it became clear how little has changed, and how far the government still has to go in order to clarify its efforts.
Whether or not the taxman has a moral or legal case against Cairn India is beside the point. After all, the taxman had a moral and legal case against Vodafone as well, and yet there were solid practical negatives to pressing the case in the manner the government did. The point is that this demand on Cairn India puts foreign investors back in an old quandary. When Finance Minister Arun Jaitley, while presenting his first Union Budget, had assured tax-payers that the government did not intend to misuse its sovereign right to make retrospective law, many heard it as an assurance that the chapter of India's economic history vitiated by the Vodafone fallout had been closed - that the organs of state would not follow up on the past transactions that were caused to be taxable by the 2012 amendment, even if that law remained on the books. Now, investors will ask whether government assurances are worth anything. This loss of credibility is something the government can ill afford. Surely it has learnt from the UPA's problems how damaging such a loss of credibility can be.
The government's own defence is an example of poor communication and legalistic hair-splitting, the exact opposite of what is needed. It maintains that no new legislation has been passed with retrospective effect; that fresh notices of retrospectively applied taxation from existing laws would require permission from the Central Board of Direct Taxes; and that earlier notices would be sorted out through the legal process. It is clear that this is a taxman's solution, and not a politician's. The actual answer is the route that the government should have taken from day one: the emphasis that retrospective taxation remains a right, alongside the tactical modification of this particular retrospective law. Keep the law on the books, but only with prospective and not retrospective effect. The government cannot have it both ways. It cannot claim that India is "past" the Vodafone effects, while having headlines hit the world press about further retrospective tax demands. This is a problem of communication and of clarity, not of economic management. The government must rein in its tax officers, and it must bring about necessary changes in the law that is holding back investor interest.
