India’s “tax terrorism” proves hard habit to kick

March 13, 2015

By Una Galani

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

India’s latest international tax shambles shows that it is easier to say something than to do it. The country’s new government could honour last year’s campaign pledge to end “tax terrorism” by scrapping a controversial law that allows it to seek payment for past transactions. The political fallout at home may be less painful than enduring embarrassment overseas by pursuing companies like Britain’s Cairn Energy.

The gap between India’s tax rhetoric and reality has hit the London-listed company hard. The authorities have used a retrospective rule introduced in 2012 to demand that Cairn pay $1.6 billion in tax plus interest and penalties on capital gains that arose from an internal reorganisation prior to listing its India unit in 2007. The demand has wiped 19 percent off the company’s market value since March 10. Though Cairn had been under investigation since January 2014, and blocked from selling its remaining 10 percent stake in the Indian business, the new government’s reassurances had led investors to believe the case would be dropped.

Fear of the political fallout may have deterred Prime Minister Narendra Modi’s government from scrapping the rule. The new administration is already feeling vulnerable after suffering a big defeat in last month’s Delhi state elections. The worry is that voters will punish the Bharatiya Janata Party further if it gives in to foreign multinationals.

Doing nothing could be worse, however. Cairn has filed a formal complaint under a bilateral treaty that leads to international arbitration. Telecom operator Vodafone took a similar step last year. Arbitrators tend to frown upon retrospective taxes. While this approach potentially allows India’s authorities to resolve the disputes without making difficult political decisions, the government could end up on the hook for damages if it loses. The case could also prompt other companies to seek arbitration for their tax disputes.

The demands imposed on Cairn suggest that a long list of companies could be hit with historical tax bills as the authorities allow existing investigations to run their course. The negative publicity and the BJP’s failure to honour its campaign pledge will damage the country’s efforts to attract more international investment. The government has to decide whether this is really better than making a politically unpopular decision.

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