Tax shockers ramp up India investor risk premium

April 17, 2015

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

India’s tax shockers are coming thick and fast. The government wants 400 billion rupees ($6.4 billion) in what it says are unpaid taxes from foreign funds. Top lawyers expect overseas private equity investors could be next. The latest surprise change to the country’s tax policy suggests investors will need to factor in higher risk premiums to protect themselves against future fickleness.

The country’s Minimum Alternate Tax, equivalent to 20 percent of a company’s adjusted net profit, has been in place in its current form since 1997. The duty was designed to ensure that large domestic companies like Reliance Industries paid a certain amount of tax. At the time, exemptions meant that Reliance and others had no taxable income even though they were reporting large net profits and distributing dividends. Until now, the rule has not been applied to foreign funds.

The move to levy the tax on overseas investors retrospectively runs roughshod over India’s capital gains rules. Foreign funds are already subject to a 15 percent tax on any profit they make from short-term investments. Treaties also mean that portfolio managers investing through Mauritius and Singapore are supposed to be exempt from tax.

It is also unclear who is on the hook: the asset managers or their investors who may have only bought into the fund recently. The $6.4 billion figure, which may apply to up to 6,000 odd funds, could well rise. The demands served so far mostly relate to the fiscal year 2012. India’s tax code allows authorities to go back up to seven years.

Despite recent demands for retrospective taxes from UK-listed energy companies Cairn Energy and Vedanta, investors had given the government the benefit of the doubt that it still intended to honour its promise to end “tax terrorism”.

Part of the blame may lie with India’s unwieldy bureaucracy. But finance minister Arun Jaitley has endorsed the claims by saying that retrospective tax on foreign funds could help to fund improvements to irrigation. That suggests that the government’s vision of reform may be very different from what investors who have charged into India had hoped for.

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