It seems Prime Minister Narendra Modi’s message of ‘Ease of doing business in India’ has not reached the Income Tax department. Just when one thought that the issue of retrospective tax was dealt with the income tax officials issued a ‘clarification’ which is more confusing than the original notification and has once again ignited the retrospective tax debate.
Here is what the issue is all about.
The previous UPA government after losing a battle in the Supreme Court to collect tax on the Vodafone deal decided to change the law by introducing a retrospective amendment to the Income-Tax Act, 1961.
In order to negate the effect, finance minister Arun Jaitley in his maiden Budget speech declared that no fresh action would be initiated on any transactions prior to 2012 under the amendment to tax indirect transfers.
However, by the time Finance Minister’s words were put in action it was 2015. Many of the clarifications in the law were announced in that year. There was thus a gap between 2012 and 2015 which needed to be addressed.
In order to clear this doubt Central Board of Direct Taxes (CBDT) came out with a clarification on December 22, saying that if the shares of an Indian company held by a fund constituted more than 50 percent of total assets and the value of the holding exceeded Rs 10 crore, the transaction would be taxed in India under the indirect transfer rules.
Earlier rules of indirect taxes were applicable to tax mergers and acquisitions taking place abroad but having substantial interest in India. The current clarification makes the tax applicable to investment vehicles. That is where things get messy.
Now these investment vehicles are like mutual funds where an investor opens an account with them. But unlike a mutual fund the investor can pick and choose their own stocks to invest. However, capital gains taxation is calculated at the fund level rather than individual level. Thus, it becomes an operational nightmare for the fund to calculate and keep track of gains and losses for each investor and then passing on the tax liability to them.
The clarification is interpreted as a retrospective tax where the fund will be taxed on gains between 2012 and 2015. For a fund, if an investor has sold his investments and closed their accounts it would be nearly impossible to retrieve the taxes. Further, even from existing investors asking them to pay for past investments, over and above the capital gains tax will only lead to further litigations.
With foreign institutional investors selling their investment for over two months now, the least the government need to do is to act fast. Not only is a clarification on the ‘clarification’ needed to clear all doubts, they need to separate taxation impact on foreign direct investments and investment vehicles like foreign portfolio investment (FPI).
If government is serious on ease of doing business, it has to start with improving its communication channels. Demonetisation episode highlighted the government and its agencies’ lack of communication skills. The same lethargy is now being reflected in its dealing with foreign investors. Government needs to come out of the fire-fighting mode and pre-empt future issues if it seriously wants to make investment in India hassle free.