The report of the committee appointed by the government to look into taxation-related matters, headed by Parthasarathi Shome, is now public. While much in the report can be questioned, it is certain that it can form the framework for the government to move forward on the high-profile tax disputes that have worried investors of late — particularly the one involving the transfer of Indian mobile phone operations from Hutchison Essar to Vodafone. The transfer took place in an offshore tax haven, as a result of which capital gains tax on the deal became disputed; when the income-tax department tried to get hold of the tax withholding liability from Vodafone, lengthy litigation ensued. The Bombay High Court ruled against Vodafone; that verdict was then overturned by the Supreme Court, which said the intent of the legislature was unclear. The 2012-13 Budget retrospectively clarified that offshore transfers in which the underlying asset was in India were subject to Indian capital gains tax — which led to an uproar. Coming at a time when India is particularly dependent on external capital flows, the uproar served to push the government into appointing the Shome panel.
The Shome Committee’s report makes the claim that the Budget’s change was not, in fact, a “clarification”, an assertion that is certainly open to debate. The report further says that retrospective changes should be the “rarest of the rare” — no argument there — and that the proper focus of any tax demand should be the party that benefits from capital gains, not the party that was supposed to withhold tax following the transaction. In other words, chase Hutchison Essar and not Vodafone, which may well be a difficult task as the former has no establishment in India at present. It also says that no interest, and no penalty, should be charged on the basis of a retrospective change in the law. The government should use this suggestion, in particular, as the basis for moving forward on its negotiations with Vodafone. It can accept the “rarest of the rare” provision, and settle the dispute with Vodafone by waiving interest and penalty. This will ensure that tax avoiders recognise that the Indian government is serious about clamping down on tax havens — a priority of the G20 reiterated by US Treasury Secretary Tim Geithner in his recent visit to New Delhi — while ensuring that this specific, highly visible instance does not continue to intimidate investors.
The thrust of the report, however, in granting excessive latitude to the continuance of tax exemptions for “participatory notes” — individuals investing in India through external financial institutions — is disappointing. The problem with the general anti-avoidance rules suggested in this year’s Budget was not their scope, in that they correctly tried to close off routes for investment like those through Mauritius which were clear attempts to avoid tax; it was that they were structured to give excessive powers to individual tax officers. Instead of correcting this problem, the Shome panel has thrown the baby out with the bathwater. This is not an aspect of the report that the government should seriously consider if it wishes to broaden the tax base and close loopholes, as is necessary in the medium and long run. It should settle, as soon as possible, with Vodafone; but it should not delay the notification of anti-avoidance rules, either.