India: Vodafone case highlights potential investor minefield
By Pia Heikkila
It’s easy to see who rules the telecom roost in India. The red and white symbol of Vodafone is everywhere: painted murals, flags, little kiosks. Its world-renowned characters, the 'Zoozos' are a national rage. But it hasn’t been plain-sailing for the company in India.
Vodafone has become snarled up in the Indian corporate tax system. It all began in 2007, when the telecom giant took-over Hong Kong-based Hutchison Whampoa's Indian mobile unit Hutch-Essar for £7bn. Shortly after the deal, the Indian government slapped Vodafone with a £1.5bn tax bill on the cross-border deal. An almighty row broke out and Vodafone argued that the authorities had no right to tax a transaction between two foreign entities. The tax department of India had fought back hard, claiming the asset was Indian.
Fast forward to January 2012 when the Supreme Court of India had dismissed the tax demand, saying that capital gains tax was not applicable to Vodafone. However, Vodafone’s relief was short-lived. The union budget in March suddenly claimed that the income tax act could be applied retrospectively from 1962, giving the taxman powers to scrutinise offshore merger and acquisition deals. The government said it wanted to plug the loopholes that help companies escape the tax net through aggressive tax planning.
Vodafone is, of course, fighting back. And so it goes on.
It’s all been a bit unfortunate for Vodafone. ‘The Vodafone transaction certainly triggered this hostile tax behaviour – the parliamentarians, politicians and policy makers need to evaluate the collateral damage to our historical reputation for adhering to the judicial rule of law,’ said Gokul Chaudhri, Partner at BMR Advisors, an India-based tax, risk and M&A advisory firm.
‘The government should make tax laws more transparent and consistent – India needs to send signals to the global investment community that this is a country that can function and has clear policies to guide foreign investors.’
Managing Director, Ocean Dial Advisers
Others focus on political motivation. ‘When Vodafone made the transaction, the government was well aware of its conditions but they were more interested in attracting money. Now they are more interested in chasing tax evaders and this could be politically motivated, maybe they want to attract the popular vote,’ said David Cornell, Managing Director of the Mumbai-based Ocean Dial Advisers.
India, like many other countries of emerging Asia, is seeing a shift in their tax framework – both in policy and administration. Soon after market liberalisation and most of the 90s, India witnessed a roll out of tax holidays and tax exemptions to promote investment and growth. But the global recession heralded widespread disapproval of tax avoidance. India’s tax policy has dramatically moved to protect the tax base, and aggressively capture taxes on cross border flow of goods, services and investments.
The government decided to introduce the Direct Tax Code (DTC), touted as the framework for taxation in the future. But many are questioning the timeframe. ‘It could well be the tax framework for India of 2050, but the question is whether the sophisticated and aggressive tax provisions, such as indirect M&A taxation, or foreign corporation tax rules, are ahead of their time at this stage of our economic development which needs liberal laws to promote growth,’ said Chaudhri.
India is seeing a shift in the tax framework
Some fear that the opaque nature of the government’s proposals could be harming foreign investment in the country. ‘The government should make tax laws more transparent and consistent – India needs to send signals to the global investment community that this is a country that can function and has clear policies to guide foreign investors,’ said Cornell.
One of the most controversial proposals of the DTC has been GAAR, or the ‘general anti-avoidance rule’, which would have given the Indian tax authorities wide powers to tax any transaction that they felt had been created to avoid taxes. GAAR was eventually postponed for a year, a decision welcomed by the investor community. ‘Thankfully, wisdom prevailed not to fast track GAAR from the proposed DTC planned in 2013. The on-going global economic volatility and absence of reforms in India is hurting India – possibly the government recognised that introduction of GAAR will add to the uncertainty and heightened concerns,’ said Chaudri.
While the proposed rules apply to all sectors, telecoms is hurting visibly because of Vodafone and because the sector has witnessed large M&A transactions that are now the target of taxation. Overall, the Indian telecom sector has suffered from the 2G spectrum scandal which saw government officials underselling the country’s 2G licenses to their own benefit. ‘It’s unfortunate that the licensing and regulatory issues, which are independent of the tax matter, have coincided at the same period,’ said Chaudri.
It remains to be seen how the Indian tax odyssey will affect investor appetite. ‘The question is whether the government will be able to balance the need for taxes from inbound investment and the attractiveness of growth and investment,’ said Chaudhri.