There’s a proposal to change India’s tax laws regarding foreign acquisitions… going back, retrospectively, to April 1962. That’s probably before some of the people dealing with the consequences were even born.

THE BACKSTORY

I’ve been reporting here about the Vodafone case: The dispute between the European cellphone company and the Income Tax authorities. It ended – I thought – in January 2012.  (If you want to go back to my posts on the subject, they’re here and here and here, in reverse chronological order.)

In brief, the European company Vodafone’s Cayman Islands subsidiary acquired a Cayman Islands subsidiary of Hutchison, a Hong Kong company. The assets consisted mainly of shares in an Indian cellphone company and the transaction took place in Mauritius. Vodafone used its new acquisition as the basis of their growing Indian operation.

The Indian government believed capital gains taxes were due on the transaction. Ordinarily, these are paid by the seller (which actually makes the gains). But Hutchison was out of reach; it had left the country. India’s Tax department went after Vodafone instead, saying it should have deducted capital gains. Mauritius is well-known as a tax haven, and the Tax people argued that they had the right to pierce the veil and recognize the transaction as a sale of Indian assets. Vodafone argued that no taxes were due since the whole transaction had been offshore, and anyway, if the Tax authorities wanted to pursue anyone, it should have been Hutchison.

The case ping-ponged back and forth through a long-drawn-out and much-watched legal process. In January 2012, the Supreme Court finally ruled in favor of Vodafone. Whatever one’s views of the outcome, I thought it was proof positive that India still has a functioning legal system. “I have to say,” I wrote at the time,  “I’m pretty impressed with how it’s all played out. Both sides have had their say, in great and excruciating detail. There’s a decision that clarifies the law. India’s legal system has actually worked like it’s supposed to.“

With legal underpinnings in many other Asian countries being questionable, it was a strong showing. I found it encouraging, especially since India’s rank in the World Bank’s Ease of Doing Business study has been slipping.

(I wrote about that here).

RETHINK

Buried in India’s 2012 annual Finance Bill that goes with the Budget was this bombshell: a proposal to tax transfers of Indian assets, even if the transfer took place overseas – retroactive to April 1962. According the Wall Street Journal, Finance Minister Pranab Mukherji didn’t even mention it in his budget speech.

But of course it was going to come out, and quickly. The budget in India generates a feeding frenzy of analysis. I’ve been part of it. In the old days, someone would go to pick up a copy at midnight, as soon as it was available. Now, the Indian government posts it on the web.  Overnight, people start to pick it apart, and by the next morning, the first reactions hit the press (and these days, the blogs). Of course it takes a few days to work out the details. Then the lobbying starts, because until it’s adopted by Parliament, the Finance Bill is a proposal, not hard-baked into law.

WHAT’S IT MEAN?

The main point of a rule of law is predictability. People living in a society governed by rules, rather than raw power or influence, need to know what the rules are. If they’re changed, they change going forward. Not, it seems, in India.

The transfer of Indian assets among overseas companies by way of tax-spared transactions has increasingly become a loophole. The Vodafone case highlighted it because of the large numbers involved.

I can see why the Indian government would seek to close the loophole. But… retroactive changes to the law are dangerous, because they undermine the predictability that is the whole point of having a law at all. Closing the loophole going forward does make sense, though companies wouldn’t like the additional taxes.  Closing it retroactively makes India look like one of those countries where the law doesn’t count for very much.