Pranab Mukherjee's seventh budget presented on Friday last has attracted varied comments with some calling it insipid and dour and others, realistic and pragmatic.

Indeed, in the sheer sweep of its taxation proposals that generate Rs.41,440 crore, one of the highest in recent years, the budget is a throwback to the bad old days of the 1980s when people awaited February 28 with trepidation wondering how much their tax burden would rise.

In that sense, this is a harsh budget indeed as it seeks to raise resources through indirect taxes which hit the rich and the poor alike, the latter more than the former.

Budget for worse

Bad as this sounds, history might remember this budget for worse. That is the proposed amendment to the Income Tax Act which will allow the government to get after Vodafone again to secure the pound of flesh that it believes is rightfully due to it.

The explanatory amendment inserted in the Income Tax Act, with retrospective effect, seeks to clarify that transactions between two overseas entities will be taxable in India if the underlying asset is located here.

The precise wording of the amendment to Section 9 is: “For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India.” And the amendment will be deemed effective from April 1, 1962, when the Income Tax Act came into force.

This means that it is not just the Vodafone deal but all transactions between overseas entities in the last 50 years are now liable to be scrutinised for their tax liability. If the Finance Secretary, R. S. Gujral, is to be believed the retrospective amendment could fetch the government as much as Rs.35,000-40,000 crore in tax revenues.

Shifting goal posts

Appetising as the revenue might appear to a famished government, the amendment has to be condemned as retrograde. Even the government (or should it be, the government especially) cannot shift goalposts to suit its game.

There is an attempt by some to deliberately confuse this issue with multinationals and their tax-haven based entities and whip up some nationalist passion.

That is not what it is all about. If the problem is that multinationals are using tax havens such as Mauritius and Cayman Islands to avoid taxes in India it is because the law allows it. If the government feels it is unjust, it can by all means legislate to end the menace.

The tax treaty with Mauritius is used by entities from all over the world to avoid tax liability in India and this avenue needs to be blocked.

It is a bizarre fact that the tiny island nation with a GDP of just $10 billion is the biggest foreign investor in India! All those who matter and their uncles know that it is not genuine Mauritius investors pumping in money into India.

And that is why the FM has proposals in the same budget that aim to make it difficult for investors to use the Mauritius treaty in future. Sections 90 and 90A of the Income Tax Act are being amended to state that in future merely producing a Tax Residency Certificate from Mauritius is not enough to avail of benefits of the tax treaty. That is the way to go.

An unjust amendment

The government is obviously piqued at losing Rs.11,000 crore due to the adverse Supreme Court verdict in the Vodafone case. Its angst during a difficult period for the fisc when the money would have come in handy is understandable. Yet, that is not enough justification to change the law with retrospective effect.

Investors, including multinational companies, plan their business based on stability of the law and regulatory regime. Indeed, stability of the law is what differentiates a respectable democracy such as India's from a tinpot dictatorship. If it is bad to keep amending the tax laws constantly, it is worse to do so going back by five decades. The problem with retrospective amendments is that they make investors nervous.

Multinationals don't invest in India (or any other country, for that matter) for charity; they are hardnosed investors and will certainly not relish the prospect of losing money to fickle tax policies. Policymakers should also be conscious of the fact that the world of today is different from that of the 1980s and the 1990s when such retrospective amendments might have gone through without as much as a ripple.

Playing fair

In the globalised world of today, India needs foreign capital for development and it has to play the game fair and square.

Tax planning is an accepted practice in the cat-mouse game that tax payers and governments play across the world. When the tax payer finds a loophole to plan his taxes legally, governments promptly plug it and then the tax payer goes on to find the next loophole and so on.

In this fascinating world of high finance, the government's endeavour should be to stay a step ahead of the tax payer. Or, the next best option is to amend the law to stop future avoidance.

Retrospective amendments are not the answer and are avoidable. Mr. Pranab Mukherjee would do well to change the amendment to take effect prospectively. He has the right and is justified in doing so.

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