Misguided intervention

Yashwant Sinha was right about the fact that some people make money when the stock market rises and when it falls. It is also true that ru...

Yashwant Sinha was right about the fact that some people make money when the stock market rises and when it falls. It is also true that rumour-mongers help to exaggerate price movements. That being so, the government would have done well after Tuesday’s crash to counter the rumours but not to intervene in other ways in the hope of restoring order. While the exact causes and effects of the second biggest fall in the history of the Indian bourses are still a matter of speculation, one outcome is crystal clear. The taxation worries of foreign institutional investors who use the Mauritius route to invest in India have ended. As a result of the panic in the market triggered by rumours and exaggerated reports of tax liabilities, those liable to pay taxes need no longer fear the income tax department.

The government did not like the panic on Tuesday and has decided in its wisdom to withdraw the Rs nine crore tax demand on five FIIs. Thanks to new official clarifications, all FIIs, including the handful suspected by tax authorities of misusing the India-Mauritius double taxation treaty, are free of present and future tax demands.

Is the government right to take a lenient view of tax dodgers? According to the pragmatists, small amounts of tax were involved whereas the impact of FIIs selling on the stock market was severe. So, the argument goes, the greater good demanded that tax dues be waived. It is further argued that traditionally the government has not taken a rigid attitude towards tax dodgers. On the contrary, successive governments have offered them tax amnesty schemes in order to collect at least a small part of outstanding taxes. So, in short, why make a fuss about a few crores owed by the FII? The counter to this is that it is wrong in principle and in practical terms.

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Every time the government fails to collect its taxes more tax dodging is encouraged. The very case that small amounts are involved can be turned around to argue for enforcement of the rules. Far from making life easier for foreign investors, obfuscation of the tax position and treaty clauses harm their interests. They need a transparent and predictable environment in which to do business more than they need tax let-offs.

Not only is the compromise between enforcing the rules and encouraging foreign investors to stay invested very messy, it may not have been necessary at all. This is the truly amazing part of the whole affair. First it is a good bet that FIIs were reacting to technology stock declines on the Nasdaq. Second, most of those who are registered in Mauritius would have studied the taxation provisions and found legal ways of minimising their tax liability. Only a handful out of hundreds of FIIs were playing truant. So why not straighten them out instead of messing with a scheme applicable to everybody? The message now delivered is that the government can be panicked into fudging the rules. This is very unfortunate. Misguided intervention by the authorities is precisely what all these years of stock market and taxation reform were supposed to eliminate.