A taxing problem

In all these cases,the point of contention is the tax treatment of these vehicles — withholding tax in the case of debt papers,capital gains tax in the case of qualified foreign investors and foreign institutional investors. India’s financial regulators should mull over this carefully. In the case of changing the tax treatment vis a vis the Mauritius route,India has attempted at least three variations since 2002,but none has worked. Significantly,in none of the global crises in the last two decades has foreign capital behaved like a herd,attempting to leave India. Instead,it is the spectre of change in India’s domestic tax laws that has often made investors pack their bags. In this context,the comment by the deputy chairman of the Planning Commission,Montek Singh Ahluwalia,that India should not alter its tax laws for several years,is welcome advice the government should take seriously. India’s aggregate savings are trailing investment requirements. This gap can only be filled by inflows of foreign investment. Also,the argument that investment through the stock market is less welcome than direct investment is specious. At a record 4.2 per cent current account deficit for 2011-12,the economy can hardly afford these arguments.

The bottom line is that while there is logic in the position that tax exemption cannot be the carrot to attract investments,India does not have the financial muscle to insist on it. Bringing a change requires concurrent steps,like migration to a residence-based taxation that is an objective of the Direct Taxes Code. This,in turn,will mean carrying out changes in domestic tax exemptions for exporting industries too. Simultaneously,India needs to revive the confidence of domestic investors in financial markets — it helps not to appoint political cronies as chiefs of institutions like UTI AMC. Ultimately,the way to reduce the importance of tax havens is to create domestic countervailing forces.