The government is struggling with its messaging about India's taxation of global capital. The National Democratic Alliance (NDA) should have learnt from the problems of the United Progressive Alliance (UPA) after the 2012 Budget: it becomes very difficult to sell an open-to-business narrative when foreign investors and companies are confused or scared by the government's tax law and administration. Unfortunately, the government seems to have squandered the goodwill that the change of dispensation from the UPA to the NDA had bought it - most recently by sending out letters to foreign institutional investors (FIIs) suggesting that their capital gains needed to be taxed under the minimum alternate tax, or MAT, which has a tax rate of 20 per cent. This came as a shock to many FIIs and led to sentiment - already vitiated by a couple of high-profile tax demands - turning negative. This may have led to the fact that FIIs are likely to turn net sellers in debt on the Indian markets, for the first time since November 2013.
The government has worked hard to do damage control. Instead of the original Rs 40,000-crore claim, the eventual notices sent out amounted to demands for unpaid tax of only around Rs 600 crore. And even some of those FIIs would be exempt if they came from countries with tax treaties, such as Mauritius or Singapore. Those paying capital gains in their home countries may also be exempt. But the damage has, in many ways, been done. Even the lower tax demand, sent out to just 68 FIIs, will not cause the hundreds of others to feel any more secure. Some funds, which entered the debt market on the promise of a concessional tax rate when India's external account was weak, could now find themselves subject to higher rates of taxation; yet others will have to account suddenly for capital gains made years ago that may already have been disbursed to the funds' original investors. The undeniable whiff of retrospective taxation in this is impossible to evade. The government's contention that this follows a judicial ruling on the subject does not hold much water for those affected, who believe that, after all, the government had ample opportunity and ability to change or clarify the law.
There is a simple and sensible way out that could be made applicable to not just foreign but also domestic investors, and would go a long way towards solving this particular problem as well as setting in place some trust that such nasty surprises won't recur. And that is to set into place a simple rule: no demands will be sent out for income or gains that may have escaped scrutiny for more than two years after that income was earned or those gains hit the books. Currently, this is a ridiculous 16 years (after the assessment year) for income related to foreign assets! This was another change made in the "taxman's Budget" of 2012. Even domestic income can be subjected to scrutiny by the taxman for up to six years of earning that income. If the tax department in general is so inefficient that it cannot act on issues for so many years, then it is neither just nor sensible to force taxpayers in general to suffer the pangs of uncertainty to make up for the taxman's dilatory approach. This period of scrutiny should be changed to just two years after earning the income and the government will help India recover its tarnished reputation.