India could face constitutional crisis over tax proposals

By Katherine Rushton, Media, telecoms and technology editor

2:24PM BST 30 Mar 2012

http://www.telegraph.co.uk/finance/newsbysector/mediatechnologyandtelecoms/9176154/India-could-face-constitutional-crisis-over-tax-proposals.html

The change, announced in the annual budget, stands to torpedo foreign investment in the country and could force companies such as Vodafone, Kraft and SAB Miller to pay hundreds of billions of pounds of capital gains taxes they hadn’t banked on.

Under the proposals set out by Finance Minister Pranab Mukherjee, Indian tax authorities would be allowed to back-date claims for any deals since 1962, between overseas companies which involve assets in India.

Lloyd Blankfein, chairman and chief executive of Goldman Sachs, has reportedly savaged the rule change as an “unbelievable” move which “will hurt India's image as a place where rule of law prevails.”

The radical move comes as India's growth slows and it struggles to narrow its yawning 4.94 trillion rupee (£60.6bn) budget deficit.

It also follows a high profile victory by Vodafone against the Indian tax office, over a $2.2bn tax bill relating to the mobile operator’s 2007 acquisition of a 67pc stake in Hutchison Whampoa’s Indian mobile unit.

After a five-year legal battle, India’s Supreme Court ruled in Vodafone’s favour saying that the Indian tax office has no jurisdiction over the deal and that the tax would amount “to imposing capital punishment for capital investment”.

The Indian tax office appealed the case, but the Supreme Court ruled in Vodafone’s favour again earlier this month.

When Mr Mukherjee outlined the proposal on March 16, it was expected to leave the Supreme Court judgment intact, as the government argued that it was simply clarifying the law to match the original intention of legislation drafted in 1962.

However, it has since emerged that it could be backdated, making the telecoms group once again vulnerable to the $2.2bn charge, and haking corporate confidence in investing in the fast-growing country.

"People are only just starting to get to grips with full implications of what is happening," said a source with knowledge of the situation.

Vodafone has said it may abandon its plans to make an initial public offering (IPO) for its Indian business next year.

"We are urgently considering a number of courses of action, both in India and internationally, in consultation with our advisers and we continue to discuss these issues with a wide range of stakeholders both in India and internationally,” the company said in a statement.

A spokesman added: “It seriously calls into question how we would proceed with an IPO.”

In the budget, Mr Mukherjee forecast record borrowing of 5.69 trillion Rupees to fund a budget deficit which is equivalent to 5.69pc of India’s gross domestic product.

The shortfall, together with a steady decline in the value of the Rupee over recent months, and a 15pc increase in oil prices since the start of the year, threaten to push up inflation – leaving India’s central bank with little scope for a series of interest-rate cuts to help spur growth.

In the last quarter, the rate of growth slowed to 6.1pc - its lowest in nearly three years.