Getting a Handle on India’s ‘Tax Terrorism’ Against Foreign Investors

The tax authorities in India have a very erratic reputation when it comes to their treatment of foreign invested companies in India. Challenges by Indian authorities, and retrospective tax liability rulings from the courts have combined to create a real challenge to Prime Minister Narendra Modi’s attempts to woo foreign investors. Multinational corporations (MNC’s) – such as Vodafone, Nokia and most recently Cairn Energy – have found that disputes with the tax bureau are a time consuming, disruptive and energy sapping exercise – not to mention costly. So why the apparent disconnect between the Prime Minister’s attempts to woo foreign investors and the tax departments attempts to brush them away? 

Much revolves around outdated thinking and regulatory systems. India has often lacked self-confidence, and also wishes to promote the rights of its entrepreneurs and industry. This has long manifested itself in a built-in wariness of foreign investors ‘taking the milk of Mother India’. It has also led to well-meaning, but long outmoded regulatory structures. In the professions, and specifically law and tax, private practices are limited to just 20 partners – local firms have grown up fractured, and remaining small, increasingly disenfranchised due to the lack of investment and personnel needed to keep up to date with modern business practices.

The notorious Satyam corporate fraud case was caused in part because the company’s accountants were smarter and more creative than the auditors. India’s tax bureau takes a negative approach to regulations that may not be entirely understood by the very body supposed to administer them.  This, coupled with the small-minded mentality common within much democratic civil services, leads to resentment of large corporate wealth, and a feeling of power when such officials have the chance to put one over the foreign corporates.  

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Such challenges can usually be resolved by hiring counsel. But India’s entrenched civil service goes even deeper in terms of mischief-making: the civil service often protects domestic businesses in that the government has expressly attempted to clean up. Just because Prime Minister Modi has a majority in government doesn’t mean that a civil servant agrees with government policy. Such is the fractured nature of Indian politics that the civil service can, and will, actively disobey the government – and therefore democratic reforms. Without actually being seen as disobedient, deliberate challenges are introduced to tie issues up in red tape, effectively stamping it with a large red ‘no’ seal. This death by a thousand bureaucrats is an insidious political, corporate, and cultural aspect of doing business in India.

There is also conflict higher up the governmental food chain. India’s judiciary is famously separate from the government, but here again this can manifest itself in clearly self-important and damaging ways. High Court judges have been known to throw out government cases based on the premise that the government has no right to instruct the High Court what to do. This is a partly admirable sentiment, especially when viewed in the context of China, where government is the regulatory body, judge, jury and executioner. However, in India, the democratic ability to have a separate legal system, designed to keep government excesses in check, has also been used by the judiciary to score political points. Often, such as in the case of India’s long standing tax reforms, an inability to persuade High Court judges to accept the government position has stymied reform and damaged the nation.  
However, these are issues that affect larger MNCs more than small and medium sized foreign investors.

Bureaucrats are attracted to big beasts – for most foreign investors, there is simply no issue. Still, civil servants are doing a grave disservice to their country when they unilaterally decide, for example, that opening up India’s retail sector will damage mom and pop stores. It makes life awkward for MNCs wishing to enter the market, and stands in opposition to the government’s wishes and legislation. China survived, and then flourished, after opening up this sector. Much needed investment was made into infrastructure for supply chains – this is exactly what India desperately needs. Interference in projects or initiative disliked by India’s civil service, in defiance of the government, is a real issue for MNCs however, and this needs to be built into business modelling as a political risk factor – both in terms of time, and money.

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Prime Minister Modi knows this. While the media looks to him for tax transparency, and introducing more stability for foreign corporates in India, the real battle he faces is getting accountability into the civil service. He is making progress: if matters within India’s multitude of ministries are not resolved within set time periods, the Prime Minister’s office gets to hear about it and explanations are demanded. But getting that level of accountability into the High Court is going to prove more difficult. 

It is time for political egos to be set aside. India’s lawmakers and judges need to be aligned with government interests. Prime Minister Modi needs to get this dealt with in order to prevent India’s legions of small-minded, career-safe civil servants and judges get in the way of the greatest opportunity to develop and reform the country that has yet presented itself. India’s demographics dictate that the country should become an economic powerhouse within the next decade. But it needs a common platform to achieve this, and India’s civil service needs to wise up fast. Harassing foreign investors just ties off vital arterial investment, and this can ultimately stunt the nation. India’s civil servants need to start serving more, and interfering less.
 
This article was first published on India Briefing

Since its establishment in 1992, Dezan Shira & Associates has been guiding foreign clients through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and emerging ASEAN, we are your reliable partner for business expansion in this region and beyond.

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