India’s Union Budget last year carried a seemingly-innocuous reference to tax avoidance, which spooked many foreign investors. Now a different finance minister, P. Chidambaram, has done it again. The response to the budget was overshadowed by a reference to tax residency norms, and the markets fell as foreign investors using the Mauritius route, the main source for fund flow into India, thought they were being targeted. The government later clarified that there was no such intention. But was there a message between the lines? Is Chidambaram telling foreign investors that they can’t take India for granted?

The clause that prompted the concern stated that a tax residency certificate (TRC) was necessary — but not sufficient — to be eligible for benefits under the Double Taxation Avoidance Agreement (DTAA). Foreign investors who come to India through Mauritius pay no capital gains tax in the country because of the DTAA. Chidambaram’s addition of the “not sufficient” qualifier sparked fears that capital gains could be made taxable on some other grounds. A government spokesperson had to clarify later that the status quo would remain in place as far as Mauritius is concerned.

“The amendment proposed in the Finance Bill was intended in another context, which … is not relevant in the capital gains clause,” according to the clarification. “Mauritius-incorporated entities deriving capital gains from India would still be able to avail the benefit of the India-Mauritius capital gains exemption clause provided they have a TRC from Mauritius,” adds Ketan Dalal, joint tax leader for PricewaterhouseCoopers (PwC) India. “This issue, which seems to recur with alarming regularity, is again put to rest.”

In a news conference after the budget, Chidambaram admitted that the clause may have been clumsily worded. He was far more aggressive when it came to the issue of transfer pricing. The income tax department has made claims against companies such as Shell and Vodafone and they have reacted in dismissive fashion. “We are not a banana republic,” Chidambaram said according to economic daily Business Standard. “As a developing country, we must protect our tax base…. In one particular case of Shell, since it involved a large amount of money, it also involved interpretation of a crucial section of the IT Act. I have decided to refer the matter to the Attorney General. The government voluntarily referred the matter to the highest law officer to interpret a section, to know what the scope of the section was. I think we are going about it without any bias and without any preference. We are not making any pre-judgment about tax liabilities.”

Post-budget, Standard & Poor’s (S&P) gave the effort a passing grade. “The latest budget details have no rating impact on our sovereign credit rating on India,” S&P said in a statement. “[But]… there is little progress in structural reforms to reduce the vulnerability of the government’s fiscal position.” In an interview to ET Now, a business news channel of The Times of India Group, Chidambaram responded by saying: “I do not make a budget for rating agencies. I make a budget for the people of India.”

Blowing Hot — Blowing Cold?

The Finance Minister has just returned from a four-nation trip to woo foreign investors. Even earlier in his budget speech, Chidambaram spoke of the need for foreign investment. “I have been at pains to state over and over again that India, at the present juncture, does not have the choice between welcoming and spurning foreign investment,” he said. “If I may be frank, foreign investment is an imperative. What we can do is to encourage foreign investment that is consistent with our economic objectives.”

India may be becoming a shade prickly on this issue. The government nearly collapsed amid debate on foreign direct investment (FDI) for single-brand retail. Even now, a Parliamentary panel is investigating the entry of Walmart and several applications by companies like IKEA have had to run the gauntlet of protest.Once the high-flier among the BRIC nations (Brazil, Russia, India, China), the India growth story appears to have slowed. GDP growth is currently at 5%, the lowest in 10 years. A recent S&P report asked: “Will India be the first BRIC fallen angel?” In his budget speech, Chidambaram, too, acknowledged that “the Indian economy is challenged.”

Is the Mauritius brouhaha and the debate surrounding it a case of the Indian government blowing hot and cold?” I think the issue about TRC is a very important and essential move. It was a clear statement [from Chidambaram], but he has muddied the water by giving explanations,” notes Jayati Ghosh, professor of economics at Jawaharlal Nehru University. “He also said something about explaining the explanations, if needed. This suggests that it could get diluted under pressure. In the past, too, we’ve had decent measures undone by lobbies.”

“It’s very difficult to understand what the finance ministry is trying to do,” adds Pranay Bhatia, partner at Economic Laws Practice. “They had brought out this amendment last year and had clearly said that their intention was to not stop with the TRC but to go further. So the need to bring it as a budget amendment is just not clear to us.” Bhatia touches on another issue. “The government’s complete silence on retrospective amendments [introduced in last year’s budget, but put on hold by Chidambaram] has added to the uncertainty and shaken investor confidence. Investors are not averse to paying taxes; what they want is clarity upfront.”

Mixed Reactions

Away from the unnecessary controversy, what does this budget bring for India? Reaction to the budget ranges across the spectrum. “We were hoping the budget would breathe more life into the economy,” says Ranjit Shahani, vice chairman and managing director of Novartis India. “The expectations of a big-bang announcement to restart the economy were belied. Given what the market was grappling with, there is dearth of big ideas. On the other hand, it is a responsible budget.”

According to Sujit Sircar, chief financial officer of iGate, “The budget has nothing interesting to look forward to. With the economic climate demanding high-voltage reforms and measures, the budget prefers to stay conservative and indecisive.” Those who expected a game-changing announcement “have been disappointed,” adds Abheek Barua, chief economist of HDFC Bank. “The Finance Minister seems to have gone through a laundry list of different challenges facing the economy and done a little to address each of them.”

Others are more positive. “Overall, the Finance Minister has presented a responsible budget,” notes Vinita Bali, managing director of Britannia Industries. Agrees Rajesh Chakrabarti, executive director of the Bharti Institute of Public Policy at the Indian School of Business: “Overall a quite reasonable budget given the macro constraints in place. The focus on infrastructure is well chosen.”

“The Finance Minister’s intentions are very clear: to move India back to a higher growth plane,” adds N. Chandrasekaran, CEO and managing director of Tata Consultancy Services. “And given his lack of runway, he has taken lots of small measures, which together could boost growth.”

New Proposals

One of these small measures is, as Chakrabarti points out, infrastructure. Chidambaram has announced a host of investment opportunities and instruments. The target is an outlay of US$1 trillion over the next few years. But infrastructure projects by their very nature have a long gestation and this didn’t excite the markets. A more immediate benefit is a 15% allowance allowed on investments above Rs. 100 crore (US$18 million) over the next two years. According to a Business Standard estimate, this will increase the total profits of India’s major firms by Rs. 25,000 crore (US$4.5 billion). Not everybody is happy, however: Rahul Garg, leader of direct tax at PwC India, suggests that the investment allowance floor of Rs. 100 crore should be reduced so that small businesses can also avail of it.

Chidambaram has also changed the classification norms of foreign investment. “There are many categories of foreign portfolio investors such as FIIs [foreign institutional investors], sub-accounts, QFIs [qualified foreign investors], etc.,” he said in the budget speech. “When an investor has a stake of 10% or less in a company, it will be treated as FII and, where an investor has a stake of more than 10%, it will be treated as FDI.” This may impact portfolio investors in some sectors. In banking, for instance, the Reserve Bank of India (RBI) is committed to allowing the entry of a certain number of foreign banks into the country. There is some confusion over the status of banks like ICICI Bank and HDFC Bank where the foreign holding is high. RBI officials think the institutions should be classified as foreign banks, which means it doesn’t have to allow others in at the moment. Chidambaram has said that he will clarify several aspects of the budget while it is being debated in Parliament.

Among the other changes Chidambaram made was a 10% surcharge on people having a taxable income of Rs. 1 crore (US$181,000) or more a year. This may seem trivial; Chidambaram points out that it affects only 42,800 people. But it is evidence of a mindset. Leading up to the budget, there has been a lot of discussion on “soaking the super-rich”. There were also suggestions that estate duty be reintroduced. In the era of estate duty, ownership structures in business families were made extremely complicated to avoid paying this inheritance tax. The imposition of the surcharge on the super-rich is seen by some as a return to India’s post-Independence socialist ethos, which stifled the country’s growth for several decades. But Chidambaram says the surcharge and the tax he has introduced on several luxury items are temporary measures to tide over the fiscal crisis. He predicts that the economy has reached rock bottom and the only way to go is up.

Chidambaram told ET Now that he has delivered on his financial promises. “I am sure that the RBI Governor has taken note of all that I have said in the Budget speech, all that we have done in terms of budgeting, the fact that we have contained fiscal deficits to 5.2% and the fact that I am pretty confident I will be able to contain fiscal deficit to below 4.8% next year.”

The Finance Minister has done his bit to encourage investment. But Corporate India will not take the bait while interest rates are so high, experts suggest. The RBI has been hesitant with regards to cutting rates in its fight to contain inflation. “Moderate interest rates will lead to revival of growth,” former ICICI Bank chief K.V. Kamath said in a story in the Economic Times. “Now it’s over to the Central Bank.”