Tax Planning In India: Start With A Crystal Ball

For a company that does business internationally, it’s always a challenge to keep track of all relevant national tax laws. A firm operating in India, however, needs more than just smart financial and legal advisors; it needs a crystal ball.

Indian legislators recently passed a bill that retroactively imposes $7 billion in taxes in connection with about 18 corporate mergers that were not subject to Indian tax at the time they occurred. The law affects deals in which Indian assets were transferred between non-Indian companies.

India has already tried to collect taxes on at least eight of these deals, including the acquisition of a controlling interest in Hutchison Whampoa Ltd.’s Indian operations by the Dutch subsidiary of U.K.-based Vodafone Group PLC in 2007. In addition to seeking a tax bill of around $2.2 billion on the $11 billion deal, India demanded penalties that might have doubled Vodafone’s liability. Vodafone took the case to India’s Supreme Court. The court ruled earlier this year that the company didn’t owe Indian taxes because Hutchison’s Indian assets were held by a unit registered in the Cayman Islands, meaning no Indian companies were involved.

At the time of the ruling, experts already expected that India’s new tax code, set to be implemented in 2013, would subject similar future deals to tax in India. But the Indian parliament went a step further, amending the country’s 1962 Income Tax Act to make it as if the new taxes had been in effect all along.

This is not the first time India has ensnared a foreign company with a law that seems to require precognitive powers or the aid of a time machine. Last year, the country sought to deny the American telecommunications company Qualcomm, Inc., the right to use broadcast spectrum licenses after it had already collected nearly $1 billion from Qualcomm (QCOM) in an auction. Qualcomm finally got its spectrum last month, nearly two years after the auction, but its usage period is now down to 18 months. The company has entered into a deal to transfer ownership of its Indian assets to Bharti Airtel Ltd., India’s largest mobile operator, by the end of 2014.

Vodafone has indicated that it intends to seek international arbitration on the grounds that the retroactive taxes violate an India-Netherlands investment treaty.

Vodafone is right to stand up for its interests, but it should not be required to stand alone. As I wrote at the time of the Qualcomm dispute, individual companies, no matter how big they are, cannot be expected to go head-to-head with sovereign nations. When a country abuses its rulemaking power at foreign companies’ expense, national governments (and, in the case of European firms like Vodafone, the European Union) have a responsibility to defend the rights of their enterprises and those enterprises’ shareholders around the globe.

Perhaps the international community is already working behind the scenes to deal with India’s undue affinity to foreign companies’ money. There is a place for quiet diplomacy. The fact that this is a recurring problem, however, indicates that if diplomatic pressure is being applied, it is not being applied very effectively.

Until the international community signals that it is dealing seriously with India’s game-playing, or until the Indian government recognizes that a stable regulatory environment is the best way to attract much-needed foreign investment, businesses would be well-advised to approach the country with caution. Or to invest in a fortune-telling department.

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