India Defers Tax Avoidance Rule in Boost for Currency By Tushar Dhara and Unni Krishnan - May 7, 2012

Indian Finance Minister Pranab Mukherjee retreated on tax proposals to salvage investor confidence in Asia’s third-largest economy, lifting stocks from a four-month low and buoying the nation’s currency.

The applicability of a new rule to reduce tax avoidance will be delayed until the fiscal year beginning April 2013, Mukherjee said in parliament yesterday. The clampdown in the planned General Anti-Avoidance Rule, or GAAR, had stoked concern that foreign investment will decline, hurting growth.

The postponement follows a series of policy reversals by Prime MinisterManmohan Singh’s government, which is struggling to revive an economy expanding at the slowest pace since 2009. While the earlier setbacks dimmed the outlook for investment, stocks and the rupee rose as Mukherjee backed down from the anti-avoidance measure less than two months after announcing it in India’s annual budget.

“It’s a flip flop in the positive sense since the finance minister wouldn’t want to tarnish the image of the economy,” said Jay Shankar, chief economist at Religare Capital Markets Ltd. in Mumbai. “But it shows the indecisiveness and lack of leadership in the government.”

The rupee strengthened 1.1 percent to 52.9150 per dollar yesterday, while the BSE India Sensitive Index of stocks rose 0.5 percent, erasing earlier losses. The currency weakened 16 percent last year, the worst performance in Asia.
Short-Term Boost

In the March 16 budget, Mukherjee unveiled GAAR to target avoidance by companies that use tax treaties between India and other countries. Foreign funds that route investments into India via other nations were concerned the new rule may apply to their holdings.

The burden of proving tax evasion under GAAR will be on the revenue department and steps will be taken to ensure it’s applied objectively, he said.

The deferral of the rule “should be positive in the short term,” said Prasanna Ananthasubramanian, chief economist at Mumbai-based ICICI Securities Primary Dealership Ltd. “I expect capital flows should pick up because the India-related uncertainty has gone away.”

Mukherjee in the budget also proposed retrospective clarifications to ensure the taxation of deals conducted overseas in which an Indian business is transferred. That plan followed a ruling in January by India’s Supreme Court that Vodafone Group Plc (VOD) doesn’t have to pay $2.2 billion in tax on its purchase, conducted offshore, of the Indian business of Hutchison Whampoa Ltd. (13) in 2007.
Foreign Investment

The retrospective clarification won’t override India’s double-taxation agreements and cases where assessment orders have already been finalized won’t be reopened, he said.

U.S. Treasury Secretary Timothy F. Geithner discussed the tax plans with Mukherjee last month after American trade and lobby groups said they may lead to retroactive bills for periods of as much as 50 years and deter foreign investment.

The Indian finance minister also said yesterday that the long-term capital gains tax rate for non-resident investors and private equity firms will be reduced to 10 percent from 20 percent. Proceeds from initial public offerings will be exempt from the levy, while being subject to a securities transaction tax of 0.2 percent, he said.

Mukherjee, who faces the widest fiscal deficit among the biggest emerging economies, was introducing changes to his budget in parliament. He has said he aims to narrow the shortfall to 5.1 percent of gross domestic product this fiscal year from 5.9 percent in the 12 months through March 2012.
Challenging Periods

Singh’s administration is facing one of the most challenging periods since taking office in 2004 as opposition from within the ruling coalition stymies efforts to further open up the economy. Among the setbacks was the suspension in December of plans to open India’s retail industry to foreign companies such as Wal-Mart Stores Inc. (WMT)

India is also grappling with the fastest inflation in the so-called BRIC group of biggest emerging nations that also includes Brazil, Russia and China. India also has a record trade deficit that’s pressured the rupee.

Standard & Poor’s lowered India sovereign credit outlook to negative from stable on April 25, citing weaker investment and a deterioration in the current account, the broadest measure of trade. The move took the economy a step closer to so-called junk status.

Governor Duvvuri Subbarao cut India’s repurchase rate by a greater-than-forecast half a percentage point on April 17 to 8 percent, seeking to bolster expansion with the first reduction since 2009. Inflation was 6.89 percent in March.

The government estimates that India’s economy expanded 6.9 percent in 2011-2012, the slowest pace since in three fiscal years, hurt by costlier credit, inflation and slower exports.

To contact the reporters on this story: Tushar Dhara in New Delhi at tdhara1@bloomberg.net; Unni Krishnan in New Delhi at ukrishnan2@bloomberg.net

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net
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