Will they, won't they? Rules still unclear on FII taxes

The tax uncertainty for foreign investors continues.

The relief was expectedly short-lived. The rally in stock markets on Friday over Finance Minister Pranab Mukherjee's announcement that holders of participatory notes (P-notes), an offshore derivative instrument, would not be liable to tax has given way to concerns over whether foreign institutional investors (FIIs) themselves -- or their India-based brokers -- would be pursued over their customers' possible liabilities.

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According to media reports, tax consultants remain uncertain over the implications of the FM's statement.

Uday Ved, head of tax at KPMG, told Financial Times that even though investors would take comfort in Mukherjee's statement, a further clarification was needed on FIIs tax liability.

"With this [statement], investors will be more comfortable and confident in India," Ved said. "But so far these are just statements. There still needs to be a formal clarification from Indian tax authority's central board of directors on whether FIIs are going to be liable for offshore transactions...and transactions coming via Mauritius [ a popular base for Indian offshore transactions]."

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Indeed, according to The Economic Times, from Monday, chartered accountants and audit firms will add a caveat when issuing a clearance certificate, or in other words, issue conditional clearance certificates, to foreign institutional investors (FIIs) remitting funds overseas from the sale of Indian securities.

Reserve Bank of India rules require FIIs to submit a clearance certificate to their custodian banks when transferring funds overseas.

Banks will now have to decide if they want to accept a clearance statement with a caveat or deduct tax before allowing a funds transfer. "The dilemma is most accountants will prefer putting in a caveat since there is no full clarity on the tax issue. On the other hand, there is a fear that custodian banks may not remit funds if clearances come with the caveats," an advisor to FIIs was quoted as saying to the newspaper.

Audit firms, custodian banks and advisors to FIIs will meet this week to decide the format and language of the clearance certificate that will be acceptable to banks, the report added.

Of course, as we all know by now, ambiguity on tax rules is not the only headache for foreign investors. The government is also seeking to introduce a proposal that will tax offshore deals involving Indian assets retrospectively. It will almost certainly renew the battle between British telecom giant Vodafone and Indian tax authorities over the telco's tax obligations on a 2007 offshore deal that allowed it to acquire the Indian assets of Hutchison Essar.

In another troubling development, UK-based The Children's Investment Fund has launched legal action against the government, the main promoter in Coal India, claiming that its (government's) actions are hindering the company's operations and business profitability.The move highlights the poor corporate governance at state-owned companies -- and adds to the unattractiveness of investing in India.

As this Firstpost story noted, India seems to be turning into hostile ground for foreign investors.

With the government spending more time trying to (weakly) assure foreign investors that it is not trying to drive them away, it will be spend less time on resolving the real problem of the economy - jump-starting growth.

As this Business Standard column notes: ".....there is nothing resembling a coherent plan to revive flagging growth. In the circumstances, an investor who seeks exposure to Indian stocks does so strictly on the basis of company-specific factors, after discounting the deteriorating macro-story. There are plenty of good Indian companies. But valuations always suffer when investors are forced to discount a risky macro-environment."

Worse, it will cause foreign investors to rethink their investments in India.

You'd think that a government faced with a slowing economy, a faltering rupee, surging global oil prices and desperately in need of funds for infrastructure development would be trying to do all it can to welcome investments from all sources -- local and foreign.

Instead, it seems to have decided that now is the time to start picking fights with foreign investors.