Much brouhaha has been created by the recent reports about the Vodafone Tax case with respect to whether or not a capital gains tax is due from them on the purchase of assets in India. New lexicon has been created for the uninitiated - “tax avoidance” versus “tax evasion”; “look at” versus “look through” etc - to devise ways and means to dodge taxes and perpetuate crony capitalism, as if there was not enough already.
 
Vodafone is right. Primarily, the tax is not due from them (the buyer), but from the seller (Hutchison). Vodafone’s crime is that they should have withheld the capital gains tax and paid that amount to the Government of India when a demand was raised on them. Whether or not they withheld the amount can be found out by going through their books for provisions they must have made against such possible liabilities, being a listed company.

It is highly naïve to assume that they would not have withheld the capital gains tax amount, sillier to have assumed that none was payable. At best the company is posturing so that it can save the amount or at least earn some interest or improve its cash flow.
 
Smart as the company is, when demands were raised, it took the Government of India to the courts and got a favourable verdict from the Supreme Court. The Supreme Court Judgment (SCJ) says that the way the deal was structured resulted in a tax avoidance situation and not evasion. There is a statement in the judgment that suggests we simply “look at” but not dissect and “look through” the facts. The SCJ thus implies continuance with all the loose rules and regulations and let investors enjoy, because they bring in dollars.

  

The prescription is to treat the cancer in the system with a headache pill. Although it is hardly difficult to see in the judgment that the tax is not payable, but it indicts the Government which should have had the rules in place to address situations like this rather than crying over split milk now.

But unfortunately, the Government of India has now resorted to retro-taxation, becoming wiser only after the event. Retro-taxation has been challenged on the grounds that it is investor unfriendly, and a manifestation of an unstable, unpredictable tax environment etc. This issue has already been taken care of by appropriate legislation by the mother of democracy the British Parliament, which has mandated that retroactive legislation can be enacted to cover such smart moves. Quote “In some nations that follow the Westminster system of government, such as the United Kingdom, ex post facto laws are technically possible, because the doctrine of parliamentary supremacy allows Parliament to pass any law it wishes” Unquote.

As a result Barclays Bank Barclays Bank has been ordered by the Treasury to pay half-a-billion pounds in tax which it had tried to avoid. Barclays was accused by HM Revenue and Customs of designing and using two schemes that were intended to avoid substantial amounts of tax. The government has taken the unusual step of introducing retrospective legislation to end such "aggressive tax avoidance" by financial institutions. Tax rules forced the bank to tell the authorities about its plans, thus the government has closed the schemes to retrieve £500m of lost tax and safeguard payments of billions of pounds of taxes in the future.

   

That is precisely what the Government of India has also done following that Supreme Court Judgment overruling the Tax demand from Vodafone. Therefore, the question which one begets is why does Vodafone not raise a hue and cry in its own backyard, but kick up a storm in India? The answer may lie in the much maligned culture of jugaad and the ill-repute invited by rampant corruption, which is so typical of a banana republic. Thus, companies don’t think twice before trying to punch holes into our legal and administrative fabric.
 
The perseverance of the taxman to retroactively collect the dues from Vodafone is welcome, and possibly the first step towards recognising the flaws within the approach to FDI policy in India.
 
The allegations pitted by Vodafone that the government is attempting to tax the company twice over are completely unfounded. In a global economy of massive trans-national entities, it is only natural that financial instruments will be inspected way after they have been applied, to understand the full scope of their utility to enterprises and the motivation behind their use, and in the larger public interest.
 
This leads me to the entire conundrum of the history of so called Foreign Direct Investment (FDI). To me the phased manner in which FDI has been invited is completely flawed. Stepping stones like sectoral caps, and within sectors increasing the caps in stages has proved to be not only unfruitful but also, questionable.
 
Further, there is the dubious practice of creating layers of investing companies, which for purposes of investment are counted as Indian should they be in the 49% (foreign) to 51% (domestic) ratio. There also used to be these preferential shares with limited rights leading up to ownerships up to 80% or so. One could at each step of these road blocks cash out at premiums of multiple times. These steps or toll gates were precisely created with vicious mind to enrich few unscrupulous citizens of India and not the Aam Admi at large.
 
It is becoming increasingly clear to citizens that the way in which FDI bars are set in India encourages crony capitalism. More often than not, shell entities, either in India or abroad, are used to funnel funds into companies above and beyond the FDI caps and controlling interest remains with Indian companies only on paper. As a result, the Indian economy suffers from having to bear the cost of surrogacy and only a handful of crony capitalists with access to the corridors of power gain from the various projects in the era of liberalisation.

The Vodafone tax case has stuck out like a sore thumb in the judicial landscape of India, known for its pragmatism with respect to tax disputes. This has happened because the executive has underplayed the Supreme Court’s decision to “look at” the transactions in Cayman Islands between Vodafone’s subsidiary and Hutchison Essar’s holding company, rather than “looking through” them, do not treat the disease, but only the symptoms.
 
The government had drawn up the General Anti-Avoidance Rule (GAAR) to address the issue, but it was postponed till 2016 as a result of the intense advocacy against it by foreign investors in name but in reality the crony capitalist and the surrogates who benefit from it must be gloating over the fact that it got postponed.
 
Further, the other reason for us to stand strong on these issues is the fact that today India is a robust entrepreneurial economy in its own right. On 15 January 2008, Reliance Power had attracted USD 27.5 billion of domestic bids on the first day of its initial public offering (IPO), equivalent to 10.5 times the stock on offer. This incident in itself should be enough to enable the Indian policy environment to sanitise itself from foreign investors who reap the unfair benefits of investing in India through entities resident in tax havens such as Mauritius and Cayman Islands.
 
This is just one example amongst others demonstrating the availability of resources within India with rampant black economy, which no one wants to address. Of late another of the legislation to declare notes issued before 2005 as legal tender, which could have sucked in black money, has been withdrawn and postponed.  There is absolutely no will to take the issues head on with hard decisions for the sake of Aam Admi.

  

The recent cabinet decision to consider calling off negotiations with Vodafone and collect its dues would have been, therefore, a strong message to global players operating in India, but has been passed on to the next government. Further, these developments reinforce Chinnappa Reddy’s Supreme Court judgment back in 1985, in the McDowell and Company Limited vs Commercial Tax Officercase which said that, “It is neither fair nor desirable to expect the legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and...to avoid the devices for what they really are and to refuse to give judicial benediction.”
 
Besides raising some interesting legal questions, the Vodafone case has also opened up the floor for a scrutiny of how FDI has actually worked in India. Hutchison Max Telecom Ltd., a joint venture between Hutchison Whampoa and the Max Group, was established on 21 February 1992. Between 1992 and 2006, Hutchison acquired interests in all 23 mobile telecom circles of India. However, during this period Max ensured that the stocks of this joint venture were issued as depository shares by Kotak Mahindra so that ostensibly the 49% cap on FDI was respected. Therefore the initial seeds of breaching FDI norms through pyramid structures and preferential shares were sown in this first phase. This complicated matter to a great extent for the regulators of a roaring telecom sector and at the behest of the finance minister, the cap was raised to 74% in order to flatten out these irregularities, because of the breach in 74% by direct and indirect investments.

Vodafone Group Plc. on 10 February, 2007 made a final binding offer of US$ 11.076 billion “in cash over Hutchison Telecommunications International Limited’s interest” (67%), based on an enterprise value of US$ 18.800 billion of Hutchison Essar Limited. Following this, in 2011 Vodafone acquired Essar’s 33% stake in the Joint Venture at around US$ 5billion and therefore owned 74% of the company by some convoluted structuring. Finally, earlier this month, the company’s proposal to buy out the minority stakes of its local investors, businessman Analjit Singh and Piramal Enterprises and take full ownership of the entity, was approved by the Foreign Investment Promotion Board (FIPB).

This move was quite expected, considering the FDI cap of 74% was the only reason Vodafone was sharing the pie with these investors, and now with the cap being increased to 100% there was room for the company to consolidate. Also, considering insiders are of the opinion that the cap was increased to allow full FDI only because with direct and indirect investments made by Vodafone amounting to about 97% anyway, a pyramid structure had emerged yet again.  The 100% FDI provided respectability, legitimacy and most importantly few bucks for the high and mighty for holding the can in a conspiratorial, conniving and convenient way.
 
Therefore, what we see here is an extremely shoddy approach to FDI. On various occasions, i.e., when the cap was increased from 49% to 74% and then to 100% a very limited number of people have walked away with the direct benefits. And not only have the key decision makers failed to crush these colluding entities that have repeatedly cheated the country, they have also encouraged fiscal irregularities and illicit structuring by adjusting FDI caps ex post facto. It is no mere co-incidence that every time the cap has been pushed up, share holding has become regularised among these trans-national interests and a select group of investors have cashed out.
 
In the disputed transaction that happened outside Indian territory, Li Ka-Shing took home a neat US$ 11.076 billion, Essar Group some US$ 5 Billion and as a result of the recent FIPB approval we will now see US$ 1.6 billion being shared by Analjit Singh and Piramal Enterprises. How much has come into India out of the much touted US$ 18 Billion or so? Zilch. There is a clear exclusion of the larger group of shareholders who could have gained much more from a US$ 18.8 billion entity resident in India. Had the policy regime been a little more pragmatic and disallowed this pyramid-structured ownership of equity, India would not have had to pay the cost of surrogacy.

Today critics of Indian business point at the fact that we have not been able to create global companies such as Google and Amazon because product development capacity is low in our country. This perception can be reversed if full or 100% FDI is allowed as soon as an innovation is conceived in terms of either product development or service delivery or an infrastructure Hydroelectric power project or Coal or Nuclear.

  

Let them in and allow them to invest 100 % in the projects identified in all sectors of infrastructure, with all clearances given. Such an approach will test the seriousness and the appetite of the MNCs. Taking a step-by-step approach to FDI provides tremendous scope for crony capitalism and the benefits of a truly open economy are denied to the citizens. Further, analysts have made a habit of calling the telecom sector “debt-ridden” but one wonders why they have not asked the more pertinent question about the real beneficiaries of FDI in this sector. In the mind of this author at least, FDI in telecom has helped neither the fiscal health of the sector, nor the consumers, but crony capitalists and surrogates who held the baby until legitimised and baptised. 

For its own good Vodafone should stop this Quixotic tilting at the windmills, and not pursue a debilitating war with a sovereign government.

(The views are entirely personal and in no way must be associated with any past and present affiliations)