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GAAR Grounds Market

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The Finance Minister's move to postpone the implementation of the general anti-avoidance rules (GAAR) by one year had perked up the equity and the currency markets on Monday but it was a different story on Tuesday.  The rupee in the afternoon session fell so much that it prompted the Reserve Bank of India to step in when the rupee touched 53.30 against the dollar. This in turn sparked a tumble in domestic stocks and fears of continued outflows. The BSE Sensex dropped 2.17 per cent after investors sought more clarity over India's suggested amendments of controversial GAAR proposals.

In a strong message to multinationals campaign against taxing Vodafone, Government of India on Tuesday ruled out any rethinking on the issue making it clear that India cannot be a tax haven just to attract foreign investment. It also asserted that Parliament has the right to make amendments to law to correct Supreme Court judgement and would not allow a situation where a corporate would avoid paying tax here by operating from a tax haven.

The 30-share Sensex fell 366.53 points to end at 16,546.18, while the 50-share Nifty lost 2.23 per cent to end at 4999.95 points. It appears the Finance Minister did a good turn, but did not go far enough. Investors in general and India in particular seems to have been left in an uncomfortable position.

The Finance Minister had shown his sensitivity to investor unrest and has reduced the scope of the backward-looking changes by promising not to tax capital gains on deals made in countries which have a double taxation treaty with India. The last adjustment protects deals done from Mauritius from retrospective tax. But the Cayman Islands have no such treaty. That means Vodafone, which structured its purchase of Hutchison Whampoa's Indian mobile phone operations with a Cayman Islands vehicle, has to pay the retroactive tax.

Lok Sabha Passes Finance Bill
At Parliament, on Tuesday, Mukherjee stood his ground on deferring the implementation of GAAR and said his move was not a result of fear or apprehension. A Left motion against his move was defeated in the Lok Sabha 342 to 22, with the BJP backing the government.

He also justified the retrospective tax law change which would make Vodafone liable to pay taxes worth over Rs 10,000 crore.

The government accepted a BJP suggestion that it bring an amendment to give effect to Mukherjee's deferral of GAAR till 2013. But the Left, accusing the UPA of surrendering to market forces and the US, insisted that it be part of this year's Finance Bill. It then brought the motion which was easily defeated in the Lok Sabha, which passed the Finance Bill.

In his reply to the debate on the Bill, the Finance Minister said, "GAAR I have agreed to defer, but not because of fear or apprehension. I am not afraid of any consequences." He also defended a retrospective tax on overseas deals involving assets in India, such as the one involving Vodafone's 2007 acquisition of Hutchison Essar.

Mukherjee said such deals must be guided by the double taxation avoidance agreements or the companies must pay tax in India. "(You) cannot make money on assets made in India by not paying tax in India or somewhere else, some tax haven through a series of subsidiaries and make huge capital gains on assets based in India," he told the House.

"My whole argument against Vodafone was on that point. I would like to be guided by double tax avoidance agreement or tax. It cannot be that someone will make money on an asset in India and not pay tax in India or in its country of origin," Mukherjee said while debating on the Finance Bill in Lok Sabha on Tuesday.

The Income Tax department had claimed that Vodafone was liable to pay $2.2 billion in capital gains because the underlying assets for the deal were based in India, but that argument was rejected by the Supreme Court. The Finance Minister countered criticism that he was challenging the ruling of the Supreme Court on the retrospective taxation issue by saying that it was solely the right of the legislature to frame laws. "I am aware of the power of legislature, it is the power of legislature to make law. Supreme Court can interpret, but legislature can make amendment to correct the flaw," he said.

"Law has to be framed by us. If there is conflict between intent and interpretation of judiciary, then we respectfully say that it is our right," he added.

Mukherjee said that the UK had also allowed taxes to be applied retrospectively if the acquisition had taken place prior to a double tax avoidance agreement being signed and India could do the same.

"If they are entitled then India is surely entitled. India is not inferior to anyone. We cannot be a tax haven just to attract foreign investment," the Finance Minister said.

Mukherjee said that the Supreme Court was free to interpret law but as a legislator he had the freedom to amend the laws.

"I will say I am fully aware of my right as legislator," he said adding that Parliament was entitled to make legislation in the country.

"The Supreme Court may interpret law but Parliament has ability to make amendments to law to correct Supreme Court's judgement," he said.

"By interpretation of law our ability of amending law is not taken away," the Finance Minister said.

India has proposed to amend laws retrospectively to tax some already-completed mergers of foreign companies with Indian assets, potentially putting Vodafone back under the taxman's spotlight for more than $2 billion in taxes even after the Supreme Court ruled the tax office did not have jurisdiction over cross-border deals.

Vodafone has not yet approached the government for an out of court settlement for the tax dispute, but the government is determined to tax the British telecom company over its 2007 acquisition of Hong Kong-based Hutchison Whampoa's mobile operations in India.

Rupee Falters On Foreign Outflow Fears
The rupee fell on Tuesday on worries foreign investors would not be swayed by the government's move to address their concerns over taxation, sparking a tumble in domestic stocks and fears of continued outflows.

The falls in the afternoon session prompted the Reserve Bank of India to step in when the rupee weakened to 53.30 against the dollar, according to four dealers, continuing a series of interventions since last week.

The rupee erased the gains on Monday when the government announced it would postpone controversial tax rules for foreign investors and would shift the onus of proving evasion on tax authorities.

Despite the moves, foreign investors sold a net of 10.3 billion rupees in domestic stocks on Monday and Tuesday, according to provisional data from the National Stock Exchange.

"The initial euphoria about the GAAR is done. The market is now looking at actual flows," said Uday Bhatt, senior manager of dealing with state-run UCO Bank.

The rupee fell 0.4 percent against the dollar to 53.12/13, weakening from its Monday close of 52.9050/9150.

The rupee is fast approaching a record low of around 54.30 to the dollar, weighed down by worries about India's fiscal and economic challenges, and increasingly, that foreign investors will exit from the country.

(With Agencies)