Dubai: The outlook for shares in India is growing murkier as a new tax proposed in the annual budget has the potential to scare foreign portfolio investments, which have been the driver of the market's rebound this year after the main stock index slumped a quarter in 2011.
Although the government was forced on Friday to clarify that holders of participatory notes, popularly known as P-notes, would not be taxed, some foreign institutional investors (FIIs) would still come under the taxman's scrutiny.
FIIs have bought shares worth more than $8.9 billion (Dh32.7 billion) this year, betting the $1.3 trillion Indian economy would pick up steam after a sharp slowdown. Much of this money is routed through Mauritius and other tax-havens and is not taxed in India.
Now, the government wants to bring such FIIs under the tax net. It has introduced a legislation, called General Anti-Avoidance Rules (GAAR), which if approved would give revenue officials wide powers that would overrule tax treaties such as between India and Singapore, or with Mauritius against double taxation.
Clearly, foreign funds are jittery about GAAR, whose language is so vague it would leave them at the mercy of India's notoriously bureaucratic taxmen who revel in interpreting laws in different ways.
"Policymakers in New Delhi seem to be at sea about the country's deep economic problems," said one fund manager at a Hong Kong-based FII, who did not want to be named. "Their overzealous tax moves could well kill the goose that lays the golden egg."
According to one estimate, about 16-20 per cent of the FII investment is via P-Notes. "The Indian tax authorities would not go beyond the FIIs to check any further details about P-note holders," Finance Minister Pranab Mukherjee said on Friday. "Accordingly, question for liability in tax of the participatory note holders does not arise."
After the clarification, the Sensex rebounded but still ended down 2 per cent for the month at 17,404.20. For the quarter, the benchmark gained 12.6 per cent, but the outlook remains cloudy. The market could drift lower even if the central bank cuts rates in April, Bank of America said, citing the tax uncertainty which has also weighed on the rupee.
Mukherjee has also proposed to amend a 50-year-old law after the government lost a case in the Supreme Court against slapping taxes on British telecommunications giant Vodafone Plc's overseas acquisition of Hong Kong-based Hutchinson's holding in India.
New Delhi's move is seen as trying to overrule the verdict of the Supreme Court, and claim back-dated taxes. "Some worry that the rule of law, one of India's great strengths, is being eroded," The Economist wrote.
The writer is a journalist basedin India.
