Did Pranab-da pull a fast one on Voda and P-notes?

Pranab Mukherjee is not going to emerge from 2012 with his reputation intact. His recent Union budget has been so widely panned for messing up investor sentiment and going back to the days of babus-know-best, that it will take several flip-flops to wipe the egg off his face.

But even then the damage has been done. Consider just one day's critiques.

On Monday, Mukesh Butani, Chairman of BMR Advisors, more or less suggested (in much nicer words) that Mukherjee must have been bluffing when he said that the retrospective amendments to tax overseas transactions were merely a "clarification" on the intent of the 1961 Income Tax Act. They were not really amendments.


However, no one doubts that the clarifications were essentially intended to reverse the Supreme Court's Vodafone judgment in January. And the Supreme Court threw out the government's review petition without a second look. This shows what they think about the government's old law which needed a clarification.

In an article in Business Standard, Butani asks: "I wonder how the intent of a 1961 law would have been to bring such offshore transactions to tax by simply clarifying the terms such as "direct and indirect" or "capital asset in India."

Overseas transactions involving underlying Indian assets were hardly on anyone's radar at that time.

Butani's clincher: the 1961 law was more or less the same as the one we had during British rule in a 1922 Act. He asks: "Hypothetically, are we saying that we intended to tax such transactions in the 1920s?"

Touche. Mukherjee should be red in the face.

The real clarifications on a 1922 law can only come from the Brits, whose Chancellor of the Exchequer had the opposite agenda in his meeting with Pranab Mukherjee on Monday. He must have asked Mukherjee to back off on the Vodafone taxation.

Another issue on which the FM will be embarrassed is GAAR - the General Anti-Avoidance Rules introduced in the 2012-13 budget. Faced with an outcry from the stock markets, he announced that GAAR would not apply to investors in participatory notes (P-notes). P-notes are derivative instruments used by an investor abroad who does not wish to advertise his presence in the Indian markets. He invests indirectly through a foreign institutional investor (FII) registered with Sebi. He gets to share profits and losses and dividends through the P-note - which confirms his participation in the transactions.

Pranab-da said last week that P-notes won't attract GAAR or taxation.

But if that's the case, what about FIIs themselves? As a report in The Economic Times noted, an FII official raised this query: "The finance minister's clarification that participatory note holders will not be taxed has raised a bigger concern: does this mean that FIIs investing directly will come under the tax net? Most accountants will not issue an unconditional certificate based on the FM's statement on television."

It would also be perverse if P-notes - usually used by hedge funds and benami Indian investors keen on investing their overseas money anonymously - are not taxed, but FIIs are. Legit institutions will then be taxed, but not potential black money transactions.

So, Pranab Mukherjee will have to issue yet another clarification to clarify his clarifications.

His budget is now in a state of utter disrepair.

Updated Date: Dec 20, 2014 17:20 PM

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