Vodafone tax conciliation seems fated to flop

The Cabinet decision on Wednesday to refer the tax dispute with Vodafone for a non-binding conciliation process bears all the hallmarks of an effort undertaken in good faith by both parties to sort out the matter that has dragged on for too long.

Both sides, for instance, have had to climb down from their respective maximalist positions. For Vodafone, this amounts to acceptance in principle of its liability to pay tax in India for the 2007 transaction for the acquisition of Hutchison Telecom’s India assets. That goes against the grain of what the company has held thus far: that it was not liable to tax in India because the deal took place between two overseas companies and the target asset was registered in the Caymen Islands. In fact, it had initially asked for the settlement discussion to be conducted under the UN Commission on International Trade Law, but has been compelled to yield ground on that front too.

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For the Indian government, too, the prospect of a dispute resolution through the conciliation route gives it the chance to close the door on what has proved a high-profile, bothersome episode that has come to represent everything that is ham-handed about its efforts to enforce its tax jurisdiction - and walk away with whatever it can.

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The retrospective amendment to tax laws that the then Finance Minister Pranab Mukherjee introduced in the 2012 Finance bill spooked international investors - who even today invoke the threat of voting with their feet if the Indian government overreaches in its effort to fill its tax coffers.

It’s an empty threat, of course, seeing that similar tax-loophole plugging efforts are being undertaken virtually everywhere - from the US to the UK to other countries in the OECD. In any case, Vodafone hasn’t exactly endeared itself even in its home country with its reputation as an artful tax dodger.

So, even though the outcome of the conciliation process is non-binding and, in India’s case, has to be approved by Parliament and will likely involve legislative changes, both sides have stepped up in good faith in the hope of turning the page and moving on.

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And, yet, for all their manifest earnestness, it’s entirely possible that the conciliation process may be doomed to fail.

For one thing, much bad blood has been spilt over the past few years of the dispute. And, secondly, the severely scam-tainted UPA government doesn’t have the political goodwill to sell any “resolution” it may hammer out.

Additionally, as economist Bibek Debroy points out, even if a settlement is reached in the Vodafone case, international investors’ sense of disquiet over the retrospective taxation amendment provision may not be so easily overcome. The government does, of course, have a persuasive case to make that it was within its rights to ensure that Vodafone, in this case, did not escape the tax net in its entirety. But that argument would have worked only if the investor community was pawing the ground and eager to invest in India.

But seeing how the Indian economy has ground down and the Indian government’s policy outlook for investors has become so opaque, the government isn’t exactly in a position to call the shots. With the economy teetering on the brink of a sovereign rating downgrade, there is if anything only downside risk in the short term.

Bad as this scenario is, there is one that’s even worse. If the government hard-sells the Vodafone dispute resolution through the process of conciliation, it may recoil on both the parties if, as Debroy suggests, it gets challenged again in court. That will drag the dispute back to square one, and accentuate the rancour on both sides.

All this holds a lesson for the government. Even though it was entirely within its rights to ensure that Vodafone did not play fast and loose with tax laws, it would have done better by itself if it had not entered into a pitched battle with the company and invoked the bazooka of retrospect amendment to tax laws, and endured the mortification of seeing the Supreme Court rule against it.

Instead, Mukherjee as Finance Minister waded in with heavy artillery. In one memorable intervention in Parliament, he went over the top with his shrill rhetoric, suggesting that life in India had gone on at a stately pace before international investors had discovered India, and would doubtless continue even if they went away with their moneybags. “We were not eating lizards before you came,” he thundered.

Governments, as we all know, are not without coercive powers to deal with recalcitrant corporates - and particularly with a serial tax-dodger with Vodafone, there were other tactful levers that it could have exercised in order to have its way. But that required political goodwill, which is among the many things that the government is deficient in. Which is why Finance Minister P Chidambaram is fighting a valiant rearguard action to undo the damage inflicted by Mukherjee. All his best-laid plans could, however, seem fated to come apart at the seams.