Programming Note: We will be taking off next week. We will return on Aug 22.
Not(PolicyWTF): Retrospective Admission Of A Mistake
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
On Thursday, the Finance Minister tabled the Taxation Laws (Amendment) Bill, 2021 which sought to scrap the tax claims raised on the back of an amendment to the Income Tax Act brought about by the UPA-2 government in May 2012. The 2012 amendment was meant to prevent business entities incorporated in offshore locations but deriving most of their value from the Indian market to merge or acquire control in one another without paying capital gains taxes. This was seen as a loophole in the tax laws and the amendment was meant to plug it. All good with that. Except there was a small clause in there. The amendment was to be applied to past transactions too. The tax was to be retrospective in nature.
Why Retrospective Taxes Are Bad
We have written about the problem with retrospective taxation in a previous edition. We made three key points then.
One, retrospective taxation is unfair and goes against what Adam Smith called the ‘canon of uncertainty’. I wrote earlier:
The Canon of Certainty as set out by Smith states:
“The time of payment, the manner of payment, the quantity to be paid, ought all to be clear and plain to the contributor and to every other person.”
Retrospective taxation goes against this principle of fairness. It taxes a transaction that’s happened prior to law being framed. In the bigger picture, it is a human right violation since the state cannot remove a right without a transitional period.
Two, there’s a legitimate reason to tax retrospectively. It is to avoid what’s called ‘forestalling’ – the practice of taxpayers acting to avoid the impact of a change in tax laws before it can take effect. Now, it is possible to nip this practice by making the tax changes applicable almost immediately upon their announcement. But this isn’t practical all the time. There are laws that need Parliamentary approval or change in systems and processes that could take time. Therefore, in most cases, there is always a lag between a tax change announcement and its effective date of implementation. This is what gives rise to forestalling. And that’s the reason lawmakers opt for retrospective tax laws.
But there’s a fair way to do this. In the UK, the ‘Rees Rules’ are a set of four conditions that must be satisfied for any retrospective tax legislation to be considered fair:
“A warning in the House of Commons by some recognised method – either by an answer to a Parliamentary Question or by some statement with plans to legislate in the subsequent Finance Bill back to the date of that warning. The warning must be precise in form. A mere suggestion that there are vague schemes of tax avoidance that must be counted should not suffice.”
Secondly, the problem at which the warning has been directed should immediately be referred to a committee to devise the precise legislative measures which should then be introduced in the parliament.
Thirdly, if the committee can hit on appropriate legislative provision, the draft clause ... should immediately be published in advance of the Finance Bill so that those who are likely to be in the field of fire will have a second clear intimation of what to expect.
Fourthly, such a clause must, without fail, be introduced in the following Finance Bill to formalise it into law
In the Vodafone case, it is clear there wasn’t a semblance of Rees Rules that was followed. This is what made it perverse. That the law had a loophole that allowed Vodafone and Hutchison to avoid taxes wasn’t their fault. They can’t be blamed for it. Had they known of the tax, the contours of the deal or the deal itself could come into question?
Three, I had predicted in that edition that the Indian government will continue to battle these cases till it starts getting adverse judgments. The rationale was simple. It had come this far with a terrible piece of legislation. What’s there more to lose? Why not see how far it goes and then decide?
Well, things went from bad to worse since then. Cairn Energy, which was also sent a retrospective tax demand of over Rs. 10,000 crores in March 2015 went to an international arbitration tribunal over the issue. In December last year, the tribunal overturned the retrospective tax and asked India to refund Rs. 8800 crores that the government had expropriated from Cairn’s entity in India plus interest and legal costs to Cairn Energy. The company since then has been busy. It got the tribunal award registered in multiple jurisdictions and threatened the seizure of Indian assets overseas. This had gone being beyond embarrassing.
Don’t Hold Your Breath On Change
Churchill had once said: “You can always count on the Americans to do the right thing after they have tried everything else.” He might have been speaking about India too. We have finally scrapped an amendment that brought us no additional net tax revenues and a lot of infamy as an investment destination low on rule of law. Of course, we have seen an inflow of foreign capital through FPIs and investments in digital startups over the past decade. But we haven’t had investments in sectors where we truly needed long-term capital like infrastructure, energy and industrial goods because of a lack of faith in the Indian regulatory environment. This has been a self-goal like no other. We could have gotten rid of this a long time back.
There are two questions now. Is this enough to dispel the misgivings about the arbitrary nature of the Indian state on taxation? Have we learnt the right lessons from the retrospective tax episode? I’m not sanguine about either for a few reasons.
Firstly, the political class in India loves painting the MNC as the enemy of India. We are forever paranoid about another ‘East India Company’ colonising us. The reactions from the opposition parties to this amendment has been predictable. We have ceded our sovereign rights to tax retrospectively apparently. This shouldn’t come as a surprise to the government. They have been using the sovereign rights and ‘digital colonialism’ arguments for the past few months on the Big Tech companies. The shoe is on the other foot now. So, this is not any philosophical change of course for India. It is a mere face-saving retreat.
Secondly, our growth that has stalled since demonetisation has a direct bearing on the revenues of the state. Since the expenditure continues to grow and we aren’t too keen on widening the deficit or monetising it, the state will continue to find innovative ways to raise revenues. The pandemic has only queered the pitch further. This almost always means more arbitrary tax demands to raise revenues. There are already early signs of this with various states and the union sending GST notices and raking up ancient cases with companies across the board. Both Indian and global capital have learnt to live with this and have calibrated their exposure to India based on this risk. The scrapping of retrospective taxation alone will not move the needle for them. We will continue to hear paeans from global industry leaders about our markets, enterprising spirit and our reform-oriented government. But words are cheap.
Lastly, as they often say, in India the legal process is the punishment itself. The Vodafone Hutchison deal was done in 2007. The tax dispute started soon after and after the SC ruled in favour of Vodafone, the retrospective tax amendment was passed in the Lok Sabha in 2012. The Cairn Energy deal was done in 2006. It has taken 15 years to achieve some kind of closure after years of litigations and appeals in India and across global tribunals. Cairn has since sold its interests in India and left it for good. Vodafone (Vodafone Idea now) is on the edge in India with debts of over Rs. 2 lakh crores and multiple demands of revenue share from the DoT under litigation. With neither of the promoters interested in supporting it with further capital, it is quite likely it will go under making the Indian telecom market a duopoly.
So, while the government has done well to bite the bullet and scrapped the retrospective tax amendment, I’m not holding my breath on a change in our approach to taxation. The state is all-powerful and capricious. So long as that remains true, we will see this kind of saga play over and over again.
If the content in this newsletter interests you, consider taking up the Takshashila GCPP. The certificate course is customised for working professionals. Intake for the 30th cohort ends on 22nd August.
The cartoon strip below, made by a GCPP student and ace cartoonist Khyati (@ohthescribblebee) captures the key insights from the course.
India Policy Watch: Sports and Societism
Insights on burning policy issues in India
— Pranay Kotasthane
There's something inexplicably uplifting about sporting success. Not only does it inspire — even if fleetingly — at an individual level, it fosters national pride, a feeling rarely experienced in our networked world of partisan sniping. India’s best-ever performance at the Tokyo Olympics gave me, you, and millions of other Indians a reason to chin up in these challenging times.
Our Olympians will deservedly get a lot of attention and adulation over the next few days. Their stories of grit, determination, and perseverance are sure to inspire more young Indians to pursue their sporting dreams. But this is a public policy newsletter, and I want to turn your attention to the portrayal of our governments in sports narratives.
Observe how governments often get portrayed as the second-most important protagonist in these narratives. The most common narrative arc is one of apathy — the government provided no facilities, the sportsperson doggedly persevered — and eventually won — not because of the government but despite it. A second, less common narrative arc, by contrast, highlights the positive role that governments can play in nurturing sportspersons. In the Tokyo Olympics, Odisha government’s contribution to both the hockey teams is a case in point.
The two seemingly divergent narrative arcs are actually deriving a similar conclusion — governments should pay more attention to sports; the more that our governments invest in sports, the more Olympic medals India will win. While there is a lot of truth about both these narrative arcs, it is this conclusion that needs deeper thought.
There's no doubt that India — its lakhs of villages and thousands of urban centres — need far better sporting hardware and software. But to depend on governments for producing world-class athletes because that’s how it is done in the more prosperous countries would be to fall into the ‘isomorphic mimicry’ trap.
I say this because a low-income, democratic setting must impose certain constraints on governments, and for good reasons. A low-income setting implies that the government would have low enforcement, monetary, and intellectual capacities. Hence, it would be in our collective interest to have governments do fewer things and do them well. Moreover, unlike authoritarian regimes which can sponsor projects of national pride at the cost of other expenditure items, democratic governments are elected to prioritise areas that benefit a majority of the electorate. Taken together, governments — regardless of their intentions — will not (and probably should not) prioritise sporting excellence.
And that’s perfectly okay. Since governments cannot be at the forefront in this area, we need to unleash the power of the two agents of change — markets and society. In a previous essay on societism, I had written that:
Institutionally, there are three major actors in any sovereign community— the market, the State, and the society. They are complementary—each of them is better at some tasks and is worse at others. For example, the state is very adept at employing force, but efficient usage of resources is not its forte. A market is efficient, but is oblivious to inequality. And a society has several self-correcting mechanisms, but is susceptible to majoritarianism.
For sporting excellence, the complementary strengths of markets and societies are far more vital than government attention.
Consider the role of markets first. Not too long ago, cricket would be criticised by players of other sports for hogging all the popularity, attention, and resources. And then a commercial, entertainment-focused enterprise such as the IPL turned this argument on its head. The city-based league format pioneered in India though IPL proved to be a positive-sum game for other sports. It spawned similar leagues in several sports, even managing to bring back Kabbadi to primetime TV screens. This commercial model energised many sports in ways that no government medals could have done.
At the amateur level, reforms in India's FDI policy finally brought world-class sporting retailers such as Decathlon to India. Earlier, the sports retailing scene was stagnant, with few old-style shops only catering to demands of select, mass-market sports. By getting out of the way, the government helped change the sports equipment landscape for millions of budding sportspersons in the country. In short, markets are critical to lasting sporting success.
Now consider the role of the third agent: the society. This is by far the most underappreciated agent of positive change. In the essay, I had posited that:
..once the State failed in providing basic public services, even well-meaning civil society initiatives were directed towards plugging the government’s leaky bucket. Instead of complementing the state, civil society initiatives started substituting the state. So, we do have philanthropy, but a lot of it is for providing basic amenities, which fall squarely in the domain of the State. Philanthropy for the big, bold tasks that governments can’t do, like Carnegie’s public library network, is yet to come of age.
Sports is definitely one such big, bold task that is ideally suited for philanthropy. Take the role that the MRF Pace Foundation has played in producing fast bowlers in India. Or the contribution of the Tata Group in improving hockey facilities in Odisha. We need many more philanthropic initiatives of this nature.
Besides the well-established corporates, there are smaller non-profit organisations such as the GoSports Foundation and Olympic Gold Quest. These organisations sponsor and support talented Indian sportspersons so that they can become world-class. Perhaps, we need hundreds of such societal initiatives outside the government to achieve sporting excellence.
In short, just like it takes sacrifices from many friends and family members to create one champion, it takes contributions from the government, markets and societies to create a sporting culture.
PS: You can play a small role too. Instead of ruing the lack of governmental support for our athletes, consider contributing to organisations that are dedicated to sports. For that would be a perfect tribute to the Indian contingent of Tokyo Olympics 2020.
If coming up with theories for why a country doesn’t win more medals at international events were a sport, we’d have won a few more golds in Olympics over the years. This is an evergreen topic of discussion. Theories abound. Government apathy, poor diet, weather, lack of corporate sponsorship, absence of world class infrastructure, limited international exposure, world class coaching, mental fortitude, genes - the list is long. There’s always an example quoted picking up any one of these reasons and showing how it is done in some other country for some sport or the other. But here’s the thing. Almost every one of these reasons for failure can be falsified by examples of multiple other countries who are worse off on them and yet win medals consistently. There are countries that rank higher than India despite being poorer (sub Saharan Africa), that are rife with civil wars and coups (Central American and Balkan states), that have worse weather (Indonesia, Philippines, Thailand) and so on. You get the picture.
So, I would like to add an additional point apart from societism that Pranay talks about. This too relates to our society. It is about how we view sports and sportspersons. We think of sports as a career of last resort meant for the poor, the underprivileged or those with no other redeeming ability. And this isn’t just us alone. Our neighbours who were part of our society not so long back are the same. It is no wonder that Pakistan, Bangladesh or Nepal also don’t produce any world class sportspersons. This view permeates the administration, investments and support in sports right to the grassroots. Barring a few exceptions, there’s never any real respect for talent in sports among those who run or those who follow sports. If you don’t agree, I suggest you visit any of the SAI or sports hostels in the country and see for yourself. Or, check the toilets in any of our arenas or stadiums where athletes train. It is not about funds alone. Our attitude towards athletes is marked by the same biases we bring to the table elsewhere - their background, their caste, their communication skills or some other marker of their social rank. And once we have pegged them, we aren’t shocked by the conditions in which they live, travel or train. Their athletic prowess is of limited interest to us till they show up on screen during an Olympics or Asian Games. A few weeks later we forget all about them.
There’s a gradual change that’s happening to this attitude around us. But it’s slow. Till we change our attitude towards sports, funds or foreign coaches won’t amount to much.
Reading and listening recommendations on public policy matters
[Article] Shankar Sharma in the Business Standard writes: “Institutional arrogance in taxation has cost India dearly in terms of its image as a business-friendly, rule-driven country.”
[Article] A lovely profile of the MRF Foundation in The Cricket Monthly.