Reform in India
Tax Battle in India Tests Modi’s Mettle

Narendra Modi took office just under one year ago, after a land slide victory for his platform of liberal economic reform and Hindu Nationalism. He promised to slash red tape, to dismantle the “license raj” that adds reams of paperwork and layers of bureaucracy to business operations, and to create a tax environment that makes India attractive to foreign investors.

The biggest of those is probably the tax reform drive. Modi says he wants to create a less onerous tax system in lieu of the difficult to manage and often unpredictable one currently in place—sometimes described in India as “tax terrorism.” Indeed, India has a reputation among foreign firms for calling in huge, unexpected tax bills. The 2012 fight that erupted when New Delhi charged Vodaphone $2.6 billion claiming that the charge was incurred retrospectively now that a new tax law had passed is emblematic.

But Modi’s management of the reforms has been checkered. The FT reports:

…Mr Modi’s administration [recently] caused alarm by suggesting that foreign portfolio investors may be charged up to $6.4bn under India’s minimum alternative tax (MAT), a form of taxation that traditionally applied only to domestic companies.

The MAT row hit Indian markets over recent days, contributing to an outflow of portfolio capital and sending the rupee to its lowest level since late 2013.

In an attempt to placate alarmed investors, Arun Jaitley, finance minister, announced the formation of a committee examining ways to end the dispute, to be led by former judge A P Shah, the head of the India’s Law Commission,

“We have decided to refer this matter [MAT], as well as a few other tax issues, which are essentially legacy issues,” he said on Thursday.

The new committee is likely to be welcomed by investors, who fear the MAT row will prompt protracted legal battles, following moves by fund managers such as Aberdeen Asset Management to take legal action over the issue.

India’s finance ministry said the committee would have a broad remit to look beyond MAT, as part of wider attempts to build what Mr Modi has described as a new “non-adversarial” tax regime.

As the FT goes on to note, officials from the Modi government blame the problems of the tax system on their predecessors. They’re not wrong; the rule of India’s long-serving National Congress Party, coupled with cultural and institutional leftovers from British rule, have created a messy system that makes it harder and less profitable than it needs to be to do business in India.

But now it’s up to Modi to shepherd his liberal economic reforms through the tough political process. Even with his strong voter mandate, reform is proving more politically difficult to uproot than many had hoped. Whether he succeeds at this will go a long way toward determining whether the Indian economy lurches forward into the 21st century, or gets lefts in the dust. It’s crunch time for Modi the reformer.

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