How Two Tax Notices May Put PM Modi’s Government on Backfoot

Prime Minister Narendra Modi’s government sent two notices demanding a total of Rs. 31,000 crore in taxes from Cairn Energy and its former subsidiary Cairn India last week for a transaction that occurred in 2006-07.

Cairn Energy has been asked to pay Rs. 10,247 crore for the capital gains it allegedly made in 2006 while transferring all its India assets to Cairn India and getting it listed on the stock exchanges. The Rs. 20,495 crore tax demand on Cairn India is for the company’s alleged failure to deduct withholding tax on capital gains made by Cairn Energy for the same transaction. Cairn India is now owned by billionaire Anil Agarwal’s Vedanta Group after Cairn Energy sold its majority stake in the company in 2011.

Both companies have said that they will contest the tax notice. Cairn Energy has filed a dispute notice under the terms of a UK-India Investment Treaty, meaning the Indian government and Cairn will negotiate or otherwise turn to arbitration. Cairn India said it would pursue all possible options to “protect its interest”.

The two companies will join firms such as Vodafone, Royal Dutch Shell, IBM, Microsoft, etc. that are involved in tax-related litigation in India arising out of the retrospective tax law – a 2012 amendment allowing taxation of indirect transfer of shares in the past. The retrospective tax law has often been cited as the single biggest deterrent to investing in the country.

In the short-term, however, a lot of damage has already been done. Shares in the two companies have come under a huge selloff because of the tax notice, resulting in a large scale destruction of shareholders’ wealth. Cairn Energy shares plunged more than 20 per cent in a single session last week, while Cairn India is trading at its 52-week lows.

More importantly, the tax demands have raised fresh concerns of tax terrorism, a phrase used to describe the adversarial approach adopted by tax authorities under the previous UPA regime. Analysts say new tax notices go against the Modi government’s promise of establishing a non-adversarial tax regime and may scare foreign investors away.

“India is sending out wrong signal at the wrong time,” Tom Albanese, chief executive officer of Vedanta Resources told Bloomberg. “It is currently the best positioned under BRIC to attract foreign direct investments. Any corporate CEO that’s thinking of investing in India will take notice.”

Finance Minister Arun Jaitley has termed the development as a “legacy” the Modi government has inherited from the previous regime. Speaking in London, Mr Jaitley said, “As far as earlier notices and legacy issues are concerned, they’ll have to be sorted out through a due judicial process. We’ve stuck to that word.”

He reminded that on Vodafone and Shell issues, the government accepted whatever the courts decided. However, Mr Jaitley’s statement has failed to satisfy analysts, it seems.

Fund manager Sandip Sabharwal tweeted, “Tax department slaps $1.6 billion notice on Cairn India. Some departments never change. So much for government not harassing corporates.”