Foreign companies tempted by India’s call to scale up manufacturing in Asia’s third-largest economy need to consider one big potential headache: tax.

Nokia OYJ, Vodafone Group Plc, Cairn India Ltd and Cadbury chocolate maker Mondelez International Inc. are among those embroiled in tax spats for total claims of about $10 billion. A separate row flared this month with foreign portfolio investors over demands for $95 million on past capital gains.

Prime Minister Narendra Modi has pledged a friendlier tax regime since taking power a year ago as he woos investment, but officials on the ground also face pressure to boost one of the lowest collection rates as a proportion of the economy in the world. Add a byzantine tax code to the mix, and the threat of inflated and arbitrary demands on foreign companies lingers, according to consultancy Control Risks.

“Once a tax order has been sent out, it’s like a bullet fired from a gun,” said Ketan Dalal, a managing partner for PricewaterhouseCoopers Pvt. Ltd in Mumbai. “Globally, a country’s taxation policies weigh into about 10% of an investment decision. In India, it could be 25% to 30%.”

In the Nokia case, tax spats forced the company to suspend operations at its factory in Chennai last year, with thousands of workers offered voluntary retirement. Nokia wants the impasse resolved so the plant can be sold.

‘Tax terrorism’
Modi is trying to cut down such red tape. Through his “Make in India” campaign, he’s aiming to borrow from China’s playbook by taking manufacturing’s share of the economy to 25% from about 16%.

India is a “changed country” with a more “transparent, responsive and stable” regulatory framework, he said during a trip to Germany this month.

His government blames the prior administration for disputes with companies such as Vodafone, promising an end to what it calls the earlier regime’s tax terrorism.
That includes a vow to refrain from fresh retrospective claims under controversial laws passed in 2012, and the deferment of anti-avoidance rules for two years. The government hasn’t appealed court rulings that companies including Royal Dutch Shell Plc’s Indian unit won in some tax cases last year.

Finance minister Arun Jaitley plans to lower the corporate tax rate to 25% from 30% over the next four years. He’s also striving for a goods and services tax (GST) to subsume a range of federal and state taxes, a step that would make India more of a single market for commerce.

Legal tangle

“The government has simplified tax procedures and is following a non-adversarial tax regime,” said D.S. Malik, a spokesman for the finance ministry in New Delhi. “Tax officials will be fair with taxpayers.”

At the same time, a pledge to refrain from examination of historic deals falls short of repealing the legislation allowing such scrutiny—leaving implementation hostage to political fortune.

The anti-avoidance rules due in 2017 may separately spur more probes of companies in India. State governments also have tax enforcement powers beyond Modi’s control.
Last week, India said foreign portfolio investors can use tax treaties to reject demands on past capital gains, stepping up efforts to defuse the most recent row.
The tiff cast a cloud over the $48 billion that’s poured into stocks and bonds from overseas in the past year, and contributed to the 1% drop in the benchmark S&P BSE Sensex equity index so far in April.

Investor sentiment

Such cases “undermine government efforts to attract fund flows and investments through its Make In India initiative,” said Hugh Young, managing director at Aberdeen Asset Management Asia Ltd in Singapore.

Jaitley’s priorities also include curbing the budget deficit, no mean feat in a nation with a tax-to-gross domestic product (GDP) ratio of about 11%, less than the 15% in Brazil and 25% in a developed economy such as the UK.

The $3 billion case over capital gains from Vodafone’s 2007 acquisition of Hutchison Whampoa Ltd’s Indian business is going into international arbitration. Cairn India has said its $3.3 billion dispute will deter overseas investment. Mondelez is contesting an excise duty claim.

Part of the problem is the gap between the people writing tax laws and officers implementing them.

“Sometimes the sync between the two is missing,” said Pranay Bhatia, a partner at consultancy BDO India in Mumbai. “Tax offices in different cities at times work as independent units.”

Ford, SunEdison

Some companies are still expanding their industrial footprint in India. Ford Motor Co., for instance, opened an assembly line and engine plant last month. SunEdison Inc. is developing wind and solar projects. Assuaging concerns about tax would help Modi attract more manufacturers to create jobs in the world’s second-most populous nation.
“Making the tax system easier to navigate, and less prone to long-drawn litigation, is certainly critical for improving the attractiveness of India as an investment destination,” said Jan Zalewski, South Asia Analyst for Control Risks in Singapore. “Realistically, this won’t happen overnight.” Bloomberg