International financial services industry representatives continue to work with government officials to try and resolve significant issues related to the impact of the proposed Finance Bill, 2012, on the Indian capital markets. So far, two main areas of concern remain unresolved: the general anti-avoidance rule (Gaar) and the indirect transfer rules as they each apply to cross-border portfolio investments.

The Gaar provisions in particular bestow tremendous discretion upon the tax office to reconstruct transactions at later dates and in unpredictable ways. The foreign institutional investor (FII) community believes that the only solution is an unequivocal exemption for cross-border portfolio investments in Indian securities from both the Gaar and the indirect transfer rules.

It is clear that these proposed tax laws were written to address certain judicial decisions, but the overly broad nature of the draft provisions casts a wide net that will inadvertently capture non-targeted transactions and market participants. Government leaders have the ability to avoid these unintended consequences by following the international standard of exempting cross-border portfolio investments by FIIs from both Gaar and indirect transfer rules.

FIIs facilitate investments in India for clients and other investors and have a responsibility to ensure that these important constituencies understand the tax implications of such investments. As of March 16, 2012, FIIs had assets under custody of more than 10 trillion (over $200 billion), representing 17% of the capitalisation of Indian securities markets, or as much as 40% of the free-float on the Indian exchanges.

These assets are invested by broad-based global funds made up of the pensions and savings of ordinary people from around the world. In addition, these FIIs have invested 1.7 trillion ($32 billion) in Indian debt securities. Indeed, India's equity and debt markets compete with other markets in Asia and around the globe for a share of the world's investable savings.

India's economic success story is one factor that draws global capital to its shores. Ease of market access and a transparent and predictable tax system is another. The tax uncertainty now anticipated creates significant risk that these global funds will choose to avoid the Indian capital markets altogether and redirect their resources to other opportunities.

There is clear evidence that Indian equity markets are not handling this uncertainty well, with some financial institutions no longer making new investments and various international investors withdrawing their existing positions from the Indian markets. Since the announcement of Budget 2012 on March 16, net FII inflows have slowed dramatically, showing an effective daily average drop of 95% since March 16.

The reduced participation of FIIs has also had a perceptible impact on market volumes. Local brokerage houses are reporting a sharp drop-off in FII trading interest in general due to the Gaar uncertainty. The little activity that has taken place has mostly been to unwind positions so that funds can exit the Indian market altogether.