An economy of India’s size and potential must have a financial centre of global status. Most of the developed countries have developed globally integrated domestic financial centres to best utilize the opportunities of cross border capital flows. For example, UK has London, Germany- Frankfurt, and Japan has Tokyo. Among EMEs, Hong Kong has the status of the leading financial centre serving Chinese interest in future.
When Voldafone acquired Hutch in India, both companies have done their transaction though overseas Special Purpose Vehicles to avoid taxes. This means that India has lost not just taxable income but also many other associated income flows related to cross border investment because of the pinching regulations and tax treatment. India really lacks a financial centre of global or even regional status to extract benefits from foreign investment even if such investments are related with our country.
Few years back, the government has made a vision to make Mumbai as a world financial centre. But the follow up actions were not made in the context of the global financial crisis. Now the new budget has made couple of efforts to build a financial centre for the country.
The first initiative is lightening norms for Permanent Establishment (PE) norm. The budget has made that even if a foreign fund (investor) is appointing a fund manager in India, it will not be considered as a PE. The importance of PE is that if a foreign entity has a PE in India, it will be considered as a resident entity and will be taxed. Hence most foreign investors to avoid paying income tax on their business income have avoided building anything notable like offices in India.
The real loss was that has they appointed a fund manager or minimum Indian presence, the associated income earned in the country due to their income would have been higher. Similarly, the presence of a fund manager of a foreign investor may lead to more investment. This budget hence made it clear that appointment of a fund manager doesn’t constitute to the creation of a PE.
The second budget initiative is the plan to develop GIFT city in Gujarat to a world financial centre surprisingly sidelining Mumbai.
Altogether, these two measures are just very small steps in developing a financial centre for India. For that the immediate pre-requisite is trust related. Foreign investors and international business community have been shocked when the previous government has enacted a retrospective tax legislation regard to the Vodafone case. Such arbitrary tax legislations are not suiting to a responsible tax system and for a responsible democracy of reputation.
More than that, the government should prepare a better and competitive regulatory framework and tax laws to competitively attract foreign investment as well as to make a financial centre for the country. When we study the history of evolution of many financial centres like Singapore and Hon Kong, it is observable that innovative regulations and careful tax laws are the factors that brought these centres. For that, the new PE simplification norm is a welcome step but is a drop in the ocean.
