Free fall before Budget debate

RUPEE FALLS: Palanimanickam slams Mauritius on tax treaty,shaves Rs 116,900 cr off Sensex.

Written by ENS Economic Bureau | New Delhi | Published: May 4, 2012 9:38 pm

At a time when policy uncertainty and retrograde tax proposals have clouded the India growth story,a statement by Minister of State for Finance S S Palanimanickam in the Lok Sabha today triggered fresh concerns over the Mauritius tax treaty review,setting off heavy selling by foreign funds sending the Sensex down by 320 points to below the 17,000-mark.

This was combined with a plunge in the rupee which dipped to a low of 53.95 in intraday trade before bouncing back,spurring concerns that the government might find it hard to cool inflation and curb the fiscal deficit. The slump in the market wiped off a notional Rs 116,900 crore of investors’ wealth on the last day of trade before the debate over the Finance Bill begins on May 7.

Palanimanickam’s written reply in Lok Sabha claimed an “unwillingness on the part of Mauritius” to cooperate on a review of the double taxation treaty. “A joint working group (JWG) comprising members from the Government of India and the Government of Mauritius was constituted in 2006 to put in place adequate safeguards to prevent misuse of the India-Mauritius DTAC…There was unwillingness on the part of Mauritius to cooperate in addressing this problem. Consistent efforts are being made by the Indian government to find mutually acceptable solutions,” the minister said in a written reply,adding that the next meeting of the JWG is yet to be scheduled.

Nearly 40 per cent of the total foreign direct investment into India has come through Mauritius between April 2000 and February 2012 as investors take advantage of the tax treaty between the two countries.

Much of this is done by third-country investors,who frequently use the pact to avoid taxes through treaty shopping and round tripping. Under the India-Mauritius DTAA,capital gains are taxed by the country where the company is a resident. As Mauritius does not levy capital gains tax,it leads to zero taxation for companies that route their investments through the island nation.

Finance Secretary R S Gujral had earlier said that India is keen to press for a right to tax for capital gains arising in the country. This crucial revision is believed to be the reason behind the delay in the renegotiation of the DTAA. Though Palanimanickam in his reply said there are no clear estimates on revenue loss due to the DTAA,the tax department contends that nearly $600 million is lost in revenues every year because of the treaty.

The minister’s assurance to the House on the Budget proposal to retrospectively tax Vodafone-type deals also did not help soothe the markets. Pointing out that the proposed amendments are clarificatory in nature,Palanimanickam said they “will not override the provisions of Double Taxation Avoidance Agreements with 82 countries,which are relevant for taxation of non-residents in the case of offshore mergers and acquisitions.”

In the markets,bears made a killing,even forcing Samvardhana Motherson Finance to withdraw its initial public offering (IPO) of shares to raise about Rs 1,665 crore as poor market conditions have kept investors away from the issue. The 30-share Sensex,which lost 168 points in last two trading sessions,plunged further by 1.87 per cent to 16,831.08,its lowest level since January 30,2012.

Similarly,the 50-share NSE Nifty dropped by 101.55 points,or 1.96 per cent to 5,086.85,led by a steep fall in stocks of capital goods and banking sectors.

Dipen Shah,Head of Fundamental Research,Kotak Securities,said: “We believe there were concerns regarding the taxability of foreign investors (GAAR),the depreciation of the rupee in the past few days and also the weak global market (on the back of weaker-than-expected US data). We believe that,further clarity on these issues and reforms initiatives from the Government will be the pre-requisite for the markets to move up sustainably.”

Weakness in the markets has been pronounced in the last three sessions amid uninspiring FII fund flows,a weak rupee and lacklustre January-March quarter earnings. Worries over foreign outflows are also reflected in a rupee that continues to plumb four-month lows,given the deep concerns about India’s economic and fiscal challenges. Foreign investors have sold a net of about Rs 630 crore in April. Still,they have been net buyers of Rs 318 crore so far in May,according to provisional data.

Making marketmen nervous,the rupee is inching to its all-time low of 54.30. “We maintain a cautious outlook on the Indian markets and continue to hold a negative bias in the near term. Next week will be important for India as Parliament takes a final call on the Finance Bill,including the controversial GAAR issue. There could be more downside in the coming days,while the upside will be capped as long as the government doesn’t show some gumption. Till then FII flows and economic statistics will continue to determine the mood of the markets,” said Amar Ambani,Head of Research,IIFL.

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