India delayed by a year the rollout of measures to crack down on tax evasion, mollifying overseas investors rattled by uncertainty over proposals that had spurred an exodus of funds and battered the rupee.
The postponement on the so-called general anti-avoidance rule (GAAR) is the latest in a string of delays and reversals by an embattled government that has struggled to seize the policy initiative.
Investors breathed a sigh of relief, lifting the rupee and pushing stocks into positive territory after they had lost nearly 2 percent earlier in the day.
However, Monday's changes to the finance bill do not appear to give any respite to Britain's Vodafone, which India wants to tax over its 2007 acquisition of Hong Kong-based Hutchison Whampoa's mobile operations in India.
"To provide more time to both the taxpayer and tax administration, to address all related issues, I propose to defer the applicability of GAAR provisions," Finance Minister Pranab Mukherjee told parliament on Monday.
He said a committee would submit its recommendations on GAAR by May 31. The rule will apply to income starting from the financial year that begins in April 2013.
Expectations for a delay had been building in recent days as investor disquiet sent the rupee skidding, exacerbating India's balance of payments shortfall. Wide current account and fiscal deficits mean India needs to bolster foreign investment.
The rupee is down 9 per cent since the start of March, taking it close to a record low. In March and April, India saw net portfolio outflows of $540-million, compared with $13-billion in inflows in January-February.
"It's obviously a positive in the near-term," said Jonathan Cavenagh, FX strategist at Westpac in Singapore.
"Does it change the USD/INR trend? No would be my view. Twin deficits, elevated oil prices and cooling growth momentum (against a backdrop of high inflation) continue to create a poisonous environment for the currency," he said.
The GAAR proposal aims to target tax evaders, partly by stopping Indian companies and investors from "round-tripping", or routing investments through Mauritius and other tax havens.
However, foreign investors domiciled in Mauritius could also be exposed to short-term capital gains tax under the rule.
The vagueness of the original plan, which was unveiled as part of India's budget for the fiscal year beginning in April, caused uncertainty among foreign investors, putting an already weak government on the defensive.
Removing some of that uncertainty, Mr. Mukherjee said the burden of proving tax evasion would lie with the authorities rather than with overseas investors.
"I hope they're buying themselves a bit of time to make some amendments that make it clear," said David Cornell, managing director in Mumbai for British-based fund manager Ocean Dial Advisers, which manages about $100-million in Indian assets and is licensed in Mauritius.
"I don't have any issue paying tax, but I do have an issue about not being a level playing field. Funds investing via Singapore or via New York-listed instruments providing exposure to India will have an advantage. It hasn't been clearly thought through yet," he said.
Last month, Finance Ministry officials met top foreign institutional investors (FIIs), including Morgan Stanley , JPMorgan Chase & Co. , CLSA and Goldman Sachs Group Inc. in a bid to convince them that tax proposals were not targeted at investors with a "substantial commercial presence" in Mauritius.
About 40 per cent of nearly $247-billion (U.S.) foreign direct investment flows to India over the last 12 years have come from Mauritius, and tax authorities believe a large part of it is routed by Indian companies to evade taxes.
Mr. Mukherjee also said a move to amend income tax laws retrospectively would not override the provisions of double taxation avoidance agreements India has signed with 82 countries, including Mauritius.
India wants to tax some already-completed mergers of foreign companies with Indian assets, potentially putting Vodafone back under the taxman's spotlight for more than $2-billion in taxes even after the Supreme Court ruled the tax office did not have jurisdiction over cross-border deals.
Vodafone bought Hutchison's Indian operations by taking over a subsidiary based in the Cayman Islands, which does not have a tax avoidance treaty with India.
The company has threatened India with arbitration proceedings saying the tax proposals violated international legal protections granted to Vodafone and other foreign investors in India.
Mr. Mukherjee also said retrospective tax would not be applied in cases where tax assessment has been completed.
"The question here is: whether having regard to the Supreme Court's order, the Vodafone case can be regarded as complete?" said Dinesh Kanabar, deputy CEO and chairman for tax at KPMG, which advised Vodafone in the tax case.
Samir Kanabar, a tax partner at Ernst & Young, said Monday's proposals may not benefit Vodafone.
"There was no assessment in the case of Vodafone. It was held to be an assessee in default because it did not withhold tax from Hutch. So, only the fine print can say whether Vodafone has been covered by this," he said.