Tax certainty is critical if the economy is to attract enough capital

Relevance: Issue of retrospective taxation

Synopsis: The repeal of the retrospective tax decision helps to minimize the risk of authorities taking harmful and unpredictable decisions.

Background

• Read Here:  Retrospective taxation and the Taxation Laws (Amendment) Bill – Explained

Introduction

• It is hard to grow an economy without individuals and firms taking risk, and for an economy to grow at 7% or 8% annually for several decades the dependency on foreign risk capital is even larger.
• In this context, retrospective taxation laws have hampered the flow of FDI’s and undermined the ability of corporate to take risks.
• Encouraging them to invest more requires such confidence-building steps that the government is committed to reducing uncertainty, and rectifying past errors.

Adverse impact of Retrospective taxation

• Adds to the risks and destroys investment environment: According to experts, changing laws retroactively, spoils the operating environment, and adds to the imagined risks a firm must keep in mind before investing.
• Higher costs: The expected returns from an investment, depends on the cost of capital, which in turn depends on the uncertainty a project or business faces. The higher the uncertainty, the higher the cost.

Positives of curb on Retrospective taxation 

• The impact on the flow of investments is likely to be much more significant, as the change signals that retrospective changes will not happen again.
• Often, the capital comes attached with technology and skill transfers, which further helps growth.
• Tax certainty will help to attract enough capital to grow at 7%-8% for decades.
• Growth of Start-ups in India is highly dependent on foreign investments.

Terms to know

• Retrospective taxation