India’s recent federal budget measures, including anti-tax-avoidance proposals and others which allow for retroactive tax claims on overseas deals are coming home to haunt the government of Prime Minister Manmohan Singh and poisoning the climate for badly needed foreign direct investment.

FDI soared upward in 2011 by 31 percent, from US$21 billion to US$27.5 billion, giving an upper hand to officials who advocate tightening tax regulations on multinationals and Indian companies doing business overseas. Nonetheless, the latest moves have exasperated the US-based Business Roundtable, the Confederation of British Industry, the Japan Foreign Trade Council and Canadian Manufacturers & Exporters, which together represent more than 250,000 companies. They have written the prime minister saying the measures are prompting a widespread rethink “of the costs and benefits of investing in India."

"The sudden and unprecedented move...has undermined confidence in the policies of the Government of India towards foreign investment and taxation and has called into question the very rule of law, due process, and fair treatment in India," the groups said in the communique.

The letter is the most direct warning yet of global corporate frustration, adding to the groundswell of negative opinion building up against India in terms of its viability as an investment destination. After years of assiduously wooing foreign investors, companies are baffled as to how Singh, the architect of India’s globalization drive in the 1990s could allow things to come to such a pass.

It doesn’t take a rocket scientist to conclude that discouraging foreign investment after spending decades to build credibility in the international market would whittle down tax collection over the long term, worsening the fiscal scenario. While amendments in tax laws can be made applicable for the future, inserting retrospective clauses is tantamount to committing economic hara-kiri. Amendments and clarifications that apply retrospectively would undermine the credibility of the legal framework and discourage investors.

Turbulence in global markets has already pulled down India’s FDI flows to less than half their previous levels in relative terms. Further, the ruling UPA combine is buffeted by a raft of scams leading to a policy paralysis. Its flip-flop on FDI in retail and endless roadblocks that delay major investments, including that of South Korean giant Posco’s 12-billion steel plant in the eastern state of Odisha, have badly shaken investor confidence.

The latest global outcry follows close on the heels of a protracted tax struggle between London-listed Vodafone Group Plc, India's largest overseas investor, and the Indian government, and underlines the risks and ambiguity foreign investors are exposed to. Vodafone was subjected to a protracted five-year legal battle that finally ended in January when India's Supreme Court dismissed a US$2.2 billion tax demand over the British company's acquisition of Hutchison Whampoa Ltd's Indian mobile assets in 2007.

Policy confusion in India's telecom sector over the tainted allocation of mobile licenses in 2008 recently saw Abu Dhabi's Etisalat announce the winding down of its Indian operations. Norway's Telenor has also been embroiled in a dispute with its Indian partner, Unitech Ltd, and has said it would seek to migrate the business to a fresh pasture with a new partner.

As pointed out by Reuters, the freshly proposed tax measures could also adversely impact Kraft Foods Inc's 2010 acquisition of Cadbury's Indian business and deals involving Indian assets sold by AT&T Inc and SAB Miller Plc's purchase of Fosters.

The measures are likely to be challenged in court as the trade bodies’ letter has elevated the issue from a bilateral dispute between Vodafone and the Indian government to a multilateral row that could end up in international courts. Following industry protests, the Indian government has decided to set up an advisory panel on international taxation and transfer pricing, which would include discussions with industry representatives. The trade groups have welcomed this step and said they want an ICC nominee to be included in this group as well.

What was the reason behind this desperate move? Possibly India’s current struggle to close a whopping Rp4.94 trillion budget deficit and the general ominous fiscal scenario with GDP growth at a three-year low of 6.1 percent.

Responding to the strong reaction by the foreign lobby, Finance Minister Pranab Mukherjee has emphasized that the legislative intent behind the recent tax measures is “not vengeful.” The law, in fact, does not allow reopening of corporate tax cases older than six years, he said.

“Perhaps his intent was to target the most high-profile deal in this league to convey the message that foreign capital is welcome provided it comes through regular channels,” says an industry source.

However, despite the drumbeat of anti-India sentiments, many analysts take the view that India needn’t be defensive about its tax measures as it has all the rights to get choosy about inbound investments and craft rules which vet overseas candidates rigorously. Besides, India is the market of the future, they say. Global businesses are tired of the prolonged drought in western markets and are keen to shift operations to India. Industry surveys point out that FDI will climb to an estimated US$2 trillion in 2012 in emerging Asian markets and India will be a primary gainer from this windfall.

“India can afford to insist that foreign capital be subject to a suitable tax regime,” said Shriram Desai, formerly with Federation of Indian Chambers of Commerce & Industry (FICCI). “Britain recently plugged its own tax-haven loopholes. China has also been wary of foreign businesses in the high-end manufacturing sector. Several other Asian economies similarly employ safeguards to protect their national interests. So why should India’s move attract such an adverse reaction?” he added.

Vested interests, say industry sources, are loathe to any additional form of scrutiny from Indian authorities, more so as India is one of the few frontiers of high growth left in today’s age of economic gloom.

However, this is not to discount the discomfiture foreign investment firms have been lately facing in India. Since January the government has been served a raft of legal notices by multinational companies in the telecom and coal sectors. Telenor of Norway and Russia’s Sistema have already moved gone to court. The Children’s Investment Fund, a UK-based hedge fund, too has asked its lawyers to move against public sector Coal India.

India has also recently lost a case involving White Industries of Australia against Coal India in the International Court of Arbitration. All of these are under one or other of the 50-odd bilateral investment treaties that India has signed with its major trading partners.

Perturbed by threats from these foreign companies to drag India to international courts over breach of investment promises, the commerce ministry is now scrambling to erase a key clause in bilateral investment treaties that allows for international arbitration in order to protect itself. Currently, India has treaties with Singapore and South Korea, among others, that allow companies coming under their jurisdiction to challenge any adverse policy action by New Delhi as a breach of investment promise in international tribunals.

The government is also in direct talks with several countries to amend the investment treaties so that any supposed violation of an investment promise through Indian government action can be challenged only in Indian courts.

But will these preemptive measures be enough to gloss over the UPA’s poor governance and shoddy business administration record? Only time will tell.

(Neeta Lal is a New Delhi-based senior journalist; neetalal@hotmail.com)

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