The Hindu Business Line : Defence levy: Tax or fine?

Given the minuscule tax base in India, it is inevitable that the middle-class will wind up paying the fine of 5 per cent Defence levy. And, yet, it is only appropriate that the Indian middle-class, the BJP's clandestine vote bank in spite of its high educational level, now pays for its failure to understand the implications of that party's patently non-viable foreign policy and its antipathy to minorities that have resulted in hair-trigger tension along its borders.

THE Union Finance Minister, Mr Yashwant Sinha's proposal to slap a 5 per cent Defence levy on companies and individuals with an income of over Rs 60,000 per annum in Budget 2002-03 is no tax at all but a fine will pay the people of India for voting into a power a government that has been sensational in its failure in pursuing viable foreign and defence policies as also in resolving domestic conflicts such as the ones prevailing in Kashmir and the North-East.

Given the minuscule tax base in India, it is inevitable that the middle-class will wind up paying this fine. And, yet, it is perhaps only appropriate that the Indian middle-class, the BJP's clandestine vote bank in spite of its high educational level, now pays for its failure to understand the implications of that party's patently non-viable foreign policy and its antipathy to minorities that have resulted in hair-trigger tension along its borders. And then again, it is this very same middle-class, smug in its moral superiority, which viewed with voyeuristic delight the tehelka expose on the dark mysteries of the country's Defence procurement practices — and did nothing about them.

Perhaps the fine imposed by Mr Sinha in the Budget is a just one after all!

Levity apart, let us proceed on the premise that the people should not be fined for the government's incompetence, in general, and its venality, in particular, and examine whether Mr Sinha has any other option.

The answer is that he does.

Consider, for the moment, the implications of the recent Directorate of Revenue Intelligence (DRI) report that money-laundering is on the rise. The DRI attributes the surge in money laundering this fiscal to an increase in narco-trafficking and the smuggling of arms, among other things. Mr Sinha is a former bureaucrat and, as such, presumably sees no evil, hears no evil and talks no evil. But even he cannot but be aware of the linkage between an increase in narco-trafficking and gun-running on the one hand and the need for increased external defence/domestic security outlays by India on the other.

But what can he do about all this? Well, for one thing, he can look to what the West is doing about these problems. After all, it would not be the first time that India, in spite of the brilliance of its legislators and bureaucrats, is pinching ideas and systems from the West. In specific, he can commit India to the diverse initiatives that are being carried out by the developed countries to force tax havens and offshore financial centres to adopt transparent bank laws and exchange information on tax matters. Even better, he could carry the existing initiatives farther and introduce some of his own as developing countries suffer far more at the hands of tax havens than the developed countries do.

An Oxfam policy paper sums up the negative impact of tax havens on developing countries succinctly: "It is difficult to estimate the full impact of tax havens and other harmful tax practices on developing countries, not least because the secrecy involved obscures the true extent of international capital movements and the use of havens by transnational corporations. However, it is clear that tax revenue losses are significant, especially in relation to the limited budgetary resources available to poor countries.

"... The increasing scope for foreign corporations to minimise tax obligations due to tax competition between countries and the use of tax havens has important implications for the tax base of individual countries. This causes particular problems for developing countries, some of which rely heavily on corporate income taxes."

The Oxfam report goes on to state: "Financial havens are used to launder the gains from corrupt and illegal activities, including narcotic trafficking, various types of fraudulent activity, public corruption, tax evasion, smuggling, and arms and diamond trafficking."

Presumably, Mr Sinha is aware of the above. But then again, he may claim, as he did in the case of Unit Trust of India (UTI) when it was going down the drain, that nobody had bothered to tell him that anything was amiss.

But that will be a claim Mr Sinha will find difficult to sustain. After all, it was as recently as 1998 that India's double taxation avoidance agreement with Mauritius, a tax haven, came under public scrutiny when an income tax collector in Mumbai denied the firms covered by the treaty (as identified by the Securities and Exchange Board of India) the tax benefits granted thereof. The Central Board of Direct Taxes (CBDT), presumably at the behest of the Finance Minster, moved with remarkable alacrity to override the collector — and the whole matter landed up in court. Meanwhile, the media had some fun at the expense of the Finance Minister as his daughter heads one of the US-based funds that come under the treaty. That the issue is still very much alive in and out of court is evident from the fact that a former Chief Economic Advisor to the Finance Ministry, in an article published recently in a section of the business press, has thought it necessary to make an impassioned defence of Mr Sinha on the grounds that the controversial India-Mauritius treaty is a "foreign policy" instrument. Mr Sinha, it would seem, has responsibilities that we never suspected!

Interestingly enough, treaties that India has entered into with various countries contain special anti-treaty shopping provisions (Article 24 of the Indo-US Double Taxation Avoidance Agreement, for instance) — but no such provision exists in the Indo-Mauritius Double Taxation Avoidance Agreement. The question now is whether we need a double taxation avoidance agreement with tax havens such as Mauritius any more. The answer is in the negative. The treaty with Mauritius dates back to 1983 when that country was trying to develop its offshore sector and India was opening up its economy to foreign investors. The treaty seemed a good idea in those heady times. But no longer — as there is overwhelming evidence that it facilitated the inflow of hot money which, when it flowed out, left behind it a trail of destruction.

Further, just about every capital market scam in India has originated with money coming in from Mauritius and going back to that country.

The argument tendered by the Finance Minister that Mauritius is an excellent conduit for investment just does not hold water any more as, in recent times, companies domiciled in that country have not generated any quality investments.

As for the manifestly ridiculous argument put forward by his apologists that says that the double taxation avoidance treaty is a component of India's foreign policy, it is no longer relevant as India is no longer important to Mauritius.

According to Mr Satyadev D. Bikoo, Director of MOBAA, the Mauritius regulator: "Our focus has gone to South Africa." If, despite these considerations, Mr Sinha still insists on retaining this dubious treaty, he would be well advised to explain at some length his position, considering the fact that none other than the Mauritius Minister of Economic Development, Mr Sushil K. C. Khushiram, has conceded the need for his government to come down heavily on Overseas Corporate Bodies (OCBs) domiciled in his country and owned and/or controlled by non-resident Indians (NRIs) who manipulate the Indian capital market.

Such an explanation will not be complete unless he makes clear why he prefers to give a tax break to these shady OCBs — than to the people of India who have already paid enough taxes owing to his government's ineptitude.

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