Many western consumer firms operating in India have been successful at adapting to the country’s unique market challenges, which range from distinct consumer tastes and preferences to the logistical challenges of reaching a population that is still overwhelmingly rural.  Taxation and regulation have often been less pliable obstacles, as demonstrated by the deep resistance to allowing foreign investment in multi-brand retail outlets.  However, a key tax reform included in India’s 2015 budget, which was released this weekend, should materially improve the business environment, particularly for foreign consumer goods companies and single-brand retailers with a presence in India.

The Goods and Services Tax, or GST, will be a comprehensive tax levy on the manufacture, sale, and consumption of goods and services.[1]  The GST will be “collected on value-added goods and services” at each transactional stage of the supply chain.  Firms will be permitted to use the GST paid on the “procurement of goods and services” to offset GST owed on the “supply of goods and services.”[2]  Under the current tax regime in India, businesses are subject to a bevy of indirect taxes including central and state sales taxes, entry tax, stamp duty, and taxes on the transportation of goods and services.  The GST replaces this multi-layer tax scheme and instead creates a unified market with one principal indirect tax.

The GST will bring many advantages, but, for foreign investors, one stands out—the simplified tax structure will increase transparency and decrease corruption.[3]  Implementation of the GST will reduce the discretion of government agents to exempt companies from tax or to deviate from rate structures, which is possible for certain taxes under the current regime.  The GST also relies heavily on technology to ensure compliance, reducing contact between companies and government agents and thereby decreasing the opportunities for low level corruption.[4]  The resulting reduction in bribery risk is particularly important for investors subject to U.S., U.K. or other anti-bribery regimes in their home countries.

It is important to note, however, that the passage of the GST bill requires an accompanying constitutional amendment.  As a result, the bill must pass by a two-thirds majority in both houses of parliament, and be approved by at least fifteen of the twenty-nine states.[5]  Because this exceeds the majority that the government enjoys in the parliament, the government will have to work with other parties to successfully pass this bill.

The GST reform complements other attempts by the government to rationalize what has historically been a confusing and disjointed tax system.  As part of the current budget, India has proposed reducing the corporate tax rate from 30% to 25%.[6]  Additionally, it has postponed the introduction of General Anti-Avoidance Rules (GAAR), which would allow the Indian government to scrutinize corporate transactions structured to minimize or avoid taxes.[7]  And finally, by choosing not to appeal an unfavorable tax ruling from an Indian court in its case against Vodafone, the Indian government has indicated an end to controversial recent enforcement trends involving the threat of retrospective application of tax laws to corporate transactions.[8]  Collectively, these policies evidence clear and concrete steps that the Indian government has taken to remove obstacles for foreign investors and ease their concerns over India’s tax policies.

Nikhil Gore of Covington & Burling LLP contributed to this post.