India’s proposed move to retrospectively tax overseas transactions and capital gains by foreign companies through a change in law has provoked fierce criticism from the international business community. In an open letter signed by seven leading industry associations from the US, the UK, Japan, Canada and Hong Kong, the Indian prime minister, Manmohan Singh, has been warned that the proposal could cause foreign businesses to reconsider their investments in India.

The proposed Finance Bill 2012 would enable the government to receive as much as $8bn of tax payments that officials claim is currently under litigation. The move would also reopen a $2.9bn tax dispute between the government and UK-based telecommunications group Vodafone Group. The dispute was settled early in 2012 in Vodafone’s favour, but a change in law would once again call into question the telecommunications group's $11.2bn acquisition of a controlling stake in a local mobile operator from Hong Kong corporation Hutchison Whampoa.

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In the open letter, international trade groups representing more than 250,000 companies wrote: “The sudden and unprecedented move in the bill has undermined confidence in the policies of the government of India toward foreign investment… India will lose significant ground as a destination for international investment if it fails to align itself with policy and practice around the world and restore confidence in the relevance of the judiciary.”

The UK chancellor, George Osborne, was the first foreign official to criticise India’s proposed law. Speaking at the British High Commission in New Delhi, he cautioned that this proposed change to the law would set a negative precedent and damage the overall investment sentiment in India.

Facing an onslaught of criticism, India finds itself stuck between a rock and a hard place. Having one of the largest budget deficits among major emerging economies, worth an estimated $60bn according to online business news site Aol Money, the government is under mounting pressure to put its finances in order. While the proposed law would enable it to reduce its budget deficit, it could also lead to an exodus in foreign capital.

The proposed bill would tax any overseas transaction dating back to 1962 in which an underlying Indian asset was transferred. Thus if written into law, in addition to Vodafone, it could also affect US-based food conglomerate Kraft Foods, global brewing company SABMiller and telecommunications firm AT&T.

The open letter stating opposition to the bill was signed by Business Roundtable, Canadian Manufacturers and Exporters, Capital Markets Tax Committee of Asia, Confederation of British Industry, Japan Foreign Trade Council, National Foreign Trade Council, and United States Council for International Business. It warns: “If enacted, these proposals will significantly alter the Indian taxation of our member companies, with retroactive effect extending back for as much as half a century, and reverse many decided cases. Some of our member companies had already begun re-evaluating their investments in India due to increasing levels of controversy and uncertainty regarding taxation in recent years.”