Narendra Modi won election as India’s Prime Minister last year on an investment-friendly platform that included abolition of retroactive taxation. He even called the previous government’s policy of suddenly demanding back taxes from companies “tax terrorism.” So imagine the surprise of foreign investors when Indian authorities recently imposed a 20% levy on their years-old capital gains under a law that for two decades never applied to them.

The controversy centers on the Minimum Alternative Tax, or MAT, which exists so New...