Open Forum

New Delhi, 23 January 2013

Hold On GAAR

WOOING ELUSIVE INVESTORS

Dr PK Vasudeva

The Government is pleasantly in a proactive mode, at least on one front—wooing investors. Finance Minister P Chidambaram’s recent declaration that the nation has buried the “ghost” of General Anti Avoidance Rules (GAAR), viewed as a ‘monster’, should be hopefully re-assuring to many investors.    

GAAR, which was proposed by the then Union Finance Minister Pranab Mukherjee in the 2012-13 Budget is an anti-tax avoidance rule, which prevents tax evaders, from routing investments through tax havens such as Mauritius, Luxemburg and Switzerland. This was long-awaited and was overdue because tax evaders are increasing by the day. However, as the rules gave unchecked powers to the taxman to check evasion of taxes by foreign investors, it led to major apprehensions among them, which upset the calculations of the Ministry to get investments into the country. 

According to the draft, GAAR would have originally come into effect from 1 April this year. As per the guidelines, Foreign Institutional Investors (FII) not opting for treaty benefits and ready to pay taxes would not come under GAAR, but those who did opt for dual taxation avoidance agreements would  come under its purview.

For starters, New Delhi was forced to defer the rules until April 2013, and now subsequently to April 2016 as foreign investors had expressed their reservation about the language used in the rules. They had maintained that the ambiguous language used could lead to the misuse of the rules and some of the FIIs therefore may take undue advantage by misinterpreting the language.

The GAAR provision’s objective is to insist upon the principal of “substance over form,” meaning the real intention of the parties involved and the purpose of establishing an arrangement are taken into account for determining the tax consequences, irrespective of the legal structure of the transaction or arrangement. This immediately impacts upon Mauritius, which has been the single largest investor into India for much of the last 15 years.

The reason for this is the Mauritius-India tax treaty, which allows for tax exemption in capital gains. As a result, much of the Mauritian investment into India is actually round tripping by Indian companies setting up a Mauritian entity to avoid capital gain tax (CGT) in India. The GAAR rules, however, are being interpreted as suggesting that investors into India using the Mauritius route will now be subject to CGT unless they can demonstrate a “substantial commercial presence” in Mauritius.

This is currently under review, with representations being made to the Government from a variety of major financial investors in India, including Goldman Sachs, JP Morgan, Morgan Stanley and so on. Clarification will be issued once the Finance Bill is passed, but for now investors would be wise to note that the Mauritius route for investing into India may be about to be trimmed down in tax value terms.

Keeping in view the difficulties in executing GAAR, Chidambaram had little option but to withhold implementation of GAAR till April 1, 2016, which is a welcome step in the current economic environment. However, it would require Parliamentary sanction, considering that GAAR become law with the passage of the Finance Bill 2012, providing for its enforcement from April 1, 2014.

It is now for the Government to convince the Opposition about the need for a two-year deferral and to incorporate it in the ensuing Union Budget/Finance Bill to be voted upon. The case for postponement is definitely strong and sensible on two counts.

Firstly, it relates to administrative preparedness as the Government is not yet prepared to implement GAAR by April 2014 because of the clarity on GAAR, as the term indicates, is about tax ‘avoidance’ as opposed to blanket ‘evasion’ that is to be dealt with an iron hand. Avoidance involves transactions undertaken purely with a view to derive tax benefits; these are illegal in substance, but not in form.

However, proving that an assessee has entered into an arrangement lacking any purpose other than obtaining tax advantage requires revenue officials well versed with the finer aspects of international taxation rules. Without creating this specialised cadre and machinery that also inspires confidence among assessees – about the GAAR provisions not providing latitude for exercise of discretionary powers – there is more harm to be done by introducing a radically new approach to taxation in a hurry.

Secondly, timings of GAAR implementation are not opportunistic. The present macroeconomic context is certainly not conducive to any measure that unnecessarily spooks foreign investors. With a current account deficit that crossed $78 billion in 2011-12 and looks set to further widen this fiscal, the country requires huge capital inflows to bridge the gap and prevent the rupee’s free fall. This concern simply cannot be brushed aside because the Finance Minister is finding it very difficult to keep the fiscal deficit within 5.3 per cent of the GDP though desirable to keep it less then 5 per cent of GDP.

Once the implementation of GAAR gets deferred as per the Government’s plans, details regarding its response to various other recommendations of the Parthasarathi Shome Expert Committee become irrelevant. That includes abolishing tax on gains from transfer of listed securities and levying a higher securities transaction tax to compensate for revenue loss; making GAAR applicable only on investments undertaken after April 1, 2016 and so on.

These are matters for the next Government to consider. Right now, the issue is only when GAAR gets implemented. By seeking a two-year deferment, Chidambaram has taken the right call, but the Opposition has to play ball for its approval. Let us hope and let hope be not in vain.

Additionally, the same needs to be done vis-à-vis recent suggestions to impose an additional surcharge on the ‘super rich’ or taxing dividends in the hands of investors at rates applicable on ordinary incomes. One cannot doubt the legitimate equity concerns surrounding these proposals. But addressing these now is to rock the boat at the wrong time. ---INFA

(Copyright, India News & Feature Alliance)