New Delhi: The general anti-avoidance rules (GAAR) that will kick in on 1 April next year could see some investor-friendly changes being made to the draft proposals, the Prime Minister’s Office (PMO) indicated on Friday.
The rules will be finalized by Prime Minister Manmohan Singh after taking into consideration feedback received from all stakeholders, the PMO said in a release.
“The GAAR guidelines that have been put up...are only draft guidelines and have been put out for receiving wide-ranging feedback and for discussion purposes only,” the PMO said. “These have not been seen by the Prime Minister and will be finalized with the approval of the Prime Minister, who holds the finance portfolio, only after considering the feedback received.”
Late on Thursday night, the finance ministry had issued the draft GAAR guidelines, which will empower the tax department to invalidate transactions that have been entered into in order to deliberately avoid paying tax.
The proposed introduction of GAAR along with retrospective amendments to tax laws had evoked large-scale protests from foreign investors and led to the drying up of foreign inflows due to what they regarded as uncertainty in the tax laws. This came at a time when India needs to drum up investment in order to help shore up flagging growth.
This prompted the Prime Minister, who took charge of the finance portfolio after Pranab Mukherjee resigned to contest the presidential election, to direct finance ministry officials to remove the air of uncertainty surrounding tax laws in a meeting earlier this week.
Sunil Jain, a tax partner at J Sagar Associates, said the GAAR recommendations already reflect some dilution in the government’s stand. “They have brought in some clarity, but still there are a lot of provisions that are not taxpayer-friendly. But given the Prime Minister’s diktat to sort out tax issues, we could expect some further dilution when the final GAAR rules are notified,” he said.
According to the draft guidelines, the tax department hinted that foreign investors using low-tax jurisdictions such as Mauritius and Singapore to route their investments into India would be subject to scrutiny under GAAR if they don’t establish the commercial substance of the arrangement. Companies should have a board that meets in the specified country and carries out business with adequate manpower, capital and infrastructure of their own for establishing substantial commercial substance, as per the committee’s recommendations.
“What FIIs (foreign institutional investors) would have wanted is a complete exemption from GAAR when the transaction is governed by domestic treaties,” said Sudhir Kapadia, tax markets leader at audit and consulting firm Ernst and Young. “The definition of business operation also requries more clarity.”
According to the draft, when an FII chooses not to take any benefit under a double tax avoidance agreement that India has with other countries and subjects itself to tax in accordance with domestic law provisions, GAAR provisions will not apply.
Ketan Dalal, joint tax leader of PwC India, said there will be a negative impact on FIIs and private equity companies. “Indirect references to Mauritius and, to some extent, Singapore treaties seem to indicate a resolve to attack tax exemption claims based on GAAR, unless there is commercial substance in such companies,” he said. Nearly 40% of investments into India are routed through Mauritius.
The draft guidelines also said GAAR will kick in at a particular income threshold, but left this undefined. The guidelines also set a time limit of 60 days for the assessing officer, in the event of a dispute, to approach the approving panel.
“FIIs will have to pay 15% short-term capital gains tax along with the securities transaction tax if they subject themselves to domestic tax laws. There is a need to make the domestic tax package more sugar-coated for that,” Jain said.
However, according to the draft, where an FII chooses to take a treaty benefit, GAAR provisions may be invoked in the case of the overseas entity, but would not be invoked in the case of the non-resident investors in the FII.
While the government has clarified that it will not tax Participatory Notes (P-Notes) directly, analysts point out that as long as FIIs are taxed, P-Note holders will be subject to indirect taxation.
“When an FII is taxed for trades on behalf of P-Notes, it will pass it on to the P-Note holders,” Jain said.
P-Notes are a preferred route used by foreign investors, who have not registered with the country’s markets regulator, to route their investments into India.
Indirect transfer rules also need to be clarified, Kapadia said. “When it’s an India-centric fund, what will be the taxation rules? Will the government carve out FIIs for indirect transfers as well?”
If a company raises funds from an unconnected party through borrowings, when it could have issued equity, using the interest payment on the debt as an expense deduction could also invoke scrutiny under GAAR.
However, in cases where businesses set up an undertaking for carrying out manufacturing activities in an underdeveloped area by making a substantial investment of capital and claim a tax deduction on sale of its production, GAAR will not be applicable, the draft said.
The committee argued it’s a case of tax mitigation when the taxpayer takes advantage of a fiscal incentive, such as in the case of special economic zones, and GAAR will not be invoked.
Companies involved in mergers and amalgamation, where the merger of a money-losing company into a profit-making entity results in lower profits and lower tax liability of the merged company, will also escape GAAR provisions.