Finance minister P. Chidambaram on Monday deferred the implementation of the general anti-avoidance rules (GAAR) by another two years, a move that could encourage foreign investors to consider India a safe destination for their money after being spooked last year when first proposed.
Coming as it does in the backdrop of the decision to raise rail fares after a gap of 10 years and its intent to push through greater fiscal consolidation by tweaking diesel prices, this sets the perfect stage?for?Chidambaram?to launch his global roadshows to woo foreign investment next week in Hong Kong and Singapore.
The amendments proposed by the finance minister to the controversial tax provision in the Income-Tax Act, 1961, seek to walk a fine line between creating an investor-friendly environment by providing clarity in tax-avoidance rules and preventing their abuse. He will move the amendments in Parliament’s budget session to bring them into effect.
“It is necessary for developing countries like India to protect its revenues. But at the same time, it is important to provide a fair, just, stable and non-discriminatory tax regime,” Chidambaram said. “I have tried to strike a balance between the interests of the investors and the revenue department. These changes should allay all apprehensions expressed by investors.”
Accepting most of the recommendations of the Parthasarathi Shome committee, the finance minister deferred GAAR till the 2015-16 fiscal year, set a monetary threshold of Rs.3 crore in tax benefits to invoke GAAR, and said that the provisions would be used to target only those transactions where the sole intent was to avoid tax.
The finance ministry has also excluded foreign institutional investors (FIIs) from GAAR provisions in cases where they do not avail of the benefits of double tax avoidance agreements India has with other nations. It also made explicit that if an FII derives benefits of a double-taxation treaty, GAAR will override the treaty.
Similarly, non-resident investors in FIIs have also been excluded from the tax net, effectively putting investments through participatory notes (P-notes) outside the purview of GAAR. The government has, however, decided only to protect investments made before 30 August 2010.
The finance ministry said in a statement that only those investments made before the introduction of the Direct Taxes Code Bill 2010 in Parliament will be “grandfathered”—meaning that investments before that date remain subject to the old rules.
Since the tax department can reopen cases from the past six years, this will ensure all investments made after August 2010 will be open to scrutiny under GAAR. The Shome committee had recommended that all investments made before the commencement of GAAR should be protected. The government will move amendments to the Income-Tax Act in the forthcoming budget in February.
“It is a much-awaited decision and will provide relief to foreign and strategic investors. But ideally, investments made till the implementation of GAAR should have been protected,” said Manisha Girotra, chief executive officer of Moelis India, the local unit of US investment bank Moelis and Co. “It may, however, not have much of an impact on private equity investors since hardly any large investments have been made in the post-2010 period.”
GAAR seeks to empower the tax department to invalidate transactions undertaken to deliberately avoid paying tax. Introduced in the Union budget last year, it was deferred by one year by then finance minister Pranab Mukherjee after the provision was strongly opposed by the industry and foreign investors.
After Mukherjee exited the cabinet to become President, Prime Minister Manmohan Singh constituted a committee in July last year under Shome, now adviser to the finance ministry.
“Deferring of GAAR for two years is a welcome step and will help tax payees plan better. But it is important that the main crux of the Shome committee recommendations—that the applicability of GAAR should only be in select tax abusive transactions— is retained,” said Sudhir Kapadia, national tax leader at audit and consulting firm Ernst and Young. “If that is retained, it will ensure that even if investments come from Mauritius, they will come under GAAR only if they are tax abusive in nature.” Mauritius and India have a double tax avoidance treaty with each other.
The finance minister also announced a three-member approval panel for deciding cases with only one representative from the tax department, thus addressing the criticism that such a body should have an arm’s length relationship with the tax authorities. The panel will be headed by a retired high court judge and will consist of an income-tax officer of the rank of chief commissioner and an academic specializing in direct tax and international trade practices. The decision of the panel will be binding.
The amendments will also ensure that income will not be taxed multiple times, and only that part of the transaction which is impermissible avoidance will come under GAAR. Time limits will also be provided.
It is also suggested that where GAAR and specific anti-avoidance rules are both in force, only one of them will apply to a given case. This may protect investments under the Singapore treaty, where there is a provision that a company has to make investments up to a certain limit to benefit from the treaty.
“My impression is that GAAR will apply if there is treaty abuse resulting in tax avoidance. It effectively means that GAAR shall override treaties under circumstances where tax avoidance is proven. This can dilute circular 789 applicable to the Mauritius treaty and to that extent, expert panel recommendations have not been accepted,” said Mukesh Butani, chairman of BMR Advisors. He added that GAAR shall not apply to all investors in FIIs, including P-note holders.
As per circular 789, a tax residency certificate issued by Mauritius would be enough for getting benefits under the double-tax avoidance treaty and there would be no further investigation by the department. “On its own, this announcement will not drive FII inflows, but it will certainly provide a clearer picture of the country’s tax structures for FIIs. This, if coupled with positive economic factors, may work well to attract foreign investments,” said Pratik Gupta, managing director and head (equities) at Deutsche Equities India.