January 15, 2013
Finance Minister announces 2 year breather from GAAR
Relief for P-note holders, Prior investments grandfathered
FIIs, private equity players and other India focused strategic investors have reason to celebrate, thanks to the Finance Minister's confirmation yesterday that the general anti-avoidance rules ("GAAR") shall be effective only from April 1, 2015 (and not from April 1, 2013 as proposed initially).1 Investments made prior to August 30, 2010 shall be grandfathered and investors into an FII shall not be subject to GAAR. The Government has also agreed to limit the scope of GAAR and incorporate key safeguards recommended by the Expert Committee on GAAR chaired by the renowned economist, Parthasarathi Shome.
The Government's decision is a welcome step, especially at a time when investors have become increasingly wary about India's 'policy paralysis' and the uncertainty surrounding provisions such as GAAR and various retroactive amendments. However, no comments have been made on other critical issues addressed by the Shome Committee including tax treaty override and the impact of GAAR on investments via the Mauritius route. Once GAAR comes into force, tax audit reports issued by accountants will have to disclose arrangements likely to attract GAAR. The penal implications of failing to make such disclosures are not known at the moment. Another area of concern is the potential retroactive operation of GAAR to investments between August 30, 2010 and the date when GAAR is actually implemented.
GAAR, which was introduced into India's tax statute last year, has been widely criticized on account of ambiguities in its scope and application, lack of safeguards, and possibility of misuse by the tax authorities. GAAR empowers the Revenue with considerable discretion in taxing 'impermissible avoidance arrangements', disregarding entities, reallocating income and even denying tax treaty benefits to a non-resident investor.
With a view to address dampening investor sentiments, the Government appointed the Shome Committee to consult with stakeholders and review GAAR as well as the retroactive amendment for taxing offshore share transfers. In its detailed report, the Shome Committee had recommended a substantial narrowing down of the GAAR provisions and other safeguards in the interest of fairness and certainty. Click here to read our insights and analysis of the Shome Committee's report.
Now that the Government has accepted most of the Shome Committee's recommendations, the next step is to implement them via relevant statutory amendments and circulars.
We have set out below a summary of the important changes to the GAAR regime that the Finance Minister confirmed yesterday.
Targeted approach to GAAR
FIIs, P-note holders
GAAR shall not apply to non-resident investors into an FII, including holders of participatory notes. However, the FII or its sub-account would be subject to the scrutiny of GAAR if it claims tax treaty benefits. Difficulties may arise if the FII passes on the tax costs to the p-note holder. FIIs (especially tax exempt investors such as foreign pension funds, endowments and mutual funds) also have to be cautious about availability of credit in the home country against any taxes paid in India on account of GAAR.
Grandfathering existing investments
Investments made prior to August 30, 2010 would be grandfathered and GAAR shall not apply to exits from such investment. This was date when the Government introduced the Direct Taxes Code Bill (still pending before Parliament) which initially proposed GAAR. To the contrary, the Shome Committee has recommended that GAAR should only apply to investments made subsequent to the implementation of GAAR. Therefore, GAAR may retroactively apply in relation to transactions and investments taking place between August 30, 2010 and the date when GAAR comes into force, thereby creating issues for present deals and those that will close in the near future.
Business purpose test
GAAR shall apply only if the main purpose of an arrangement is to obtain a tax benefit. Currently, GAAR may apply even if obtaining the tax benefit is one of the main purposes of an arrangement. Presumably, the new GAAR provisions may not apply if an arrangement is backed by sufficient business purpose.
While determining commercial substance, one may consider factors such as the time period of the arrangement, availability of an exit route and whether taxes have been paid in connection with the arrangement. Interestingly, these were the key factors considered by the Supreme Court when it decided that the USD 11.1 billion Vodafone-Hutch transaction was not a sham and could not be taxed in India.
GAAR shall apply only if the value of the tax benefit exceeds INR 30 million. The threshold is, in our view, too low and may cover more cases than the enforcement machinery can handle.
No double taxation
GAAR provisions shall be applied in a manner that it does not result in double taxation of the same income in different assessment years. However, double taxation issues arising in a cross-border context have not been addressed.
GAAR and SAAR
GAAR shall not be invoked when a specific anti avoidance rule (like transfer pricing) is applicable to a particular transaction.
Implementation of GAAR
GAAR cases shall be scrutinized by an Approving Panel chaired by a retired High Court Judge, a senior member of the tax office (of the rank of Chief Commissioner of Income Tax) and a reputed academician or scholar with expertise in taxation or international trade and business. The existing provisions relating to the Approving Panel only contemplate members from the tax department, which raises issues of independence, lack of objectivity and bias.
Enforcement of GAAR
While invoking GAAR, the tax officer shall issue a detailed show cause notice backed with sufficient reasons. Time limits shall be prescribed for action by various authorities in relation to GAAR proceedings.
Taxpayers may seek an advance ruling on the issue of whether an arrangement is an impermissible avoidance arrangement subject to GAAR. Advance rulings have become quite popular among foreign investors and provide a good degree of certainty on the Indian tax implications of a transaction.
Disclosure of avoidance schemes
Currently, taxpayers having a turnover exceeding INR 10 million have to get their accounts audited by an accountant who will provide a tax audit report. Post introduction of GAAR, the tax audit report will have to disclose arrangements of the taxpayer which are likely to be covered under GAAR.
The report of the Shome Committee has been appreciated by professionals and the industry, both for its quality and depth of analysis. It was the silver lining on a dark cloud of uncertainty that surfaced ever since GAAR was proposed back in 2010. The incorporation of GAAR into India's tax law last year came as a matter of shock, with investors and MNCs feeling compelled to revisit their existing structures to determine the potential impact of GAAR and whether there is a need to change the strategy vis-Ã -vis India. The report of the Shome Committee has been appreciated by professionals and the industry, both for its quality and depth of analysis. It was the silver lining on a dark cloud of uncertainty that surfaced ever since GAAR was proposed back in 2010. The incorporation of GAAR into India's tax law last year came as a matter of shock, with investors and MNCs feeling compelled to revisit their existing structures to determine the potential impact of GAAR and whether there is a need to change the strategy vis-à-vis India.
The decision to defer GAAR till April 1, 2015 will provide taxpayers with much needed time to grapple with the new provisions and rationally plan and (re)organize their affairs. It will also help the tax department to prepare themselves for the enforcement challenges that lie ahead.
While the Finance Minister's announcement is most welcome, as always, the devil will lie in the details and language of the revised GAAR provisions and official guidance on GAAR which the Government is expected to release. It is hoped that the guidance shall have the same depth and quality of the Shome Committee report or similar guidance issued in other countries such as the US, Canada, New Zealand, Australia, and South Africa, where GAAR has been introduced. Recently, UK also introduced GAAR in its 2012 budget (proposed to be implemented from 2013 onwards).
Most countries that have introduced GAAR are far ahead of India on matters such as ease of doing business, ease of paying taxes and corruption perception index. It is imperative that India takes the time to deliberate upon and draft clear rules and guidance for application of GAAR. Certainty, fairness and stability should continue to serve as guiding principles. It is necessary to guarantee and enforce internationally recognized taxpayer rights. Safeguards have to be included to counter excessive discretion and corruption. Considering that GAAR can exponentially increase litigation in the country, the success of its implementation calls for enhanced relationship between taxpayer and Revenue based on trust and mutual respect.
1 The press report released by the Finance Minister states that GAAR shall come into effect from April 1, 2016, but we understand that this relates to assessments for the financial year commencing on April 1, 2015. Currently GAAR will be effective from the financial year beginning from April 1, 2013 (and assessed in the year commencing on April 1, 2014).
The contents of this hotline should not be construed as legal opinion. View detailed disclaimer.