The government on Monday deferred implementation of the general anti-avoidance rules (GAAR) by two years to April 1, 2016, and promised to dilute them a bit as proposed by the Shome panel. However, investors who used the Mauritius route to invest in India after August 2010 may have to face queries from tax authorities, in sync with the “substance-over-form” doctrine that GAAR is founded on.
While reiterating that when implemented, GAAR will apply on FIIs investing in India and not non-resident investors in these FIIs like participatory note holders “directly or indirectly”, the finance ministry also said tax residency certificates furnished by investors in the recently prescribed format would now be subject to verification for “bona fide substance” of the residency.
This means the government would try and restrict the treaty benefit to investors who can prove the substance of their Mauritius residency. Under the India-Mauritius tax deal, capital gains can only be taxed in Mauritius where it is minimal, the reason for around half of the FDI and a large part of FII investments in India coming in from/through the country.
While being keen to accelerate capital inflows in the wake of the record current account deficit of 5.4% of GDP in the July-September quarter, India is equally concerned about the misuse of the Mauritius route by investors to mitigate/nullify their tax liability in India and has been insisting on a review of the treaty to include the limitation of benefit clause intended to prevent “treaty shopping.”
India’s relatively recent bilateral tax agreement with Singapore includes the limitation of benefit clause restricting benefits of the pact to only those entities which spend a minimum $200,000 in the city state, and preventing third-country investors from enjoying benefits.
Analysts said FIIs would have no big problem with the announcement. This is because pre-August 2010 investments via Mauritus would be grandfathered — no questions on residency will be asked — and for investments since then, FIIs have been nudged to embrace India’s law (in preference to the treaty) in cases where residency might not be proved to the taxman’s satisfaction.
In cases wherever tax residency certificates are truly verifiable, treaty benefits would also flow to them.
Underlining the concept that “while tax mitigation is recognised, tax avoidance is frowned upon,” finance minister P Chidambaram said only those arrangements with the main purpose of which is to obtain a tax benefit would be deemed as “impermissible” under GAAR. Although