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 “main purpose” would be defined only in the GAAR rules to be notified later, analysts said this would essentially mean that only of the “predominant purpose” of the arrangement is to avoid tax with no sufficient commercial rationale for the arrangement, only then would GAAR prevail over tax treaties. The threshold for GAAR to kick in has been fixed at Rs 3 crore.
The Shome panel had also suggested that capital gains tax on listed securities be abolished and securities transaction tax (STT) raised to offset any revenue loss. The panel, in its final report, made public by the finance ministry on Monday rephrased its recommendation demanding the abolition of “the tax on gains arising from transfer of securities, being equity shares or units of equity oriented mutual funds, which is subject to STT, whether in the nature of capital gains or business income, to both residents as well as non-residents.” The idea is to give the same benefit to all investors irrespective of their tax residency and the nature of income from investments. Although Chidambaram remained silent on this recommendation, experts remained hopeful that it may eventually make its way to the statute book. “Since the minister has not said anything to the contrary, we could expect a decision on this when the Union Budget for 2013-14 gets presented,” said KR Sekar, partner, Deloitte Haskins & Sells.
Importantly, Chidambaram also laid down the broad procedure for GAAR operations by proposing to set up an neutral approving panel – headed by a serving or retired high court judge and an independent expert and not restricted in strength to three as in the Finance Act – and said its views would be binding on the assessee as well the tax authorities. Pertinently, he said: “The approving panel may have regard to the period or time which the arrangements had existed...” (Mind that in the Vodafone case, the corporate structure that allowed London-headquartered telecom firm and Hong Kong-based Hutchison to clinch the deal that created Vodafone Essar in India had existed much before the 2007 transaction and the Supreme Court had stressed this while negating India's tax jurisdiction over the deal). This means that in future Vodafone-like cases, one of the criteria for deciding the taxability in India would be how long the arrangement had preexisted.
Chidambaram's statement on Monday, however, did not dwell on the other aspect the Shome committee had looked into – namely, retrospective amendments including that on taxation of cross-border transactions with underlying Indian assets. While Vodafone has received a fresh tax demand from tax authorities under the retrospective amendment that overturned the SC judgement, the tax authorities have scheduled a meeting with the firm this week.
Mukesh Butani, chairman, BMR Advisors said: “Several path-breaking changes proposed to the law could mean significant dilution of the 2012 budget proposals. Appropriate provisions have been made for initiating GAAR proceedings by way of show cause notice (to be issued by the taxman) and a reasonable opportunity to the tax payer. This means due process of law coupled with justness and fairness. He added: “The panel for evoking GAAR shall include representatives from the ministry of law and individuals having knowledge of business accounting and commerce. This will bring some degree of independence. Similarly, GAAR shall apply only to that part of arrangements which is classified as impermissible. GAAR and Specific Avoidance Provision shall not apply simultaneously.”
Sunil Kapadia, tax partner, Ernst & Young said: “Investors often come together for reasons other than tax avoidance to benefit from being under a common jurisdiction. GAAR will need to be carefully applied in such cases.”