AN ANAL­Y­SIS OF GAAR AND ITS IM­PLE­MEN­TA­TION IN THE PRESENT ECO­NOMIC SCE­NARIO IN IN­DIA

Economic Challenger - - CONTENTS - − Su­jata Pandey

AB­STRACT

The pro­posed in­clu­sion of GAAR in In­dian in­come tax sys­tem in the Bud­get 2012 has in­vited lot of in­ter­na­tional and domestic re­ac­tions and has cer­tainly af­fected the in­vest­ment cli­mate in In­dia. This pa­per is an at­tempt to un­der­stand the con­cept of GAAR, why is it a ma­jor con­cern be­fore the government , what are the rea­sons for the re­ac­tions across the world and how has it af­fected the for­eign ex­change in­flow in In­dia . Based on th­ese data, the pa­per will dis­cuss its ef­fec­tive­ness in the present eco­nomic sce­nario. The anal­y­sis will in­clude the back­ground of GAAR im­po­si­tion in In­dian sys­tem and few cases re­lated to this is­sue to mea­sure pros and cons of its im­po­si­tion.

IN­TRO­DUC­TION

The Gen­eral Anti Avoid­ance Rule (GAAR) is a set of rules that em­pow­ers the tax author­ity of any coun­try to in­ves­ti­gate and ex­am­ine the trans­ac­tions done with the ob­jec­tive of tax avoid­ance or tax eva­sion. It also em­pow­ers the author­ity to dis­re­gard any such ar­range­ment. Tax col­lec­tion, as we know is the main source of rev­enue for the government. This rev­enue al­lows the government to al­lo­cate funds for var­i­ous sec­tors through its fis­cal pol­icy. It is pub­lic fi­nance which is utilised by the government for the devel­op­ment and growth of any econ­omy. There­fore, if any ar­range­ment en­ters into le­gal con­struc­tion only for the eva­sion or avoid­ance of tax then it is bound to af­fect that econ­omy.

Of late, In­dia re­al­ized that cer­tain treaties that we en­tered into for at­tract­ing good in­vest­ment in In­dia were be­ing misu­tilised to gain tax ben­e­fit un­der that le­gal con­struc­tion. It was cre­at­ing a huge loss of rev­enue for the government. In this re­gard, a Di­rect tax code bill along with a dis­cus­sion pa­per for pub­lic de­bate was re­leased in Au­gust 2009 which was re­vised again in June 2010.

A for­mal bill to en­act a law known as Di­rect Taxes Code 2010 was tabled in par­lia­ment on 30th Au­gust ,2010. The code is meant to re­place the cur­rent In­come tax Act of 1961.For the first time , the in­tro­duc­tion of GAAR into in­come tax law of In­dia was pro­posed. Tax avoid­ance like tax eva­sion se­ri­ously un­der­mines the achieve­ment of ob­jec­tive of pub­lic fi­nance of col­lect­ing rev­enues in an ef­fi­cient, eq­ui­table and ef­fec­tive man­ner. Sec­tors that pro­vide a greater op­por­tu­nity for tax avoid­ance tend to cause dis­tor­tions in the al­lo­ca­tion of re­sources. Since the bet­ter off sec­tions are more en­dowed to re­sort to such prac­tices, tax avoid­ance also leads to cross sub­si­diza­tion of rich.

There­fore, tax avoid­ance needs a re− ex­am­i­na­tion from all as­pects and a tax payer should not be al­lowed to use le­gal con­struc­tions or trans­ac­tions to vi­o­late hor­i­zon­tal eq­uity.

In the past, the re­sponse to tax avoid­ance has been the in­tro­duc­tion of leg­isla­tive amend­ments to deal with spe­cific in­stances of tax avoid­ance. Since the lib­er­al­i­sa­tion of In­dian econ­omy, in­creas­ingly so­phis­ti­cated forms of tax avoid­ance are be­ing adopted by the tax pay­ers and their ad­vi­sors. The prob­lem has been com­pounded fur­ther by tax avoid­ance ar­range­ments span­ning across sev­eral tax ju­ris­dic­tions. This has led to the se­vere ero­sion of tax base.

In bud­get 2012, on March 16th, GAAR was

pro­posed in the In­dian tax sys­tem. It was retroac­tive in na­ture which was ef­fec­tive from April 1, 1962. Amend­ments were made for tax­ing sale of shares of a for­eign com­pany whose value is sub­stan­tially de­rived from the as­sets lo­cated in In­dia. It po­ten­tially cov­ers sale of shares of for­eign listed com­pa­nies also. It will also in­clude In­dia fo­cused funds and any in­ter­na­tional trans­ac­tions that in­volves un­der­ly­ing In­dian as­sets. That means, in­vestors would be ex­posed to dou­ble tax­a­tion since they would also be taxed in their home coun­try with­out any credit for taxes paid in In­dia.

Im­me­di­ately af­ter this was pro­posed, we re­ceived sharp re­ac­tions from in­ter­na­tional play­ers. We had im­me­di­ate im­pact on in­vest­ments coming to us. This is dis­cussed with fol­low­ing cases:

VODA­FONE CASE

Voda­fone, the largest mo­bile op­er­a­tor of the world, had bought own­er­ship of Hutchi­son which was a Hong Kong based com­pany hav­ing a ma­jor­ity stake in Es­sar, an In­dian com­pany. Since the un­der­ly­ing as­set here was In­dian, Voda­fone was asked to pay a huge sum as tax li­a­bil­ity on ac­count of this trans­ac­tion. The com­pany re­fused to pay as they claimed that a trans­ac­tion that had taken place in 2007 will be gov­erned by the tax law pre­vail­ing at that point of time. Amend­ments made at the will of government can not force any com­pany to pay back­dated tax. The com­pany was forced to pay tax but it filed a case in Supreme Court of In­dia. The ver­dict of the apex court came in favour of Voda­fone. The government was asked to re­fund the money it had taken from the com­pany.

Voda­fone fur­ther ar­gued that the above trans­ac­tion was done through the Nether­lands branch of Voda­fone and there­fore as per the treaty signed be­tween In­dia and the Nether­lands, no cap­i­tal gain should be taxed. It re­sulted into hot de­bates on cred­i­bil­ity of In­dian laws and a ques­tion on in­vest­ments in In­dian mar­ket.

MAU­RI­TIUS CASE

In 1982, In­dia Mau­ri­tius tax treaty sought to elim­i­nate dou­ble tax­a­tion of in­come and cap­i­tal gains to en­cour­age mu­tual trade and in­vest­ments. The most dis­cussed and con­tro­ver­sial clause of the treaty is clause 13, which says that any cap­i­tal gain made by a Mau­ri­tius firm in In­dia, in­clud­ing those on sale of se­cu­ri­ties by a res­i­dent of the coun­try will be taxed in Mau­ri­tius only. Since Mau­ri­tius does not tax cap­i­tal gains, any in­vest­ments in In­dia by a Mau­ri­tian es­capes cap­i­tal gains tax on profit on in­vest­ments in In­dia.

In­dia gets ap­prox­i­mately 40% of FDI from Mau­ri­tius. A large por­tion of port­fo­lio in­vestors also come from there. Most of th­ese in­vestors have set up spe­cial pur­pose ve­hi­cles or shell com­pa­nies in Mau­ri­tius to take ad­van­tage of tax treaty. There is also an ap­pre­hen­sion that a lot of in­vest­ments may ac­tu­ally be In­dian money (round trip­ping) coming via Mau­ri­tius.

To pre­vent the mis­use of this treaty a joint work­ing group was set up in 2006 but it did not make much progress be­cause of the un­will­ing­ness of Mau­ri­tius to change the treaty. In­dia, now with this pro­posed GAAR can deny tax ben­e­fits to any ar­range­ments en­tered solely for the pur­pose of avoid­ing tax. Tax au­thor­i­ties could club shell com­pa­nies set up in Mau­ri­tius to in­vest in In­dia with such ar­range­ment and deny tax ben­e­fit to them.

On 5th of July 2012, In­dia strictly warned Mau­ri­tius that In­dia’s uni­lat­eral ac­tion could un­der­mine the treaty which will have di­rect im­pact on Mau­ri­tius econ­omy. Mau­ri­tius re­verted with prom­ise of mak­ing pro­vi­sions to re­strict ben­e­fits. Re­cently government has come out with a pro­posal to al­low FDI di­rectly in In­dia with­out tak­ing Mau­ri­tius route and that can have tax ben­e­fits sub­ject to cer­tain con­di­tions.

IM­PACT ON FIIs

FIIs´ turnover in April 2012 plunged 51% in cash mar­ket and 53% in de­riv­a­tives com­pared to March 2012. GAAR puts an onus on the overseas in­vestors to prove that it has not chan­nelled money into na­tion’s stock mar­kets through Mau­ri­tius to claim ben­e­fits. Bro­kers say that the prospect of paying short term cap­i­tal gains in the wake of this rule has re­duced In­dia’s po­si­tion among emerg­ing eco­nomic mar­kets as a pre­ferred des­ti­na­tion.

The re­ac­tions from overseas in­vestors com­pelled the government to re­work the mat­ters on this is­sue which stated that GAAR will ap­ply only to in­come earned af­ter April 1, 2013.

The other points of th­ese guide­lines were:

1. Where an FII chooses to take a treaty ben­e­fit, GAAR pro­vi­sions may be in­voked in the case of FII but would not in any case be in­voked in the case of the non res­i­dent in­vestors of the FIIs. It fur­ther states that if a FII chooses not to take any ben­e­fit un­der a treaty en­tered into by In­dia and sub­jects it­self to tax in ac­cor­dance with the domestic law pro­vi­sions, then GAAR shall not ap­ply to such FIIs or on their non res­i­dent in­vestors. Now again changes were made to in­clude NRIs also.

2. A unit set up in a tax ex­empt area would not at­tract GAAR, but if the unit di­verts its pro­duc­tion to other con­nected man­u­fac­tur­ing units and shows the same as man­u­fac­tured in the tax ex­empt unit, it would con­front GAAR.

3. The merger of a loss mak­ing com­pany into a profit mak­ing one re­sults in losses off­set­ting profit, a lower net profit and a lower tax li­a­bil­ity for the merged com­pany will not at­tract GAAR.

4. P−notes are kept out­side the GAAR bracket.

Fi­nally the Shome com­mit­tee Report ( com­mit­tee con­sti­tuted for this pur­pose) pre­sented in the first week of Septem­ber 2012 seeks to ad­dress num­ber of con­cerns on GAAR. Many of the sug­ges­tions are open to de­bate . For ex­am­ple the one to scrap the cap­i­tal gain tax on listed se­cu­ri­ties,both for res­i­dents and non res­i­dents and raise se­cu­ri­ties trans­ac­tion tax to meet any rev­enue deficit is not

Source of this write−up: Eco­nomic Times var­i­ous is­sues

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