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