If the economy starts growing at a robust rate, global capital may be subjected to a anti-tax avoidance tax regime that the Government intended all along.
In constituting an expert committee for laying down new guidelines for implementing of General Anti-Avoidance Rules (GAAR), the Prime Minister, Dr Manmohan Singh, has clearly engaged in a damage control exercise. The Finance Ministry's draft guidelines, released late last month, had badly dented the sentiment of overseas investors towards India. This was at a time when they were not too sanguine about global economic growth prospects or the ability of national governments to manage the transition from stagnation to revival. Their safety-first approach had itself been threatening to choke off capital flows to emerging economies. Ordinarily, India would have been able to weather the storm. But in this case, uncertainties on the export front and a ballooning oil import bill — coupled with the inability to make corresponding adjustments to domestic fuel prices — have undermined the stability of the external sector even with a reasonably comfortable foreign currency reserve position. With no relief on the external front any time soon, the obvious question was whether the economy could afford to do without the capital inflows trickling in even in these uncertain times. The Prime Minister has seemingly concluded that irrespective of the merits or otherwise of the Finance Ministry's draft GAAR guidelines, this was no time for experimentation.
The guidelines and the tax policy considerations underpinning it should hardly have come as a surprise in the context of the Ministry’s stance in the Vodafone case and the GAAR provisions introduced in this year’s Budget. It can be nobody's case that there has been a fundamental rethink in the Government's approach towards business arrangements by taxpayers, especially overseas investors, aimed at reducing their tax burden. The investor community, even while recognising that the Government meant business, somehow drew comfort from the fact that the GAAR proposals in the Budget were of a general nature. It was possible, therefore, to assume that even if the Government would be harsh towards tax avoidance in general, their own arrangements would somehow escape adverse scrutiny. But the draft guidelines — by spelling out specific types of tax avoidance arrangements that would be considered impermissible or otherwise and giving illustrative examples — rendered any such facile assumptions about benign tax treatment, unsustainable. Hence, the negative stock market reaction that followed.
The expert committee has ample time to engage in consultations, as the new rules are to apply to incomes earned only after April 1, 2013. The Government, too, is in a position then to accept or reject its recommendations. If the external sector stabilises or if the economy shows signs of recovery, the Government could still subject foreign investors to a regime of tax avoidance rules that it had intended all along. They, too, may reluctantly go along. Between erosion of capital — which is what awaits them if their monies stay in safe Western havens — and the prospect of earning some returns net of tax in emerging economies such as India, they might end up opting for the latter.