With India signing on to a new global tax avoidance treaty, foreign portfolio investors (FPIs) hope to escape the draconian provisions of the General Anti Avoidance Rule (GAAR), India’s much-feared tax law, which gives sweeping powers to the taxman.
The Multilateral Instrument (MLI), to which India and 68 other jurisdictions became signatories on June 7, will preside over 2,300 treaties among various jurisdictions. As compared to GAAR, many FPIs consider the MLI, which is likely to take effect in November, the “lesser of two evils”.
Conceptualised by the OECD, the MLI is aimed at preventing base price erosion and profit shifting (BEPS), which are broadly tax avoidance strategies.GAAR vs MLI
However, experts are unsure whether GAAR or the MLI will prevail over the other. Under GAAR, the taxman has powers to lift the corporate veil on any pretext. The MLI, on the other hand, has set principal purpose test (PPT) and limit of benefit (LoB) measures, which if fulfilled will shield entities from “harassment”. But the spirit of the MLI may be crushed if domestic laws override it in the event of conflicts.
“The MLI’s introduction raises the question of which prevails over the other,” said Suresh Swamy, partner tax and regulatory services, PwC. “Under the MLI, Action Plan 6 on ‘Preventing the Granting of Treaty Benefits in Inappropriate Circumstances’ examines various scenarios to conclude that such conflict should not normally arise. However, where a conflict does arise, it states that ordinarily, the MLI provisions will prevail.”
Under the PPT provision, treaty benefits can be denied if one of the principal purposes of an arrangement or a transaction was to, directly or indirectly, obtain tax benefit. According to Swamy, this test appears wider than GAAR.
But a government document on GAAR explicitly states that the domestic law overrides every other law in case of disputes.
“As of now it is believed that GAAR overrides everything, but a conflict cannot be ruled out when the MLI kicks in,” said Girish Vanvari, Head of Tax, KPMG India.
Mauritius and Singapore, the major contributors of FPI flow into India, are yet to sign the MLI. If they keep India as a reserve country, and opt out of a deal with India, it raises the prospects of conflicts, experts fear.
“Once the MLI takes effect, there will be no major difference in the tax rate for FPIs in India, but clarity over which will prevail is required,” said Riaz Thingna, Director, Grant Thornton Advisory.