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The past year has been fraught with debates and discussions on a tax rule that could invalidate a business structure or arrangement that has an attendant tax advantage. This rule, embodied in what is known as GAAR (General Anti-Avoidance Rule), was originally intended to be introduced in the Direct Taxes Code Bill (which is meant to replace the existing income tax law). After GAAR was fast-tracked and introduced in Finance Act 2012, there have been many attempts to calibrate and cushion its impact in a manner that would lend clarity and certainty to investors. This month, the final report of the expert committee on GAAR constituted by Prime Minister Manmohan Singh was published, followed by Finance Minister P. Chidambaram’s statement on the Government’s response to the panel’s recommendations.
Key takeaways
The Finance Minister has agreed in principle to the recommended deferral of GAAR as it is an advanced instrument of tax administration requiring in-depth understanding and training for tax officers. However, against the recommended three years, the Minister agreed to defer by two years, and, accordingly, GAAR would come into force from tax year April 2015-16.
As GAAR has been in the public domain since its introduction in DTC 2010, the Minister stated that the Government would grandfather investments existing before August 30, 2010, and not those that exist on the commencement date of GAAR.
Other positive affirmations of the Minister include acceptance of the main purpose test (as against ‘one of the main purposes’) for an arrangement to have tax benefit; acceptance of an independent GAAR approving panel; providing a monetary threshold of Rs 3 crore; the onus of proof on the tax authority; and availability of the AAR (Authority for Advance Rulings) route for GAAR transactions to resident and non-resident taxpayers.
Impact on Mauritius route
Mauritius has been a popular jurisdiction for establishing a holding company to make investments into India, with FDI equity flows from April 2000 to October 2012 accounting for 38 per cent of all inflows. The main advantage of a holding-company jurisdiction such as Mauritius is the beneficial Double Taxation Avoidance Agreement it has with India, in addition to the general non-tax benefits associated with holding companies.
However, the availability of DTAA benefits to a company resident in Mauritius has been controversial in the recent past. This in spite of an administrative circular clarifying that a tax residency certificate (TRC) issued by the Mauritian tax authority is proof that the company is resident in Mauritius, and eligible for DTAA benefits. The report recommended that GAAR should not be invoked in circumstances covered by the circular. The Minister’s silence on this is bound to increase the uncertainty for taxpayers.
Mauritius is also used to route foreign portfolio investments [comprising foreign institutional investors (FIIs) and Qualified Foreign Investors (QFIs)] into India. In this regard, it is significant that the Minister has accepted the recommendation that GAAR will not apply to non-resident investors in FIIs. Further, the Minister has stated that GAAR will not apply to FIIs that choose not to take the benefit of a DTAA.
Over the years, there has been much speculation on the introduction of anti-treaty shopping provisions [technically referred to as the limitation-on-benefits (LOB) clause] in the India-Mauritius DTAA. If, and when, an LOB is introduced, the Minister has not clarified whether GAAR will be invoked even if LOB conditions are fulfilled.
tax management, the key
In framing GAAR, there is always the danger of penalising those who have genuine reasons for entering into bona fide transactions. While the Government’s stance has been positive so far, greater clarity on the substance and scope of the provisions is awaited. It should be noted that the Minister stated that structures, or income arising from structures, put in place on or after August 30, 2010, will not be grandfathered — that is, they will be within the scope of GAAR. Therefore, careful and comprehensive tax and risk management would go a long way in avoiding possible pitfalls for multinationals, especially as there is no precedence in the Indian context to indicate how these provisions may be interpreted by the taxman and the courts.
Rajendra Nayak is Tax Partner, Ernst & Young
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