A mature approach to GAAR

Last Monday, the Finance Ministry accepted several significant recommendations of the expert committee on General Anti-Avoidance Rules led by Parthasarthi Shome.

The GAAR legislation, first mooted in 2009, codified in 2012 and intended to be effective from 2013, is now proposed to be applicable from 2015. Following an outcry from investors and ramifications immediately felt in the stock market, the Government sat up and took notice. For those who thought investment decisions are not driven by taxation issues, the proposal to introduce GAAR proved otherwise.

The Government has shown maturity by acknowledging that the administration should be adequately equipped to implement this legislation effectively. It is important to reiterate that the legislation is not intended to harass taxpayers but bring to tax transactions blatantly structured to evade it without any commercial imperative.

The proposal to accept grandfathering of investments made before August 30, 2010 — that is, sale of such investments on or after the commencement of GAAR — implies that such investments will not be tested for applicability of GAAR and denied tax benefit. Conversely, investments pumped into India after August 2010 are under the net and likely to be examined for ‘motive’ and ‘substance’ at the exit stage. Although some investors may lament that certain tax costs were not factored at the initial investment stage for assessing return on investment, there is now certainty on how far back this legislation can go. Many saw it as a surrogate retrospective amendment if it were to go back indefinitely for scrutiny of transactions.

The guidelines on interplay of Specific Avoidance Rules and GAAR will aid sensible application. Recognising factors such as an arrangement’s duration, tax payments, exit route for holistic assessment of an arrangement under GAAR will provide weight to ‘substance’ and ‘motive’. In a major relief, the Government clarified that foreign institutional investors (FIIs) not claiming tax treaty reliefs and their non-resident investors contributing through participatory notes via FII route would not come under the purview of GAAR. Now, it is for FIIs to carry out a cost-benefit analysis of claiming a tax treaty relief vis-à-vis staying clear of GAAR and consequent litigation.

Setting a Rs 3-crore monetary threshold will entice small-timers, but it is too low a benchmark for investors with a high risk-appetite and huge investments. Good or bad, now tax administrators and taxpayers would know their tolerance limits.

A welcome move overall, but the silence on issues such as the specific treaty override provided for GAAR, and GAAR invocation for residency check is disappointing. The Government seems to have awakened to the adage “In levying taxes and in shearing sheep it is well to stop when you get down to the skin”.

Robust and careful documentation and an eye on commercials will prove the cornerstones for all investment structures of the future.

In the Grant Thornton Global Dynamism Index 2012 survey of the business growth environment of 50 world economies, India ranked fifth most dynamic in terms of economics and business growth fundamentals, but came a disappointing 46th for conducive business operating environment. The rankings reflected the country’s policy flip-flop of the past few years.

Given the Indian economy’s resilience and dynamism, our favourable demographics, certainty and transparency in Government policy framework will go a long way in spurring the economy.

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