Bringing cheer to investors

After intense consultations with various stakeholders, the Prime Minister’s Expert Committee on the General Anti-Avoidance Rule (GAAR) submitted its draft report last week. The report is a game changer in many ways and succeeds, to a large extent, in achieving a fine balance between addressing genuine concerns of global and domestic taxpayers, and the revenue’s need for legislative means to counter abusive and artificial arrangements.

It has come at an opportune time, when GDP growth has slowed and global investors’ confidence is at a low.

An important recommendation is the deferral of GAAR by three years. When enacting far-reaching provisions such as GAAR, it is important to ensure that the requirements of consultation, transition and judicious enforcement are adequately met. The in-depth consultative approach adopted by the Committee, as well as the systematic process of obtaining a buy-in from various stakeholders, will go a long way in enhancing trust between the Government and taxpayers. Secondly, by recommending a three-year transition period, the Committee has adopted the internationally accepted practice of pre-announcement (as in the case of the UK), which will allow taxpayers to reorganise business operations as needed. Most importantly, the Committee recognises the need to beef up the tax administration to ensure the law is in the right spirit. The three-year gap meant to facilitate intensive training of tax officers on the finer aspects of international taxation is a welcome one.

Another key concern sparked by the wide-ranging terms of GAAR was that several decisions made by taxpayers in the ordinary course of business could be subject to examination merely because they gave rise to tax benefits. Specifically, the Committee has recommended setting out a negative list of cases — such as decisions on buyback versus a dividend, setting up a branch versus a subsidiary, and funding through debt or equity — to ensure that business choices of taxpayers are not circumscribed. It also clarified that where only a part of the arrangement is impermissible, the application of GAAR would be limited to that.

The Committee also recommended that all existing investments (and not existing arrangements) made prior to the commencement of GAAR be “grandfathered” — whereby the provisions of new laws will not be applicable to past transactions, but only to fresh transactions. This is meant to ensure that gains on future exit from such investments are not subject to scrutiny under GAAR. This step will go a long way in reassuring those who have made significant investments in India on the basis of existing treaty provisions. At a practical level, it would imply that if an investment is made in India by a Mauritius company prior to GAAR coming into force, gains on exiting such investments would be outside GAAR’s purview.

The language of GAAR, coupled with the provisions for a treaty override, caused significant anxiety among the foreign investor community, especially foreign institutional investors. In this context, the Committee has made a far-reaching recommendation to abolish capital gains tax on the transfer of listed securities for both residents and non-residents, with a suitable adjustment to the Securities Transaction Tax rate to compensate for lost revenues. It also recommended retaining the CBDT Circular 789 of 2000 validating a tax residency certificate issued by Mauritius tax authorities until the abolition of capital gains on listed securities.

It also specifically recommended that where a tax treaty provides for a suitable anti-abuse provision in the form of a limitation on benefits (LOB) article, GAAR should not be invoked to override tax treaties. Most importantly, it recommends that if there are violations of the anti-abuse provisions in a treaty, the treaty should be revisited through bilateral negotiations rather than unilaterally overriding through GAAR. The recommended inclusion of independent members in the Approving Panel, as well as the comprehensive set of illustrations annexed to the report will lend significant credibility to the proposed GAAR regime. Some of the above recommendations may also require legislative changes in the Income-tax Act.

Incidentally, the Committee’s mandate has been expanded to cover a review of retrospective amendments with respect to indirect transfers, taxation of royalties, and so on. This too is a step in the right direction, and will help bring objectivity in the application of tax laws.

All in all, the report marks a first step towards ensuring the GAAR regime does not lead to enhanced litigation and uncertainty among investors. It will also herald a new era of increased investor confidence, which, in turn, could provide significant long-term advantages to the Indian economy.

(Uday Ved is Head of Tax, KPMG in India)

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