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The taxman will not invoke the much feared General Anti-Avoidance Rules (GAAR) against Participatory Note (P-Note) holders.
This has been reflected in the draft guidelines for GAAR implementation released by the Central Board of Direct Taxes late Thursday night.
However, the GAAR provisions may be invoked against foreign institutional investors if these investors choose to take a treaty benefit, say, under the India-Mauritius double tax avoidance agreement or the India-Singapore pact.
But GAAR will not be invoked against FIIs or the non-resident investors of FII in situations when the FII does not choose to take a treaty benefit, but is ready to subject itself to tax under the domestic tax law provisions.
Revenue interests
Simply put, the draft guidelines have ring-fenced P-Note holders from any tax liability. It ensures that the Indian tax authorities will not go beyond the FII level to check any detail about the non-resident investors of FII (read P-Note holders).
The draft rules, however, protect the revenue interests in the sense that the taxman can invoke GAAR against an FII if it fails to substantiate the substance in jurisdiction and transaction.
The non-resident investors in FIIs will certainly be out of the taxman’s net, but FIIs themselves may not escape tax liability if these draft rules get implemented from April 1 next year, say tax experts.
Participatory Note is a derivative instrument that allows overseas investors to buy shares without going through the mandatory ‘know your customer' norms in the Indian market. P-Notes have been a key source of investment flows into Indian stock markets.
Proposes monetary limit
The draft rules have also specified that GAAR will be invoked only above a monetary threshold and it would be applied only for incomes earned after April 1, 2013. The monetary threshold, however, has not yet been decided.
Although GAAR has been brought under the statute book through Finance Act 2012, its implementation was deferred till April 1, 2013, in an apparent bid to soothe the frailed nerves of foreign investors.
FIIs see GAAR as unbridled powers in the hands of tax authorities that could be misused in the absence of clear guidelines on the situations under which the anti-avoidance rules will be implemented.
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