‘Anti-avoidance rules too harsh'

Talk of revisiting the Mauritius tax treaty recently spooked stock markets and sent the Sensex tumbling down. We interact with Mr Naresh Makhijani, Executive Director, KPMG, to understand the concerns over re-negotiating the tax treaties with other countries and on the implications of the proposed General Anti-Avoidance Rule on foreign investors. Excerpts :

What is the key concern over money coming from destinations with whom India has Double Taxation Avoidance Agreement (DTAA)?

Today, the concern of the Indian tax authorities is round-tripping. While it is fancy to use the term round-tripping, we cannot generalise that whatever inflows are coming in to the country, whether through direct (FDI) or institutional investment (FII) takes a bad colour. There are genuine investors and the money has been used for many productive purposes.

If you take the FDI policy, I do not think the government of India encourages gaming activities or those undesirable from a socio or economic standpoint. Money has come into sectors such as telecom. This is true of software, manufacturing activities and so on. It has created economic activity.

So the point is that there are people who come directly from their home country and there are those that come via Mauritius or Singapore because it may be a hub for investing in a particular region, say China or Africa or Indonesia. It is similar to the investment holding companies in Netherlands for investment into European regions. The question is whether the tax benefit was the main motive for such an arrangement.

What was the intent at the time of entering in to DTAA agreements?

If you look at the India-Mauritius treaty, it did not talk only about DTAA. It also talked about trade – to encourage bilateral trade.

The government did not envisage then that India will open up to the world economy and foreigners will use that route to invest . This is because the Mauritius treaty was notified way back in 1983, prior to the opening up of the Indian economy in 1991.

What exactly is the issue now, especially after the draft DTC was revised?

The issue is that in case of long-term capital gains, neither the residents nor foreign investors pay tax. But if the holding period is less than 12 months you and I pay tax whereas a person from Mauritius does not suffer tax. So the issue is why they should enjoy a special regime of taxation.

Now the context is important; the Indian economy opened to FIIs way back in 1992-93. You know the Securities and Exchange Board of India (SEBI) was also born at that point in time.

We were also in need of capital. So there was a special regime of taxation. There must be some incentives for people to come inBesides non-tax considerations, tax is also a big driver because it impacts financial viability.

If you look at all economic zones in China, there are lot of tax benefits. In Singapore, the tax rates are the lowest at about 17-18 per cent.

So every government, depending upon what stage of development they are in and what they want to achieve, offer incentives, both fiscal and non-fiscal which is part of public policy.

The question here is that of misuse.

I am not saying you should not have exchange of information or should not limit the benefits. You should have safeguards in place. People have invested for several years now and you need to have grandfathering clauses.

Why is the General Anti-Avoidance Rule (GAAR) viewed negatively?

On one hand, the Indian government wants to remove any kind of discretionary powers. However, here under the GAAR, the commissioner has got discretionary powers.

Secondly, what the GAAR provision says is the taxpayer would have to prove ‘not guilty'. Three, all the transactions done by the taxpayer in the past are open to scrutiny.

Also there is no grandfathering clause, which means that it is not clear as to whether it will apply just prospectively. So even your current transaction or transaction structures that were done legitimately in accordance with the provisions of law are open to challenge.

So a commissioner can sit in judgement over whether what I have done is solely driven by tax consideration.

I'll give an example. A businessman may have limitation on the equity capital he can put in to his business. So he may decide on issue of preference share or a debenture.

Now the subtle difference is that you pay dividend on preference shares and dividend is never a tax-deductible item for the payer, but interest on debenture is a tax-deductible item.

Now as a commissioner equipped with GAAR, I may say this amounts to tax avoidance; you should have issued preference shares because the dividend on these shares is not tax deductible. I may invoke GAAR and treat the debenture interest as if they are in the nature of dividend. This is just an example in a plain vanilla transaction.

Our worry is that even simple things can get in the purview of GAAR. If you look at overseas jurisdictions too, we have taken time to implement GAAR. I don't know if this is a right time. So we have to do some thinking whereby the international community does not shy away.

India has DTAA with over 69 countries. But why is the bulk of FDI and FII money routed through Mauritius? How is the DTAA with Mauritius different?

It gives you capital gains tax exemption. Other countries such as Cyprus, Singapore and Netherlands also offer this. Singapore also offers tax benefits, but the only thing is that there they say you need to have an operating expenditure of 200,000 Singapore dollars. There is a limitation on benefits.

See sometimes it is also perception. Mauritius is perhaps also a victim of perception.

Mauritius is also a tried and tested path. We have got a Supreme Court ruling in Azadi Bachao Andolan where it respects form over substance. Then you have a CBDT circular to bless that.

Indonesia recently revoked its DTAA with Mauritius. What prevents India from making a similar move?

For whatever reason, I don't think India considers a unilateral withdrawal as a right option.

They want to follow the path of mutual discussion and respect as it involves two sovereigns.

And if you look at the bulk of the Mauritian population, it is of Indian origin. So it could be mutual respect.

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