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Welcome seal on GAAR deferral

New Delhi, Jan. 14: The general anti-avoidance rules (GAAR) India’s hugely contentious piece of legislation that aims to stop companies from creating “abusive, contrived and artificial” corporate structures to funnel funds into India with the main purpose of dodging tax — will come into effect from April 1, 2016, two years later than planned.

The government today accepted most of the recommendations of the Parthasarathi Shome Committee after poring over the report for well over three months.

The GAAR provisions will be invoked only above a monetary threshold of Rs 3 crore in terms of tax benefits, finance minister P. Chidambaram said here today.

The Shome committee report has tried to introduce an element of certainty and consistency in the administration of India’s tax laws and quell foreign investors’ concerns over the draconian manner in which tax authorities interpret laws.

Investments made before August 30, 2010 will not be covered by GAAR.

Chidambaram said the GAAR rules would not apply to the non-resident individuals who route their money through the FIIs.

The announcement came as a huge relief for investors who park their money in the participatory notes — a derivative instrument that draws its value from investments made in Indian stocks — floated by the FIIs.

“No investor should have any apprehension about their investments in India,” Chidambaram said, adding that the GAAR provisions had tried to strike a balance between the government’s need for revenue generation and investors’ interests.

The minister said the Rs 3-crore threshold would mean that GAAR would not affect a large number of investors.

The finance minister also said officials from India and Mauritius would meet by March to review the provisions of a bilateral tax treaty signed in 1982.

Since the island nation does not tax capital gains, investors have misused provisions of the treaty to evade taxes. India gets nearly 40 per cent of its total foreign direct investment inflows through Mauritius in addition to large portfolio investments.

The country’s reputation for capriciousness in tax matters came to the fore last year after the government introduced a 60-year retrospective amendment in tax laws, a thinly-veiled attempt to force Vodafone Plc of the UK to pay tax on its $11.2 billion buyout of Hutchison Whampoa’s 67 per cent stake in India’s third largest mobile telephony company in April 2007. The change in the law effectively blunted a Supreme Court verdict that went in favour of the world’s telephony company by revenues.

If the Vodafone tax issue was bad, GAAR was seen as something more sinister. It was supposed to empower the taxman to pierce the corporate veil and question the treaty-protected tax shields that companies use to pump investments into the country and skim off returns without having to pay a tax on these transactions.

The UK — a tax jurisdiction whose laws have served as a model for India — imposes GAAR but the levy is based on a residence-based principle, which means that a taxpaying entity must have an establishment in that country.

India, on the other hand, adopts a source-based rule, which leads to contentious interpretations about the true objective behind the creation of a web of companies to funnel investments into India. Under sections 4 and 5 of the income tax act, income is said to have its source in India if it accrues or arises in India, is deemed to accrue or arise in India, or is received in India.

Pranab Mukherjee, then finance minister, had proposed in Budget 2012-13 to introduce GAAR from April 1 this year, sending a frisson of fear through investors.

Investors saw the proposed rules as desperate means by a cash-strapped government to raise funds to rein in its yawning budget deficit. Many of them said the anti-avoidance rules, which give authorities powers to scrutinise any deal that they feel had been structured to evade taxes, would give unbridled power to tax authorities and all deals could be viewed with suspicion.

Some feared it would be used to target transactions routed through jurisdictions such as Mauritius.

Ketan Dalal, joint tax leader of PwC India, said: “While there is no mention of Mauritius in the finance minister’s statement, the government has accepted that, if the treaty benefit is availed, GAAR should not apply by implication so long as the Mauritius tax residency certificate is available.”

“The indication from the government seems to suggest that attracting capital flows has become imperative to fund the growing current account deficit,” said Dhananjay Sinha, co-head of institutional research at brokerage Emkay Global.

Sinha added the deferral was in line with India’s stated objectives and recent policy measures such as opening up its supermarket and aviation sectors, which were also aimed at attracting increased foreign capital inflows.

The current account deficit hit an all-time high of 5.4 per cent of gross domestic product in the July-September quarter, putting the rupee under pressure and increasing the reliance on volatile capital flows to fund the shortfall.

 
 
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