GAAR REPORT – A tax reform or a Shenanigan?

Author : Chakshu Aggarwal,NMIMS

                 
The confusion over the General Anti Avoidance Rule (GAAR) cropped up when on 21^st January, 2012 Supreme Court ruling went in favor of hutch-vodafone deal on grounds that the deal between two companies was incorporated outside India and thus exempted Vodafone from tax of $2.5 billion. This led to series of events which resulted in weakening of investor sentiments and thus goaded the government in July to set up a 4 member panel to look into the concerns of foreign investors in GAAR. 

DEVELOPMENTS IN GAAR TILL JUNE,2012 AND ITS IMPLICATIONS

• The Supreme Court ruling in favor of Vodafone led to introduction of a retrospective clarification to Income Tax act 1961 thus amending the law to tax cross border transactions such as Hutch-Vodafone deal.

• The new provision in Income Tax act stated that any company situated outside India shall be deemed to be situated in India if it derives its value or shares from the assets located in India.

• The provision was disclosed in the Union budget of 2012 by then finance minister Pranab Mukherjee. Post inclusion of this provision it was estimated that it could earn the exchequer Rs 35000-40000 Crores in back dated revenues.

• INCOME TAX department filed a petition in SC in March, 2012 for reversal of its earlier decision on back of the retrospective clarification in Income Tax act.

• The amendment to Income Tax act did not bring any gains to Income Tax department and petition was turned down by Supreme Court.

• The argument given by government for introduction of GAAR in form of change in Income Tax  act was that it will come into action where in particular transaction tax avoidance is one of the motives.

• This led to a lot of uncertainty as foreign investors feared that this provision will bring the past transactions under the purview of Income Tax act that were completed in last five years since 2007 when hutch-vodafone deal happened and will tax them retrospectively

• This took the foreign investors by shock leading to erosion of investor sentiment and Prime minister Manmohan Singh had to reign in by forming a 4 panel committee headed by Dr. Parthasarthi Shome to look into concerns of foreign investors in GAAR.

 NEED FOR GAAR COMMITTEE AND HOW DID THE COMMITTEE GO ABOUT IT

The investor sentiment already dented by policy paralysis, decelerating growth, spiraling inflation and high interest rates was being further impacted adversely by the clouds of retrospective taxation that was hinted upon by the retrospective clarification in Income Tax act and the first GAAR Draft guidelines issued on june 28, 2012. This impact was significant in the erosion of FIIs from Indian capital market as foreign investors saw lots of ambiguity in Indian investment climate. Anticipating the detrimental effect of the draft guidelines, On june 29,2012 PMO came out with a statement that guidelines posted have been put out for receiving feedback and discussion purposes. Furthermore, PMO stated that these guidelines have not been seen by PM and will be finalized after its approval. A day later it was announced that PM has approved the constitution of 4 member committee headed by Dr. Parthasarthi Shome to undertake stakeholder’s feedback and finalize the guidelines. The series of events followed by posting of first Draft guidelines clearly suggested that was a difference of opinion between PMO and finance ministry.

Dr. Parthasarthi Shome had major task at his hands as these final guidelines would determine the fate of FIIs and hence the investor sentiment in the Indian capital market. A roadmap was laid down to go about the task at hand and the main highlights of the roadmap were:

• Record comments from the stakeholders and the general public on the first draft guidelines that have been published on government website and complete this task by end-July 2012

• Rework the guidelines based on this feedback and formulate second draft of guidelines and publish it for comments and consultations by 31^st august 2012

• Undertake consultations on the second draft guidelines

• Finalize the GAAR guidelines based on the consultations and prepare the implementation plan and submit it to government

HIGHLIGHTS OF SECOND DRAFT OF GAAR GUIDELINES SUBMITTED BY GAAR COMMITTEE

• GAAR delayed by 3 years and will be applicable from assessment year 2017-2018
• Approving panel of GAAR will have 5 members including a retired HC judge and two from outside government in contrast to 3 members ( all from government) recommended by first draft
• Abolition of tax on transfer of listed securities for resident as well as non-resident Indians.Prospective positive impact of this provision: Earlier short term capital gain (less than 1 year holding) used to be taxed at 15% and short term business gain used to be taxed at 30% and to prevent the tax foreigners used to invest via Mauritius route which is a tax haven. This move will make the Mauritius route redundant and will facilitate pooling of funds directly in India.
• Limit of Rs 3 crore has been kept for tax benefit exceeding which GAAR will be applied in contrast to the first draft where this limit was not certain
• Investors from Singapore and Mauritius have been spared from GAAR. The rationale given behind this provision is that these places already have limit of tax benefit in their treaties and so GAAR should not be applied as they already have tax avoidance rule
• GAAR will be invoked only when tax benefit is the main purpose in contrast to earlier draft which stated that GAAR to be invoked where tax benefit is one of the main purposes.
• There will be no retrospective taxation on transactions that happened in past

After taking a glance at the guidelines submitted by GAAR committee, provisions look encouraging and one would think that it would do enough to revive investor sentiment. The main motive of government behind setting up of GAAR committee was to clean up the mess created by the earlier finance minister Mr Pranab Mukherjee who introduced the provision of retrospectively taxing the transactions which made the investment environment ambiguous and shocked the foreign investors. The government sees latest GAAR guidelines as tool to placate the volatility in the investor sentiment. The move aimed at discounting the trade and fiscal deficit woes to some extent by revamping the investor sentiment through GAAR report. But it was not to be as share market in turn discounted GAAR and Sensex fell 0.26
% on the day subsequent to publishing the guidelines of GAAR. Market sees policy inaction and want of reforms as more important issues than GAAR . Also, there is lots of skepticism about delaying the GAAR by 3 years and it questions the government’s effort of GAAR as serious tax reform. It is yet to be seen that whether GAAR will prove to be a positive tax reform or just a shenanigan by Government to improve the investment environment which has been worsened by their inaction.