After the General Anti-Avoidance Rules or GAAR was introduced, the Central Board of Direct Taxes constituted a committee to recommend guidelines for its effective implementation. The committee put out draft guidelines for public comments that comprised recommendations for framing rules as well as clarifications needed from CBDT. The guidelines explain the difference between tax avoidance, tax evasion and tax mitigation using examples; it provides broad guidance on the application of GAAR provisions with the help of 21 illustrations.
It explains that GAAR provisions will apply prospectively to income accruing or arising on or after April 1, 2013. Where Specific Anti-Avoidance Rule or SAAR (to counter a specific abusive behaviour) is applicable, GAAR will not be invoked. However, in exceptional cases where a taxpayer’s action may defeat SAAR, GAAR could be invoked.
Let’s analyse the likely impact of the guidelines on various investment and business transactions.
Foreign Institutional Investors
Where an FII chooses not to benefit under a tax treaty entered into by India and subjects itself to domestic tax laws, then GAAR shall not apply to it or to its non-resident investors. However, where an FII opts for the tax treaty benefit, GAAR provisions may be invoked on it but not on its non-resident investors. Thus, P-Note holders may not be subjected to scrutiny from tax authorities. This clarification will have a positive impact on P-Note holders, but the uncertainty surrounding FII taxation and the applicability of relevant tax treaty should be cleared to boost investor confidence.
Private equity
The guidelines propose that while interpreting the tax legislation, “substance” should override “legal form”. Further, it specifies that GAAR will not apply where SAAR is applicable, except for exceptional abuse behaviour. Where private equity or strategic investors fund an Indian company through an intermediary holding company in a low-tax jurisdiction, GAAR provisions may not apply if the overseas holding company’s Board of Directors meets in that country and carries out business with adequate manpower, capital and infrastructure of its own, and, therefore, has substantial commercial substance in that country.
The guidelines though useful are not sufficient as they do not provide objective criteria in terms of “substance”, and this could lead to subjective interpretations by Indian revenue authorities followed by controversies and litigation. Besides laying down objective criteria for determining “substance”, the Government should roll out detailed guidelines encompassing various situations that satisfy the substance test. Also, to bring certainty, it may be prudent to specify that the “limitation on benefit” clause in a tax treaty providing “specific expenditure test” should be sufficient compliance with GAAR.
Mergers and reorganisations
The guidelines explain that the merger of a loss-making company into a profit-making company should not attract GAAR provisions as there exists adequate SAAR in Section 72A of the Income-tax Act, 1961 to curb abuse. However, a question arises whether the merger of a profit-making entity into a loss-making entity could attract GAAR provisions? The Act deals with the tax aspects of merger and provides tax neutrality but does not have SAAR provisions. As a result, the merger of a profit-making entity into a loss-making entity could be challenged by Indian revenue authorities under GAAR unless there is a commercial substance in such mergers. Similarly, the reorganisation of business entities or operations could also be impacted by GAAR unless they have sufficient commercial substance or are in the nature of a tax mitigation strategy, namely, establishing a unit in an SEZ zone. The guidance for substance in the form of illustrations would be helpful and could lead to restructuring in the near future to mitigate the adverse impact of GAAR.
UK scene
Recently, the UK Government also issued a consultation document laying down a path for the introduction of GAAR in that country’s Finance Bill 2013. The detailed document systematically deals with the implementation of GAAR. The UK Government has set out its objectives in clear terms: GAAR provisions should work fairly; it is targeted at artificial abusive tax avoidance scheme; to maintain attractiveness of the UK as business investment destination; and to ensure sufficient certainty about the tax treatment of transactions.
The GAAR guidelines are the first step towards bringing clarity on its applicability to various business transactions and arrangements. It would be prudent to study international practices such as the UK’s recent effort and borrow from them. Considering the prevailing economic slowdown, a proper implementation and administration of tax policies including GAAR would go a long way in bringing certainty and improving investors’ confidence in the Indian economy.
(Uday Ved is Head of Tax, KPMG India)