The fundamental clarity provided by Thursday’s draft guidelines on the General Anti-Avoidance Rules (GAAR) on key issues, such as prospective application of the provisions, participatory notes (P-notes) and monetary thresholds for invoking provisions came as a big relief for foreign institutional investors (FIIs).
Rajesh Cheruvu, chief investment officer, India, The Royal Bank of Scotland, private banking, said a big positive was the burial given to the issue of retrospective taxation. “It’s clearly past us. While more clarity will emerge, it’s clear that entities that invest to use treaty benefits by routing investments through places like Mauritius are likely to attract GAAR.”
The draft guidelines clarified that, “Where an FII chooses to take a treaty benefit, GAAR provisions may be invoked in the case of the FII, but would not in any case be invoked in the case of the non-resident investors of the FII.”
Such a disclosure in the draft GAAR guidelines has instilled confidence among FIIs that India’s tax department would not go after the controversial offshore derivative instruments, P-notes.
FIIs have been using P-notes for nearly a decade now to invest in India’s equity market. As on May, FIIs held nearly Rs 1,30,000 crore or over $23 billion in Indian equities through P-notes.
Any negative or draconian tax treatment of P-notes could have resulted into major panic among FIIs. Although P-notes are legitimate instruments, they have been on the radar of tax authorities for providing a perfect smoke-screen to investors operating in a clandestine manner. GAAR was announced in Budget 2012-13 with the intention of cracking down on tax avoidance.
Consultants feel the certainty that has emerged on certain fronts may lead to hectic restructuring activity among corporates and investors. Uday Ved, head of tax, KPMG India, said the document has given the much-needed clarity on many issues, such as the exemption of P-notes, tax liability of FIIs and monetary limits. He expects hectic restructuring in the corporate space over the next nine months. “Since there is a requirement of ‘commercial substance’ for entities domiciled in treaty jurisdictions, there will be a lot of restructuring activity over the next nine months. This is the sense we get in our interactions with corporates. First, there will be efforts to build substance, wherever these entities are based currently. The second option is to move to jurisdictions where it is easier to build substance. The third option is to accept the tax. Whichever way you look at it, carrying on an entity in the current form is of no use.”
It was feared by investors and corporates that GAAR would put the onus on companies to prove they are using a specific structure for commercial purpose and not to avoid tax. Under such a provision, taxmen would have questioned claims of companies and FIIs even if they produced a tax residency certificate (TRC), which has been the usual practice to avoid tax claims. However, the draft guidelines put the onus on the taxman to prove that a particular arrangement is impermissible. But some fear this could give the taxman a free hand.
Cheruvu of RBS said, “Any transaction that seemingly has been structured to avoid tax will come under GAAR. However, since the onus of establishing the intent to avoid tax is with the tax authorities, a lot of dicretionary powers continue to be vested with the taxmen. This is an issue that is causing discomfort. Whether or not GAAR will be applicable will depend on how the tax department interprets the transaction. This will continue to confuse both assessees as well tax authorities.”
But these fears have been addressed to some extent by the provisions in the draft. The government has provided guidance on what the provisions entail and how they would be administered through a number of illustrations. “These illustrations have thrown light on many practical issues that will arise. This is a good way of explaining,” Ved of KPMG said.
However, some believe that certain provisions need to be clarified further and toned down in the final guidelines. Ketan Dalal, joint tax leader, PwC India, said, “There are 21 examples outlined in the draft guidelines, which do provide some clarity. This will, to some extent, reduce uncertainty. However, it’s more than a very painful provision with very wide discretion that has been made slightly less painful. A question of degree, rather than anything substantive.”