The confusion at the end of last week between the finance ministry and the Prime Minister’s Office over whether or not the draft guidelines for the General Anti-Avoidance Rules (GAAR) bore the imprimatur of Prime Minister Manmohan Singh should not detract from one basic fact: the conversation has started on how to implement GAAR swiftly, fairly and transparently. The prime minister’s initiative to have a public review and discussion on the rules is welcome and timely, though, clearly, the manner in which it was done gave rise to an avoidable degree of misunderstanding. Changes in tax policies often have implications that go beyond the revenue department’s predictions, and without a wide-ranging consultation with those affected by the changes, governments can frequently slip up. In India, this has been seen to happen several times in the past — the banking cash transaction tax and the fringe benefit tax are just two examples. Attempts to close loopholes can sometimes create more inconveniences than the social savings that they deliver.
It is very important that no such troubles bedevil the introduction of GAAR. The concept of such rules, it must be emphasised, is not in the least problematic. Across the world, tracking the move from rules-based to principles-based regulation, governments are moving to introduce anti-avoidance statutes. If implemented properly, there is no reason why they would not cause less socially wasteful effort to be spent on avoidance, leading to better outcomes all round. However, in India, the complication is that revenue officials have not exactly developed a reputation for fairness, efficiency and incorruptibility. Given that, there is a legitimate fear that GAAR could become an instrument of harassment in the hands of the taxman. The government must go the extra mile to reassure market participants, investors and taxpayers that this will not occur. If that requires comprehensive redrafting of the GAAR guidelines, so be it. That is necessary not just to ensure that short-term investments keep on coming in during a troubled time; it is also needed so that the very idea of anti-avoidance rules is not put into cold storage permanently.
There are also more complicated questions related to whether or not the tax changes in this year’s Budget, especially GAAR, apply to known tax havens like Mauritius. It is a now-acknowledged fact that India’s tax treaty with Mauritius has led to a large amount of tax avoidance. Yet many legitimate foreign institutional investors, too, route investment through Mauritius, and so any changes to the structure enabling such investment – through the applicability of GAAR, in particular – will cause concern. Yet it is important to remember that the direct taxes code was always supposed to be implemented from 2013, and anti-avoidance rules were always going to be part of it. It makes little sense, in any case, to have a new and clear tax code that does not close known sources of tax avoidance. It is, thus, important to have the debate on its implementation now, and to iron our differences. Everyone should be ready for the new tax system when it is introduced.