What is General Anti Avoidance Rule (GAAR)?

The
General Anti Avoidance Rule (GAAR)- proposed by the then Union Finance
Minister Pranab Mukherjee during the annual budget 2012-13- is anti-tax
avoidance rule, drafted by the Union Government of India, which prevents tax
evaders, from routing investments through tax havens like Mauritius, Luxemburg,
Switzerland.

According
to the draft, GAAR will come into effect from 1 April 2013. As per the
guidelines, FII not opting for treaty benefits and ready to pay taxes will not
come under GAAR, but those who do opt for dual taxation avoidance agreements
will come under its purview.

The
Union Government was forced to defer the rules until 1 April 2013, as foreign
investors had expressed their reservation about the language used in the rules.
Investors had maintained that the ambiguous language used in the draft of the
GAAR could lead to the misuse of the rule.

What
are Tax Havens?

Tax
havens are countries which have low tax regimes which provide individuals and
business opportunities of tax avoidance or tax evasion. There are roughly 45
tax havens in the world today. In Indian context, Mauritius is considered to be
the most significant tax havens or tax evading route.

In
more precise words the Mauritius route can be described as a channel
used by individuals and Multi National Companies to evade paying taxes in
India. The tax evasion in India through this route is estimated to be in tune
with 55 billion dollar, mostly attributed to the loopholes in a bilateral
agreement on double taxation.

 
1) What is GAAR: The General
Anti-Avoidance Rule was introduced by Finance Minister Pranab Mukherjee in his
Budget presented on March 16 for the year starting on 1 April with the
objective to "counter aggressive tax avoidance schemes."

2) What are its implications: It empowers officials to deny
the tax benefits on transactions or arrangements which do not have any
commercial substance or consideration other than achieving tax benefit. It
contains a provision allowing the government to retroactively tax overseas
deals involving local assets (like Vodafone). It could also be used by the
government to target participatory notes (P-Notes).
 
3) Will P-Notes be targetted: Investments into Indian stock
markets through participatory notes might slow after the introduction of GAAR.
According to data from market regulator SEBI, P-notes issuance reached Rs 1.83
trillion at the end of February, about 16.4% of total assets under the foreign
investor inflow scheme. P-Notes are instruments used by investors or hedge
funds that are not registered with the SEBI to invest in Indian securities and
they offer the buyer anonymity. The tax would be imposed on the registered
financial firm buying the security on behalf of the client, meaning the brokerage
would then pass on the taxes to the end investor.

Brokerage firm Macquarie has said that stocks bought through participatory
notes could be subject to short-term capital gains tax of 42% and long-term
capital gains tax of 21% as a result of the new taxation proposals. CLSA,
another brokerage firm, has stopped selling P-notes.

"To avoid tax altogether under GAAR, an investor may now have to prove the
P-note was not set up specifically to avoid paying taxes or to prove that the
deal has "commercial substance," Edelweiss said.

4) What happens to the Mauritius route: GAAR could give powers
to the tax department to deny double taxation treaty benefits to foreign funds
based out of tax-havens like Mauritius. India has a Double Taxation Avoidance
Agreement with Mauritius. Overseas portfolio investors, routing their
investments via countries like Mauritius, currently do not pay any tax on
short-term capital gains.

"If the bill is passed as it is, then from 1st April 2012, FIIs domiciled
in such treaty locations may have to prove that they have created this
structure for genuine business purposes and not just for avoidance of
tax," Domestic brokerage IIFL said in a note.

5) What do investors say: This is what Adrian Mowat of JP
Morgan Securities told NDTV Profit. The proposed law gives the legal right to
the government to go after anyone and it added ambiguity over the taxation.
Indian equities will see selling by foreign investors & less money will be
coming into India consequently. Investors are very uncomfortable about GAAR in
current form. FIIs run global portfolios & some invest just 1% in India.
After this they might say its not worth the hassle. The move is bad for Indian
economy, bad for Indian corporate, bad for Indian capital markets.