Several issues need to be considered for investing in India including foreign direct investment norms, choice of entities, incentives, access to tax treaties, corporate and capital gains tax, transfer pricing and indirect taxes. In recent times, the tax legislation in India has been in the forefront of controversies and is cited as one of the predominant apprehensions by foreign investors for doing business in India. One of the reasons for the uncertainty in the tax environment is the introduction in the domestic tax law of General Anti Avoidance Rules (GAAR). Although rife with expectations, the new government’s maiden budget was silent on deferring the applicability of GAAR and providing guidance on ambiguities attached in its current provisions. However, the honourable Finance Minister has mentioned that the Government will review the implementation of GAAR.
Historically, while indeed there have been several Specific Anti-Avoidance Rules (SAARs) in its tax law, India did not have a codified GAAR and most anti-avoidance principles were based on judicial precedents. The introduction of GAAR in India’s Income Tax Act, 1961 (ITA) impacts decades of jurisprudence and could also impact existing investment and operating structures. According to the current situation, the GAAR provisions would become effective from 1 April 2015.
Globally, several countries have introduced general anti-avoidance provisions, albeit in different forms — and of late this trend has gathered further momentum.
The extant GAAR provisions have the impact of regarding an arrangement as an Impermissible Avoidance Arrangement, when its main purpose is to obtain a tax benefit and it contains any of the following tainted elements — is not at arm’s length; results in misuse or abuse of provisions of tax laws; lacks commercial substance; is carried out in a manner not ordinarily employed for bona fide purposes. The domestic tax law expressly provides that GAAR provisions would override all Tax treaties. The GAAR provisions vest Tax authorities with wide powers to, inter-alia, disregard, look through or re-characterise arrangements, ignore arrangements, etc. What is further concerning is the apparently open-ended residual power in the statute, that the tax consequences will be determined in a manner, which is deemed appropriate. Therefore, invocation of GAAR could have very wide and far reaching ramifications. Where GAAR is applied in the case of a taxpayer, there is no corresponding or consequential relief available to the counter party irrespective of whether or not such a counterparty is a related party or part of the same group as the taxpayer. In fact there is no provision for grant of corresponding relief even to the taxpayer for say a different year.
Providing a silver lining to the dark GAAR cloud, last year the Central Board of Direct Taxes notified Rules that would govern GAAR. The Rules, to an extent addressed the concerns of tax payers by grandfathering investments made prior to 30 August 2010, introducing a tax benefit threshold of INR30 million and carving out exceptions for investors in foreign institutional investors (FIIs) and also for FIIs itself, if they do not claim tax treaty benefits.
The use of treaties to claim tax exemptions has tested the Indian legislative waters successfully. An administrative circular was issued (in case of Mauritius) stating that a Tax Residency Certificate of a Mauritian entity is sufficient evidence of its residential status as well as of beneficial ownership. India’s apex court has also upheld the validity and efficacy of this circular. While the question on applicability of the aforesaid Circular in a post-GAAR scenario remains unanswered, taxpayers should also bear in mind, the possible impact of any renegotiation of the India-Mauritius Tax Treaty to bring in some form of Limitation of Benefit (LOB’) clause, which press reports indicate is being revived. The Financial Services Commission (FSC) of Mauritius recently issued amendments to enhance the level of substance required to be demonstrated by Mauritius-based entities. This indicates FSC’s effort to build substance requirement under the domestic law of Mauritius. However, it seems unlikely that these requirements will be enough to pass the GAAR test. Recently investors have also been considering Singapore as a jurisdiction to invest into India. Applicability of GAAR in a case where the LOB or similar clause in tax treaties is satisfied continues to pose doubts (separately discussed in detail in this issue).
GAAR, by its very nature, has the potential of leading to significant uncertainty and litigation. It therefore, becomes critical to put in place adequate safeguards to ensure that GAAR will be applied objectively, judiciously and in a fair, consistent and uniform way. It is hoped that the Government will soon issue clear and detailed guidelines explaining various aspects of GAAR including the circumstances in which they will or will not be invoked and how the GAAR provisions will be applied (in terms of their consequences), incorporating practical illustrations covering contentious issues, which will serve as guidance both for taxpayers and Tax authorities. In fact the statute itself explicitly provides that the GAAR provisions will be applied in accordance with prescribed “guidelines”. Furthermore, one hopes that the Government will first release a draft of the guidelines inviting comments, before finalising them.
Moreover, it should be ensured, through appropriate clarifications, that a payer is not burdened with the consequences of GAAR being invoked on the recipient. For instance, if an acquirer is required to consider GAAR invocation possibility on the seller while determining withholding tax liability it may lead to considerable uncertainty and may become a significant impediment to legitimate business transactions.
It is also hoped that GAAR does not lead to unreasonable consequences, and that adequate measures are put in place to provide for, corresponding adjustments in, for example, a different year for the tax payer or for corresponding adjustments in the hands of a counter party, as the case may be, in cases of GAAR being invoked. It should also be clarified that where SAAR (such as LOB) is applicable, GAAR will not be invoked (China also has provided this in draft administrative guidance released recently), the premise being that where a specific rule is available, the general rule should not apply.
A significant shift in the approach to tax planning in various cross border transactions will be imperative once the GAAR provisions become effective (probably much earlier — given that the impact of what is done before March 2015 may well be on the income for the period after 1 April 2015).
The basic thresholds to be met before invoking GAAR are still unclear, due to absence of clear guidance from the Government. For instance does GAAR mean the taxpayer loses his right to choose how a transaction is executed or implemented? It seems difficult to comprehend that the requirement of the law could be interpreted to mean that a taxpayer, far from being permitted to choose the most tax-efficient manner of consummating a transaction, actually needs to necessarily adopt that mode, which maximises his taxes! Instances could be many — having decided to exit a business, does the taxpayer have the right to choose to implement this as either a share sale or a business transfer? And in a business transfer, can he not choose between a slump sale or an itemised sale or a demerger? Can a taxpayer entering India, choose an entity being a subsidiary (company) or an LLP or to just have a branch? Do taxpayers have a choice to consider distribution by way of dividend v. buy-back or capital reduction? Does a Taxpayer who for good business reasons needs a holding co (or SPV) have the right to choose the most efficient jurisdiction in which to house the SPV?
Businesses often face a situation of opting for equity or debt for funding Indian ventures. While currently, India does not have any form of thin capitalisation norms, choice of funding instrument could come within the purview of GAAR. For instance, in cases where the overseas parent has funded the Indian subsidiary through fully convertible debentures (FCDs), there could be an attempt to re-characterise the interest on FCD’s as dividend by invoking GAAR especially if the debt-equity ratio is considered skewed.
Even business reorganisation strategies could come under the radar of GAAR. For example, depending on facts, a merger of a loss-making company and a profit-making company of a group, with the resultant consequence of a reduced tax liability, could be questioned.
In order to bring certainty in the GAAR regime, taxpayers could consider various dispute resolution methods such as private rulings from the Authority for Advance Ruling, advance pricing agreements and in appropriate cases mutual agreement procedures, while determining their litigation strategy. Some of these methods may provide fast and more effective resolutions of potential tax controversies, and also avoid exposure to protracted litigation, which is cumbersome in India.
The introduction of GAAR does not mean that there would be no place for any thinking on bringing about savings in taxes; nor does it mean an end to tax planning. However, it does call for a paradigm shift in thinking and in mindset, about what would now be acceptable as tax planning and as to how that would be demonstrated. Tax will not be seen to be driving businesses any more – it should be business driving tax. Business reasons and commercial rationale will be central to any planning in a GAAR environment. Increasingly one will see real substance-based planning, closely aligned with the taxpayers’ business and operating model. Documentation indeed will be key — meticulous maintenance of clear and consistent documentation demonstrating the business purpose and intent will acquire critical significance as never before. Again it is advisable to ensure that robust tax governance procedures (for the entire tax life cycle, i.e., planning, provisioning, compliance and controversy) are in place to keep enterprise from being unnecessarily exposed to the application of GAAR and the significant penalty, interest or reputational ramifications that may follow.
While there can be considerable debate about the need for a statutory GAAR, especially considering the potential uncertainty it could create in an already not-so-easy business environment. If indeed it is to be implemented, one would hope that there is — appropriate and clear guidance provided well in time, that it is invoked judiciously and administered fairly and finally that there is expeditious resolution of any disputes that may arise. Admittedly there can be no objection to the objective of wanting to prevent tax avoidance, but care should be taken to ensure that the attempt to do so does not drive away legitimate business — that we do not throw the baby away with the bathwater. Whatever be the fate of GAAR, given the environment it seems clear however, that we are moving slowly but surely towards more substance-based legitimate tax planning.