Tax Avoidance is a matter of concern across the world. There are rules framed in different countries to minimize tax avoidance. General Anti-Avoidance Rules (GAAR) is a set of general rules framed so as to check the tax avoidance under which the tax department gets the right to scrutinize transactions if they believe that they are structured to avoid taxes. For example if an entity is set up in Mauritius with the only intention to get exemption from capital gains tax then tax authorities have the right to deny the claim for exemption under the India Mauritius tax treaty. GAAR was introduced in 2012 by our then finance minister Pranab Mukherjee but its implementation was deferred because of the apprehensions expressed by foreign investors. It is applicable to all investors but major focus is on foreign portfolio investors (FPIs) who invest in Indian markets through other countries where tax rates are very low. The provisions of general anti-avoidance rules will come into effect in India from April 1,2017.
Anti-Avoidance Rules are divided into two categories “General” and “Specific”. The legislation dealing general avoidance rules are termed as GAAR, whereas legislation dealing with specific avoidance rules are termed as SAAR. Till now SAAR is implemented in India and is not successful in covering all the cases of tax avoidance. Indian tax authorities now want to implement GAAR but are facing opposition from tax payers as they fear that these will be misused by tax authorities by giving arbitrary powers. SAAR being more specific, provide certainty to taxpayers where as GAAR being general can be misused and can also be subjected to arbitrary interpretation by tax authorities. Similar tax regulations exist across different countries to discourage tax avoidance practices. GAAR is applicable in China, South Africa and Australia while SAAR is implemented in China and Australia to check tax avoidance cases. Principal Commissioner of Income Tax Department or Commissioner of Income Tax Department will vet the proposal before applying GAAR which will be followed by the decision of an Approving Panel headed by a High Court judge. GAAR will not be applicable on investments done before April 1, 2017. The government also clarified that GAAR does not want to discourage investors, nor it will interfere with the right to select a method of implementing a transaction. Also the residency of taxpayers in a tax friendly jurisdiction with taxes lower than India will never be the sole reason to apply GAAR norms.
GAAR provisions will not be applicable in the following cases:
- Transactions where the tax benefits are less than Rs 30 million in a financial year.
- Convertibles such as compulsorily convertible debentures, foreign currency convertible bonds, compulsorily convertible preference shares and global depository receipts.
- Shares received on the split or consolidation of holdings , bonus for shares obtained before April 1, 2017.
- In case of any tax associated with an arrangement sanctioned by the Court or National Company Law Tribunal (NCLT)
- Provisions will not apply if the tax benefits obtained are permissible under the limitation of benefits clause provided in tax treaties. LOB states the conditions that allow benefits in a double taxation avoidance agreement (DTAA).
- GAAR will not apply to FIIs that do not claim double taxation avoidance treaty benefit. Similarly, FIIs that pay appropriate tax will not be subject to GAAR.
GAAR will affect FPIs investing in India through countries with lower tax rates. Around 80 percent of FPI investments comes from countries Mauritius and Singapore, allowing investors to avail tax benefits. This led India to amend its tax treaties with both countries, only allowing investments held before April 1, 2017 to avail treaty benefits without invoking GAAR. Both treaties allow a two year transition period wherein the tax rate will be only 50 percent of the prescribed rates whereas as full domestic rates will be applied in 2019-2020.
Some investors also believe GAAR will not have a significant effect on portfolio investments as they are getting sufficient time to adjust to the regulation and change their investment methods. Many investors have begun using alternate investment routes in anticipation of GAAR while equity investments from Mauritius declined. Hedge funds and exchange traded funds (ETFs) investing in India have also begun to adapt their practices and have advised investors to invest now to avail the GAAR exemption which will expire on March 31, 2017.There is also a fear in private sector that it will grant arbitrary powers to tax authorities so they want the government to provide further clarity and certainty on this legal framework. The levy of penalty under GAAR would depend on circumstances and facts of the case and is not automatic.
The basic criticism of GAAR provisions is that it is considered to be too sweeping in nature and there is a fear that there will be harassment of general honest tax payer too. There should be checks and balances to avoid arbitrary application of these provisions by the assessing authorities. There is a need for further legislative and administrative safeguards and a minimum threshold limit should be set for invoking GAAR should be introduced so that small tax payers are not harassed.
Recommendations to save tax payers from harassment:
- Assessing officer will be required to issue a show cause notice stating reasons for invoking GAAR.
- Taxpayer will get an opportunity to put its case before the officer.
- Three member panel that will finally approve GAAR .
- There will be a mechanism of obtaining advance ruling whether an arrangement is permissible or not.
- Time limits will be prescribed for various authorities under GAAR
- GAAR will apply only when tax benefit exceeds Rs 3 crore.
- Same income will not be taxed twice by invoking GAAR.
GAAR has the potential to lead to significant uncertainty and litigation. So it is critical to put in place adequate safeguards to ensure that GAAR is applied objectively, judiciously, fairly, in a consistent and uniform way. It is expected that Government will soon issue detailed and clear guidelines of GAAR including the circumstances in which provisions will or will not be invoked and how it will be applied, which will serve as guidance both for tax authorities and taxpayers.
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