PE investors watching GAAR provisions closely: Expert

Below is the edited transcript of the interview. Also watch the accompanying video.

Q: Is it becoming increasingly clear that investors who are coming through Mauritius and who have largely a post box there, they will come under GAAR and will be taxed now?

Desai: Yes in many ways. At the same time the GAAR is so subjective and such a perception based law that number of other issues can also come up in addition to the presence in Mauritius itself. So it is increasingly becoming even more complicated now and there is no clarity now. The main problem with GAAR is it is very subjective, it is very perception based and in many ways it is arbitrary and that is what is causing lot of trouble to the FIIs and other investors overseas.

Q: The only clarity that seems to have emerged is that come the finance bill there will be an explanation of what commercially substantial means in terms of these entities that are being discussed. Would you say though that the modalities of that may well exclude most of the companies working out of or most of the funds working out of Mauritius?

Bahl: What we see and what GAAR seems to suggest, I think it is going to be exceedingly difficult to avail the treaty benefits in fact not just from Mauritius but quite possibly with other treaties. Even treaties where there is already a definition of what is substance are likely to be tested under the treaty because one of the fundamental problems is taxation. The moment there is a tax claim or a tax reduction the burden of proof is on the investor to satisfy the department that GAAR is not to be invoked.

So that’s one very big problem. The other one which is still doing rounds is the grandfathering. I know that during the deliberations of the standing committee the department is said to have clarified that during the formulation of the DTC they will make it clear that prior transactions will not be impacted by GAAR in their unwinding. But I don’t see anything specific on that in the current finance bill.

Q: On the FIIs investing in the bond market or the fixed income market there is a lot of apprehension that all bond transactions will come under the withholding tax net. Are you clear that this is a clear possibility because a significant amount of money has come in this year into the fixed income market in India from a large number of these global investors?

Desai: It’s a real possibility because the GAAR provisions permit the tax department to restate the facts and then apply any law in any manner they like and that is a problem. So what would happen is that if they state that they would be deemed to have invested directly in India then obviously the tax implications could be different and in many ways this whole GAAR does not have any safeguards at all. We took these provisions from South African provisions but we removed what we call the safeguards that have been statutorily provided in the GAAR in South Africa.

Same thing if you look at UK, they have clearly said that the attractiveness for the UK should not be diluted and once again it should not be used as a weapon. It should be used as a shell and there is no comfort on the part of the foreign investors. I was on the road in last 10 days in California, in New York, in Europe and other places and there is huge concern about what exactly is going to be provided in the guidelines, whether they should wait until the guidelines come out and how reliable the guidelines are, how they will be worded?

So at the end of the day FIIs if you see majority of the money come from pension plans, endowments and other kind of mutual funds where a small investor moneys are involved. So there is a huge fiduciary responsibility on the part of fund managers to make sure that their investment is not impacted and they are able to provide long term returns as may be expected.

In India it has become extremely difficult to compute the cost of doing business and at this point in time that is a real concern that you do not know what they would do with this provisions. Because it is so wide and so discretionary in many ways inspite of the fact that they have said that there will be a GAAR committee which will go into – but that happens only at the time of assessment. At the time of issuance of P-Notes or otherwise what would you do? So everyone would want indemnity and without indemnity who will bear the cost of tax, that’s the issue.

As a matter of fact I may add one more point that the second segment that is going to be really impacted with the banks and the non banking financial institutions which would be issuing structured products because structured products or structured finance provides huge finance to the industry in special situations and that is all going to be extremely difficult. So far we have seen the impact of P-Notes on the market but structured finance will be the second category where we will begin to see some difficulties.

Q: On the point Nishith was making whether it seems apparent now that there will be an impact on investors into the bond market and a tax as high as 20%? Whether you think there are other cashes of investment that may get targeted?

Bahl: Naturally the whole private investment, the PE investment community is also watching this extremely carefully because while we look at FIIs as being a substantial investor, the real long term FDI is either coming from strategic investors or private equity investors. So they are going to be equally impacted by all of these provisions and again the looming uncertainty of unwinding of old positions, what really the future means, is any treaty at all protected?

Singapore protected for example, if there is a regional hub in Singapore and that regional hub is used to make the investment into India. The fact is that if the owner of the Singapore entity is US based, the question will be asked why didn’t you invest through US?

So since you invested through Singapore there is a tax benefit. If there is a tax benefit now you have the burden on establishing why GAAR should not apply to you. So it is going to go far beyond just the financial institutional investors. It is going to have a significant element of consideration and rethinking for private equity investors as well.