GAAR can't be used to generate revenues: Shome

Dr Parthasarthi Shome, who headed the committee, which authored the second draft guidelines on the General Anti-Avoidance Rules (GAAR) spoke to CNBC-TV18 shortly after submitting the report.

This committee was set up by the Prime Minister himself when he was holding the finance portfolio. Below is the edited transcript of Shome’s interview with CNBC-TV18. Q: The biggest bombshell if I may call it that in this report is that you are recommending that capital gains tax be abolished? A: I would recommend to you annex 6 of the report because the details are there. Internationally, many countries have stopped taxing capital gains because – you want investment, and investment and capital flows are very fungible. If you are looking for investment like in our case, it is very important to do that. So, countries like the US, UK etc, especially non-residents they don’t do capital gains tax. In our case I feel that it is not just a question of non-residents, but it is a matter of growth coming from investment. Therefore, there is no reason why we should differentiate between non-residents and residents either. So, I have suggested in the committee and everyone has agreed is that we need to look for what is going to rejuvenate our investment. From that investment there will be growth, employment and other things, which we have lost in the past two years or so. By the way, our rate of growth has picked up a little bit in this quarter. For the last 7-8 quarters it was always negative, but in this quarter it has gone up a little bit from 5.3% to 5.6%. The finance minister has to take action so that he can make it even higher as we go along. But, we need to provide him with some robust policies which will encourage investment. Q: Are you saying whether or not GAAR is implemented from 2016-2017 you have already asked for a deferral. Are you asking for abolition of the capital gains tax from the next budget itself? A: We were saying that in the context of GAAR, if you look at capital gains tax as an instrument of collection, it is a very small revenue yielding matter and it is impacting on investment. Internationally, mobile capital is moving from one shore to the other, they are going to low tax jurisdictions where capital gains is so little. Take a look at the number of countries we have provided in terms of information. What we are saying is if we make ourselves internationally comparable then some of these structures themselves will disappear. Q: The key concern today has been, when is GAAR going to come in because in the current world economic scenario and with India’s CAD at close to 4% the concern has been that FIIs are withdrawing, investment is at an all time low because people are scared of the draconian GAAR. A: In the GAAR committee, we have listened very carefully to a lot of stake holders. Whichever stake holder wanted to make a representation we have listened to them. Considering all their inputs, we have very much kept in mind the issue of investment, the impact on investment of tax legislation and tax rules and keeping in mind at the same time the revenue productivity needs of government. So, certainly we have kept in mind the overall issue of investment and its components in coming to our conclusions. Q: Do you think there is a strong case for a deferral of GAAR, April 1, 2013 is perhaps too soon and wrong timing if not anything else to bring in GAAR? A: There are specific recommendations on when immediately or later GAAR should be implemented, keeping in mind the overall scenario and some other related matters, which we go into great detail. Given that it’s been put for public discourse, let us wait for it. But certainly, that what I have seen in many countries looking at their experiences is that GAAR is such a sensitive tax deterrence matter; it cannot become a revenue oriented issue in tax administration. So, we have to fine tune GAAR from meeting the objective of deterrence, so that is the goal. Q: The press release also says that now the reference of the committee will include all non-residents instead of just FIIs, can you explain us the significance of that? A: When we are speaking about complex corporate structures you can have financial institutional investors making a holding company abroad. They take many individual investors from many different countries and pass that investment through a holding company abroad and the asset base then becomes in India those kinds of issues are FIIs. But when for example, instead of let us say a million investors, you have major one investor abroad and another investor and then you see an exchange of assets, while the asset base is in India, but all of those transactions are talking place externally to India, does India have the right to tax? What is the international experience? Are what we are doing very different from elsewhere and if so, is it justifiable? Or if we are kind of similar then in what ways are we similar and in what ways are we not similar? In a way, that kind of an issue is called indirect transfers. We will be looking because of the extension of responsibility; we will be looking at that issue now. Q: The section 9 retrospective amendment and its unintended consequences were also referred to you earlier. So, in the report that you submitted today, have you dealt with those? A: There are certain similarities between FIIs and FDI if you can call it that way. All of them are under the rubric of indirect transfer. To some extent, we have looked at obvious implications, but the thrust of it will be covered in the extended terms of reference now. Q: The threshold after which an indirect transfer will be subject to taxation will be dealt with, with a view at a later point in time? How substantial value is defined? A: Yes. We will certainly look at that. Value, certain thresholds, these are also issues under GAAR, but we will be taking a look at them in the context of indirect transfers separately and independently under that. Q: A key demand has been that assets listed on a recognised stock exchange should be left out of the indirect transfer net. Is that something you agree with? A: That I cannot tell you immediately because part of it will also be in the GAAR report. Many countries do exempt gains from listed securities. Q: The demand has also been that capital market transactions and FIIs should be left out of the GAAR net. The current chief economic advisor Dr Raghuram Rajan has said that at this point in time the need is India’s. We need the capital to flow in to finance our current account deficit. So, to leave out a segment of the corporate sector out of GAAR, do you think is ethical from tax department point of view? A: The issue is how these kinds of investments take place and whether the revenue department can and should spend X amount of resources pursuing these kinds of deterrents approaches. What is the optimal return from a deterrents point of view that you would get from it. So, to some extent, we do consider this issue. Q: The concern that tax payers have is that there will be too much discretionary power in the hands of the tax department and they will use it as a whip to get tax payers to pay more tax. GAAR by its nature is subjective so how do you make this objective? How do you ensure that there is not too much discretionary power in the hands of the tax department? A: By two means, one is, sometimes there are areas of subjectivity so you limit them or truncate them and define very clearly to the extent feasible all the different terms and conditions under which GAAR can be invoked. So, if you define clearly then it doesn’t have to be a very broad base instrument. You can kind of limit it to aspects of deterrence, which is a very important instrument that tax departments need. But if one can design it in a particular way so that only very clear cases of abuse, structures that are abusive and which were not intended in the legislation of that particular area we can certainly look at it in a intelligent manner and propose those kinds of conditions under which GAAR can be intelligently applied and should be applied. _PAGEBREAK_ Q: The kinds of tests used for GAAR are very subjective in nature. Is it possible to objectify them in the kind of illustrative examples that you’re talking about? A: Yes, because if look internationally how impermissible arrangements have been defined, commercial substance has been defined, what are the main purpose that you have to define, if you are very clear and incisive about these definitions you can kind of limit the subjectivity. If you really look at all of these interpretations there is a minimal amount of subjectivity that will remain and that should remain. This is because the assessing officer who will raise the issue of GAAR will have to use his own discretion to some extent to realize is it a case worth looking into and bring it to the attention of the Commissioner. So, there will be some subjectivity, but you limit the subjectivity, so that it is not used indiscriminately, but in a very careful manner. Q: Critics will now say that this is a GAAR which is not strong enough, earlier they said that it was too draconian what would you say to those critics? A: You should take a look at what we have said. Since the report is there let us see people will come back to it. We have to be internationally comparable because as we get more and more harmonised with the rest of the world in terms of trade and balance of payments, we also have to see domestically increasingly through what is called benchmarking or comparisons among various international tax administrations and even in tax administration we have to become internationally comparable. What we have tried to do is to propose a GAAR that will become internationally comparable keeping in mind two things that we do need investment at this time and at the same time preserve the efficacy of tax administration. Q: After the retrospective amendment the tax department has received a lot of negative publicity and you are saying that it needs to be compared to international standards and investor friendly? Apart from this else can the tax department do to go ahead with the road map of that sort and also to take the sting out of retrospective amendment? A: We will be looking at that whole thing of indirect transfer. Once one looks at it and how it is operating today, it is not just the matter of retrospection, but also a matter of how you actually deal with this kind of arrangement within the income tax act. Second thing is to allow for very incisive and perceive training to a class of tax officers who will become more and more familiar with international taxation aspect like transfer pricing, arm’s length, in capitalisation, GAAR, SAAR (Specific Anti-Avoidance Rules). We need a battalion of brilliant tax officers who are trained incisively and who then keep up. I do feel that is what is done in most large tax administrations that I know in other countries and we should move in that direction. Q: Are we working with a timeline of the next budget because an amendment of the Income Tax Act before that would be difficult unless it’s done through an ordinance? A: We have a very dynamic finance minister. He will be showing the roadmap of what he intends to do. I certainly hope and I expect from this finance minister that he will be taking very strong measures to ensure that, that kind of thing happens. Q: STT was something that was brought in at a time when you were advisor. Increasingly as you see STT on derivatives being a deterrent and business shifting to Dubai, London, Singapore from India, do you think a strong case is now building for also bringing down STT, not just in cash but also on derivatives? A: STT is a relatively small tax on transactions and we exempt long term capital gains of more than a year. So, it is almost like a toss up. Do, you tax capital gains in the form of gains where increasingly other countries are exempting capital gains on non-residents or you don’t use STT that much, but you do need some revenue from this. I don’t think we can have STT rates which are internationally too much of an outlier, but some countries do use STTs. I wouldn’t say that on an immediate basis that we can just get STTs out of the way. Certainly, the rate should be calibrated in such a way that we are internationally comparable. Q: We are at a very critical point in the economy where we are facing a slowdown in investment, there are international pressures and at home we face a fairly strong fiscal consolidation pressure. Do you think it would be wise at this point to withdraw the fiscal stimulus? What would you recommend out of this problem? A: I do think that we have to curtail expenditure and also improve the quality of expenditure. How we really carry out, reduce leakage and so on. Beyond a point we cannot have growth if the tax burden is too high. We compare only the tax GDP ratio across countries. But if you really look in country like ours where our per capita GDP is now just a small proportion of China’s one fifth, one quarter or one fifth of many countries in Latin America leave alone in East Asia then we have a huge portion lets say about quarter of our GDP is subsistence GDP. If you look at the non subsistence GDP which is smaller and the tax that we collect from that subsistence GDP then our tax GDP ratio is quite high, is 25% rather than 17%. We are not a lowly taxed country from that point of view. We do have to streamline expenditure. We cannot give away all kinds of subsidy programs. I do believe that efficiency in expenditure is improving but we have a long way to go.