GAAR: Onus of proof on revenue encouraging, says ALMT Legal

In an interview to CNBC-TV18, Aliff Fazelbhoy, partner - tax, M&A and employment, ALMT Legal gives a detailed analysis on the draft guidelines released by the finance ministry which would exempt foreign institutional investors if they refrain from routing money to India via tax shelters.

Concerns over the planned General Anti-Avoidance Rule, or GAAR, have dampened investor sentiment in India. Fazelbhoy finds that even though everyone cannot be pleased, the clarifications are a welcome step in the right direction.
However, the GAAR guidelines still leave a lot of ‘ifs and buts’ and still needs to offer more clarity on the fine print. Below is an edited transcript of his interview. Watch the accompanying video for more. Q: Do you think it was positive and significant enough for FIIs to feel relieved?
A: There are a lot of positives in these clarifications. You cannot please everybody but they have tried to do is to send out positive signals. Q: It kicks in only on activities from April 1, 2013. Is it the fact that it will not be retrospective? What would you say are the positives?
A: There are three-four specific positives for e.g. one is the prospective. Though that does not take care of transactions that were entered into before 2013 and exited post 2013, that is unclear what will happen. That is what they call the grandfathering clause. So we do not know about that.
But the other big positive is the burden of proof is on Revenue which earlier they proposed to be on the taxpayer. So that is the biggest positive. They are going to prescribe minimum monetary thresholds for GAAR to apply which is another positive. Prescribing certain time limits and certain reporting forms is another positive. Q: They also say tax will not be applicable to investors who are non-residents but only to FIIs. Does that mean that participatory notes are largely excluded?
A: The investors, not only in participatory notes but investors in units of funds like for e.g. you have a mutual fund in the US which is registered as an FII and invests in India. The way the earlier provisions were worded or even on indirect transfers, under those provisions those unit holders could have been taxed.
But now this clarification says they will not be taxed. I do not think there was ever the intention to tax them. That is a good clarification but similar clarification should be issued for the indirect transfer tax provisions for that to be effective. Q: On the minimum monetary threshold because GAAR is applicable not just to FIIs but to a broader basket, do you think that will be set significantly lower or could it be very high?
A: You cannot predict anything with the finance ministry but hopefully it will be a reasonable level. Q: The press release on the PIB website is a long one and has a lot of illustrations on when anti avoidance rules will kick in. Can you give us some idea of how a layman should understand it?
A: It’s good for the layman because the examples are quite nicely given so you know what can be GAAR and what may fall within. It’s not just that you come through a treaty country and you will be hit by GAAR. It clearly says that if the country has substance like you have an operating entity in a country just because that country has a low tax doesn’t mean that you will be hit by GAAR. But if you go to a country specifically to reduce your tax you may be hit by GAAR.
Take a simple example like an employee high performing individual who is promised a big bonus if you perform. People were coming up with innovative structures like – one of the examples is you are given preference shares and if the company makes a particular target we will redeem these shares at a premium. So you will save tax because redemption is capital gains, its much lower than a salary tax. That comes within GAAR and that has been clarified.
But on the other hand certain things for e.g. between two companies you say I will give you this service free of cost. Now there they said there is a specific provision for transfer pricing. That will take care of this situation. You will not be hit by GAAR because there is a specific other provision so you cannot be hit twice. These clarifications are fairly nice, some clarity is there – you cannot please everybody.
_PAGEBREAK_ Q: The onus of providing impermissible avoidance is on revenue but certain words can still be interpreted by revenue in a manner which obviously the tax payer will not like. Could there be fuzziness and therefore arbitrariness in say, lacking commercial substance - who is to say what is commercial substance, can it be more precise? How do you distinguish from tax planning? Can there be fuzziness and therefore, a desire for more clarity?
A: You can keep clarifying and clarifying but for example, they have tried to define the commercial substance in the earlier draft. Now the definition was so wide and they put ABCDEF then everything lacks commercial substance.
So is it better to have such a definition or not have a definition at all? To my mind it is better not to have a definition because you look at it in the business sense. Would two people normally do a transaction in this way? If the answer is yes, it has commercial substance. If answer is no, does – and you cannot have legislate to every particular thing. Q: Earlier the GAAR lack of clarity originally started there was a lot of apprehension that the Mauritius route was being closed through this. Have they provided any kinds of clarity in the draft guidelines yesterday or do you think there are still left to be decided?
A: The Mauritius route would largely not be closed but people would be subject to tax now if they come through Mauritius for no reason other than to avoid tax. I don’t think it is necessarily a bad thing because you see FIIs invest through Mauritius, they pay no tax, and the unit holders in the FII get the income tax free.
So I am sitting in the US, I invest in a mutual fund which is registered as an FII, invests in India. When I get the profits sitting in the US, the US government will tax that. Had that been taxed in India, he would have got a tax credit in the US. So the investor is no worse off. The US government makes tax on profits earned in India, why should that be?
So there is logic in what they are proposing that if you come in via Mauritius, you pay tax. What is wrong if you make some profit, you pay some tax, nothing wrong with it? Q: Do you think the FIIs are better placed now to come in provided the market is otherwise meeting their valuation criteria? Do you think legal structure wise, this is creating a stable environment for them?
A: FIIs to my mind – and I have spoken to a few FIIs – are not too worried about GAAR because they say we know we will be taxed if we come via Mauritius, we tell the investors, they know and 10% tax long-term is anyway exempt, short-term 10%; people are willing to pay some amount of tax so it should not affect too much as long as the rules are clear. What they are more worried about is this indirect tax that unit holder should not be taxed and that they should not be withholding obligations on the FIIs when they pay the unit holders. Q: But isn’t that fairly clear that non-resident investors are not going to be taxed? Is it not that full proof in the guidelines?
A: That is GAAR guidelines but you look at section 9 and those indirect tax provisions those can have cascading effect. Q: That is where clarity would be needed?
A: Exactly, you need clarity on that as much as this to create a stable environment.