By Ruma Dubey

GAAR. Like the word ‘ghost’ it does this “boo” and scares the wits off traders/investors. But today on Dalal Street, traders and investors of any significance are really the FIIs. And they surely seem to be totally and fully spooked with this. The markets, a few days ago had tanked on GAAR fears, that it will be implemented from 1st April 2015. There has been no clarification on the same, whether it will indeed come into effect from FY16 or would it be postponed by a year or two more. The ambiguity around GAAR remains yet everyone, for now, has decided to move on and concentrate on company earnings. That’s nice but the fact remains that the pall of GAAR, remains around the traders.

GAAR is an acronym for General Anti-Avoidance Rules.  And what is anti-avoidance? As per the proposed provisions in the Direct Tax Code, a transaction shall be considered to be a tax avoidance transaction, if it is undertaken with the main purpose of obtaining a 'tax benefit'.

FIIs simply hate the word, “GAAR”. Their main fear is that money which is routed through Mauritius, which provides a tax benefit to the FIIs due to the tax treaty with Mauritius, will no longer be applicable. This means that FIIs will cease to enjoy any tax benefit.

The biggest issue more than GAAR itself is the uncertainty. The new rule was earlier scheduled to come into effect from 1st April 2012 and was then postponed in 2013 to 1st April 2015 and the Finance Minister issued clarifications.

The ‘clarified’ GAAR as of now says this:

• GAAR will not be applicable where the tax benefit does not exceed Rs.3 crore in the relevant fiscal- apart from this, there are no other safe harbors.
• GAAR not applicable to investments made prior to 30th August 2010 – the date when the Govt introduced the Direct Tax Code Bill. There is a major grouse over this as this exemption to investments is limited and in the end, majority of the transactions, though prior to 30th Aug’10, will end up paying GAAR. Thus there is ambiguity on what exactly will be exempt or else almost everything ends up being retrospective. Ideally, it should apply to only those investments made subsequent to implementation of GAAR. This is known in tax parlance as “limited grandfathering”. For eg: income from investments made in Mauritiu, Singapore, Cyprus, Cayman Islands will get tax benefit as per the treaty but if the company has ‘other income’ from, say, interest earned on debentures, it will attract GAAR, even if the investments were made before 30th Aug’10.  There is uncertainty in tax exemption for FIIs on sale of assets including equity investments is worrying. At this juncture the FIIs do not know whether the GAAR will come into place, overriding the Tax treaty with Mauritius or it will run alongside with some tweaking’s.
• The clear clarification was on only one account – GAAR not applicable on P-note holders.
• Most worrisome – the four tests and the power of the tax man remains. There are a set of four tests – bona fide purpose test, commercial purpose test, abnormality test and misuse and abuse test.  First and foremost, the FII has to prove a legitimate purpose and once he is able to do that, if P-Notes fail even one of these four tests, GAAR will be invoked.

But now the challenge is that all these four tests are very wide and it would be difficult to prove which transaction falls under which test. There is no clear definition of what they mean by ‘commercial substance’, ‘bonafide’, misuse and abuse. The entire test process has been made very complex. Many a times, a P-Note holder’s main purpose of entering into a swap deal with the FII is with the purpose that the FII will pass on benefits like bonus, dividend and profits from sale of shares to the P-Note holder. And if that is the main purpose, clearly, it tantamounts to avoidance of tax and this is when GAAR will get invoked.

The GAAR will now wield tremendous power in the hands of the IT officers. They can determine the tax consequence for the assessee by disregarding any arrangement, even the Double Taxation Avoidance Agreement (DTAA) with Singapore, when he fails even one test.  The only solace is that when a taxman issues a notice saying that GAAR is applicable, he will have to provide a detailed reasoning. The existence of the GAAR Panel is a good safeguard against illogical and tyrannical taxmen.

• Also there is no clarification yet on SAAR v/s GAAR. SAAR is Specific Anti-Avoidance Rule. What happens if SAAR is applicable and not GAAR? Ideally, GAAR should not be applied in that particular case but there is no clarity on this – the Govt had said in 2013 that when SAAR and GAAR, both apply, guidelines will be issued to state, which of the two would be applicable. No word yet on this.

The FIIs and Corporate India are not saying don’t bring in GAAR; it is a potent tax tool and exists in China, Ireland, Australia, Canada, South Africa, Germany, France, New Zealand. USA has an in-built tax avoidance rule. In all these countries it has taken years before it could stabilize. Here, the worry is the existence of subjectivity in GAAR implementation and lack of clarity on various issues – whether it will be retrospective, which cases will specifically be outside GAAR purview and the biggest negative – lack of trust between the tax payer and the tax administrator. Constant communication, in form of clarifications is a must. There is also worry that GAAR is very specialized – are the existing taxmen trained to deal with this?

Thus the FIIs and India Inc is not worried “about” GAAR but “about how it will be implemented”.  Hope the Govt pays heed to these fears and removes this persistent sword hanging over their (consequently our) heads.