Budget 2012: PEs Deliberating If It’s ‘Fair Or Unfair’

Budget announcements are meant to tackle gaps in deficits, among other things, but after admitting that corruption, scandals and coalition compulsions have slowed down reforms, it is worth giving a thought as to how fair are the extensive proposals made in the Budget, without giving enough opportunities to global investors to plan their affairs.

The two key proposals in the Finance Bill 2012, General Anti-Avoidance Rules (GAAR) and taxation of indirect transfer of assets, have spurred anxiety among foreign investors including private equity houses.

It is interesting to note that after the bare-bone analysis when the details of the proposals are being recognised by PE funds, they have been deliberating whether these announcements are premature, given the India growth story.

What is the concern?


While it is certainly healthy to have provisions like anti avoidance and taxation of indirect transfers the concern is around the rigidity and the retroactivity around these proposals.

GAAR is introduced primarily to codify the doctrine of substance over form and to deal with aggressive tax planning.GAAR would also override tax treaties. GAAR provisions could have significant impact on PEs investing from Mauritius, Cyprus unless there is commercial substance in operations of PEs in such jurisdictions and it is proved that no part of the investment steps are undertaken for any tax benefit.

The GAAR provisions as have been introduced currently are so all-embracing that almost any transaction can be declared as “impermissible avoidance arrangement”. The detailed rules are yet to be prescribed,however, the Finance Minister (FM) has already been put to answer the many concerns of investors.The FM has assuredthat GAAR was not intended to harass honest taxpayers but just the tax evaders and that it is not applicable to P Notes.

It is important to understand the implications of vesting such wide powers under GAAR considering the levels of corruption and state of maturity of Indian economy. Such amendments can have considerableeconomic and marketconsequences which have been factually witnessed over the last fortnight on the stock markets and in investor concerns raised in the media.

There is no protest against GAAR here, however, the extent and manner of implementing GAAR is certainly worth giving a thought to be fair to the investors. The distinction between tax planning and evasion should not be erased by means of GAAR. Further, sufficient time should be given to investors to transition into the new tax policies. The issue is the “haste” – if one looks at the Direct Tax Code (‘DTC’), it also envisagedGAAR and other significant amendments but at the same time it gave investors enough time to reorganizeoperations and strategies without any shocks. Further, the level of consultations done before implementing DTC is certainly appreciable and proves maturity. Many countries globally like UK, US have such practices of such consultations and advance intimations before change in tax policies.

Indirect transfers

The Budget also proposes to tax Vodafone like transactions. In fact, on a careful analysis one would realize that all the observations made by the Supreme Court in Vodafone case have been overturned one by one in the Budget proposals. Further, these amendments are retrospective and are supposedly meant to be clarificatory. This coins a thought in the mind that the Vodafone issue was being litigated since 2007, then why the amendments are made as late as in 2012 when they were supposed to be clarificatory in nature!

The taxation of offshore transfers having India connection would impact many Global MNCs and also the foreign investors who have invested in such Global MNCs in India. Such retrospective amendments render the Judiciary and litigation process redundant and affect the confidence of investors and resultantly also the investor perception in larger gamut of things.

The Supreme Court judgment had addressedmany wider issuesand had observed that taxes are outcome of investments and that if growth is not encouraged appropriately, then the taxes are bound to shrink. However, the argument on other side is that the retrospective and aggressive amendments alone would not have a negative impact on FDI, since an investment is a result of a combination of parameters like potential profitability, scope of growthetc and tax is not the only parameter. However, the fear of losing FDI to a jurisdiction equally promising and competing on other parameters including tax cannot be ruled out.

So what’s the short point?

The BRIC countries - Brazil, Russia, India and China (BRIC) are among the top five economies attracting global FDI of more than US$20billion annually. Political stability with the speedy economic growth has made the BRIC nations attractive for foreign investments.

So the question is whether India is ready for this or are these announcements a bit too early for the country’s growth and will act as a speed breaker.

It is likely that if the Government does not address and dilute some of these proposals, the judiciary will run them down and it is only a matter of time. However, till such time, it is prudent to act as an owl and watch the proceedings.

(Anil Talreja –Partner and UrmiRambhia – Deputy Manager arefrom Deloitte Haskins & Sells. Views expressed are personal.)

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