The mould for shaping the much anticipated and elusive implementation of General Anti Avoidance Rules (GAAR) has been set by the government by issuing the draft guidelines. The draft guidelines shed a practical light on the directions and reasoning (in the form of illustrations) for invoking the provisions of GAAR by the tax officer.
The message behind these norms is that the future transaction/investment structuring / reorganisations would all have to pass the test of GAAR, with the draft guidelines forming a stepping stone towards its implementation. The draft guidelines have attempted to lay out a pathway as to what would be considered permissible/impermissible to avoid indiscriminate application. The committee has invited comments/suggestions on the draft guidelines by July 20.
Highlights of the proposals in the draft guidelines:
When can GAAR be invoked?
GAAR can be invoked if there is a tax benefit (reduction/avoidance/deferral in tax or reduction in total income / increase in loss) and creates rights or obligations (not at arm’s length)/misuse of tax law/lacks commercial substance/not for bonafide purpose.
The onus is on the tax officer to prove the tax benefit arising out of a transaction. In case, GAAR is attracted, the whole transaction could be disregarded or re-characterised.
Setting an example
It is interesting to note a few illustrations in the guidelines, depicting key areas of transactions subject to GAAR, which may impact the current investment / transaction pattern by the private equity and the corporate houses:
Commercial substance in a low tax jurisdiction
This should instil confidence in the private equity fund houses that are able to meet adequate substance. However, it is unclear on the nature of business to be carried on for establishment of substance.
Exit scenario – capital gains
Scenario 1: Beneficial ownership
Beneficial ownership of the funds invested in India would be considered as the real owner at the time of exit from India. Existing funds having a similar investment pattern i.e. low tax jurisdiction investment need to re-evaluate the investment structure.
Scenario 2: Interposing intermediate holding company
GAAR would be attracted in the following cases involving cases where intermediate jurisdiction is interposed for making investments in India:
Interest on borrowings
Arrangement of subscription to Compulsorily Convertible Debentures may need to be revisited in light of the above clarification.
Merger of loss making company into a profit making company
GAAR would not be attracted since adequate mechanism has been built in the merger provisions.
Reorganisations carried out by companies for alignment of value in the group entities would not be impacted in this case.
Overseas dividend not repatriated to India
This is a welcome clarification for corporate houses having overseas business with future investments out of the retained earnings at overseas level.
The existing investment framework of the private equity funds and the transactions undertaken by the PE deal makers and the Indian corporate houses could come under the GAAR scanner in case of lack of substance. The exit and funding strategies, current investment framework and the holding company jurisdiction structure need to be evaluated by the investors taking cue from the draft guidelines.
The draft guidelines aims to set up a stage for the deal makers to keenly watch out the commercial substance and the business rationale before undertaking a transaction.
(Anil Talreja is a Partner, Deloitte Haskins & Sells)