Govt takes first step towards bringing in GAAR regime, notifies rules

The much-awaited guidance on General Anti-Avoidance Rules (GAAR) was recently notified by the Indian government. Venture capital (VC) funds and private equity (PE) funds were expecting detailed and comprehensive guidelines on GAAR regime and the recent notification appears to be a first step taken by the government in that direction.

To recap quickly: during 2012, the Indian government introduced GAAR provisions in Indian domestic tax law. Thereafter, responding to the representations of various stakeholders, the government formed a Special Committee (the Shome Committee) to reconsider the GAAR provisions and submit recommendations. In January of this year, the  finance minister made a formal announcement indicating the government's intent to amend certain provisions of the GAAR regime. These amendments were in line with recommendations of the Special Committee.

It was expected that the Union Budget 2013-14 (which was presented by the finance minister on February 28, 2013) would legislate all the proposals announced by the finance minister. However, only key proposals were enacted, one of which was deferral of the GAAR provisions until April 1, 2015. In the recent notification, the government legislated other key proposals, which are as follows:

i) Monetary threshold prescribed: The notification states that GAAR provisions shall be invoked only where the tax benefit of any arrangement exceeds Rs 30 million (around $500,000). It is important to note that the limit of Rs 30 million is to be aggregated where multiple parties are involved in an arrangement. Accordingly, where a transaction involves two or more parties, the tax benefit to each of the parties will need to be considered. It is possible that transacting parties may choose not to share details of the tax benefit obtained in an arrangement, and thus creating a practical difficulty in application of the monetary threshold in transactions.

ii) Applicability to foreign institutional investors (FIIs): FIIs investing in listed or unlisted securities in India and which do not claim tax treaty benefits are sought to be kept outside the purview of GAAR regime. Tax-paying FIIs, as such, did not have any serious concerns relating to GAAR regime but it is still good that an express clarification has been provided.

iii) Applicability on offshore derivative instruments (ODI): The notification also seeks to keep non-residents making investment by way of ODI (aka P-notes) or otherwise, directly or indirectly, in an FII outside the purview of GAAR regime. The intention appears to keep ODI or P-notes outside of the GAAR regime.

iv) Grandfathering of existing investments: The notification states that income derived by a person on transfer of investments made on or before August 30, 2010 shall be grandfathered and GAAR provisions shall not apply to such investments. This is in line with the announcement made by the finance minister earlier this year.

The notification further states that GAAR provisions shall apply to any arrangement, irrespective of the date on which it has been entered into, in respect of tax benefit obtained from the arrangement on or after April 1, 2015. A doubt has been raised in certain quarters on whether investments made on or before August 30, 2010 will continue to be grandfathered, even if the said investments are transferred on or after April 1, 2015.

While the notification could have certainly worded in a better manner, considering the fact that the finance minister stated that investments on or before August 30, 2010 would be grandfathered and the notification reiterates the statement of the finance minister, one could take a view that income derived on or after April 1, 2015, on transfer of investments made prior to August 30, 2010, is likely to be grandfathered under the GAAR provisions. On a related note, it may be good for the government to clarify that grandfathering shall also apply in respect of other stream of income (such as royalty, interest, etc.).

The notification also provides guidance on operational matters dealing with the administration of the GAAR regime, such as that a tax officer is required to issue a show cause notice to a taxpayer; that specific forms have been prescribed for tax officers to refer the arrangement to the commissioner and for the commissioner in turn to refer it to the approving panel; and that time limits have been prescribed to govern the GAAR regime in a practical manner.

Surprisingly, the notification is silent on the applicability of GAAR in cases where Specific Anti-Avoidance Rules (SAAR) apply. Earlier this year, the finance minister announced that either SAAR or GAAR will be invoked in transactions where both rules are applicable and that the government will prescribe guidelines to address where each regime applies.

Overall, the notification is in line with the formal announcement made by the finance minister earlier this year and does provide the much-needed guidance to FIIs and investors trading in P-notes. One would hope that the government also provides additional guidance on grandfathering of other streams of income and specifies guidelines on SAAR vs GAAR (and of course on taxation of indirect transfer of Indian entities), which are also anxiously awaited by VC and PE funds.

(Suresh V Swamy is Executive Director and Devang Ambavi a Manager with PricewaterhouseCoopers Private Limited.)

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