At last the investors flinched—foreign institutional investors (FIIs) sold shares worth Rs 723 crore, domestic institutional investors (DIIs) about Rs 45 crore in a day! The confusion over GAAR played the perfect spoilsport and led to one of the biggest falls in Nifty in last 16 months last Friday. While the budget announcements were silent on the implementation of GAAR, the Minister of State for Finance reiterated GAAR would be applicable by April 1, 2015. Then came the confusion, the revenue secretary spelt out the new government would examine the whole matter, they still have roughly about two quarters to review the implementation. Markets were expecting to tap dance to the orchestrated governance and implicitly assuming the GAAR roll out date to be deferred by at least a year. But for now it is in the law to be operational by April 1, 2015, which can only be deferred by an amendment.
GAAR was first proposed in 2009 by the UPA government in the Direct Tax Code (DTC) to curb ‘Impermissible Avoidance Arrangement’ – i.e. an agreement entered into with sole or main purpose of obtain tax benefit and no other material impact. The government needed a tool to manage aggressive tax planning consequential to sophisticated structures that channel profits through tax havens et al. The proposal was baptised by fire and faced severe criticism from the investor community. Consequently, Shome Committee was constituted which suggested a deferred implementation of GAAR to FY2015-16
The coverage of GAAR is over encompassing and includes all arrangement with an attempt to reduce tax liability. It applies to the following:
1) An arrangement where the tax benefit arising is more than Rs 3 crore
2) Does not apply to an FII who is an assessee under the Act; not takes the benefit under section 90 or 90A; invested in securities with prior permission of competent authorities (SEBI in this case)
3) Similarly, it is not applicable to a non-resident person invested through offshore derivative instrument in an FII
GAAR is proposed to be applied to tax benefit obtained from the arrangement on or after April 1, 2015 with exclusions to income from transfer of investment made before August 30, 2010.
GAAR allows inundated powers to tax authorities to declare a structuring to be ‘impermissible avoidance arrangement’. Adequate usage of such assessment power seeks well informed, updated tax department officials with competent ability to adequately comprehend complex arrangements. A slight disconnect can lead to initiation of arbitrary actions.
Then comes the wave of interpretation related challenges, varying acceptability amongst business groups, quality of preparedness at all levels and a broad question on the timing of implementation voiced by the businesses.
The investor’s perspective
At a broader level, investors seek clarity on the guideline and regulations they have to operate under. This draws the contours of the long and short positions held by them. GAAR regime in its earlier avatar was marked with excessive concentration of assessing powers, ambiguous guidelines on have and have nots and needed to establish an investor friendly implementation approach. Vague letters in the guidelines and lack of clarity on implementation and assessment left scope for potential mishandling. Investors took cues from countries such as Canada (1988), China (2008), South Africa (2006) and Australia (1981) where GAAR has already been under implementation and has seen legal and financial litigations. Realising the need for swift implementation, government took measures to build acceptance of GAAR rules by inclusions of monetary benchmarks, declaration of non-applicability to FIIs in case of non-usage of tax treaty benefit, flexibility around grandfathering of investments and setting up of an implementation date for applicability of GAAR provisions. The current form of GAAR provides a relief in form of time based limit on conclusion of the proceedings. Such measures along with a cast of obligation on the tax authorities to conduct a detailed assessment exercise before initiating GAAR proceedings was widely welcomed.
The market reactions
There seems to be an almost open agreement that implementation of GAAR may impact the market expectation in the short term thorough some untimely and haphazard exits from overweight interests in the country.
With advent of globalisation and liberal economic policies investors have look at pastures of higher return on capital employed, in doing so harped on tax havens. Countries worldwide have re-examined usage of havens and there are more than 15 countries which implement GAAR. Capital availability opportunities can clearly be improved through timely actions on the fancy and deceptive tax avoidance mechanisms. Hence, widespread belief is GAAR is an eventuality and popular tool for the state to generate much needed capital for the current economic situation.
Markets need clarity, which the current framework does not offer with its ‘sweeping’ approach. On a scale with confusion at one end and absolute clarity on the other, the current GAAR lies somewhere in the centre. Genuine investors in the India story would view the current developments as initial days of anxiety; this is not new and has been witnessed by almost all the countries where GAAR is considered by the incumbent government. As long as the government does a good job in maintaining investment attractiveness of the country, investors would continue to believe in long-term country level optimism.
With over 100,000 offshore entities and trusts involving more than 150 countries the coverage of GAAR would be huge and leaves a lot to fretfulness of investor community. MNCs and other foreign investors would be cautious enough to run GAAR stress test to the existing structures and make arrangements in case of a failure.
Some of the recent industry surveys point towards an expectation on delay in implementation of GAAR for the want of better preparedness on implementation, clarity on nuances, clear view on impact on select participant classes. Will the markets crash? No. Will GAAR continue to keep investors uneasy? Definitely. Will we witness a temporary disorder? May be.
While there would always be scope for clarity on matters related to tax regulations the current investor sentiments are reminiscent of an anxious beginning.
(Sandeep Lal is a Senior Consultant, M&A advisory at KPMG)
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