GAAR: Here's what you need to know

The finance ministry has provided some helpful clarifications on the General Anti-Avoidance Rules (GAAR).

Recently introduced as an anti-tax avoidance measure, GAAR seeks to examine the commercial and economic substance of a transaction, arrangement or investment, and to declare it as an impermissible, avoidance arrangement in case the prescribed tests are satisfied.

An expert committee headed by Parthasarathi Shome made recommendations for the re-design of GAAR after a comprehensive review. Clarifications from the government indicate that some of the major recommendations have been accepted.

The major clarification is that GAAR will be deferred to April 1, 2016. Investments made before August 30, 2010 will be grandfathered, meaning they will be taken out of the purview of the new legal provisions.

Do these clarifications address investor concerns? Let's look at a few important questions and try to find answers:

How to interpret deferral to April 1, 2016: GAAR will apply in relation to income arising on or after April 1, 2015 to be assessed in the assessment year beginning April 1, 2016. One must, however, await the Finance Bill, 2013 next month for confirmation.

What grandfathering of investments made before August 30, 2010 implies: Such investments will be safe and should not be subject to GAAR. This result should obtain even if such investments are sold after April 1, 2015.

However, the same treatment should not be expected for the entire fund or special purpose vehicle (SPV) as such.

If funds or SPVs were set up before August 31, 2010 but investments were made by such entities after August 31, 2010, GAAR will still apply.

What happens to investments made after August 30, 2010 and sold before April 1, 2015: No specific clarification has been provided.

The statement on grandfathering and the general scheme of GAAR is widely interpreted to mean that such investments will not be subject to GAAR.

Effectively, it means there is a two-year window to sell investments. If such investments are sold after April 1, 2015, GAAR will apply.

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The status of specific anti-avoidance rules (SAAR) or limitation on benefits (LOB) clauses in tax treaties, such as India-Singapore vis-a-vis GAAR: No clarity yet.

It is mentioned that where both GAAR and SAAR are applicable, only one of them will apply. This can be interpreted to mean that GAAR or SAAR, whichever is beneficial to the interest of revenue, will apply.

The implications for funds and SPVs in Mauritius and Singapore: Currently, GAAR overrides tax treaties, including the LOB clause (that is, circumstances in which the benefits under the treaty will not be available).

SPVs and funds proposed to be set up in Singapore will need more clarity on the status of the LOB clause in the India-Singapore treaty vis-a-vis the GAAR framework.

In other words, the issue of whether benefits under the India-Singapore treaty will be accorded to a non-resident where one satisfies the LOB clause under the treaty is unresolved.

Proposed SPVs or funds looking at Mauritius need clarity on whether a tax residency certificate issued by the Mauritius revenue authorities will be accepted as a proof of tax residency (as suggested in circular 789 of 2000) and entitlement to the benefits under the India-Mauritius tax treaty.

Also, the LOB clause in the India-Mauritius treaty seems to be a work-in-progress, going by recent press reports.

Similarly, existing SPVs and funds will need to await more clarity on LOB clauses and "substance" requirements wherever a tax treaty benefit is planned.

The term "substance" refers to the commercial and economic rationale behind an investment or a transaction. It also means financial and other commitments in terms of personnel, facilities and plant and machinery on the ground in the relevant tax-friendly jurisdiction.

The need to review the LOB clause and "substance" will arise because GAAR will apply on investments made after August 30, 2010 and sold after April 1, 2015 or any other date of implementation.

Migration from Mauritius to Singapore or even vice-versa in the absence of actionable clarity at this stage may be premature and a wasteful exercise. Hopefully, the Finance Bill, 2013 will provide more certainty.

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The implications for foreign institutional investors (FIIs): FIIs choosing to be governed by any tax treaty will be subject to GAAR.

FIIs choosing to be governed by Indian tax laws and not any tax treaty will not be subject to GAAR. Investors in FIIs (widely interpreted to include participatory note holders) are not expected to be subject to GAAR.

In any case, there may not be a need to go after FIIs that have accounted for tax liability in relation to all the trades executed by them.

Pertinent expectations from the Finance Bill, 2013 in relation to FIIs: In order to encourage FIIs to choose Indian tax laws, short-term capital gains tax and securities transaction tax rates will need to be calibrated, as the expert committee has recommended.

A compelling domestic tax regime will always obviate the need to seek recourse to any tax treaty.

The implication of the binding effect of an approving panel decision on both taxpayer and the tax department: Given that an ex-judge of the high court will chair the approving panel, it is not clear whether a taxpayer can refer an appeal to the Income Tax Appellate Tribunal or needs to approach the jurisdictional high court by way of a writ petition. Clarity is required here.

What to expect in 2015 or, say, 2016: The present GAAR framework will be about five years old by then.

Hopefully, any government taking power after the general elections in 2014 will review international experience and recently introduced domestic transfer pricing provisions before implementing GAAR.

Further, all investments made before the date of eventual implementation of GAAR should be out of the purview of GAAR and not merely those made before August 31, 2010.

The author is Partner, J Sagar Associates. These views are personal. He can be reached at sunil.jain@jsalaw.com