GAAR is back, this time in the form of draft guidelines which were issued by the tax department on late Thursday evening. The key highlights are
- A monetary de-minimus, as yet undefined
- A 60 day time limit for a reference to be made to the approving panel and a hard limit of 6 months
- A government dominated 3 member approving panel, the first of which will be located in Delhi
- FIIs paying tax in India will not be subject to GAAR, treaty benefiting FIIs will come under GAAR jurisdiction
- GAAR will also not apply to non-resident investors of FIIs
- GAAR will apply to income accruing on or after 1st April 2013
- If a specific anti-avoidance rule is violated by abusive behaviour then GAAR will apply
- The 'connected' person definition has been clarified to include 'associated enterprise', 'relative' and 'persons'
- Only the 'impermissible' part of an arrangement will be subject to tax
- Tax mitigation or the claiming a tax incentive benefit will not be considered as tax avoidance and hence GAAR will not apply
- The onus of proving an arrangement as 'impermissible' is on revenue
Those points cover 17 pages in the 29 page release. To explain the remaining 12 pages I have with me Rohan Shah of ELP, Punit Shah of KPMG and Andrew Gavan of Alvarez & Marsal. Gentlemen, I’ve done most of the hard work; all you have to do is take us through the 21 illustrations provided by the tax department to distinguish between permissible & impermissible arrangements!
Doshi: What do you make of what these draft guidelines deliver?
Punit: I think guidelines coming out at this stage and the intention clearly is to clarify some of these provisions, so I think it's a welcome step but what I was expecting is a much better guidance in terms of applicability of some of these provisions.
Doshi: Some more illustrations you mean?
Punit: More illustrations and more positive illustrations as to what is ‘permissible' rather than what is ‘not permissible'. I think that is equally important to my mind.
Doshi: Yes; Rohan?
Rohan: To my mind what is very critical here is the sort of approach they are going to take in terms of administering these definitions and in terms of administering the impermissible avoidance agreement. I think what is said here is an indication of what will happen in the future and from that perspective it is most important in terms of what it is indicating- administration of tax will be into the future of this concept.
Doshi: Andrew your first cut opinion on what you make of these draft guidelines and how they compare, let's say, with GAAR guidelines elsewhere in the world?
Gavan: I also agree that seeing some worked examples is very useful. But all I see is these limited number of examples, which is clearly not enough. I see nothing about a pre-clearance procedure and huge problem with the GAAR is the uncertainty it causes to commercial structures and I think this will still leave that uncertainty. The problem with GAAR is trust. The government doesn't trust its legislation to do the job and tax payers don't trust giving a government a blank cheque to rewrite the legislation. The positive thing of course is it's not retrospective; nevertheless there is limited amount of time to clarify these issues.
Doshi: There are 21 illustrations and that helps to be able to differentiate or distinguish between permissible and impermissible and I would like to throw this open to all three of you as we go through some of the common categories to try and understand what happens to commonly used structures now based on the illustrations that these guidelines provide. The first category I want to talk about is FIIs and P-Note holders. To me it seems that they have made it very clear that if you come through Mauritius and you are accessing treaty benefits, then you definitely are going to come under GAAR and scrutinized for GAAR, correct?
Punit: Yes, absolutely. I think that's very clear. Initially the intention was to exempt FIIs from GAAR provisions so to say.
Doshi: That was the request in the lobbying; I don't think that was the intention ever.
Punit: There was a request and I had heard several announcements to say that we will consider this positively. That's my first comment. So, it's like saying that if FIIs are paying full tax in India, in that case GAAR will not be invoked. I don't see any meaning to this particular provision because if you are paying full tax, then there is no question of any GAAR being invoked anyway.
Doshi: This FII drama has played on the markets ever since the mention of GAAR came up in the budget speech. What do you make of what these guidelines do to either quell the commotion or to further exacerbate the situation?
Rohan: I don't think that they ever intended to quell it. To me the important thing is in terms of FIIs- they have literally rewritten Section 90 of the statute book. What they are saying is even if you have Section 90 and therefore treaty benefits, if you choose to take those you are a candidate for GAAR. If you forsake those or they are not available to you then that's the only scenario in which you will not come under GAAR. So, what this really does is seek to rewrite this whole situation in terms of the law and in terms of the practice as to what happens to FIIs who come from treaty jurisdictions and many of them do. So you are literally saying I am going to write this off the statute book. If you are FII from a treaty countrym you are going to face the GAAR.
Doshi: What if you are coming via treaty country and vehicle in that treaty country has a degree of substance- would that not spare you the GAAR hammer?
Rohan: The situation again is each treaty has its own articulation of what you need to do within that jurisdiction for you to qualify. If you can do that minimum and let's say in some cases it's a certificate of incorporation, it's a certificate of …. (Interrupted by Doshi)
Doshi: Let's take Mauritius because most FIIs come via Mauritius, so lets use that as an example.
Rohan: Situation is, in a normal scenario and given your Azadi Bachao and everything else, you would have said I have my registrations and therefore I fulfill the local requirement, which is the tax residency certificate and that's what the treaty would endow on you. If this is going to say that I am redefining the threshold and I really want to see substance and substance according to me is X amount of investment, your board of directors meetings, your investment committee, X amount of transaction, they could now go out and articulate whatever they want, which is their perception …. (Interrupted by Doshi)
Doshi: Is that substance a fixed list of substance items or is that substance a moving target, is that defined so that those coming via Mauritius can make sure that their entities there comply with the list of substance requirements or is it still very grey?
Punit: It would be very difficult to define substance. GAAR by definition is supposed to be subjective rather than objective. So, there are not many objective criteria's which have been prescribed.
Doshi: But there are several objective criteria in our treaty with Singapore, right?
Punit: Yes, we can talk about that.
Rohan: Question is the adequacy of those. Today if I feel a 200 thousand threshold is adequate, is there a sense that tomorrow I could feel it is not or do we proceed on the basis that if the treaty says 200 thousand, then that is sacrosanct.
Doshi: So, the treaty says tax residency certificate, but that is not sacrosanct. Even if you have a tax residency certificate, which should have been enough substance, you could still come under the purview of GAAR, that's your key takeaway from all the GAAR conversation and these guidelines?
Punit: In terms of substance creation, what Rohan mentioned, I think there is one example which clearly says that if you have adequate manpower, capital and infrastructure of its own, that's something which is bit vague, so you need to have your own office….. (Interrupted by Doshi)
Doshi: I though that infrastructure of its own was a dig at the many name plate offices that exist where you are outsourcing ….. (Interrupted by Punit)
Punit: If you rent an office, is it infrastructure of your own? If you share the office is that infrastructure of your own?
Doshi: They have said that GAAR would apply if you don't have all of these?
Punit: That's right.
Doshi: How do you think foreign institutional investors into India are going to look at these guidelines and asses their tax liability if they are using low tax jurisdictions, treaty countries like Mauritius?
Gavan: I think it will cause alarm. It will cause alarm because there is no prior clearance procedure, it will cause alarm because of the current track record of the Indian tax authorities. What we are facing is a new missionary zeal of tax authorities in India to collect more tax. It's not the correct amount of tax, but simply more and this may dissuade foreign investors who clearly want to do business in India, but cannot do it at any cost and particularly not at such an uncertain cost. So, I do welcome the examples that have been given and the clarity that's there, but I do stress, it is not enough and the GAAR discussions in UK have focused very much on using it sparingly, in extreme circumstances. I do not get this impression from these GAAR proposals. It looks much more like the gloves are off and if a structure can be shot at, it will be shot at.
Doshi: If you have to fix this FIIs situation whereby we give some degree of assurance to those FIIs coming via Mauritius that if you have a tax residency certificate that's enough, then what would you do? Just exempt them from GAAR altogether or how do you fix it because these are draft guidelines; you have the opportunity to go back and dialogue with the tax department?
Rohan: For me, the fundamental issue still remains. You are rewriting that treaty. Let us say, having rewritten the treaty and you consciously want to do that, if you had to give far better guidance, then use of adequate infrastructure etc as we have just discussed is not adequate. So, you then need prescription, so you would have to say, X amount of spend, a minimum of X amount of employees ….. (Interrupted by Doshi)
Doshi: Which is like what we have with Singapore to some extent?
Rohan: Yes, because once you have that, then there is nothing nebulous, but if you don't have that then you are going to change the goal post every time that you want. So, is the Singapore prescription now good for all of these countries? That's a question to ask. But if it is good for Singapore, then please apply it also everywhere else and prescribe that this is what we expect of you.
Doshi: I want to move this on from just FIIs coming via Mauritius to all kind of investments or transactions using lower tax jurisdictions or treaty countries and I think like you have pointed out right in the beginning Punit that almost all these kind of transactions in these illustrations, GAAR would apply. That means that there are very few transactions that are escaping the GAAR net, correct?
Punit: Yes. One thing which strikes me is that, they could have easily provided that any FII which is SEBI registered is supposed to be exempt from GAAR provisions, that's one thing which can certainly come.
Doshi: You are still lobbying for exemption; I don't think that's going to happen.
Punit: I will tell you why, because they are saying that the non-resident investor in FII, GAAR will not be applicable to them. So, why not to FIIs themselves that's the point I am making.
Doshi: I think you are trying to provide some relief to the P-Note guys, but it is already common understanding that the P-Note guys would have never come under this and the FII will just pass on the tax burden to the P-Note guy through some sort of transaction fee etc.
Doshi: I want to look at the use of Mauritius because I think there are several types of transactions that they have listed in these illustrations where they have said if you are using a lower tax jurisdiction, then GAAR would definitely apply and to give some very random examples here without taking too much time.
If you are using an offshore wholly owned subsidiary (WOS) of a non-resident (NR) company funded by that NR company and that WOS buys and sells shares in India then that would be taxable or would come under GAAR.
I am using commonly used structures in India to point out that all of these now will have to change or become GAAR proof.
Rohan: That's right, that's true.
Doshi: True, is that all? How commonly used structures will be at risk now because of this?
Rohan: You look from illustration 10 to 21 and these are not things that they have sort of dreamt up, these are in the main, real life examples of stuff that they have seen and these are structures which have been used and they have consciously gone to say within one of the four criterion in terms of what is impermissible, they will fall under one or more of them. So it's a conscious effort to say here are 12 good illustrations of what people have been doing and from our perspective these are amiss, these are events of tax avoidance.
Doshi: You want to add OTIS to that list?
Punit: Yes, absolutely OTIS is obviously…(Interrupted)
Doshi: Curtailing dividends & distributing reserves...(Interrupted)
Punit: Now what they have done is the example which they have given is a very specific example that a company stops distributing dividends from the date when the dividend distribution tax is introduced and then you start accumulating reserves and then do buyback and that also selective buyback where other shareholders do not exercise buyback or shares and then only one shareholder which is in Mauritius for example would exercise the buyback and would take the money back.
Doshi: And they have said GAAR will apply.
Punit: And the GAAR will apply in that situation. Now what does it mean, does it apply to ordinary buyback because there could be under other situations where there are several buybacks where dividend distribution tax is already paid, so part dividend so part buyback. What do you do in those situations? So there is no guidance available here on those kind of situations. Obviously it's practically impossible to cover all the situations but to my mind in such situations GAAR then should not apply.
Doshi: But on the flip side if you don't repatriate dividend from an offshore holding company, then because CFC will eventually deal with it, they have said GAAR will not apply, so haven't they tried to be fair?
Rohan: All they are saying is, if there is another set of provisions which governs that sort of situation, so whether its CFC, transfer pricing then we already have a piece of legislation which deals with it therefore we are saying that GAAR will not apply.
Doshi: If the Vodafone like transaction were to happen now, once GAAR comes into effect assuming these guidelines hold, Section 9 would take care of it anyways but assuming Section 9 had not been retroactively amended, GAAR would definitely look at it, right?
Rohan: There is a very telling illustration, illustration three. When they talk of indirect transfers they say if a holding company sets up a subsidiary in its own jurisdiction where it has substantial business, people, tax paying, etc then that is fine. We would not interfere with that. What happens now, nobody normally invests in terms of coming in from his own country. Most people will move to another jurisdiction and for apparent reasons. Now from that perspective if you isolate three as the only example wherein indirect transfer is not taxable then you really cast a huge shadow in terms of any indirect transfer from any country which has any sort of tax benefit to offer.
Doshi: Foreign investors, be they institutional investors or large corporations- will they now reconsider the use of lower tax jurisdictions or treaty countries as a route to invest in India if these draft guidelines were in fact to come into force?
Gavan: Clearly they will have to review the structures but what's striking me is what is actually in it for the tax benefit? What is the benefit to the corporate investor to encourage him to invest in what is a marvelous economy and help it grow? There is a whole raft of specific provisions, weapons that the tax authority can use. Unless GAAR is not replacing them, it's not making life simpler and clear, it's overlaying them and making it more complex, a specific problem that we have asked the UK authorities to address as well. So yes structures will get revisited but what concerns me is whether it will actually make the cost of business too high because of the uncertainty.
Doshi: What would you like to see fixed especially when it comes to the use of lower tax jurisdictions or treaty countries that would help make these guidelines a fairer set of guidelines or a more realistic and viable set of guidelines?
Gavan: I think two things, I think some clarity on substance so there is not a constantly moving target which you can never, as an advisor or as an investor, ever be wholly comfortable on. So some clear guidelines and secondly a pre-transaction or pre-investment clearance procedure and clearly if thousands of such request come in, it becomes ungovernable and that's why I think GAAR should be moved more towards specific extreme circumstances rather than simply maximizing the collection of existing tax because I think that will damage the collection of future taxes due to adversely affecting investment decisions.
Doshi: Unfortunately though, I think substance is in the Finance Bill or what is now become an Act- commercial substance and that's still as broad as ever so there is no scope of being able to narrow that down unless you provide more illustrations that specifically tell you what is substance or what is not substance?
Gavan: I think so, I think the idea that, say an office would be sufficient or as one of your speakers said sufficient decision meetings by capable of taking such decisions in territory, in other words something less than a full scale domestic headquarters.
Doshi: The second point that you asked for was pre-transaction clearance and I thought that too was discussed. I am taking that back to my India guests - that too was discussed and it was shrugged off. So, both these things - more specific substance parameters and a pre-transaction clearance have been talked about, discussed while the Finance Bill was still pending and now it has become law and none of these have actually been introduced. So, there is a pretty good chance that it still will not get a kind hearing from the government?
Rohan: Very good chance that it won't. Therefore there is expectation gap that Andrew talks about in terms of foreign investors and what they are used to seeing even in terms of GAAR provisions elsewhere. That expectation gap remains exaggerated by the other issue in terms of how we administer this and huge credibility gap that we already have there. So, if we don't get this right, then this whole situation of the PM saying we want to do more things through tax which encourages investment - I think we are reading out two very different messages.
Doshi: Let's not conclude this yet because there is one more set of transactions I want to talk about. We have spoken of overseas or offshore transactions, corporate actions taking place here in India and I thought there were two interesting ones. So, when you borrow and get an interest deduction versus issuing equity, they said GAAR could apply if the payments are made to connected parties and those connected parties are in low tax jurisdictions. You see several large group companies where the parent of group company would be part financing an acquisition by another group company through a third offshore company in the lower tax jurisdiction - that will now come under GAAR scrutiny, right?
Punit: I think that would definitely come under GAAR scrutiny. Again, it boils down to substance again creating in that particular jurisdiction. So, for example whether that entity in that jurisdiction had the ability to lend… (Interrupted)
Doshi: I don't even think they have brought up substance in that illustration and in that illustration they have not even said if you have substance in the lower tax jurisdiction, we will let this pass. They have just said if the connected party is in a lower tax jurisdiction, GAAR may apply. This has gone beyond substance being not defined.
Punit: GAAR will apply. So, GAAR would actually examine whether there is substance or not and whether that entity is capable of providing that kind of finance in receiving that kind of interest charge..(Interrupted)
Rohan: So what sort of network of guarantee support this, what sort of comfort letter supports this because that particular entity- is it meritorious enough to get that sort of funding.
Punit: That's exactly the point that are you creating enough substance there to provide that kind of support services, to provide that kind of lending to the group entity and whether the lower withholding tax should apply.
Doshi: The second transaction I wanted to bring back was sell and lease back. They said - if you lease an asset to claim lease rental deduction versus purchasing an asset, GAAR would not apply unless in the case of circular leasing and you pointed out sell and lease back which is commonly used in the aviation industry - that could now come under scrutiny, right?
Punit: The point which I am making is that sell and lease back is considered to be action which is permissible and the Income Tax Act today recognizes such action where you have got depreciation on the written down value rather than the actual value.
Doshi: Now it is no longer permissible.
Punit: Now it seems that GAAR would apply but to my mind of course the domestic law has a provision and therefore it should be able to.
Rohan: Though in fairness the focus there seems to be circular leasing. You had an asset; you parted with it and after a series of transactions you got it back. Why those series of transactions? Do they have a commercial rationale or are they just a facade that you are creating to sort of show that it has passed through a series of hands. That really seems to be the essence of that particular illustration.
Doshi: There are several illustrations. I won't go through the long list of them because we have entirely run out of time. I think I will ask you both for closing comments. You have made your opinion of these guidelines fairly clear - both of you. Now I think the problem is how do you get this fixed? How hopeful are you Rohan that feedback from the tax fraternity, from within industry, from investors outside will help moderate this? I have often asked the question and I have asked this earlier as well on the show - that when the law itself, if you look at the Finance Act, is fairly draconian in the way it lays out what is impermissible or what is commercial substance, can softer guidelines moderate that law at all? We have begun on a very harsh note. Can we soften it?
Rohan: It will need to be softened if it really has to have any positive impact in terms of things like investment. I am only hopeful from one perspective. You have the PM now as FM, he has stated his intent. When these comments effectively come in, if the right thing has to be done then I think we will see that reflected in how they treat these guidelines and how they expand these guidelines. But if we don't do them and if we don't get the law right, we don't get the guidelines right, we certainly aren't getting the tax interpretation and administration right. If we don't get the first two right, we are pretty much lost on the last one in any case.
Punit: I just want to make last point and there are there sub parts. (1) The advance ruling which I think Andrew has been talking about to my mind is very critical and certainty and the timeframe within the advance ruling should be given. (2) Define substance - monetary limits, number of employees. (3) Is the SAAR - specific anti avoidance like Singapore where you have a monetary limit - USD 200,000 or whatever and then hopefully, GAAR will not apply. There again I am using the word ‘hopefully' because it says that if SAAR or Singapore treaty has been abused and therefore again the GAAR could apply. So, GAAR can apply in a SAAR situation also. Those kind of uncertainties to my mind needs to be removed.
Doshi: I will close by using Andrew's words and that is - let's hope the government tones down on the missionary zeal before implementing GAAR in this country.