Written by:
Ambika Vora

GAAR: Generally Annoying but Advantageous Reforms

Over the past few months, the infamous GAAR, or General Anti-Avoidance Rules, have taken India’s economy by storm. And like the actual storm which buffeted America’s East Coast just weeks ago, GAAR managed to inflict substantial damage - sinking the rupee and deluging the economy with disinvestment woes - something the government would not have anticipated when they proposed the rules in the country’s 2012-2013 Annual Union Budget.

GAAR and its Provisions

What exactly is GAAR? Though the acronym in the title reflects some of the contrasting opinions regarding it, the GAAR is actually a set of tax rules introduced by the Budget, initially intended to be effective from 2013. Their purpose in a nutshell: to curb tax avoidance. They would supplement the pre-existing SAAR (Specific Anti-Avoidance Rules), but as a more formidable legislative tool to combat tax avoidance since they cover transactions that do not fall under the specified jurisdiction of SAAR. Essentially, they shift the power from taxpayers to the tax department, by granting the latter arbitrary powers to aggressively scrutinize various aspects of commercial transactions.

Naturally, this notion instigated tremendous dissent among taxpayers, particularly foreign investors, since the GAAR targeted overseas transactions, and those routed through tax havens like Mauritius, where capital gains tax (CGT) is exempted. However, with GAAR and the subsequent new India-Mauritius tax treaty, these exemptions would no longer be valid unless companies proved that the ‘main purpose’ behind the transaction was not merely tax avoidance, and displayed a ‘substantial commercial presence’ in the country.

There is also fear that GAAR obliterates the distinction between tax evasion and tax avoidance. Tax evasion is the illegal avoidance of paying taxes wherein taxpayers resort to fraudulent methods. Tax avoidance involves no subterfuge, but rather circumventing tax laws through loopholes and legitimate forms of tax planning within the legal framework. Through GAAR, the onus of disproving allegations of tax evasion or avoidance lies with the taxpayer and not the tax department. This means that the authorities can claim tax evasion or avoidance without proof, and the burden of proving innocence falls on the taxpayers. GAAR would follow a judicial practice of ‘guilty until proven innocent’; a complete antithesis to the more humane judicial maxim used worldwide, of ‘innocent until proven guilty’. Moreover, certain key terms in GAAR, such as ‘main purpose’ and ‘tax avoidance’ were very widely defined. The all-encompassing nature of these terms enables the deliberate misuse of GAAR by tax authorities to harass taxpayers.

GAAR made investing in India more expensive and aggravating, by obstructing certain tax avoidance routes and facilitating the non-judicious use of powers by tax authorities. And nobody likes being embroiled in convoluted court cases or paying more money. Following GAAR, investor spirit in India took a turn for the worse. Disparaged foreign investors turned elsewhere, and this triggered a steady stream of disinvestment that weakened India’s economy. The country’s balance of payments, which was heavily dependent on foreign investment to finance the current account deficit, plummeted sharply, pulling down the value of the Indian Rupee with it.

The Vodafone Case and Retrospective Amendments

One of the prime controversies that sparked an altercation between the Indian government and foreign investors was regarding the retrospective amendments proposed in the Union Budget. These amendments would override the Indian Supreme Court’s (SC) January 2012 decision in favor of British telecom giant Vodafone. Vodafone bought shares of India-based Hutchison Essar Telecom services in 2007, through an overseas indirect transfer of shares between two foreign companies. Later, it was sucked into a tax dispute with the Indian Income Tax Department regarding the CGT liability of this transaction, a liability worth US $2.5 billion. This is a tremendous amount of money, which could ease India’s budget deficit. As fallout of the SC’s ruling that Vodafone was not liable to CGT, the government propositioned retrospective amendments to levy GGT on all indirect transfers of assets.

In view of the abovementioned amendments, the Vodafone transaction is taxable, but in 2007, no such laws were in place. Nonetheless, the amendments opened up the possibility of taxing Vodafone retrospectively, adding fuel to the fire. How is it fair to tax a company for breaching a law that never existed in the first place? How can a government revise its laws after 5 years and still hold Vodafone accountable? Can such a vacillating, unsure government even be trusted? Those were the doubts that rose in the minds of investors, and further dampened investor outlook in India.

The Governmental Perspective

Though certain portions of GAAR’s mandate were admittedly murky, some of the criticism is overblown. A government’s prime source of revenue is through tax collection. To quote the Discussion Paper on Direct Taxes Code 2009, India: “Tax avoidance like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner.” It is also basic human nature to want to pay less; hence tax avoidance is inevitable. And as individuals and companies begin to abuse tax laws by formulating ingenious and complex ways to avoid taxes, the government too, is forced to implement more stringent rules to prevent this. Thus, the government is in no way doing anything wrong or unfair by tightening tax measures; the increasingly intricate tax avoidance schemes were a catalyst that necessitated the implementation of GAAR, and laying all the blame on the Indian government is irrational.

The Shome Panel and Current Status

Nevertheless, following the investment outrush, GAAR decisions were postponed. In July, Prime Minister Manmohan Singh directed the setup of a special committee, the Shome Panel, headed by leading tax analyst and expert Parthasarathi Shome, to investigate this issue and submit a report by end-September regarding their recommendations about the same. The recently submitted report has many suggestions likely to appease investors: including the deferment of GAAR by three years until 2016-2017, prospective rather than retrospective levying of CGT on indirect asset transfers, applicability of monitory threshold for GAAR fixed at 30 million rupees of tax benefit and the exemption of GAAR on intra-group transactions.

The Indian government has not yet released the official post-Shome decisions pertaining to the GAAR, though they are likely to be out soon. Recently, Finance Minister P. Chidambaram stated that he had “finalized the amendments to... the Income Tax Act” and that “GAAR is under control”. The decisions are now subject to the Prime Minister’s approval and that of the Cabinet.

It is speculated that the government will implement a diluted version of Shome’s recommendations, deferring GAAR for only a year, till April 2014. Moreover, the revenue department has voiced its concern regarding the logistical difficulties in accepting Shome’s proposals regarding prospective and retrospective taxation on foreign mergers and acquisitions.

Following the financial ruckus stirred up by GAAR, it will be interesting to see the stance the government finally adopts, when the finalized rules are released. Will the new GAAR alleviate foreign investors? Or will it be equally problematic and rekindle the debate? And what impact will it have on India’s currently volatile market situation?