GAAR & Tax Havens

The General Anti Avoidance Rule (GAAR)- proposed by the then Union Finance Minister Pranab Mukherjee during the annual budget 2012-13- is anti-tax avoidance rule, drafted by the Union Government of India, which prevents tax evaders, from routing investments through tax havens like Mauritius, Luxemburg, Switzerland.

According to the draft, GAAR will come into effect from 1 April 2013. As per the guidelines, FII not opting for treaty benefits and ready to pay taxes will not come under GAAR, but those who do opt for dual taxation avoidance agreements will come under its purview.

The Union Government was forced to defer the rules until 1 April 2013, as foreign investors had expressed their reservation about the language used in the rules. Investors had maintained that the ambiguous language used in the draft of the GAAR could lead to the misuse of the rule.

What are Tax Havens?

Tax havens are countries which have low tax regimes which provide individuals and business opportunities of tax avoidance or tax evasion. There are roughly 45 tax havens in the world today. In Indian context, Mauritius is considered to be the most significant tax havens or tax evading route.

In more precise words the Mauritius route can be described as a channel used by individuals and Multi National Companies to evade paying taxes in India. The tax evasion in India through this route is estimated to be in tune with 55 billion dollar, mostly attributed to the loopholes in a bilateral agreement on double taxation.

GAAR and its Effects

The idea of GAAR became popular in the backdrop of Vodafone tax case.. GAAR is general anti avoidance rules made to prevent intentional tax avoidance by manipulating tax laws. It empowers the Income Tax dept. to investigate any deal or joint ventures which involves huge capital. however the announcement of GAAR created havoc in Capital market and is believed might lead to tax terrorism.. Main reasons were:

1. The arbitrary method to investigate any commercial deal.
2. Due to the possibility of retrospective taxation 
3. Vagueness of tax laws might be used against a particular company. eg recent Vodafone case of transfer pricing . Under GAAR they have much more power.

Impact on economy:
1. Less investment by foreign companies so less growth.
2. Reduced employment 
3. Poor service delivery as less competition .

Impact on ease of doing business:

1. GAAR will weaken the investors faith in stability of Indian tax regime.
2. Cost benefit analysis favors delay in implementation unless a properly detailed and acceptable norms are formed.
3. One big case like Vodafone may have ripple effect on investor's confidence.

As shome panel recommended we should delay it's implementation for now and should strive toward a stable and predictable tax regime,avoid retrospective taxation and work to provide a transparent business environment in Indian economy.

Sending the right signal

The government’s decision not to appeal against the adverse verdict of the Bombay High Court in its Rs.3,200-crore tax case against Vodafone is the first concrete demonstration of its resolve to do away with what Prime Minister Narendra Modi and Finance Minister Arun Jaitley termed “adversarial” taxation policies of the erstwhile UPA government. Though the BJP had during its election campaign, referred to “tax terrorism” in its election campaign there was little that happened in the first eight months of the new government to show that such policies would be reversed. The latest Cabinet decision sends out a strong signal to foreign investors that this government will be fair in its tax policies and avoid needless litigation. The decision not to appeal has implications for other such similar cases involving multinationals and is, in that sense, a significant one. It is also an acknowledgment that the Income Tax Department’s assessment of the case was erroneous. The Vodafone case was about wrong classification of a capital receipt as taxable income at the hands of the company. Applying transfer-pricing guidelines, the I.T. Department held that Vodafone had underpriced its shares issued to the parent. So it revalued the shares and deemed the difference to be a loan given to the parent. This was clearly high-handed and a wrong application of transfer-pricing regulations.

The government’s decision to accept the High Court verdict is also a signal to assessing officers that they should refrain from making unreasonable tax demands, relying on aggressive and faulty interpretations of rules and sections. Yet, it is also true that the government turns the heat on these officers when it decides that tax collections need to be augmented. If the tax official is confused he cannot be blamed. What is needed is a stable policy that sends out the signal to both assessing officers and taxpayers that the government will crack down on evasion but within the framework of the law; there will be no extraordinary interpretations of rules and sections even in times of revenue distress. The focus will now shift to whether the government moves to neutralise the mischief caused by the retrospective tax amendment; this is a major demand of foreign investors who were disappointed that it was not addressed in the first budget of this government in July last year. The General Anti Avoidance Rules, or GAAR, are a cause for worry for taxpayers and foreign investors as they confer wide discretionary powers on the I.T. Department. It will be interesting to see if Mr. Jaitley makes a Budget announcement to postpone its implementation once again as per the recommendations of the Parthasarathi Shome Committee.

source: http://www.thehindu.com/todays-paper/tp-opinion/sending-the-right-signal/article6836457.ece