Given how the rupees strength very largely depends on what happens to FII and FDI flowshalf of FDI and two thirds of FII come through Mauritius and Singaporeits not surprising the finance minister has accepted most of the Parthasarathi Shome committee recommendations on toning down General Anti-Avoidance Rules (GAAR) that sought to put too many powers in the hand of the taxman by allowing him to reinterpret transactions with very little independent oversight. If the rupee continues to be under pressure despite record FII inflows$24.4 billion in calendar 2012 as compared to minus $0.4 billion in 2011imagine where it would be if FII/FDI flows were to dry up. And dry up they would given how the budget allowed the taxman to look at whether inflows through treaty-countries like Mauritius or Singapore were lacking in commercial substance and whether they were structured to help avoid taxes. So, apart from putting off GAAR by two more years, to April 2016, during which period the taxman is to get trained in the finer aspects of international taxation, the ministry has clarified both Mauritius and Singapore investments are protected till the treaties are not renegotiated.
It is disappointing that the finance ministry has not clarified its mind on taxation of Vodafone-type transactions and on the budgets retrospective amendment of the lawthis is likely to have got stuck due to the exceptionally poor tax collections. For what its worth, the short note issued by the ministry along with the detailed Shome Committee report yesterday indicates the government doesnt want to tax such transactions. An arrangement, it says, the main purpose of which is to obtain a tax benefit, would be considered as an impermissible avoidance arrangementthe Supreme Court, in its Vodafone judgment, had said the main purpose of Hutchs corporate structure, which Vodafone took over, was not tax avoidance.
The grandfathering of investments till just August 30, 2010, which is when the Direct Taxes Code was introduced in Parliament, is curious since the Bill is yet to be passed, but the important change is the way the Approving Panel which allows transactions to be reinterpreted by the taxman has been changed. For one, the tax officials, or their superiors, doing the re-interpretation will no longer be part of the Panel which would now have to be headed by an ex-judge of the High Court and will also have a scholar on tax mattersmaking the Panels ruling non-appealable is unfortunate though. Allowing the taxman to decide whether to apply GAAR or Specific Anti-Avoidance Rules (SAAR) is a bad idea, though putting guidelines in place mitigates the problem somewhat. There is, sadly, no clarity on whether short-term capital gains taxes will be removedthats what Shome favouredso some part of the derivatives market will continue to be offshored. Nor is there any clarity on whether the taxman can reconstruct transactions to conclude, for instance, that equity is really debt, or vice versa, especially in the case whereas in PE transactionsbuyback agreements are often part of standard agreements. At one level this is irrelevant since GAAR has been put off till 2016, but given the taxmans poor track recordin FY12 the taxman won a tenth of the cases he filed in the Supreme Court, less than a third in the High Court and a fifth in the CESTATits important to keep his powers under check.