GAAR deferral: Impact on Mauritius investments

Updated: Jan 19 2013, 06:45am hrs
Sameer Gupta

While the idea of the introduction of General Anti Avoidance Rules (GAAR) was mooted in the Direct Taxes Code (DTC) Bill, the Finance Act, 2012, fast forwarded the enactment of GAAR provisions into Income-Tax Act, 1961, and the same were set to come into force with effect from April 1, 2013. An expert committee (EC) constituted by the Prime Ministers Office on July 13, 2012, to recommend GAAR guidelines submitted the final expert committee report (ECR) to the government on October 1, 2012, which was released on January 14, 2013, along with a press release containing a statement from the finance minster (FM) on the decisions taken by the government of India (GoI). The ECR has provided an illustrative list of transactions where GAAR will and won't be applicable. These illustrations seek to enunciate certain points of principle which, inter alia, provide guidance on when can it be said as to whether the main purpose of the arrangement is to avail a tax benefit.

Considering that GAAR is an advanced instrument of tax administration requiring awareness of its finer aspects and intensive training /specialisation, the EC has recommended that GAAR be deferred for three years and brought into force from April 1, 2016. The GoI has, in principle, accepted this recommendation but the provisions have been deferred only for two years and the same would be effective April 1, 2015.

Further, the EC has recommended that all investments existing on the date of the commencement of GAAR provisions be grandfathered. However, the FM has stated that only investments made before August 30, 2010, (being the date of introduction of DTC Bill, 2010, in the Lok Sabha) will be grandfathered even though sold post April 1, 2015.

This rather unique way of grandfathering could potentially expose the future effects/exits (made after April 1, 2015) from the investments made on or after August 20, 2010. While the private equity investments into India have generally dipped in the past two years or so, FII investments have been robust in 2012. Of these investment flows, it becomes important to consider the impact on investment flows from Mauritius. Given the long history of litigation that Mauritian investments in India have witnessed, the investors would be looking for some kind of certainty before making similar investments.

The EC has recommended that GAAR provisions should not be invoked to deny the benefits of the India/ Mauritius tax treaty as far as the Mauritius entities making investments in India hold a valid TRC (containing prescribed particulars). This should be the case so far as the Circular 789, which states that a TRC issued by the Mauritius government should constitute sufficient evidence for accepting the status of residence, is not withdrawn. Significantly, the FMs statement is silent on these recommendations.

In the event that GAAR provisions are invoked to examine the income earned by Mauritian entities post April 1, 2015 (to the extent the same do not benefit from grandfathering provisions) it should not mean that all structures will be regarded as impermissible avoidance arrangements. For instance, where the pooling of the various investors happens in a Mauritian entity or another efficient jurisdiction, which in turn makes investment in India, the main purpose of establishing such an entity is to achieve pooling in an efficient jurisdiction and not only for availing of tax benefit. This position is actually stated in one of illustrations covered in the ECR (the FMs statement makes no specific reference to these illustrations but it would seem that these would be included in the guidelines in due course). Similarly, other structures need to be evaluated to ascertain whether the the main purpose of the arrangement was to obtain a tax benefit.

The EC has also recommended that GAAR should not be invoked in situations covered by specific anti-avoidance rules. The FM has indicated that where GAAR and SAAR are both in force, only one of them will apply and guidelines will be specified. It remains to be seen as to whether the India-Mauritius tax treaty is re-negotiated to include a limitation of benefit (LoB) clause with some objective thresholds to counter tax avoidance, if so, and where it is clarified by the GoI that such LoB provisions in the tax treaties would override the GAAR provisions, the same would then provide much desired certainty.

The author is tax partner, Ernst & Young. Views expressed are personal