In the meantime, the GAAR provisions were also closely examined by an expert committee under the chairmanship of Parthasarathi Shome, which made several key recommendations to ensure that an appropriate balance is struck between the tax authorities need to scrutinise and re-characterise abusive transactions and the taxpayers need for simplicity and certainty in the tax system. Several of these recommendations were incorporated into the statute by the Finance Act, 2012. A few were incorporated in the rules notified last week, and it is expected that others will form part of the guidelines contemplated under GAAR. On some of the recommendations clarity is yet to emerge; more important of these are the recommendations with regard to the grandfathering provisions and the continued applicability of the India-Mauritius tax treaty.
The recently issued rules on GAAR mark an important step in Indias move towards operationalising its GAAR regime. In addition to several procedural provisions, they also provide the operational framework within which GAAR will be applied. Specifically, important areas such as the monetary threshold for applicability of GAAR, its applicability to foreign institutional investors and the grandfathering of past investments/arrangements have been dealt with in the rules.
The monetary threshold for applicability of GAAR is an important aspect with widespread consequences. In this regard, the rules provide that GAAR will not apply to arrangements where the tax benefit in the relevant year does not exceed R3 crore. This threshold has limited significance in the context of large corporates and may only protect individuals and small businesses from the ambit of GAAR. While this threshold is in line with the Shome Committee recommendations, one hopes that unlike other monetary limits set out in the Act, this threshold is suitably revised from time to time to take into account the impact of inflationary trends in the economy.
The rules provide that the provisions of GAAR will not apply to foreign institutional investors (FIIs) who do not claim benefit under Indias tax treaties. It is also provided that GAAR will not apply to investments made by non-residents in FIIs through offshore derivative instruments or otherwise. Though these clarifications are welcome, their overall impact may be somewhat limited considering that FIIs generally rely on treaty provisions in connection with short-term capital gains or gains from unlisted securities. As far as such FIIs are concerned, further guidance as to the interplay between treaty provisions and GAAR would be a welcome step.
The most keenly awaited provision relates to grandfathering of past investments and arrangements. There are two rules at play here. The first provides that GAAR will not apply to income from transfer of investments made before August 20, 2010, by such person. It is interesting to note that this exclusion is limited to income from transfer of investments, and does not apply to all income from the investments such as dividend, interest, etc. The second and perhaps more far-reaching provision extends the applicability of GAAR to arrangements entered into before GAAR comes into force on April 1, 2015. This rule provides that GAAR can be applied to any arrangement, irrespective of the date on which it has been entered into, in respect of a tax benefit that arises after April 1, 2015.
In other words, transactions entered into today, or at any time in the past, can potentially be subject to scrutiny under GAAR if a tax benefit is obtained from the arrangement after April 1, 2015. It is, therefore, imperative to ensure that past transactions as well as transactions being undertaken today are closely evaluated to ensure that they are not caught within the ambit of the GAAR provisions. Clearly, this is the most challenging aspect of the GAAR provisions. Just to take an example, if a restructuring of an organisation was undertaken in the past and tax benefits were alleged several years later, it would be an onerous task to prove why the provisions of GAAR ought not to apply.
On a positive note, the rules cast an obligation of thorough exercise on the revenue authorities and provide for an opportunity of a rebuttal to the taxpayer. The rules also lay down definite time lines. If implemented in true spirit, the rules will help allaying the investors fear on procedural front. However, clarity is still required on the operation of GAAR where Specific Anti-Avoidance Rules (SAAR) already exist under the domestic law or under the relevant tax treaties in the form of limitation of benefit (LOB) clause. It, indeed, is a vital missing link. The Shome Committee had specifically recommended that GAAR would not apply where there is SAAR and those have been complied with. It is important that this recommendation is accepted, else the implementation of GAAR could result in needless litigation.
In addition to the statutory provisions and the rules, detailed guidelines on the applicability of GAAR are also envisioned. These guidelines will play a crucial role in determining not only the cases where GAAR is to be applied but also the manner in which it will be applied and enforced. One hopes that these guidelines too are released in short order, so that both the taxpayer as well as the taxman has adequate time to become familiar with the finer nuances of GAAR before its provisions come into effect.
Finally, the GAAR provisions have been introduced in several developed jurisdictions like Canada, Australia and the UK. Indeed, there is nothing inherently wrong with these provisions. The practical application of these provisions is, however, critical. It is, therefore, important that the tax administration be alive to concerns surrounding this key aspect.
The author is deputy CEO, KPMG in India