The stock markets have been quite nervous these past few days due to fears that the finance ministry might use the newly-introduced General Anti Avoidance Rules (GAAR) against foreign hedge funds and other entities who invest in the secondary market through Participatory Notes (PNs). A good 16.4% of all outstanding FII investments are through PNs and the real owner of these investments is often difficult to establish. In any case, nearly 85% of all FIIs invest in the Indian market through the tax haven Mauritius.
There is a scare in the market because it has begun to believe the worst about the intentions of the finance ministry. The market thinks the finance ministry will use GAAR to start questioning all investments coming through tax havens like Mauritius. GAAR legally empowers the government to question the tax-free status of an entity investing from Mauritius if there is suspicion that the arrangement through Mauritius is simply meant to avoid paying tax. The market fears that the government would use GAAR to harass FIIs and other investors. They say under GAAR the burden of proof is on the corporate entity registered in Mauritius. The tax authorities, however, claim the burden of proof shifts to the tax authorities once the corporate body in Mauritius proclaims its authenticity from a taxation standpoint.
In effect, the corporate world is doubting the intent of the tax authorities. There seems to be a growing trust deficit which the finance minister needs to address. Pranab Mukherjee has done the right thing by publicly assuring that GAAR will not be used to harass the honest taxpayers. He may have to do a lot more to demonstrate that the tax bureaucracy does not get drunk on its new powers under GAAR.
Fundamentally, there is nothing wrong with GAAR itself. It was an integral part of the Direct Taxes Code and was accepted by the industry after an exhaustive debate. Besides, GAAR is being adopted by many countries as part of the renewed global drive, especially post G20 deliberations, to bring good governance and greater transparency in global money flows through a better exchange of information among tax jurisdictions. Interestingly, many established tax havens like Mauritius, Cayman Islands and Luxembourg have also agreed to be part of the new norms of governance in the global tax system. So, in future, Mauritius and Cayman Islands will be legally obligated to share information with the tax authorities on any entity registered there.
So India implementing GAAR must be seen as part of this movement towards greater transparency that the OECD and G20 are trying to bring about in the system of cross-border capital flows and taxation.
Unfortunately, the trust deficit between the tax authorities and the taxpayers is causing avoidable apprehension among the market players. Some of the decisions in the Union Budget have aggravated these fears.
The decision to retrospectively amend the Income Tax Act to bring Vodafone and many other corporate entities under the tax net has, understandably, caused the trust deficit to widen.
The government can still ask these corporates to come to the table and do a negotiated settlement on the tax to be paid in a spirit of give and take. This was done in the case of ITC more than a decade ago after the government had similarly passed an ordinance which nullified a court order that had gone in favour of ITC in a tax dispute with the government.
Former Attorney General of India Soli Sorabjee recently brought sanity to the debate on retrospective tax amendments by arguing that governments the world over pass retrospective amendments as and when required in the larger interest of justice. However, such amendments should not be done in an arbitrary manner. There is clearly a subjective element here.
For instance, in the Vodafone case, the timing of the retrospective amendment?after Vodafone had won the case in the Supreme Court?seemed clearly arbitrary. If the finance ministry had done the same thing immediately after it had won the case against Vodafone in the High Court, the retrospective amendment would have been seen in a different light altogether. Effecting an amendment after getting a court verdict in one?s favour would have carried greater moral weight.
So the timing is critical in determining the arbitrariness in the government?s actions. If the finance ministry had anticipated that deals such as the one involving Vodafone would naturally happen in a globalised economic environment, the original intention of the Income Tax Act could have been made clear in 2008 itself through a retrospective amendment. That would have carried a lot of credibility.
Purely on a rational and moral plane, any government has the right to tax the gain arising from sale of an asset that exists within its jurisdiction even if the seller, who owns the asset, is sitting in some tax haven abroad. If the Income Tax Act had made this clear in 2008 then Vodafone, which bought the telecom asset, would have been obliged to deduct the tax before paying the seller?in this case Hutchison. It is the lack of clarity in law that created this confusion in the first place. In the end, it is delayed government action or the tax authorities? inability to be ahead of the curve that caused arbitrariness to creep into the policy framework.
Otherwise, as a principle, there is nothing wrong in making retrospective amendments to law in order to make the intention of the Income Tax Act crystal clear in a fast changing global tax environment. Finally, even if one agrees that there was arbitrariness on the government?s part in the Vodafone case, it is difficult to escape the larger moral question of whether global corporations should avoid paying tax on massive profits?about $10 billion in Vodafone case?made by selling underlying assets in a poor country like India.
mk.venu@expressindia.com