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Dear GAAR, see you later!

Finance minister Pranab Mukherjee has delayed the introduction of the controversial General Anti-Avoidance Rule (GAAR) that seeks to empower taxmen to clamp down on deals and income if they believe that these were structured in a particular way only to avoid paying taxes. HT explains. De-coded

business Updated: May 08, 2012 23:22 IST
Gaurav Choudhury

Finance minister Pranab Mukherjee has delayed the introduction of the controversial General Anti-Avoidance Rule (GAAR) that seeks to empower taxmen to clamp down on deals and income if they believe that these were structured in a particular way only to avoid paying taxes.

HT

explains.

What is GAAR?
GAAR or General Anti-Avoidance Rule is aimed at preventing deals or incomes that are structured only to avoid paying taxes.

But isn't tax planning and tax saving legitimate?
In India, the courts have ruled that saving of taxes through permissible instruments of tax planning is legitimate. But tax avoidance is illegal.

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Whom does GAAR affect?
Almost anybody and everybody. Corporations may be forced to restructure salaries of employees if taxmen conclude that these were structured only to avoid taxes.

Foreign institutional investors (FIIs), who invest through countries such as Mauritius to exploit bilateral tax treaties will be affected after GAAR comes into force. It's feared that once GAAR is invoked, FIIs will have to pay capital gains tax for their investment in Indian equities.

Why are anti-avoidance measures necessary?
In an environment of moderate rates of tax, according to the government, it is necessary that the correct tax base be subject to tax in the face of aggressive tax planning and use of opaque low tax jurisdictions for residence as well as for sourcing capital.

How can an individual be affected by GAAR?
In many ways. For example, if you have taken a loan from your spouse for which you are paying an interest, the tax department can conclude that you have structured the loan from a family member only to claim a tax deduction on the interest paid. Your spouse, on the other hand, will pay a lower tax on the interest earned. This may be seen as violating GAAR.

How do people use tax havens to avoid paying taxes?
The most obvious is to move to the tax haven country and become a resident.

So what is the problem?
The problem has arisen because of 'round tripping' or 'treaty shopping'.

What does it mean?
Round tripping refers to routing of investments by a resident of one country through the other country back to his own country.

How does it work?
An Indian resident investing directly in shares of an Indian company would have to pay capital gains taxes. However, if he routes his investments through an entity incorporated in Mauritius, the taxes can be avoided under a double taxation avoidance treaty (DTAA) between the two countries.

What is DTAA?
These are bilateral treaties signed between governments to prevent companies from paying taxes both in their country of origin as well as in the country where they are doing business.

What is the global practice on anti-avoidance rules?
Most countries have codified the "substance over form" doctrine in the form of General Anti-Avoidance Rule (GAAR). Internationally, several countries have introduced, and are administering statutory general anti-avoidance provisions.

The Indian government is of the view that the aggressive tax planning with the use of sophisticated structures, there is a need for statutory provisions so as to codify an anti-voidance doctrine.

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What is the basic criticism against GAAR?
The basic criticism against GAAR is that it provides a wide discretion and authority to the tax administration, which at times is prone to be misused. This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime.

What has the finance minister announced on Monday?
The finance minister has deferred its applicability by a year to April 1, 2013 and placed the onus on taxmen for proving tax avoidance reversing the original budget proposal which had placed the onus on the tax payer.

An independent member will be inducted into the GAAR approving panel to ensure objectivity and transparency and the taxpayer has been granted the right to approach the Authority of Advance Ruling (AAR) for a ruling on whether GAAR provisions are applicable as determined by the taxmen.