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GAAR far away

By delaying the controversial retrospective tax rule, the government has tried to keep investment inflows going, writes Gaurav Choudhury.

business Updated: Jan 16, 2013 01:25 IST
Gaurav Choudhury

The government on Monday deferred by two years the controversial General Anti Avoidance Rules (GAAR) that seeks to empower taxmen to clampdown on deals and income suspected to have been structured only to avoid paying taxes. An explainer:

What is GAAR?
GAAR or General Anti-Avoidance Rule is aimed at preventing deals structured so as to avoid paying taxes.

Why is GAAR required? 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.

Why are anti-avoidance laws needed?
Experts say that in an environment of moderate rates of tax, 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.

Who is affected by GAAR?
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 when GAAR comes into force. It is feared that once GAAR is invoked FIIs will have to pay to capital gains tax for investments in Indian equities.

How can GAAR affect an individual?
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, if your spouse pays a lower tax on the interest earned. This may be seen as violating GAAR.

Why was GAAR proposed?
Former finance minister Pranab Mukherjee while presenting the Union Budget for the current fiscal had proposed GAAR to check tax avoidance.

It was proposed with a view to bar companies from aggressive tax planning by using opaque low tax jurisdictions for residence as well as for sourcing capital.

What's the basic criticism against GAAR?
GAAR is seen as providing wide discretion and authority to the tax administration, which is prone to be misused. This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime.

It also sparked fears among global and domestic investors, who said the move would choke foreign investment into India.

How do people use tax havens to avoid paying taxes?
The most obvious mechanism is to move to the tax haven country and become a resident for the purpose of paying taxes. The problem has arisen because of 'round tripping' or 'treaty shopping'.

Why was the Shome-panel set up?
In July, the government set up a committee under Parthasarathi Shome, head of the think-thank ICRIER, which includes former insurance regulator N Rangachari, economist Ajay Shah and bureaucrat Sunil Gupta to recommend the norms and implementation roadmap for GAAR.

What has the committee recommended?
The Shome-panel had proposed deferring the rollout of GAAR and recommended that GAAR shall apply only to cases where taxes amount to than Rs.3 crore.

This effectively implies that about 6,141 companies with a pre-tax profit of more than Rs. 10 crore will initially come under GAAR's ambit - a move aimed at minimising adverse impact on smaller taxpayers.

What about past investments?
The provision of grandfathering investments made prior to August 30, 2010 will remove enormous uncertainty among companies, as will the fact that GAAR would be invoked only when the main purpose is to avoid tax - as opposed to 'one of the main purposes'.

According to experts the decision to constitute an approving panel with majority non-revenue members will send out a comforting signal to investors as it will ensure that the same income is not taxed twice.

How do FIIs feel about the latest move?
There was a lurking fear among FIIs that they would have to pay to capital gains tax for their investment in Indian stock markets. FIIs may be disappointed that they would be exempt from GAAR only when they do not claim benefits of a double taxation avoidance treaty.