India's Finance Minister announced on January 14, 2013 that the Government of India would adopt a majority of the recommendations of the committee constituted to review India's pending income tax anti-avoidance rule. The committee's recommendations, summarized in a previous Jones Day Commentary, " Recommendations of the Expert Committee on the Indian General Anti-Avoidance Rule: A Welcome Step," dated September 2012, are likely to be included in the forthcoming 2013 Budget, which will be debated in Parliament in late February 2013.
Background
India's Finance Act, 2012 (the "Act") inserted
into the Indian Income Tax Act a general anti-avoidance rule (the
"GAAR") permitting the Indian Revenue Service to
disregard, in assessing a taxpayer's liability, any agreement,
structure, or device (referred to in the Act as an
"arrangement") employed not for bona fide commercial
reasons but rather "to obtain, directly or indirectly, a tax
benefit."1 The GAAR was intended to be effective
from April 1, 2014.
The GAAR attracted strong opposition from Indian businesses,
foreign investors, and even select foreign governments, such as the
Government of Mauritius, which argued that the GAAR would violate
benefits secured under that country's tax treaty with India.
Consequently, Prime Minister Manmohan Singh constituted an Expert
Committee under the leadership of Dr. Parthasarathi Shome (the
"Shome Committee") to review the GAAR and make
recommendations for its modification and application.
The resulting draft report was first released for comment on
August 31, 2012,2 and was received favorably by
investors. After considering feedback from investors and others,
the Shome Committee submitted its final report to the Government on
September 30, 2012 (the "Shome Committee Report"), which
was released to the public on January 14, 2013.
The Finance Minister's Statement
Speaking on behalf of the Cabinet as a whole, the Finance Minister announced on January 14 that the Government "accepted the major recommendations of the Expert Committee."3 Some of the key reforms are as follows:
1. Implementation of GAAR: The
effective date for implementation of the GAAR will be pushed back
by two years to April 1, 2016.
2. Primary Purpose Test: Only
arrangements, "the main purpose of which is to obtain a tax
benefit," will be subject to the GAAR. The Act had provided
that it would suffice for a tax benefit to be "one of the main
purposes" of a targeted arrangement.
3. Grandfathering of Investments: Investments
made before August 30, 2010 will be exempt from the GAAR. This
reflects only partial acceptance of the Shome Committee's
recommendation that all investments predating the implementation of
the GAAR be grandfathered.
4. Non-Application of GAAR: The
GAAR will not apply in a range of specified situations, such
as:
- Where the tax benefit resulting from an arrangement is less than INR 30 million (approximately US$550,000);
- To a foreign institutional investor, where such investor elects not to claim benefits under a dual tax avoidance treaty, and to nonresident investors in such foreign institutional investor; and
- Where a specific anti-avoidance rule applies and the application of the GAAR would result in a duplicative penalty (e.g., in cases involving divided stripping or bonus stripping).
5. Procedural Protections Under
GAAR: The Act provides that taxpayers subject to the GAAR
would be provided with (i) notice and (ii) an opportunity to prove,
first before the Commissioner and then before a reviewing Approving
Panel, that the challenged arrangement had a bona fide purpose
unrelated to the resulting tax benefit. The Government has
committed that a majority of the Approving Panel will be
independent of the Indian Revenue Service. While one of the
Approving Panel's three members will be a Chief Commissioner of
Income Tax, the remaining two will be a retired judge and an
"academic or scholar," respectively.
6. Indicia of Purpose for Applicability
of GAAR: The Act provides that three factors "shall
not be taken into account" in determining whether an
arrangement violates the GAAR: (i) the period for which the
arrangement existed; (ii) that taxes were paid under the
arrangement; and (iii) that the arrangement contains an exit
mechanism. The Government will amend the act to allow the Approving
Panel to "have regard to" the foregoing factors, but
these factors will not be "sufficient to determine whether an
arrangement is an impermissible avoidance arrangement."
Because the burden of proof in challenging a GAAR determination is
on the taxpayer, it may be on balance preferable to the taxpayer
that the Approving Panel consider as much evidence on the nature of
the challenged arrangement as possible.
The Finance Minister's statement also set out certain
principles that will be incorporated in future regulations.
Notably, (i) the GAAR will apply only to the "the tax
consequence of that part" of an arrangement targeted at
avoiding taxes, and not the arrangement as a whole, and (ii) the
Indian Revenue Service will be obliged to "ensure that the
same income is not taxed twice in the hands of the same
taxpayer," whether in a single year or across multiple tax
years. It goes without saying that the value of those very general
commitments will be proved only in the details of their
implementation.
Open Issues
While the Finance Minister indicated that the Government had accepted the Shome Committee's "major recommendations," the specifics of his statement omitted to mention several significant issues raised in the Shome Committee Report. Among these are the report's recommendations that the short-term capital gains tax be abolished and that certain arrangements contemplated by other legislation be expressly excluded from the GAAR, regardless of the motive for their use. Such exempt arrangements would have included: a company's choice between paying dividends and buying back its shares; a company's choice of a debt or equity-weighted capital structure; and a company's decision to lease rather than purchase a capital asset. The Finance Minister also failed to address the continuing validity of Direct Taxes Circular No. 789,4 which provides that the Indian Revenue Service will not challenge the veracity of a validly issued Mauritian tax residency certificate.5 It is not yet clear whether these unaddressed recommendations have been rejected by the Government or whether the Government is still considering their adoption in the 2013 Budget or through future legislation.
Conclusion
While the Finance Minister's statement was not an unconditional embrace of the Shome Committee Report, it does indicate that the Government will significantly leaven the application of the GAAR as contemplated in the Act. Moreover, the Finance Minister's announcement comes as part of a series of announced measures, including reforms of the banking and insurance sectors, aimed at accomplishing the "immediate priority of the Government ... to keep the investment cycle going."6 Investors should be cautiously optimistic that, at a minimum, the announced reforms to the GAAR will soon be passed into law.
Footnotes
1 Finance Act, 2012, Section 41. See " Impact of the Indian Finance Bill 2012 on Foreign Investment in India," Jones Day Commentary, May 2012.
2 Final Report of the Expert Committee on General Anti-Avoidance Rules (GAAR) in the Income Tax Act, 1961 (2012), available h ere. See " Recommendations of the Expert Committee on the Indian General Anti-Avoidance Rule: A Welcome Step," Jones Day Commentary, September 2012.
3 Press Information Bureau of the Government of India, "Major Recommendations of Expert Committee on GAAR Accepted," January 14, 2013, available here.
4 Central Board of Direct Taxes, Circular No. 789 (April 13, 2000).
5 According to Indian Government statistics, close to 40 percent of foreign direct investment in India between 2000 and 2011 was routed through Mauritius, the result of a favorable tax treaty between the two countries. See Department of Industrial Policy & Promotion, "Fact Sheet on Foreign Direct Investment," December 2011, available here.
6 Press Information Bureau of the Government of India, "Immediate Priority of the Government is to Keep the Investment Cycle Going: Foreign Minister," January 7, 2013, available here.
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