India postpones GAAR after investor outcry

08 May 2012

The General Anti-Avoidance Rule (GAAR) introduced in India's 2012 federal budget is being deferred by a year.

When it was announced in March, the GAAR was intended to have immediate, and indeed retrospective, effect. However the news provoked a chorus of criticism from international investors and foreign governments, and weakened equity values on India's financial markets. Several private equity firms also indicated they might move their operations to Singapore. Official figures show that net portfolio investment inflows into India of USD13 billion in January and February turned into a net outflow of USD540 million in March and April, just after the budget announcement.

Finance Minister Pranab Mukherjee yesterday told India's parliament (Lok Sabha) that the rule would not now come into effect until 1 April 2013. The reason, he said, was ‘to provide more time to both the taxpayer and tax administration, and to address all related issues’.

Under GAAR, business transactions will not be allowed tax relief if they are undertaken purely to obtain a ‘tax benefit’. This is likely to be aimed especially at round-tripping - the process whereby Indian corporate investors place funds in Mauritius companies, which then invests the money in business ventures in India. Such investments are free of Capital Gains Tax (CGT) under the India-Mauritius double taxation treaty.

Mukherjee reassured investors that it will be up to the tax authorities to prove intent to avoid tax. Moreover, investors will be able to obtain advance clearance that their transactions will not fall foul of the GAAR.

But when the GAAR does finally come into force next April, it will retain its retrospective action. This means that its principal target, Vodafone, is still vulnerable to a possible CGT charge of billions of dollars on the 2007 acquisition of Hutchison's India subsidiary. Earlier this year India's Supreme Court ruled that Vodafone need not pay CGT on the deal because it was conducted through a Cayman Islands company.

Mukherjee did however give an assurance that retrospection would not be applied to disputes where the assessment orders have been finalised.

• Mukherjee also announced that CGT on the sale of unlisted securities by private equity investors will be cut from 20 to 10 per cent, the same level as for foreign institutional investors.

Sources

Economic Times of India

Calcutta Telegraph

Times of India

Reuters

Indian Express

Asianet

Economic Times (2)