India is not unique in unleashing this strange animal on tax-payers
To tax and to please, no more than to love and to be wise, is not given to men.
— Edmund Burke
Pranabda must be reminded of the quote as opposition grows all around to his Budget proposals that seek to tighten tax laws. At a meeting that the Finance Minister had with U.S. Treasury Secretary, Tim Geithner, in Washington last week, the latter brought up the subject expressing concern over “certain tax provisions”. Industry associations and lobbies have also been active in opposing the proposals. What is interesting is that the two separate issues of retrospective clarification that will bring the Vodafone-Hutch deal into the tax net and the framing of General Anti-Avoidance Rules (GAAR) are being grouped together as retrograde proposals. This is being very clever because some of the heat over what is arguably an unjustified move to bring retrospective amendments is being transferred to opposition over GAAR, which is a perfectly valid proposal.
GAAR is necessary
The issues over GAAR are different. Tax avoidance is of international concern now and several countries have either already codified GAAR in their tax statutes or are in the process of doing so. Globalisation and the free movement of capital across the world in search of returns using tax havens as staging bases has prompted nations to re-examine their tax codes and India is no different.
Tax planning, as opposed to tax evasion which is illegal, is an accepted practice whereby the tax-payer uses provisions of the law or loopholes to minimise his tax liability. Some countries, in addition to GAAR, have specific anti-avoidance rules (SAAR) to plug particular loopholes in the law or prevent some types of transactions that result in loss to Revenue.
An excellent research note from Deloitte titled “General Anti-avoidance Rules — India and International Perspective” points out that GAAR has been a part of the tax code of Canada since 1988, Australia since 1981, South Africa from 2006 and China from 2008. Australia and China also have SAAR in place to check abuse of tax treaties and transfer pricing.
It is not as if India is unique in unleashing this strange animal on tax-payers. And again, it is also not as if the Vodafone setback prompted the government to cook up GAAR; the fact is that GAAR was already a part of the Direct Taxes Code Bill and would have been codified as law anyway. Vodafone probably hastened it, that's all.
There is apprehension that the combined effect of GAAR and treaty override provision that has also been proposed will turn off the foreign investment tap. The double taxation avoidance treaty that India has with Mauritius has been exploited by foreign investors, especially in the capital market, to avoid capital gains taxes in India. With the GAAR now set to override the treaty, foreign investors may have to cough up taxes in India unless, of course, if they can prove that they have more than an address and a Tax Residency Certificate from Mauritius.
This might deter some foreign investors, especially the ‘hot money' types but that should not worry India because it can do without them. Genuine investors in search of returns that only an emerging market such as India's can provide will not be deterred by GAAR, especially if they are based in countries that have a bilateral tax treaty with India. It is more important for India to ensure that economic growth accelerates and the rupee stays stable because they are the twin magnets that attract foreign investment. If these two are taken care of, investors will be drawn to India, GAAR or not.
However, it is important that the GAAR rules are framed carefully taking into account the feedback of the last one month. The onus of proving that a transaction is not designed to avoid tax should be on the taxman and not on the tax-payer.
This is the international practice and the government should keep it in mind while framing the rules. The presumption now appears to be that all transactions are designed to avoid tax, which is not a fair one.
Second, the issue of treaty override needs to be handled with care as it could lead to a violation of international convention. Ideally, treaty override should be built into the Limitation of Benefits clause in bilateral tax treaties which means that the government will have to reopen sealed agreements. This might be worth the trouble though and is also the way to go legally.
Third, the rules should also clearly specify eligibility norms to claim domicile status — is it having a permanent office, or a time-period of existence in that country, or a particular level of business measured in financial terms? Merely defining domicile status as “not being a post-box company” will not do.
Finally, as a measure of reassurance, it may be worthwhile to concede a position in the GAAR panel to a person other than a tax department representative.
Having said all these, it should be conceded that the timing of the move is probably not right. Vital indicators of economic health such as the fiscal deficit and the current account deficit are not encouraging and India can do with higher foreign investment, FDI or FII. The stern tax face that the country is now projecting may probably add to the loss of attraction.
Yet, the message that India is not a tax haven should go out clearly. Genuine investors will understand the signal and frame their strategies accordingly.