The government has finally declared what action it intends to take on the General Anti-Avoidance Rules (GAAR), which were announced with much fanfare in the last Budget and prompted widespread concern among investors. A committee headed by Parthasarathi Shome, now an advisor in the finance ministry, had gone into GAAR and come out with several recommendations, many of which have been accepted by the government and others that have been slightly modified. In particular, the formation of an approving panel for applications of GAAR to specific transactions, which will not be dominated by members from the Indian Revenue Service but include a judicial and an academic member, is an important change that should ease concerns that a desire to maximise revenue will cause the unnecessary harassment of investors. The tax department’s enthusiasm over tax collections to meet revenue targets will perhaps be kept under check by such an independent body. In another important change, it has been clarified that GAAR will cover only those arrangements whose main purpose (as opposed to one of the main purposes) is a tax benefit — this increases the burden of proof imposed on the investigating officials.
Yet there are many confusing points that remain. What, precisely, is the status of double tax avoidance agreements in a post-GAAR administration? The government should provide greater clarity. It must explain whether GAAR will cover double tax avoidance agreements if the arrangements are solely aimed at avoiding taxes — several tax experts have interpreted the revelations to mean that similar tax treaties with Mauritius and Singapore are exempted. Further, if all investments made after August 30, 2010, will be covered under GAAR, why precisely is its enforcement being delayed? The government has said it will delay the introduction of GAAR by three years, extending the Shome committee’s recommendation of two years. This is puzzling.
It is not that puzzling, however, if it is seen as a surrender of long-term principles of sound and progressive public finance to much more short-term considerations born of India’s external vulnerability. India, crippled by an adverse balance of trade, has come to depend on volatile external fund flows — which are precisely those that would react adversely to GAAR’s introduction. The delay in introducing GAAR, along with the confusions over the status of Mauritius and Singapore, then makes much more sense. Another related and problematic decision is the exclusion of the offshore derivative instruments named participatory notes, or PNs, from GAAR. There is little doubt that many PNs are being used to camouflage the identity of the real investors in Indian financial instruments, often for the purposes of evading taxes. It is, thus, particularly disappointing that they have been specifically excluded from the purview of GAAR. The know-your-customer norms for PNs are sadly weak, and India has found it impossible to crack down on them — even if they are used for round-tripping of funds to avoid detection by the authorities. Essentially, the government has watered down GAAR so much, fearing India’s external weaknesses, that these rules have lost much of their value.
