GAAR still remains an irritant for FIIs, doubts persist over FII structure
MUMBAI: Anxiety still prevails among foreign institutional investors (FIIs) with regard to General Anti Avoidance Rule (GAAR), which will come into effect from April 1, 2017. While the draft rules in GAAR may have cleared the air over retrospective taxation and treatment of Participatory Notes ( P-notes), experts say doubts still persist around issues pertaining to FII structure and their tax treatment in India.
There is confusion over how tax authorities will determine commercial substance to consider FII eligibility for claiming treaty benefit and also what 'commercial substance' will be considered sufficient for this purpose. Will the substance once established be sufficient or will it have to be justified every year? There is a belief that lack of clarity over this could lead to uncertainty.
Any transaction that seemingly has been structured to avoid tax will come under GAAR. Also, since the onus of establishing the intent to avoid tax is with the tax authorities, a lot of discretionary powers continue to be vested with the taxmen. This is an issue that is causing further discomfort. Whether or not GAAR will be applicable will depend on how the tax department interprets the transaction. This will continue to confuse both assesses as well tax authorities, experts believe.
The purpose of GAAR is that it puts the onus on companies to prove they are using a specific structure for commercial purpose and not to avoid tax. Taxmen can question claims. This was not the case till now if a tax residence certificate was produced. Without GAAR, India's authorities could do nothing even if a structure was artificially created to take tax advantage. As even if the structure violated the spirit and purpose of the income tax legislation, it was nevertheless legal.
"Government's firm decision to implement GAAR may have taken away uncertainty over the timing of the tax law but certainly there is discomfort among investors with regard to lack of clarity over various key issues," said Siddharth Shah, partner at law firm Khaitan & Co. "Failure to issue clear guidelines over many issues sufficiently in advance could go against government's efforts in creating a stable tax environment."
"The government should avoid any element of surprise over GAAR and issue guidelines well in advance with regard to various rules involving commercial structure, onus and other powers that the taxmen will have under the new law," said Rajesh Simhan, partner with Nishith Desai Associates. "Issuance of clear rules in advance could give more time to FIIs to prepare and take a conscious call."
In the case of fund structure, FIIs are not clear if the substance needs to be demonstrated in the fund entity itself or whether the investment manager having sufficient substance in the jurisdiction where the fund is organised would be considered as sufficient condition for the fund to avail the tax treaty benefit.
Almost all the FIIs investing in India come through treaty countries and major foreign direct investment too flows in via tax havens like Mauritius and Singapore. In such a case, there is question over the fact that whether the limitation of benefit provisions under a tax treaty which defines certain substance requirement be overridden by the domestic GAAR provisions? Where does that leave the sovereign rights of the contracting states?
There is confusion over how tax authorities will determine commercial substance to consider FII eligibility for claiming treaty benefit and also what 'commercial substance' will be considered sufficient for this purpose. Will the substance once established be sufficient or will it have to be justified every year? There is a belief that lack of clarity over this could lead to uncertainty.
Any transaction that seemingly has been structured to avoid tax will come under GAAR. Also, since the onus of establishing the intent to avoid tax is with the tax authorities, a lot of discretionary powers continue to be vested with the taxmen. This is an issue that is causing further discomfort. Whether or not GAAR will be applicable will depend on how the tax department interprets the transaction. This will continue to confuse both assesses as well tax authorities, experts believe.
The purpose of GAAR is that it puts the onus on companies to prove they are using a specific structure for commercial purpose and not to avoid tax. Taxmen can question claims. This was not the case till now if a tax residence certificate was produced. Without GAAR, India's authorities could do nothing even if a structure was artificially created to take tax advantage. As even if the structure violated the spirit and purpose of the income tax legislation, it was nevertheless legal.
"Government's firm decision to implement GAAR may have taken away uncertainty over the timing of the tax law but certainly there is discomfort among investors with regard to lack of clarity over various key issues," said Siddharth Shah, partner at law firm Khaitan & Co. "Failure to issue clear guidelines over many issues sufficiently in advance could go against government's efforts in creating a stable tax environment."
"The government should avoid any element of surprise over GAAR and issue guidelines well in advance with regard to various rules involving commercial structure, onus and other powers that the taxmen will have under the new law," said Rajesh Simhan, partner with Nishith Desai Associates. "Issuance of clear rules in advance could give more time to FIIs to prepare and take a conscious call."
In the case of fund structure, FIIs are not clear if the substance needs to be demonstrated in the fund entity itself or whether the investment manager having sufficient substance in the jurisdiction where the fund is organised would be considered as sufficient condition for the fund to avail the tax treaty benefit.
Almost all the FIIs investing in India come through treaty countries and major foreign direct investment too flows in via tax havens like Mauritius and Singapore. In such a case, there is question over the fact that whether the limitation of benefit provisions under a tax treaty which defines certain substance requirement be overridden by the domestic GAAR provisions? Where does that leave the sovereign rights of the contracting states?
