Restoring Confidence that was being Lost
The Shome Committee has dispelled the cloud of tax arbitrariness that otherwise prevailed in the minds of investors going into India, whether through the Mauritius DTA or otherwise to the point of drying up FDI inflow at a time India has a significant current account deficit on its balance of payments
Investor confidence was seriously shaken with the announcement in India’s 2012 budget of impending implementation of General Anti Avoidance Rules (GAAR). A general perception was immediately created that tax administrators in India had been given wide unilateral discretionary powers to challenge without limit benefits derived by investors investing in India, including even those which were derived under Double Taxation Agreements, such as under the Indo-Mauritius DTA (DTA).
Seeing the scale of the global adverse reaction to this proposal, it was first proposed that the GAAR would be implemented only as from April 2013 rather than with immediate effect. The markets appeared to be taking this development positively but the deep-rooted feeling of uncertainty that this measure had added to an existing environment of mutual distrust, remained the dominant feeling with investors. Prime Minister Manmohan Singh decided to take the bull by the horns by appointing an expert panel headed by Dr Parthasarathi Shome to review the provisions of the GAAR and make recommendations by end of August. The panel has now given its report, which has been posted publicly, for stakeholders’ comments thereon to be received up to 15 September 2012.
The speed with which the government of India has reacted to set right the negative investor sentiment generated by the GAAR is highly commendable. Not many governments have this kind of capacity to act quickly enough to reverse a deteriorating condition. To give reassurance to the market, Finance Minister P Chidambaram has stated to be in support of a fresh approach to tax issues recommending that tax officials adopt a friendly rather than a ‘hounding’ approach to taxation. This looks like turning over a new leaf even though the markets have not shown any enthusiasm following the more pragmatic and realistic approach being put up for adoption by the expert panel of Dr Shome.
The basic thrust of the Shome Committee recommendations is that tax mitigation action (which is normal) taken by genuine investors should not be mixed up with tax avoidance and tax evasion (which are often contrived up) based on aggressive tax planning. It recommends that only arrangements which have the main purpose of obtaining the tax benefit should be covered under the provisions of the GAAR. Where obtaining the tax benefit is one only of the features of an arrangement, the provisions of the GAAR should not apply. Moreover, it goes on to state that GAAR need not be invoked by Assessing Officers (AOs) in every tax avoidance arrangement unless it is an abusive, contrived and artificial arrangement. GAAR is thus not perceived as a general tool in the hands of AOs to go on the rampage but it is rather an instrument that is to be applied only exceptionally in the case of blatant abuse.
While this restricts the wide scale powers that Assessing Officers were previously assumed to be exercising vis-à-vis investors, it puts the latter under a duty as well. Investors planning their investments into India through the Mauritius route have to keep themselves ready to establish that their arrangements are not single-mindedly artificial constructs designed solely to walk away with tax benefits due to the operation of the Indo-Mauritius DTA. They should demonstrate that there is more ‘substance’ that what might appear at the surface, through an acceptable level of local value-addition – by way of express self-identification of genuine investors going into India, explicit decision-making in the country of domicile of the investment vehicle, accountability to regulatory and other local authorities for acts and omissions, incurring a sufficient amount of local monetary expense for services availed of, use of specific local intellectual and professional resources, etc., — by choosing this route.
That means Mauritius should by all means not operate solely at the margins but should get involved deeper into the origination, operationalisation and decision-making processes of investments to stand up to the test of ‘economic and commercial substance’ of arrangements. By virtue of such deeper involvement in the conduct of investments from its jurisdiction, Mauritius would have an opportunity to prove that it is not acting as a mere pass-through of convenience for investments but is actually contributing, like Switzerland, intellectual expertise which normally goes into the making of substantial financial centres across the world.
The Shome Committee has stated specifically that the Mauritius DTA should be revisited only if policy so dictates but not by challenging it indirectly through the use of GAAR provisions as it was widely interpreted to be the case during the 2012 introduction of this tax instrument. In other words, issues such as limitation of benefits under the Indo-Mauritius DTA should fall outside the ambit of the GAAR. These are matters that are better left to be straightened out at the level of governments. The Committee has dealt with another uncertainty regarding the admissibility of tax residence certificates issued to investors by the Mauritius Revenue Authority. It considers that it is outside the purview of tax administrators to challenge the genuineness of a tax residency certificate based on commercial substance issued by the Mauritius authorities. Assurances of the sort will hopefully put to rest the doubt created in investors’ minds that the Indian tax authorities would have had the intent to jettison the core attractiveness of the DTA to investors. It is becoming clearer as to who can travel how far and in which direction; this indicates the coming into place of a framework of good governance that it should be the sincere duty of both sides to uphold.
It states that instituting the GAAR requires its sufficient pre-announcement before implementation, a common practice in the global environment of free capital flows. Its recommendation is therefore that the Indian government should postpone the implementation of GAAR by three years to fiscal 2017, a span of time that will be sufficient to allay fears and do away with the uncertainty that has been created in the minds of stakeholders by its recent hurried announcement. The Committee believes that this gap of time will also give appropriate time for the effective training up of tax administrators by fully seizing the intended mode of the GAAR implementation. This broad-based approach towards a fair regime of taxation should give comfort to investors who had been frightened away at the risk of having to face retrospective changes to tax laws, opening up investigations into the sources of incoming investments.
The Committee has gone one step further to give reassurances even in those exceptional cases that would be subject to GAAR. It has expanded the approving panel for GAAR. It recommends that this panel should be a permanent body chaired by a retired judge of the High Court and comprise four other members, two being eminent practising professionals outside of government and two others being Chief Commissioners of Income Tax or simply a Commissioner in lieu of the second Chief Commissioner. This broad-based panel will take decisions to go ahead or not on cases brought up to it by means of an approving majority of its members.
We do not know the changes that will be considered to the Shome Committee’s recommendations by 15th September 2012. What one can confidently say however is that the Shome Committee has dispelled the cloud of tax arbitrariness that otherwise prevailed in the minds of investors going into India, whether through the Mauritius DTA or otherwise to the point of drying up FDI inflow at a time India has a significant current account deficit on its balance of payments. It has fixed parameters much more clearly, going into details to state out examples of cases that would not be covered by the GAAR provisions. It remains for all the stakeholders to take full cognizance of the message which is being given out and act responsibly so as to consolidate the direction indicated by the Committee.
Even though the markets might not have reacted positively so far to those recommendations posted on 1st September, for reasons unknown, it is undisputable that the new recommendations will go a long way towards sustaining back the momentum that India’s economy had gathered shortly before serious apprehensions started being felt about the real intentions of the Indian tax administration a little more than a year ago. If they bring back the credibility of policy making, that should go towards reinforcing a positive business climate that is already working up its way dynamically in the internal market of India, notwithstanding a substantial fiscal deficit (± 10% of GDP) limiting scope for significant public sector spending, sustained high inflation (± 9%) maintaining its continuing erosion of consumers’ purchasing power and a threateningly high level of restructured debt in total bank lending. The external output by way of incoming investments has its own part to play – free from unwarranted abuses. Mauritius can responsibly contribute to the success story that India is bound to become – and earn a couple more of dollars by perking up the quality of services it delivers on this front.