General Anti-Avoidance Rules (GAAR )

GAAR Abbreviation

GAAR abbreviation stands for general-anti-avoidance rules and it has been introduced in India due to VODAFONE case ruling in favour of this company by the Supreme Court. The new rules will come into effect from 01 April, 2012.

GAAR Implications in India
Indian Government is trying to give powers to income tax authorities as implementation of GAAR provides tremendous powers to deny tax benefit to an entity if a transaction has been carried with the sole intention of tax avoidance. Due to powers in the hand of taxmen, now innocents may be harassed by them.

FII & FDI money coming to India through Mauritius route will now become taxable.

Increased litigations.

GAAR – Worst Scenario

The onus lies on the assesse to prove that there is no tax benefit and the transaction is not an avoidance transaction.

GAAR – Example

To make it easier to understand GAAR; we can say that suppose a person or a company is setting up business in Gulf Country and its clear intention is to claim exemption from capital gains tax, in such a scenario Indian govt has the right to deny the legitimate claim for exemption provided under DTAA as it falls under tax avoidance and Indian govt is trying to plug the loopholes.

5 facts about the general anti-avoidance rule

1) What is GAAR: The General Anti-Avoidance Rule was introduced by Finance Minister Pranab Mukherjee in his Budget presented on March 16 for the year starting on 1 April with the objective to "counter aggressive tax avoidance schemes."

2) What are its implications: It empowers officials to deny the tax benefits on transactions or arrangements which do not have any commercial substance or consideration other than achieving tax benefit. It contains a provision allowing the government to retroactively tax overseas deals involving local assets (like Vodafone). It could also be used by the government to target participatory notes (P-Notes).

3) Will P-Notes be targeted: Investments into Indian stock markets through participatory notes might slow after the introduction of GAAR. According to data from market regulator SEBI, P-notes issuance reached Rs 1.83 trillion at the end of February, about 16.4% of total assets under the foreign investor inflow scheme. P-Notes are instruments used by investors or hedge funds that are not registered with the SEBI to invest in Indian securities and they offer the buyer anonymity. The tax would be imposed on the registered financial firm buying the security on behalf of the client, meaning the brokerage would then pass on the taxes to the end investor.

"To avoid tax altogether under GAAR, an investor may now have to prove the P-note was not set up specifically to avoid paying taxes or to prove that the deal has "commercial substance," Edelweiss said.

4) What happens to the Mauritius route: GAAR could give powers to the tax department to deny double taxation treaty benefits to foreign funds based out of tax-havens like Mauritius. India has a Double Taxation Avoidance Agreement with Mauritius. Overseas portfolio investors, routing their investments via countries like Mauritius, currently do not pay any tax on short-term capital gains.

5) What do investors say:  The proposed law gives the legal right to the government to go after anyone and it added ambiguity over the taxation. Indian equities will see selling by foreign investors & less money will be coming into India consequently. Investors are very uncomfortable about GAAR in current form. FIIs run global portfolios & some invest just 1% in India. After this they might say its not worth the hassle. The move is bad for Indian economy, bad for Indian corporate, bad for Indian capital markets.