Union Budget 2015-16: GAAR regime needs to be more objective

The GAAR, if it comes into force, has the potential to bring in significant uncertainty in the tax treatment of non-resident investors.

Abhay Sharma and Suhas Sagar         Last Updated: February 23, 2015  | 21:09 IST

Abhay Sharma
Suhas Sagar
At the recently concluded World Economic Forum in Davos, Finance Minister Arun Jaitley assured the investor community that the government was looking to simplify the tax regime and will not attempt to raise tax revenues by following a policy of "aggressive taxation".

The government has in the past few months also acknowledged the need to overhaul the tax system in India to make it more business friendly. For instance, at the launch of the much publicised 'Make in India' campaign, the Prime Minister of India stated the need for the country to rank higher in the Ease-of-Doing-Business Index.

One of the key parameters for measuring the ease of doing business is simplicity and fairness of the tax system. Given the desire of the government to encourage business and investment in India, one would expect them to address some of the key issues and concerns faced by the private equity (PE) industry.

The elephant in the room of course is the General Anti Avoidance Rules (GAAR) regime and its impending implementation from April 1, 2015. The GAAR, if it comes into force, has the potential to bring in significant uncertainty in the tax treatment of non-resident investors.

In the event the government does not defer GAAR by a few years, one would expect that at least the current provisions would be amended and the recommendations of the Expert Committee headed by Dr Parthasarathi Shome incorporated and objective criteria introduced for applying GAAR. A GAAR regime that leaves little scope for subjectivity would be much appreciated by the investor community.

The other big-ticket issue for the PE industry is the taxation of indirect transfer of Indian assets. There are many loopholes that plague the provisions seeking to tax such indirect transfers of foreign assets deriving 'substantial value' from underlying Indian assets.

For instance, there is a lack of clarity on what constitutes 'substantial value', how one must determine the value of the Indian assets vis-à-vis the total value of the foreign company whose assets are being transferred and on the manner of computing the capital gains chargeable to tax.

The law should be amended in order to address these issues. Implementation of the recommendations of the Expert Committee in this regard as well as their recommendations regarding exemptions to small shareholders, foreign-listed companies, is one way of bringing a measure of certainty to the law.

Another unintended consequence of the law on indirect transfer of Indian assets is possible in the case of transfer of shares of an unlisted foreign company holding substantial assets in India as part of a group restructuring exercise.

In such cases, the ownership of the Indian assets may end up being transferred as a result of internal restructuring. The reorganisation could be entirely driven by commercial, non-tax considerations. The current law would bring the same under the ambit of Indian capital gains taxation. In order to address this situation, the law should be amended to provide specific exemption in case of internal group restructuring exercises.

The Finance Act, 2012 had introduced a concessional tax rate of 10 per cent on long-term capital gains arising to non-resident investors on sale of 'unlisted securities'. However, owing to the language of the current law, gains on sale of shares of private limited companies stand seemingly ineligible for the concessional tax treatment. The intention behind the 2012 amendment was to bring parity between FIIs and "other non-resident investors including PE investors", which indicates that the intent was to cover shares of a private limited company as well. Considering that a majority of the PE investment in India is in private limited companies, the concessional rate of 10 per cent should extend to gains on sale of private company shares as well.

The process of getting a nil/lower tax withholding certificate is also in need of fine tuning. Under the current law, where a taxpayer is of the belief that any payment received by him should not be subject to any withholding tax or should be taxed at a lower rate, he can apply to the tax authorities and obtain a certificate to this effect.

However, in practice obtaining such a certificate often becomes a time-consuming affair and the certificate is sometimes denied without any cogent reasons being provided for the denial. The process needs to be streamlined. Further, the Tax Authorities, despite issuing a tax withholding certificate, reserve the right to make a final determination with respect to the taxability of a payment at the time of assessment. This approach needs to be relooked at.

After a prolonged spell in the mire, the Indian economy has begun looking up. For this new found momentum to be gather real pace, a simpler and friendlier tax regime is a must. The changes suggested, if implemented in the upcoming Union Budget, will no doubt aid the process of establishing India's position as an attractive investment destination.

(Abhay Sharma is Principal Associate and Suhas Sagar, Associate, at Khaitan & Co)

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