Budget 2012-13 introduced the General Anti Avoidance Rule (GAAR). The finance minister managed to resolve the issue to a large extent, but Mauritius would no longer be a tax haven for doing business in India.
In his reply to the discussion on the Finance Bill, Pranab Mukherjee extended implementation of the GAAR to the next financial year. He also clarified it would not be applicable retrospectively, adding the onus of proving tax avoidance would be on the income tax department and not on the assessee. The clarification has helped sooth ruffled feathers, but it looks like the Mauritian route is no longer likely to find favour with foreign institutional investors (FIIs). Hence, it would be appropriate to say, "Mauritius, rest in peace".
Is GAAR unique to India? No. A large number of countries have it. Australia has it since 1981, Canada 1988 and South Africa 2006, while China introduced it in 2008. Though the US and the UK do not have specific laws on GAAR, they have enough restrictions and safeguards to ensure payment of taxes.
India is a growing economy and cannot survive by being a tax haven. It needs to tax transactions, widen the tax base and ensure stricter compliance if it has to continue to grow at seven per cent or more.
The opposition to GAAR and its implementation basically stemmed from a couple of facts. With these being addressed, this issue will cool off in the 10 to 11 months between now and implementation. The primary concern was the retrospective nature of the Act, which could have gone to extremes. The I-T department could challenge companies which received tax breaks in certain investment-encouraging states like Himachal Pradesh, Uttarakhand and those in the North East. Second, with one eye on portfolio investments and the other on the fiscal deficit, we heard conflicting views that participatory notes would not be taxed while brokers issuing these would be. This confusion caused FIIs to liquidate positions and shift from Mauritius to Singapore. With the clarifications, it is now clear that Mauritius is no longer a good choice. The extension till April 2013 gives ample time for funds to relocate, without much impact on cost.
The effect of this legislation on GAAR will have far-reaching implications. The importance of India in the future because of our population, growth and consumption story will remain attractive and encourage foreign direct investment. If India's tax laws become clearer, investors with longer horizons would come to the country, rather than portfolio investors who generally are around for the short term. The global currency volatility and rupee weakness make earning returns much more difficult. And, with some tax to be paid, would make those institutions having at least a medium-term horizon invest in India. This would also help reduce stock market volatility.
I believe giving a year's time to digest the rules and assuring no retrospective amendment(s) and putting the onus of proving avoidance on the department will make GAAR meaningful. It will ensure better tax compliance and less litigation. The icing on the cake would be stable markets, as short-term foreign players would look for greener pastures elsewhere.