Some tax treaties could be overridden by GAAR

GAAR will not override the recently revised double taxation avoidance agreements with Mauritius and Singapore.

The finance ministry sent positive signals to foreign portfolio investors on Friday by clarifying that the general anti-avoidance rules (GAAR, on taxes) will not override tax treaties with suitable limitation of benefit (LoB) clauses, but which had certain grey areas to interpret. 

Experts said it would have been better if these clarifications could have come earlier, as it takes time to wind up some commercial arrangements. However, this is still better than the rules on place of effective management, which have been enforced from the current financial year.

The GAAR takes effect from April 1, when the next financial year begins. 

Investments made through compulsory convertible instruments, among others, would not draw GAAR, if made prior to April 1. Some other safeguards have also been put to avoid arbitrariness.

“...if a case of avoidance is sufficiently addressed by LoB provisions in the tax treaty, there shall not be an occasion to invoke GAAR,” the Central Board of Direct Taxes clarified.

This means, GAAR will not override the recently revised double taxation avoidance agreements with Mauritius and Singapore, as both the treaties have LoB clauses, explained Amit Maheshwari of Ashok Maheswary and Associates.

However, GAAR could override the revised pacts with Cyprus and Netherlands, as these don’t have LoB clauses, he said.

The LoB clauses with Mauritius and Singapore are, however, for availing of benefits over a transition period of two years. Maheshwari said after the transition period, capital gains tax would anyway be imposed on those routing their investments from these two countries, and there is little fear of GAAR overriding these.

And, the CBDT clarifications categorically say if the jurisdiction of an FPI is finalised on the basis of non-tax commercial considerations, and the main purpose of the arrangement is not to obtain a tax benefit, GAAR will not apply.

And, that GAAR will not interplay with the right of a taxpayer to select or choose the method of implementing a transaction.

“It is a very positive development for markets, as it puts an end to ambiguity on the taxation front for foreign institutional investors. It also addresses lot of concerns of the foreign investors, including that of retrospective taxation. After GAAR, we are likely to see an uptick in foreign inflows into the country,” said Deven Choksey, managing director, KR Choksey Shares & Securities.

Rajesh Gandhi of consultancy Deloitte said the clarifications had partially fulfilled a long-standing demand, though the benefit had got diluted to a large extent because the LoB clause in the Singapore and Mauritius treaties were relevant only for availing the 50 per cent tax rate for two years. 

“In the present form, the guidelines leave some room for interpretation and dispute. To provide certainty to foreign investors, it would be better to clarify that if the conditions specified under LoB clause are met, GAAR would not apply,” said Vikas Vasal of Grant Thornton.

Also, the CBDT clarifications have said the adoption of anti-abuse rules in tax treaties might not be sufficient to address all tax avoidance strategies and these are required to be tackled through domestic anti-avoidance rules. 

This means some of the treaties could be overridden by GAAR.

Abhishek Goenka of consultants PwC said as the clarifications cannot envisage all possible scenarios, it does leave room for subjectivity and one could still need to pass the GAAR test even where the arrangement is cleared under LoB provisions. “This creates an unduly onerous obligation on investors,” he felt.

On this point, the guidelines are subjective and could be more directional, said Girish Vanvari, national head of tax, KPMG. “This is an important area, which needs more attention,” he said.

A committee headed by Parthasarathi Shome had earlier recommended that where a specific anti-avoidance rule is applicable on a particular aspect or element, GAAR not be invoked on that. 

“Similarly, where anti-avoidance rules are provided in a tax treaty in the form of an LoB clause, the GAAR provisions shall not apply overriding the treaty. If there is evidence of violations of anti-avoidance provisions in the treaty, the treaty should be revisited but GAAR should not override the treaty,” the committee had recommended.

CBDT said grandfathering (the term for an old rule continuing to apply for some existing situations, while the new rule would apply to all future cases), in line with income tax rules, would be available for compulsorily convertible instruments, bonus issuances or splits, and consolidation of holdings in respect of investments made prior to April 1 in the hands of the same investor. 

And, that if at the time of sanctioning an arrangement a court has explicitly and adequately considered the tax implications, GAAR will not apply.

“It has also been clarified that GAAR will not apply if an arrangement is held as permissible by the Authority for Advance Rulings,” the Board said. 

A proposal to apply GAAR will be vetted first by a principal commissioner of income tax (PCIT) or commissioner of income tax (CIT). And, at the second stage, by an approval panel headed by a judge of a high court.

“The stakeholders have been assured that adequate procedural safeguards are in place to ensure GAAR is invoked in a uniform, fair and rational manner,” CBDT said.

If an arrangement has been held to be permissible in one year by PCIT and CIT or the approval panel, and the facts and circumstances remain the same, GAAR will not be invoked for that arrangement in a subsequent year.

“The CBDT has taken adequate steps to ensure GAAR is invoked in deserving cases. The proposal to declare an arrangement as impermissible will undergo a two-stage vetting process. This will ensure proper evaluation of cases and target only genuine tax avoidance arrangements,” said Partho Dasgupta, partner-direct tax, BDO India.