GAAR rollout postponed to 2016, markets cheer

Finance minister P Chidambaram's announcement of Monday, that the introduction of the controversial General Anti-Avoidance Rules (GAAR) was being postponed by a further two years to April 1, 2016, has boosted the equity market. However, the announcement leaves some grey areas as grey as before, such as the fate of investments being routed to India through Mauritius.

"I believe deferral is the larger piece," says Sunil Jain, Partner at law firm J. Sagar Associates. "There is a concessional approach now."

The concessional approach lifted the Sensitive Bombay Stock Exchange index (or Sensex) by 242.77 points, or 1.23 per cent on Monday. The markets closed with the Sensex at 19,906.41.

The decision to defer GAAR's rollout was announced by Chidambaram at a hastily summoned press conference. "It's necessary to have GAAR, but in a manner that tax avoidances are precluded, and administration of the Act is fair," he said.

*Apart from deferring the introduction of GAAR, Chidambaram said the new rules would not cover participatory notes, or offshore derivative instruments. The position of FIIs with regard to GAAR was not clear.

Monday's decisions would, in normal circumstances, have been announced along with the union Budget, to be presented just weeks from now. Chidambaram clarified that legislation would be needed to give effect to Monday's decisions.

The decisions stem from the final report of an expert committee headed by Parthasarathi Shome, submitted on September 30, 2012. Shome subsequently became Chidambaram's advisor in the finance ministry.

GAAR is a tool meant to target tax avoidance, where the deal falls within legal parameters, but the tax department feels it violates the spirit of the law. Invoking GAAR would mean taking a call on the intent of the tax payer.

Former finance minister Pranab Mukherjee introduced GAAR in the last budget, but chose to defer the implementation to April 2014, following apprehensions expressed by investors. Following Mukherjee's exit from the finance ministry, Prime Minister Manmohan Singh asked Shome's committee to revisit the matter.

On the committee's report, Chidambaram said: "Major recommendations of the expert committee have been accepted, with some modifications." He did not elaborate on which of the major recommendations had been accepted.

This is where the applicability of GAAR on investments coming through Mauritius is not clear. Shome's group recommended that GAAR ought not to apply if India has a tax treaty of the kind it does with Singapore, where there is more substance required for investments routed through the country. Mauritius does not have similar safeguards.

The announcement of the decisions on GAAR in the middle of Budget preparations may have something to do with the weakness of the rupee and balance of payments. In the last four months of 2012, India received $14 billion in portfolio flows, comparable with anything received in similar timeframe over the last 20 years. However, the rupee appreciated just 1.95 per cent from the level of Rs 55.72 on August 31 to about Rs 54.63 at present.

"The currency's lack of strength is a reflection of the persisting external account deficit, driven by a sustained import demand for oil and gold," concluded Deutsche Bank in a research report released January 14.

The external account deficit indicators have been hitting record levels. In the second quarter of (July-September) of 2012/13, current account deficit was 5.4 per cent of gross domestic product, which resulted in a marginal drawdown of foreign exchange reserves by $ 0.2 billion.

"Financing such a large deficit is non-trivial in the best of times," said Deutsche Bank.

That may explain the advance announcement of what should have been a Budget proposal.

*An earlier version of this story wrongly suggested the new rules would not apply to FIIs.