GAAR: A Grey Bargain

It is by nature that people try to tinker with tax laws to the best of their creative ability so that their tax liabilities can be avoided. Seemingly Indian policy makers have no problem if their tax laws are trampled which is why honorable Finance Minister P. Chidambaram has finally deferred the execution of General Anti Avoidance Rules (GAAR) by two years. In this era of complex capital flows, every mature economy strives to fight better with the prospect of tax avoidance by enterprises and investors in the guise of tax mitigation. Many countries such as China, Canada, and Australia have GAAR rules enshrined in their tax statute. UK and USA have recently tightened GAAR. It is unfortunate that India couldn’t muster courage to go for such stern and essential tax laws.

GAAR is the set of rules which empowers tax authorities to clampdown on transactions primarily driven towards tax-evasion. If implemented, instead of routing through courts, income tax officers can directly reach out to tax fraudulent by invoking GAAR provisions. It was earlier introduced in March 2012 by the then Finance Minister Pranab Mukherjee but giving in to intense outcry from domestic and foreign investors, PM Manmohan Singh while holding finance portfolio in July, appointed an expert committee headed by Parthasarathi Shome, a former advisor in the finance ministry, to review the GAAR recommendations and suggest a suitable way forward. It is by accepting Shome committee recommendations that Chidambaram has postponed the implementation of GAAR till FY 2015-16.

Lately, Mauritius has emerged as India’s favourite destination for overseas investment replacing Singapore. It is also a major source of capital inflows in India accounting for about 40% of total flows. India’s Double Tax Avoidance Treaty with Mauritius and Singapore is exceedingly manipulated by domestic and foreign investors to minimize their tax-liabilities. Voluminous investment is made via so called Mauritius and Singapore entities of multi-national-business targeting Indian market. This is popularly known as treaty shopping. Few Indian or foreign companies inflate volumes of transactions via continuous and frequent purchase and sale of particular security, commodity or asset, thus indulge in round-tripping trade to avoid capital gains taxes. This round tripping and treaty shopping swallows a good portion of revenues in India who is relentlessly reeling under huge deficits.

There is a school of thought who believes that autonomous power given to tax authorities will result into unnecessary harassment of entrepreneurs and industrialists. Investor sentiment will also be badly affected leading to less FII and FDI inflows. However, leveling these criticisms against GAAR is nothing but an attempt to secure undue interests of investors. The truth of black money converting into white by entering Indian markets through tax havens, as discussed above, is clearly opaque. Accountability of Income Tax Dept. can be maintained. It is not a big deal.  Removing shortcomings of tax laws to outwit its misuse is what is more important.

Global economic environment is quite insecure and uncertain. Seeing this, it is imperative to maintain decent level of law and order in the country. GAAR experience of other countries has rendered positive results to them. Foreign investment in those countries hasn’t come down as it is being feared in India. Govt must motivate fresh FII and FDI as core of its policy initiatives. But it is also paramount to have modern tax laws to avoid misuse. A judiciously tough tax regime makes a nation more credible in the long run.