The General Anti-Avoidance Rules (GAAR), only last week badly spooked the markets, continues to rattle investors.
Last week, Finance Minister Pranab Mukherjee calmed markets somewhat after he announced that individual holders of participatory notes (P-notes), a derivative instrument used to invest in Indian stocks, would not be be forced to pay taxes or reveal their identities.
Finance Minister Pranab Mukherjee calmed markets somewhat after he announced that individual holders of P-notes would not be be forced to pay taxes or reveal their identities. PTI
P-notes are issued by foreign portfolio investors registered with markets regulator Sebi, or by their sub-accounts, to investors overseas; they offer the buyer the benefit of anonymity.
Investors abroad invest indirectly through a foreign institutional investor (FII) registered with Sebi. The overseas investors shares the profits and losses and dividends through P-notes, which confirm their participation in share buying and selling transactions.
While P-note holders will not be liable to tax, it remains unclear whether FIIs, or their brokers, will be liable for their customer’s possible liabilities — and continues to create much angst among FIIs.
There’s still considerable debate about the implications of GAAR.
As a Business Line report pointed out, “If the cash-strapped Finance Minister had specific anti-avoidance measures in mind, why did he stir up a hornet’s nest with his Budget Speech one liner about General Anti-Avoidance Rules? ”
What Mukherjee essentially meant to say is that even if a foreign institutional investor hails from a tax-friendly jurisdiction like Mauritius, unless Indian tax authorities find significant commercial substance in a transaction, they will investigate and perhaps, tax the transaction.
A finance ministry official told the Economic Times that ” If you are not operating through a post box or a letter box company then there will be no tax,”, adding that GAAR had been introduced to tackle investments that are specifically designed to avoid taxes. However, a foreign investor will be required to pay capital gains in India if he doesn’t have substantial commercial interest in Mauritius.
Earlier, no short-term capital gains tax was levied on FII funds routed through Mauritius because of the Double Taxation Avoidance Agreement between India and the island nation. In any case, Mauritius does not tax capital gains. India taxes short-term gains at 15 percent, while long term capital gains are tax-exempt.
The implication of GAAR is that profits accruing on P-note investments through FIIs from tax havens, including Mauritius, could now be subject to tax, if it can be shown that a company was set up in Mauritius just to avoid tax.
The bottom line is this: The FM thinks foreign institutional investors have been getting a free ride for too long. Since FII flows have transformed from a trickle into a flood, the finance minister now wants to introduce new rules that make it clear that if the sole purpose of investing in India is to avoid tax, the taxman will surely disallow it.
—-PTI