GAAR shadow over payments abroad worries India Inc

India Inc is awaiting the government to clear the fog on invocation of the General Anti-Avoidance Rules (GAAR), which deters aggressive tax planning, on a slew of payments like dividends, interest, royalty and fees to foreign shareholders, entities in the aftermath of the Supreme Court's unsettling ruling on the American investment firm Tiger Global.

On Wednesday, amid a looming slowdown and fall in net foreign investments, the state gave a partial relief by addressing one of the components in the SC verdict relating to the applicability of GAAR on old stock investments.

Corporates now want the government to dispel the shadow of GAAR on payments by Indian companies to foreign entities, particularly because the court verdict has given wider latitude to tax officials.

Companies withhold tax before paying dividends to foreigner shareholders, royalty to foreign parent, interest to overseas lender, and fees to non-resident technical service provider. The withholding tax is generally lower if such foreign entities are from countries having tax treaty with India.

THE CONCERN

Companies fear that the Income tax (I-T) department may use GAAR to deny treaty benefits and claim a higher tax-more than what has been withheld-if it suspects that the foreign entity receiving the payment is a shell or paper entity, a kind of conduit, lacking adequate 'substance', and set up to simply take tax advantage under a treaty. In such a situation, the Indian company (the payer) will come under the taxman's glare.

"Amending the rules to bring clarity on GAAR grandfathering for investments is a welcome move, but there should be clarity on the level of diligence required from Indian payers' standpoint on the structures of the foreign recipients of income. GAAR applicability requires understanding of facts and structures which the payer may not have access to. GAAR provisions therefore should apply only to the recipients of income, and not to the payers while withholding taxes and applying treaty rates," said Bhavin Shah, partner, PwC.

Following Wednesday's notification, tax officers cannot invoke GAAR to deny treaty benefits and claim capital gain tax on sale of shares bought before April 1, 2017.

"The retrospectivity issue remains unaddressed in the notification, and taxpayers may still need to seek judicial recourse for transactions undertaken before the notification and where GAAR has already been invoked. While the framework now aligns with the GAAR exemption for investments made before 1 April 2017, a cautious approach is warranted in light of the Supreme Court's ruling in Tiger Global, which limits treaty benefits to direct transfers and excludes indirect transfers," said chartered accountant Ashish Karundia.

CLARIFICATION TO HELP

According to Sanjay Sanghvi, partner, Khaitan & Co, "Payers concern on GAAR applicability is understandable. The mechanism/process for this is for the payer to approach tax authorities to determine the taxable amount and the applicable tax rate on proposed remittance to a non-resident. That approach gives it protection from any risk of being treated as 'assessee-in-default' for lower/Nil tax withholding. However, if the government clarifies that payers will not be treated as 'assessee in default' citing GAAR as a reason for non-applicability of the concerned tax treaties, it will avoid unnecessary tax litigation and help in ease of doing business."

Besides indicating breach of GAAR, the SC had pointed out three other issues in the ruling on Tiger: tax residency certificate (TRC) which is given the foreign investor to avoid capital gains tax is not sacrosanct; 'indirect share transfer' are not covered under the India-Mauritius treaty; and, India would tax an offshore investor which escapes tax in India as well as in the overseas jurisdiction. The latest notification only takes care of GAAR on share sale transactions.