What is this GAAR and what is the implication of this for our share market?

Day before yesterday Indian share market had given thumbs down to GAAR by negative closing and  yesterday after gettins assurance from Finance Minister for Modify GAAR Markekt had given positive close.  For many of us it is new term and want to know more about it.

The GAAR stands for General Anti Avoidance Rule. That GAAR was mentioned by the finance minister a year back during budget as a part of the Direct Tax Code. Before talking about GAAR there are one term which is known as P-notes (Participatory notes) we should understand first.

P-notes are financial instruments used by investors or hedge funds that are not registered with SEBI to invest in Indian securities. There are no need to fulfill KYC (Know Your Client) for investors who invest through P-notes. By avoiding KYC norms one can invest whatever amount by keeping his own identity hidden.

In Jan 2008 when SEBI had tighten the norms for P-notes our market tasted lower circuit very next day. So the P-notes issue is very crucial for our market and govt. also. The first one is first is a taxation regulation that will make investors pay tax who otherwise legally avoid it.

This year’s budget made it clear that it will be applicable from 1 April 2012. So under GAAR, the evenue authorities (IT Dept) will get to tax transactions or arrangements which were conducted or set up just to get tax benefits.

There is confusion in the market whether the gains from these instruments will also be taxed. So routing transactions through outside from India (Most P-note transaction done through Mauritius) when there is no substantial purpose to route it from there other than achieving the tax benefit will not be allowed.

Sections 9 and 95 of the new Finance Bill (under which GAAR was introduced) says clearly that any transfer of shares in India which gives rise to income anywhere else will be taxable here. These sections will clearly have to be amended if cash investments of P-notes routed through tax havens like Mauritius will have to be exempted from tax.

According to an one broking house, P notes will be facing indirect taxes only. Direct taxation is not possible if the note or the contract is carefully worded because shares or voting rights are not transferred through these. The nature of transaction is a contract and does not transfer share or interest, that Section 9 talks about.

Taxes will also be applicable to indirect transfer, which alludes to the recent Vodafone case where the Supreme Court, much to the shock of tax authorities in India, had ruled against levying tax on transactions fully carried out abroad. The main contradiction in Section 9, therefore, lies with the retrospective effect of the tax which might go back even to 50 years (1962 to be precise, when India’s existing tax code got enacted). This would retrospectively tax all cross-border deals the government might fix upon and gives a wrong signal to foreign investors.

In case of companies routing investments through Mauritius, under the new law, the onus lies on the taxpayer to prove that the transaction or the arrangement of any transaction did not have tax benefit as the main purpose. It might be difficult for most Indian corporate entities to prove they have any other sound reasons for having an establishment in Mauritius.

The scope of the Indian GAAR is very wide as it seeks to cover within its ambit nearly all the arrangements (the term ‘arrangement’ is very widely defined to cover almost every transaction, scheme, understanding, etc.) and therefore could be difficult to favour the taxpayer in any way.”

Once GAAR is invoked, a commissioner of income tax (CIT) has been entrusted with enormous powers to settle the issue and revoke tax benefits which might have gone to the taxpayer.

In such a situation, there are options to move establishments to countries like Singapore, though that also includes additional costs. P-note issuers like CLSA have halted issuing such instruments for now till there is more clarity on the issue. They have made it clear that taxes will be passed on to clients who are ultimate gainers of the transaction. However, they say, there is no need for panic selling if one is fundamentally bullish on India.

But it is definitely easier for companies like CLSA to shift clients from Mauritius to say, Singapore, where they already have a formidable base. But entities who will not be able to justify a base in Mauritius for reasons other than tax planning will be in deep trouble.

There could be immediate volatility in the market mainly in futures and options section, but ultimately investors might just begin to price in a tax cost when they invest in India.

Dear friends above article about GAAR based on market news sources which available to me please verify with your own sources and if you have any query and want more clarity feel free to ask……I would appreciate your valuable feedback.