What do Dodd-Frank and India’s new tax rules have in common? They’re both controversial and ambiguous.
The proposed General Anti-Avoidance Rule (GAAR) has become India’s very own Dodd-Frank Act: fraught with controversy and filled with ambiguity.
The proposed tax rules introduced in the annual budget in March go into effect starting April 1, 2012, after the Finance Bill is passed. These rules would allow the Indian government to tax any overseas merger dating back to 1962 in which an underlying Indian asset was transferred. This overrides a Supreme Court of India decision on multinational transactions. In January this year, the Court ruled that the UK-based Vodafone Group PLC was not liable to pay taxes on a deal it struck to enter India in 2007, as the transaction was between entities based outside of India.
But the proposed rules, if passed, could override the ruling. In a recent article in the Wall Street Journal, Mukesh Butani, chairman of consulting firm BMR Advisors declared that it was “utter nonsense,” and added that the move doesn’t bode well for foreign direct investment. “It’s hard to explain to an American or European lawyer that India can amend a law” to go back 50 years.
The proposed tax-law change could also impact transactions in countries where India has a special tax treaty, such as Mauritius. India’s tax treaty with Mauritius exempts capital gains from being doubly taxed, but GAAR could override such tax treaties. Critics of the bill point out that any future investments which are coming in through Mauritius, unless there is “adequate” and “justifiable” commercial rationale are likely to fall within the purview of the Anti-Avoidance Rules.
This new rules directly impact a few companies in the NeuGroup universe. At a recent spring meeting of the NeuGroup’s Foreign Exchange Managers’ Peer Group (FXMPG), one member noted that his company had already started to move their financing structure from Mauritius to Singapore, in anticipation of the tax treaty passing. Ironically, at the same meeting the sponsor bank recommended using the Mauritius option in order to enable parent companies to acquire equity at much lower cost. Here’s a snapshot of the Standard Chartered recommended structure:
The new proposal has also fed fears that it could target “participatory notes,” an instrument that foreign institutional investors use to invest in India’s capital markets.
Overall, India remains a highly regulated market. High taxes and the maze of rules and regs have never been easy to navigate. The new tax rules are being opposed by overseas bodies such as the Asia Securities Industry & Financial Markets Association along with the Securities Industry and Financial Markets Association, both of whom have written to the Indian finance minister. “Such onerous taxation or even the risk of such taxation could threaten this important source of capital for India’s businesses,” one letter said. What remains to be seen is whether the lobbying will work and if the bill will be passed in its current form.