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Mr.Gautam Mehra

(Executive Director, PwC),

Mr.Nehal D. Sampat

(Associate Director, PwC)

Impact of GAAR rules on FIIs

Date : October 01 2013

The General Anti-Avoidance Rules or GAAR provisions in the Indian income-tax

statute will be effective from from financial year 2015-16.

Substantial water has passed under the bridge since the insertion of GAAR

provisions was originally proposed. After the Expert Committee on GAAR

consulted various stake-holders and submitted its report to the Government a

year ago, the Finance Minister issued a statement in January 2013 setting-out

the decisions taken by the Government in relation to GAAR provisions. Some of

the announcements were incorporated in the statue by the Finance Act, 2013,

some others including procedural aspects have been considered under the

GAAR Rules notified last week and some remain yet to be clarified.

GAAR Rules

The income-tax law empowers the Revenue authorities to notify rules to administer its provisions. Section 101

of the Income-tax Act, 1961 (the Act) states that the GAAR provisions shall be applied in accordance with

such guidelines and subject to such conditions, as may be prescribed. Section 144BA of the Act dealing with

references to Commissioner/Approving Panel empowers the Central Board of Direct Taxes (CBDT) to make

rules for efficient functioning of the Approving Panel and expeditious disposal of GAAR references. Similarly,

section 295 of the Act empowers to the Board to make rules for matters specified in GAAR provisions.

Pursuant to the exercise of the above powers, the CBDT notified the GAAR Rules last week.

GAAR Rules: Whats in it for FIIs?

The Rules prescribe that GAAR provisions would not apply to a Foreign Institutional Investor (FII) who:-

(i) Is an assessee under the Act;

(ii) Has not taken benefit of an agreement referred to in section 90 or section 90A, as the case may be; and

(iii) Has invested in listed or unlisted securities with the prior permission of the competent authority in

accordance with the SEBI FII Regulations and such other applicable Regulations.

The term assessee has been defined vide section 2(7) of the Act to mean any person by whom any tax or

other sum of money is payable under the Act and in respect of whom proceedings have been initiated for

assessment of his income/loss/ refund due. It includes representative assessee and any person deemed to be

an assessee/assessee in default under the Act.

For the above purposes, the term FII has the same meaning as assigned in the Explanation to section

115AD of the Act. Under the said section, FIIs have been defined to mean such investors as the Central

Government may notify. FIIs/sub-accounts that are registered with the SEBI are automatically notified for the

purposes of section 115AD.

Thus, the Rules carve-out an exception from applicability of GAAR provisions for FIIs who have not claimed

treaty benefits or relief from double taxation in accordance with an agreement with specified territories. This is

in accordance with the draft guidelines on GAAR and the recommendations of the Expert Committee which

were accepted by the Finance Minister earlier this year.

The Rules also carve-out an exception for non-resident investors in relation to investments made by them by

way of offshore derivative instruments or otherwise, directly or indirectly, in a FII. In this context, the term

offshore derivative instrument has been assigned the same meaning as provided under the SEBI FII

Regulations. The SEBI FII Regulations define that term to mean any instrument issued overseas by a FII

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against securities held by it as its underlying.

FIIs tend to offer the gains earned by them to tax as capital gains. Tax treaties are beneficial for FIIs to the

extent that they provide relief from short-term capital gains tax. The relief granted by the Rules appears to be

bit extraneous since (i) FIIs subjecting themselves to the provisions of capital gains taxation in the domestic

law may not have a potential GAAR challenge anyways and (ii) whether p-note holders, in a typical p-note

structure, are taxable in India on the gains earned is itself debatable. Nonetheless, the above provisions, to the

extent they provide certainty to investors, are welcome.

FIIs desirous of availing treaty benefits may have to wait for some more clarity to emerge as regards the

approach of the Government/the Revenue authorities on GAAR generally. Given conditions such as 2-year

gestation period under the India Singapore Tax Treaty, the clock to plan for potential GAAR regime may have

already started ticking!

GAAR Rules: Other provisions

GAAR provisions will not apply where the aggregate tax benefit in an arrangement to all parties does not

exceed INR 30 million in the relevant assessment year. The threshold prescribed may not be material in thecontext of investment by FIIs.

The Finance Minister had indicated that investments made prior to 30 August 2010 will be grand-fathered.

Though the Rules prescribe grand-fathering provisions to that effect, the provisions are a bit ambiguous. If one

were to weigh the intent and consider the developments leading to the GAAR Rules, they appear to point

towards grandfathering of investments made prior to August 30, 2013. It would be useful if this was expressly

clarified so as to not leave even an iota of doubt in the minds of the investors. From an FII perspective, this

may have limited relevance only for long-term capital gains on off-market transactions that are not subjected to

STT.

Conclusion

The notification of the GAAR Rules, well in advance before the GAAR provisions being effective, is a step in

the right direction. With such proactive-ness, one hopes that the following issues are clarified as well in due

course (these were discussed in the earlier reports of the Expert Committee/Finance Ministers statement):-

- Interplay between GAAR and SAAR; and

- Prescribing a "negative list" of transactions for non-applicability of GAAR provisions.

One also hopes that the larger issue for FIIs i.e. the potential impact of offshore transfer provisions on India

focussed funds, is clarified too in favour of offshore investors. FIIs may have a reason to celebrate then!

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