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India AAR Update - 2013

India AAR Update - 2013

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Jones Day
Jones Day

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Published by: norrr26 on Jul 06, 2013
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Update: Indian Government to Adopt Majority of Recommendations of Expert Committee on
Indian General Anti
Avoidance Rule
January 2013
India's Finance Minister announced on January 14, 2013 that the Government of India would adopt amajority of the recommendations of the committee constituted to review India's pending income taxanti
avoidance rule. The committee's recommendations, summarized in a previous
 Jones Day Commentary 
, "Recommendations of the Expert Committee on the Indian General Anti
AvoidanceRule: A Welcome Step," dated September 2012, are likely to be included in the forthcoming 2013Budget, which will be debated in Parliament in late February 2013.
India's Finance Act, 2012 (the "Act") inserted in the Indian Income Tax Act a general anti
avoidancerule (the "GAAR") permitting the Indian Revenue Service to disregard, in assessing a taxpayer'sliability, any agreement, structure, or device (referred to in the Act as an "arrangement") employednot for bona fide commercial reasons but rather "to obtain, directly or indirectly, a tax benefit."
 The GAAR was intended to be effective from April 1, 2014.The GAAR attracted strong opposition from Indian businesses, foreign investors, and even selectforeign governments, such as the Government of Mauritius, which argued that the GAAR wouldviolate benefits secured under that country's tax treaty with India. Consequently, Prime MinisterManmohan Singh constituted an Expert Committee under the leadership of Dr. Parthasarathi Shome(the "Shome Committee") to review the GAAR and make recommendations for its modification andapplication.The resulting draft report was first released for comment on August 31, 2012,
and was receivedfavorably by investors. After considering feedback from investors and others, the Shome Committeesubmitted its final report to the Government on September 30, 2012 (the "Shome CommitteeReport"), which was released to the public on January 14, 2013.
The Finance Minister's Statement
Speaking on behalf of the Cabinet as a whole, the Finance Minister announced on January 14, 2013,that the Government "accepted the major recommendations of the Expert Committee."
Some of the key reforms are as follows:1.
Implementation of GAAR:
The effective date for implementation of the GAAR will be pushed backby two years to April 1, 2016.2.
Primary Purpose Test:
Only arrangements, "the main purpose of which is to obtain a taxbenefit," will be subject to the GAAR. The Act had provided that it would suffice for a tax benefit to be"one of the main purposes" of a targeted arrangement.3.
Grandfathering of Investments:
Investments made before August 30, 2010 will be exempt fromthe GAAR. This reflects only partial acceptance of the Shome Committee's recommendation that allinvestments predating the implementation of the GAAR be grandfathered.4.
Application of GAAR:
The GAAR will not apply in a range of specified situations, such as:
Where the tax benefit resulting from an arrangement is less than INR 30 million (approximatelyUS$550,000);
To a foreign institutional investor, where such investor elects not to claim benefits under a dualtax avoidance treaty, and to nonresident investors in such foreign institutional investor; and
Where a specific anti
avoidance rule applies and the application of the GAAR would result in aduplicative penalty (e.g., in cases involving divided stripping or bonus stripping).5.
Procedural Protections under GAAR:
The Act provides that taxpayers subject to the GAAR wouldbe provided with (i) notice and (ii) an opportunity to prove, first before the Commissioner and thenbefore a reviewing Approving Panel, that the challenged arrangement had a bona fide purposeunrelated to the resulting tax benefit. The Government has committed that a majority of theApproving Panel will be independent of the Indian Revenue Service. While one of the ApprovingPanel's three members will be a Chief Commissioner of Income Tax, the remaining two will be a
retired judge and an "academic or scholar," respectively.6.
Indicia of Purpose for Applicability of GAAR:
The Act provides that three factors "shall not betaken into account" in determining whether an arrangement violates the GAAR: (i) the period forwhich the arrangement existed; (ii) that taxes were paid under the arrangement; and (iii) that thearrangement contains an exit mechanism. The Government will amend the act to allow the ApprovingPanel to "have regard to" the foregoing factors, but these factors will not be "sufficient to determinewhether [an] arrangement is an impermissible avoidance arrangement." Because the burden of proof in challenging a GAAR determination is on the taxpayer, it may be on balance preferable to thetaxpayer that the Approving Panel consider as much evidence on the nature of the challengedarrangement as possible.The Finance Minister's statement also set out certain principles that will be incorporated in futureregulations. Notably, (i) the GAAR will apply only to the "the tax consequence of that part" of anarrangement targeted at avoiding taxes, and not the arrangement as a whole, and (ii) the IndianRevenue Service will be obliged to "ensure that the same income is not taxed twice in the hands of the same taxpayer," whether in a single year or across multiple tax years. It goes without sayingthat the value of those very general commitments will be proved only in the details of theirimplementation.
Open Issues
While the Finance Minister indicated that the Government had accepted the Shome Committee's"major recommendations," the specifics of his statement omitted to mention several significantissues raised in the Shome Committee Report. Among these are the report's recommendations thatthe short
term capital gains tax be abolished and that certain arrangements contemplated by otherlegislation be expressly excluded from the GAAR, regardless of the motive for their use. Such exemptarrangements would have included: a company's choice between paying dividends and buying backits shares; a company's choice of a debt or equity
weighted capital structure; and a company'sdecision to lease rather than purchase a capital asset. The Finance Minister also failed to addressthe continuing validity of Direct Taxes Circular No. 789,
which provides that the Indian RevenueService will not challenge the veracity of a validly issued Mauritian tax residency certificate.
It isnot yet clear whether these unaddressed recommendations have been rejected by the Governmentor whether the Government is still considering their adoption in the 2013 Budget or through futurelegislation.
While the Finance Minister's statement was not an unconditional embrace of the Shome CommitteeReport, it does indicate that the Government will significantly leaven the application of the GAAR ascontemplated in the Act. Moreover, the Finance Minister's announcement comes as part of a series of announced measures, including reforms of the banking and insurance sectors, aimed ataccomplishing the "immediate priority of the Government … to keep the investment cycle going."
 Investors should be cautiously optimistic that, at a minimum, the announced reforms to the GAAR willsoon be passed into law.
 Jones Day does not practice Indian law, and the contents of this document do not constitute a legal opinion or advice on Indian law.
Lawyer Contacts
For further information, please contact your principal Firm representative or one of the lawyers listedbelow. General email messages may be sent using our "Contact Us" form, which can be found atwww.jonesday.com. For more information about this matter, please contact:
Karthik Kumar

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