The Indian government has deferred the implementation of the controversial General Anti-Avoidance Rule, which would subject offshore private equity investors to Indian tax, until April 2015, according to a statement from the ministry of finance.
Implementation was previously scheduled for April 2013.
The decision comes from recommendations of an appointed executive committee, which suggested a three-year deferral on administrative grounds so the industry could prepare for the new legislation. However, the government accepted only a two-year delay.
The government also responded to recommendations that the law not be applied retroactively, agreeing that any investments made prior to 30 August 2010 should be “grandfathered”, i.e. not subject to GAAR, even if an exit is completed after 2015. The committee had initially recommended this be applicable to all investments prior to its implementation.
“Overall it is great news, probably the best we had expected,” Mahesh Kumar, tax partner at Indian law firm Nishith Desai told Private Equity International. “At least [a two-year delay] gives some time for private equity investors and strategic investors to look at how their structures [will be impacted].”
Foreign private equity firms must now examine their investment structures aimed at India, ensuring any vehicle domiciled in previously tax-exempt countries such as Singapore or Mauritius can prove valid business purposes for being there other than Indian tax avoidance, Kumar explained.
Many firms had previously invested in India through Mauritius, Singapore or Cyprus-domiciled funds, which are protected by double tax treaties with India. GAAR threatens the tax protections offered by these jurisdictions unless funds can provide significant reasons defined as “commercial substance” for being domiciled in these locations.
For example, US investors in India face capital gains tax in both countries as their tax rules conflict, which is a legitimate commercially substantive reason although it is unclear if US firms will be protected, Kumar said. The US imposes capital gains tax based on where the shareholder is based, whereas Indian capital gains is effective based on where the portfolio company is located. This issue has previously been avoided by double tax treaties.
Therefore, although the latest announcement offers some clarity and reassurance from Indian regulators, private equity firms remain in the dark about how they can structure their funds to mitigate the risks posed by GAAR.
“Now, it is this strange situation where you know when the law is going to hit you, but you really don’t know what has to be done to manage your risk,” Kumar said. “We expect some very detailed guidance to come from the government over the next couple of months when they explain each of the ambiguous terms in the provisions, for example what is ‘commercial substance’.”
Other pending recommendations to the Indian government include that the proposed tax on indirect share transfers should not be applied retroactively. The shift in policy would mean offshore private equity firms with existing assets outside India, but that generate substantial value from the country, would not be taxed in India.