India offers some clarification on GAAR

Private equity firms in India that bought assets before 2010 will not be taxed retroactively under GAAR, although further interpretation is now needed on some new terms.

The Indian government has finally offered further clarification on who will be impacted by the General Anti-Avoidance Rule (GAAR), with new language offering comfort that it will not be applied to private equity firms retroactively, according to Krishan Malhotra, head of taxation at local law firm Amarchand Mangaldas. 

In late September, the Central Board of Direct Taxes released a new set of rules that said any income accrued by foreign institutional investors through the transfer of investments before 30 August 2010 would be grandfathered and not be subject to GAAR. 

“If you made any arrangement before 2010 but are getting a tax benefit after 2015 then you will not be grandfathered [unless] that arrangement is a transfer of investment, then you are exempt,” Malhotra explains.

Therefore, an investment made by a foreign private equity firm before 2010, but then exited after the implementation of GAAR in 2015, will still be grandfathered, according to the new clarification. 

Moreover, while new regulations may be detrimental to some GPs, the government has now at least cleared up previously ambiguous terms, most importantly that of “commercial substance”, which defines whether a foreign investor will be investigated under GAAR or not. 

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.

If all investments you are making from Mauritius are into no other country than India, then one can conclude that you do not have commercial substance in Mauritius even though all entities are routed through Mauritius.

Krishan Malhotra, head of taxation, Amarchand Mangaldas

Under the new rules, it is now clear that any arrangement using a double tax treaty with India, such as a fund set up in Mauritius, whose main purpose is to take advantage of the tax benefit, should be subject to GAAR and will be defined as “impermissible avoidance arrangements”. 

“If all investments you are making from Mauritius are into no other country than India, then one can conclude that you do not have commercial substance in Mauritius even though all entities are routed through Mauritius, so maybe the Mauritius entity is being created to take advantage of the double tax treaty between Mauritius and India,” Malhotra explained. 

In addition, any firm using round-trip financing, i.e. moving funds in and out of India and as a result avoiding taxes in India, would be considered as setting up an arrangement that lacks commercial substance. 

Nevertheless, although the latest notification provides some clarity on terms, as well as comfort with regards to whether GAAR will be retroactive, Malhotra believes further interpretation is now required over the term “transfer of investment” versus “arrangement”, as “everyone is expressing doubts” over what exactly this includes. 

“‘Transfer of investment’ has not been defined – investments could include shares, property, interests in the business or technology. We are presuming transfer means selling it, but [we are unsure] how this is different from the term ‘arrangement’, because they are not grandfathering ‘arrangements’, only the ‘transfer of investment’ is grandfathered,” he said.