GARR and the UPA
Dr Ashwini Mahajan
AN English telecom company Vodafone, made a deal to acquire India’s telecom company, Hutch-Essar, in 2007 by purchasing Hutchison’s 67 per cent stake in the company. Deal was finalised for US$ 11.2 billion and consideration of the deal was handed over to Hutchison Company outside the country. By this act, Hutchison received a capital gain of nearly US$ 10 billion, as it transferred its rights of ownership to the assets owned formerly by it. According to the principle of Income tax, if a company or person sells asset and receives capital gain, capital gain tax applies to the amount of capital gain at the prefixed rate. Capital gains tax in this type of deal is 20 per cent. On the capital gain of US$ 10 billion on the total deal of US$ 11.2 billion, worked out to be US$ 2 billion, i.e. rupees 11 218 crore. Since Hutchison sold its stake in the Hutch-Essar Company, made a capital gain, it was liable to pay tax on capital gains. Since neither Hutchison, nor the Vodafone attempted to pay tax on the capital gains, Income Tax Department sent a tax notice for rupees 11,218 crores to Vodafone.
Since transaction amount was given abroad for the assets held in India, it came under the provisions of the Double Taxation Avoidance Agreement (DTAA). India has entered into DTAT with many countries, with the objective that any person or firm entering into financial deal with Indian entity or person should not be subject to double taxation, namely, tax in India and tax abroad. Vodafone’s argument is that the transaction is not subject to tax in India as it is covered by DTAA. Argument of the Income Tax Department is that the whole process was adopted with the sole purpose of avoiding tax deliberately and therefore is subject to capital gains tax.
This is not a first case of abuse of DTAA. There are many other deals of such types, which are facing similar action by the Income Tax Department. Taking advantage of the complex rules, transactions are routed in such a manner that tax could be avoided. According to principles of taxation, if any transaction is designed with the purpose of avoiding tax, tax should be charged.
It was the first time that IT department was investigating into the source of funds for acquisition of a company. Vodafone Company got relief from the Supreme Court, but the rules under which they got relief, became the subject of discussion and controversy. Government took this matter seriously that provisions of DTAA were being misused to avoid tax on capital gains made in India. Nation’s revenue loss was to the tune of whopping rupees 50,000 crores to Vodafone and such like controversial deals, whose cases are pending at various levels. The then Finance Minister, Shri Pranab Mukherjee recommended new rules in the name and style of ‘GAAR’ (General Anti Avoidance Rules). According to these rules, income tax department was given the power to impose tax, interest and penalty, if it feels that a particular transaction has been carried out with an objective to avoid tax and the provisions of DTAA have been misused.
To bring such controversial transactions under the tax net, these rules were imposed from retrospective effect. Provisions were also made to levy interest and penalties in such cases involving recovery of taxes. But after taking charge of Finance Ministry from Pranab Mukherjee, who moved to Raisina Hills, new incumbent P Chidambram started moving towards weakening of GAAR, arguing that foreign investors are not much happy, and a committee was also constituted for the purpose under the stewardship of Parthasarthy Shome.
Need for ‘GAAR’
Significantly, India has signed DTAA with many countries. These treaties were made to encourage free flow of capital by avoiding double taxation on such deals and the income earned from these investments coming from overseas. This means that foreign investors, who come from other countries, do not have to pay tax at two places, that is, country of origin and country of destination. However, investors started misusing the provisions and started circumventing the law. Other countries take due care in collection of reasonable tax, despite signing of DTAT, by making suitable provisions in their tax laws. However, in India these laws/ rules were not in place. For instance, India has signed DTAA with Mauritius. Nearly 40 per cent of foreign investment is coming from Mauritius. All know that Mauritius is not an affluent country capable of sending any significant investment. Actually foreign investors instead of bringing investment directly, rather route it via Mauritius, simply to avoid tax. These investors neither pay any tax in Mauritius, nor in India. Such acts are against the principles of taxations, but in absence of GAAR, our government was not able to enforce these principles.
Attempt to Weaken the GAAR
Finance Minister P Chidambram has said recently that he has finalised changes in GAAR, and these changes are subject to the approval from Cabinet and Prime Minister. It is significant that Expert Committee headed by Parthasarathy Shome has already given its opinion in favour of weak GAAR, opining that such move would please foreign investors. Thus, now there is no anxiety about final report from Shome Committee. It is being argued that foreign investors are taking their steps backward due to GAAR, and thus when the new rules as suggested by Shome Committee will be implemented, investors’ confidence would be restored. Critics of GAAR also argue that making laws from retrospective effect, is also not a good practice and therefore it would be prudent to make these rules from current effect. It is significant that when Pranab Mukherjee was asked about the same, he had clearly said that when British government can make laws from retrospective effect, nothing prohibits us from doing the same, in national interest.
Government’s Attempt is Against Principles of Taxation
P. Chidambaram’s latest efforts to weaken GAAR to attract foreign investors cannot be legitimised by any arguments. Suggested new rules of GAAR are not only destined to cause huge loss to the exchequer, are also against the principles of taxation. It is very unfortunate that though these rules have not got cabinet’s approval, Vodafone has not made any provision in the its books of accounts, published recently. In India, doing anything to woo foreign investors is considered fashionable. It is expected from the policy makers, not to make any laws that unnecessarily cause loss to exchequer. Critics of GAAR are arguing that quoting GAAR rules income tax officers may spin trouble for small tax payers. This argument cannot be used to legitimise weakening of GAAR. If it is feared that taxmen can misuse these provisions, then small taxpayers could be spared and rules of GAAR could be implemented on deals involving transactions of rupees 100 crores or more. Argument that taxmen can cause hassles for tax payers cannot be used for dropping the rules altogether.
As far as issue of implementation of rules with retrospective effects is concerned, it is not the first case. If rules are made with retrospective effect to streamline the law, it is prudent to do so, especially when it is an established practice internationally and a sovereign nation is fully empowered to do so.
(The writer is Associate Professor, PGDAV College, and can be contacted at [email protected])