There has been a lot of Uncertainty over General Anti-Avoidance Rules or GAAR from last few month after it was proposed by Finance Minister in Union Budget on 16th March 2012.With this post I am trying to address how GAAR will impact the FII(Foreign Institutional Investors) inflows in Indian Equity market.

What is GAAR:

          Indian Government is trying to do some amendments to the Income Tax Act by introducing the General Anti-Avoidance Rules or GAAR. Most of the foreign investors investing in India by means of avoidance of tax rather than to do genuine business.So GAAR gives tax authorities a power to disregard such transactions and include the earning in the assesses income.

The Impact on Indian Equity Market :

             Under the Double Taxation Avoidance Agreement between India and Mauritius FIIs coming from Mauritius are required to pay tax only in Mauritius,But there is no capital gains tax in Switzerland they don’t pay tax anywhere. Investors worry that they had not taken this tax liability into consideration while invested through Mauritius because it is uncertain that the rule will be applied to those who have invested before 1st April 2012 also.

              There are lots of volatility noticed in Indian market after the announcement of GAAR by Finance Minister on Union budge 2012.FIIs making a cautious approach for new investment in Indian Equity Market.  Initial three months of the year 2012 was very positive for Indian market as there were lots of buying interest seen by FII,but after post union budget 2012 ,there was continuously selling pressure seen in the Indian market by FIIs.

Here is the statistics of FII Activity for the Year 2012 so far:

            FIIs holds the majority stake in Indian companies in stock market which directs the market moment. From last couple of month these companies are suffering from the selling pressure by the news of introducing GAAR .The market will remain volatile till the finance minister clarify about the GAAR provision which is suppose to present as finance bill on 7th may 2012.

          So this is my first post towards the Indian equity market and will keep you updating with the latest and some more important aspect of share market topics soon.Let me know with your valuable feedback how this post is helpful.

Statistics Source : http://www.indiainfoline.com

Cashier counts Indian rupees — File Photo

MUMBAI: Whatever its intentions in cracking down on abuse of tax havens, India has alienated overseas investors with the timing and communication of its measures when it can ill afford to do so.

India’s move to target tax evaders through a general anti-avoidance rule (GAAR), along with a plan to retroactively tax the indirect transfer of assets, has spooked investors and added to an exodus of funds, battering the rupee.

Starting on Monday, India’s parliament will begin considering the finance bill that includes the tax proposals but final details may be a month or more away, government sources have said, which could prolong the uncertainty and aggravate a balance of payments shortfall.

“We are hoping that because of the currency and because of inflow problems, they might either delay it by a year or do something else,” said Samir Arora, an India-focused fund manager with Helios Capital Management in Singapore.

After days of what traders said was intervention to defend the rupee, the Reserve Bank of India late on Friday took steps to encourage dollar inflows, a move dealers said may do little to improve near-term weakness in the currency, which is approaching an all-time low set in December.

Meanwhile, the gloomy mood derailed the year’s biggest initial public offering from India, with auto parts maker Samvardhana Motherson Finance Ltd on Friday scrapping its $311 million issue because of poor demand.

Foreign funds are usually the biggest buyers of large Indian equity deals.

Adding to investor ire, India said on Friday it may review its tax break treaty with Mauritius, the East African island country that the majority of foreign portfolio inflows are believed to be routed through.

Mauritius is the same source of fund flows India is targeting through its GAAR proposal.

“Govt going all out to make foreign investors flee India. GAAR is not yet settled and they are making statements on Mauritius treaty review,” tweeted Sandip Sabharwal, head of portfolio management services at Prabhudas Lilladher Group.

BATTERED SENTIMENT

The GAAR proposal and a move that would tax already-completed mergers of foreign companies with Indian assets, potentially putting Britain’s Vodafone back on the hook for more than $2 billion in taxes even after India’s Supreme Court ruled in its favour, have slammed investor sentiment.

Already, investors had been put off by policy paralysis following a spate of corruption scandals as well as slowing growth, persistent inflation and a fiscal deficit that ballooned to 5.9 per cent of gross domestic product in the last fiscal year as the government has been politically unable to cut fuel subsidies.

Macquarie’s $1.5 billion Asian Alpha Fund exited its short positions in Indian single stock futures in response to the proposed tax rules, instead using a futures contract in Singapore to get its short exposure to India.

The hedge fund also cut its India long exposure in March, joining a number of foreign investors reducing holdings in the country ahead of the expected tax rules.

“The Indian government has been making many, many big policy mistakes,” Mark Mobius, executive chairman of Templeton Emerging Markets Group and one of the best-known emerging markets investors, told Reuters on May 1.

The rupee is down about 9 per cent since the beginning of March, closing at 53.47/48 to the dollar on Friday, putting it close to a record low of 54.30. During March and April, net portfolio outflows from India stood at about $540 million, compared with $13 billion in inflows in January-February.

Outflows are painful for a country that imports 80 per cent of its oil and has a widening trade gap. Exports rose 21 per cent to $303.7 billion for the fiscal year that ended in March, while imports rose 32.2 per cent to $488.6 billion.

Late last month, Standard & Poor’s cut the outlook for India’s credit rating to negative, putting Asia’s third-largest economy in danger of losing its investment grade status. It said India had reserves to meet about six months of current account payments, down from eight months in 2008 and 2009.

GAAR

Investors worry that GAAR will give authorities broad latitude to determine tax liability and they want clarity on how it will be enforced. Some expect implementation to be delayed given India’s habit of postponing policy initiatives.

A Finance Ministry official who declined to be identified told Reuters there was no plan to defer GAAR. Government sources have also said the tax would not be applied retroactively.

In the meantime, some offshore investors have been routing investments to India through Singapore instead of Mauritius.

GAAR is intended to close a loophole that allows foreign investors to avoid capital gains tax on short-term investments by routing them through tax havens.

The report said the step is being taken to help foreign institutional investors to adjust to the new tax regime.

Foreign investors had complained loudly about GAAR, which required companies and other entities to prove that they had not undertaken transactions to avoid tax.

Foreign investors had complained loudly about GAAR, which required companies and other entities to prove that they had not undertaken transactions to avoid tax. The onus of proof was placed on the company or investor under scrutiny, unlike in other parts of the world where the burden of proof lies with tax authorities.

Foreign investors were also worried that GAAR would override India’s tax treaty with Mauritius which exempts capital gains from being doubly taxed. Most foreign funds invest in Indian stocks and bonds through Mauritius.

The report said the government would issue an extensive ‘frequently asked questions’ list that will be part of GAAR rules. This list would contain clear definitions of ‘permissible arrangements’ with examples.

The onus of proof to prove that a transaction was done to avoid tax will lie on the tax authorities, the report said. There will also be a three-stage process to invoke GAAR.

The panel assessing a GAAR claim will consist of independent experts and tax officials, said the Bloomberg UTV report.

No official comment was available from the finance ministry.

Rupesh Yatesh Dalal
Head Research Department

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According to new discussion India could introduce new capital gain tax liabiliteis for foreign investors who invest in India through Mauritius. India and Mauritius have a tax treaty to avoid double taxation but new foreign companies might not get the treaty’s protection under the new regulation if Indian officials feel that those investments are routed through Mauritius only to get tax benefits.

The responsibility of proving tax avoidance will rest with the Indian authorities. The government also will not apply the rules retrospectively as this was the main issue of foreign companies. According to clarification given by government the proposed law was never intended to tax small investors and business in the first place rather it was aimed at examining large deals for possible tax evasion through the use of innovative structures to circumvent the jurisdiction of Indian authorities.

Suggestions and Comments are welcome.

During the last thirty years case law has arisen in respect of artificial avoidance schemes and has also been used to combat arrangements seen as artificial by HMRC. More recently legislation has been implemented requiring companies or advisers to disclose tax avoidance schemes at an early stage, and penalties apply for failure to do so. This has enabled HMRC to identify avoidance schemes as soon as they are devised and to take steps to ensure that where necessary legislation is put through to render the schemes ineffective.

The pressure on the government to take further action to combat tax evasion has been spurred on by adverse publicity in respect of the relatively low tax paid by the largest companies, combined with publicity for tax lost due to compromises and mistakes in HMRC dealings with the large companies. A recent report by parliament’s public accounts committee added fuel to the flames. This report suggested that HMRC had conceded too much tax in settlements made with large companies and had made errors in relation to collection of interest on tax liabilities.

The Chancellor has announced that legislation to introduce a General Anti-Abuse Rule (GAAR) will be included in next year’s Finance Bill. The idea behind this new legislation is to target artificial tax schemes while not affecting legitimate business transactions. More consideration is to be given before the legislation is finalized but it is clear that taxpayers will be under more pressure than ever before to ensure that their activities cannot be seen as artificial schemes.

In the light of these developments taxpayers must be very careful to ensure they remain on the right side of the line with respect to tax planning. There will not be any possibility of advance clearance in relation to the GAAR so taxpayers must be sure to obtain correct advice before implementing their tax planning. Taxpayers still have the right to arrange their tax affairs in a favourable way. With the right advice taxpayers can put in place arrangements that comply with the law and with the requirements of their business.

A shining example would be the creation of a shell-holding company in a tax-friendly country like Mauritiusto invest in India. GAAR empowers tax authorities to separate transactions aimed at avoiding tax from the ones driven by commercial consideration.

For its part, the government says the move is not aimed at maximising tax revenues but plugging tax leakages. It intends to have in place a “substance over form” doctrine to determine mischief.

The Need

Truth be told, efforts to lower tax liability are rampant. An often quoted example is investment in windmills. Investors in windmills can claim 100% deduction as depreciation in the first year. The intent was to promote clean energy. But the real motive has become lowering of the tax outgo.

Similarly, many multinational companies operating in India have routed their investment through Mauritius. While there is no wrong in having a holding company there, it often turns out to be a shell company. The arrangement exploits the loopholes in the double tax avoidance treaty that India has with Mauritius. The government believes GAAR will end all this.

Fear Factor

Though the opposition to GAAR is muted, the wording of the law is giving taxpayers and professionals nightmares. For one, the scope of the law is very wide. Sudhir Kapadia, national tax leader, Ernst & Young, says the problem is that “we don’t know the instances under which GAAR would be invoked”.

Equally worrying is the sweeping powers bestowed on tax officers. They can question any transaction, even legitimate deductions, say experts. The powers are omnibus, says NC Hegde, partner at Deloitte, Haskins & Sells. For instance, the tax department can accuse companies of setting up shop in underdeveloped areas solely to claim a tax deduction. Never mind that tax is counted as one of the costs of doing business.

Another scary thought is that the panel for dispute resolution will comprise tax officers of the rank of commissioners and higher. Pranay Bhatia, associate partner, Economic Laws Practice, says the experience with similar panels for foreign investors has been bitter. “In almost all the cases, the panel endorsed the view of the assessing officer.” Worse, the burden of proof lies with a taxpayer, as GAAR is worded in a manner that authorities can presume mischief.

Foreign Companies

Foreign investors with a holding company in a tax-friendly country are concerned how the Indian tax department will define commercial presence. Normally, if the holding company is doing business in the country of incorporation, has a board of directors that meets in that country and has a predefined threshold turnover, it would satisfy conditions of commercial presence. Mauritius has in recent years become more transparent. It remains to be seen if that is enough to satisfy Indian authorities.

Indian MNCs

Indian companies expanding overseas too have reasons to be worried. Most set up a holding company outside India and will have many offshoots. A holding company overseas may also enable easier access to cheap overseas borrowings. Subsidiary operating companies may pay dividends to the holding company, which it may not transfer to the Indian parent, as that money could be ploughed into other overseas activities. Under GAAR, tax authorities could rule that the Indian parent did not bring the dividend to India to avoid paying taxes.

Domestic Companies

GAAR can prove tricky for domestic companies too, and many of their transactions, done in the normal course of business, can be questioned and tax benefit disallowed. Take for instance the merger of a loss-making company into a profit-making one. On merger, losses would offset profits and the lower net profit, if any, would mean substantially lower tax liability for the company.

The merger may have been driven by pure commercial considerations, better integration of operations or to ensure the loss-making company does not shut down, but tax department can claim it was a tactic to avoid taxes.

In another situation, a company can choose between leasing an asset and purchasing the same. On a leased asset, it can claim deduction on lease rental while on an asset that was bought, it can claim depreciation. Disputes can arise on leasing versus buying.

Likewise, a company can be asked why it raised funds through borrowing when it could have issued equity. On borrowings, a company can claim deduction on interest paid. Both decisions depend on what is more beneficial for the company.

There could be cases of the large corporate groups creating a service company to manage all its non-core activities. The service company would then charge each company for the services rendered on a cost plus basis. The tax department could dispute the mark-up in the cost of services and claim it was an instance of shifting profit from one company to another.

Individuals

This is a grey area. Given the tax avoidance rules are general, tax experts say individuals too would be covered. The finance ministry says the government does not intend to go after the salaried. But company leased cars, a perk senior executives enjoy, can be challenged as a tax avoidance measure. This is because the value of the lease would be far higher than the value used for calculating tax.

Tax-savvy high net worth individuals could also be under scrutiny. For instance, setting off losses in the stock market against gains can come under further scrutiny. What may be an attempt at balancing the portfolio with changes in investment objective may be questioned, with the tax department saying a certain set of stocks sold at losses was done only to reduce tax liability.

China Postal Express & Logistics Co. – Co. plans to launch an initial public offering on the Shanghai Stock exchange which is expected to raise RMB 9.98 b (USD 1.6 b). The company plans to offer around 4 b yuan-denominated shares as part of its IPO. (Bloomberg)

China is expected to provide development loans worth USD 8 b to South Sudan in the next two years to facilitate construction, hydroelectricity, infrastructure and telecom operations. (Bloomberg)

National Petrochemical Co. -  Iranian Oil Ministry’s subsidiary is in talks to obtain funding from local banks to develop 60 petrochemical projects by the end of 2015, expected to total USD 50 b. The state-run company aims to increase its output to 85 petrochemical manufacturing units from 25, currently. (Bloomberg)

INDIA

Foreign Institutional Investors (FII’s) have pulled out approximately INR 777 cr in April 2012.  The imposition of  government’s anti-tax avoidance rule or GAAR and S&P’s revised outlook of the country from ‘stable’ to ‘negative’ were the main factors for the FII’s bearish views on the Indian equity markets. (Economic Times)

The state government of Rajasthan discontinued tenders worth INR 12,000 cr awarded to Bharat Heavy Electricals (BHEL). BHEL has won contracts pertaining to thermal power construction projects in Suratgarh and Chhabra which comprised of a total power generating capacity of 2640 Mega watts. No official reason was cited for the cancellation of tenders. (Economic Times)

MMTC Ltd – State owned commodity trading firm MMTC will sign a three-year contract to supply iron ore with Japanese and South Korean steel companies which includes Posco, in May. Under the terms of the contract, MMTC will supply 3 m tonnes of iron ore a year to five Japanese and a South Korean companies including Nippon Steel Corp, JFE Steel Corp and Nishin Steel and 1 m tonne of iron ore to Posco. (Economic Times)

India’s Prime Minister Manmohan Singh inaugurated the INR 21500 cr Bathinda oil refinery which is a joint-venture between Hindustan Petroleum Corp and Mittal Energy Investment Pte. Ltd. In related news, Lakshmi Mittal stated that output at the downstream refining project would be doubled to 18 m tonnes per annum from the current capacity of 9 m tonnes. (The Hindu)

According to the working group of the Planning Commission in India, the Food Security Bill is expected to increase the country’s fiscal deficit marginally from 5.1 percent to 5.14 percent of GDP for FY12-13. The bill, implemented during the Union Budget, aims to provide subsidies of INR 75000 cr which could rise up to INR 1.12 lakh cr. However, the report also states that the subsidy bill is expected to increase to INR 1.26 cr, 68 percent higher than budgeted estimates for FY13-14. (Business Standard)

India will host the 46^th Annual Meeting of the Asian Development Bank in May 2013. (Business Standard)

India’s Air India has entered into a code-share agreement with South Korea’s Asiana Airways on the flights operated by each other. The airline company is also expected to enter into similar deals with Air China and Egypt Air in the coming period. (NDTV Profit)

Mahindra & Mahindra (M&M) – Automobile company M&M will launch its XUV500 model in Italy, Australia and Chile. The company plans to increase output from 4000 vehicles to 5000 a month upon commencement of the deal. (NDTV Profit)

EUROPE

Russian conglomerate Basic Element has entered into an agreement with Chinese state-owned firm North Industries Corp (Norinco) to construct a USD 1 b rolling steel mill in Russia. The deal will also provide a foray for Basic Element’s subsidiary, United Company RUSAL, in China for its aluminum production and export operations. (Reuters)

NORTH AMERICA

Haremonetics Corp – U.S based medical and healthcare product manufacturing firm is to acquire assets of Pall Corp’s subsidiary Hemerus Medical LLC in a deal worth USD 536 m. (Bloomberg)

General Motors – The company is in talks with Isuzu Motors Ltd to acquire a 10 percent stake to manufacture and market automobiles in Asia and Central and South America. (Reuters)

UPCOMING ECONOMIC DATA – 30 APRIL 2012

Japan’s Nomura/ JMMA Manufacturing Purchasing Manager Index (Apr) – Previous data at 51.1

New Zealand Trade Balance data for March – Expected at NZD 420 m against NZD 161 m, previous.

Germany Retail Sales (MoM) for March – Previous data at -1.1 percent.

European Monetary Union Consumer Price Index (YoY) data for April: Previous data 2.7 percent.

United States Core Personal Consumption Expenditure – Price Index (MoM) for March:  Expectations at 0.2 percent vs previous at 0.1 percent.

Canadian GDP (MoM) for February: Previous data at 0.1 percent.

(FxStreet)

On a different note, the scene is the Indian market is not looking all that great for VC/PE firms thanks to the proposed GAAR (General Anti-Avoidance Rule) regulation in this year’s budget. PE firms are worried about the tax implications on their capital gains if their presence in Mauritius is deemed as “not substantial”. Now this is a completely gray area and I would be very interested in understanding how the Indian tax officials are going to judge whether someone’s presence in Mauritius is “substantial” enough to benefit from the Double Taxation Avoidance Agreement.

While I cannot quite put a finger on it, I feel that in India, to move a step forward, we always take five steps in the opposite direction. It is heartening to see the government do something about the corporate tax avoidance however their efforts may be better suited for some introspection and maybe in the process weed out the corrupt in the ministry first. It is said that you can set an example for others by putting your own house in order prior to looking outwards.

These nations have resolved to establishing a development bank for financing projects in these and other developing countries. It is clear that China is trying to find some means to suitably deploy its surpluses held in foreign currencies.  the US is near to China for some reasons exclusive to those two countries and is near to India for some reasons exclusive to US and India. Similarly other nations have unique equations with US. But , every one of these nations is finding hard to adjust to mercurial policies of US in respect of many issues and want to have some platform to be able to announce a separate line of thinking without being seen as confronting the US.

One such matter is Iran related where the US wants everybody to be wary of its nuclear related ambitions and in the process impose sanctions etc.. This may suit US but it is some thing absolutely not likable to India , China and the rest as this will put pressure on petroleum availability . India and China both rely heavily on imported oil and they have to keep the supply lines open from all sources at all times. There has been a common approach in appreciating right of Iran as far as developing atomic option for peaceful purposes.

In the mean time the GAAR impact is going to be moderated by the govt about which PM and FM have made some statements. The rules may eventually be framed in a way that the FII investment is affected in the least. The points I have raised may have been responsible for the a decent upside move in Nifty which close above 5300 scoring about 2.5% gain in trading just today. In my  post earlier this week under the heading ‘Debt/Equity Equation’ , I had mentioned that market has to soon take a decisive upward turn and had given the back-drop to it. Please go through the same once more .

Hariom,

krsnaKhandelwal

1. The Government has shown its benevolent side by relaxing restrictions on External Commercial Borrowings (ECBs) in certain sectors, which most agree are key sectors for reviving the Indian economy, viz. Power, Airlines and Roads & Highways, together constituting a fillip to the otherwise sagging infrastructure sector. These borrowings are otherwise subjected to rather stringent regulations by the RBI. ECB’s are essentially one of the primary sources of forex for Indian businesses and PSUs.

2. This provision moves India towards the much-awaited GST regime. For now, the negative list is being criticised as too broad, harsh, etc. but the fact remains that it does in many ways lead to a more transparent and clear service tax regime, something that most craved earlier. The negative list essentially means that instead of earlier, where a specific service had to be mentioned particularly for it to be taxable, we now have a role-reversal, whereby every single service is taxable unless it finds specific mention as being exempted vide inclusion in the “negative list”. The relevant provision is Section 143 (F) of the Finance Bill and it reads as follows:

(…)66B. There shall be levied a tax (hereinafter referred to as the service tax) at the rate of twelve per cent. on the value of all services, other than those services specified in the negative list, provided or agreed to be provided in the taxable territory by one person to another and collected in such manner as may be prescribed.

3. Apart from the negative list, this Budget has also taken another step in the direction of transparency, with an amendment to Section 139, that mandates who has to file a return of income tax. It now includes residents who have any asset located outside India or signing authority in any account located outside India. This is presumably the Government’s baby steps towards tackling the black money menace. The relevant provision reads as follows:

56. In section 139 of the Income-tax Act, in sub-section (1),—
(a) after the third proviso, the following proviso shall be inserted, namely:— “Provided also that a person, being a resident, who is not required to furnish a return under this sub-section and who during the previous year has any asset (including any financial interest in any entity) located outside India or signing authority in any account located outside India, shall furnish, on or before the due date, a return in respect of his income or loss for the previous year in such form and verified in such manner and setting forth such other particulars as may be prescribed.”

4. There have been significant reforms as far as India’s transfer pricing regime goes. We now have provisions that allow for Advance Pricing Arrangements (APAs), that assessee’s may enter into with the Revenue to ascertain their tax liability for a specific transaction and freeze it, subject of course to caveats pertaining to misrepresentation, fraud, etc. These arrangements shall bind both the Commissioner and the assessee. Section 39 is the relevant provision, that states:

39. After section 92CB of the Income-tax Act, the following sections shall be inserted with effect from the 1st day of July, 2012, namely:—
‘92CC. (1) The Board, with the approval of the Central Government, may enter into an advance
pricing agreement with any person, determining the arm’s length price or specifying the manner in
which arm’s length price is to be determined, in relation to an international transaction to be entered into by that person.

Of equal importance, perhaps, is the introduction of a domestic transfer pricing regime, for a range of “specified domestic transactions”, enumerated in Section 92BA of the Act.

5. The last aspect I shall discuss is that of the removal of the cascading effect of the Dividend Distribution Tax (DDT) levied in Section 115-0. Earlier, complex holding structures were discouraged due to the neccessity of having to pay tax at each stage, a situation modified three years ago by the addition of sub-section (1A) that granted an exemption to subsidiaries. That amendment has been now taken forward, with further deletions in (1A), that now allow holding structures since tax would be payable only on one occasion.

Further, several further amendments to the Income Tax Act, 1961 have been made, most of which are retrospective in nature, and a lot of which seem to aim at overcoming the decision of the Supreme Court of India in the recently decided Vodafone  matter. There has also been the (anticipated) introduction of the General Anti – Avoidance Rule (GAAR) into Indian fiscal jurisprudence, with the addition of a Chapter X-A to the Act. These amendments include:

1. A GAAR, which one thought would arrive only with the DTC, seems to have inserted with the intention of testing its validity (and its validity is indeed sure to be tested before the Courts soon enough). An entire chapter has been added to the Act, with the first of the provisions declaring:

95. Notwithstanding anything contained in the Act, an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement and the consequence in relation to tax arising therefrom may be determined subject to the provisions of this Chapter.
Explanation.—For the removal of doubts, it is hereby declared that the provisions of this Chapter may be applied to any step in, or a part of, the arrangement as they are applicable to the arrangement

It must be noted that the Chapter is set to apply in derogation to all other provisions, and this would technically include Section 90(2) as well, which is the statutory authority under which the State enters into DTAAs with other countries. Resolving this conflict will be a duty soon to be cast upon the Courts.

2. The most shocking amendment to my mind was that of the addition of Explanations to Section 9(1)(vi), dealing with royalty. There had been controversies pertaining to several aspects of royalty, especially as to whether the transfer of copyrighted items (off the shelf software products, books, etc.) could be equated to a transfer of copyright itself. Similar disputes regarding royalties payable by satellite TV providers too had surfaced.  The new amendment pre-empts any further adjudication sans a constitutional challenge to the provision, by declaring retrospectively that:

(…)in clause (vi), after Explanation 3, the following Explanations shall be inserted and shall be deemed to have been inserted with effect from the 1st day of June, 1976, namely:—
‘Explanation 4.—For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred.
Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes and has always included consideration in respect of any right, property or information, whether or not—(a) the possession or control of such right, property or information is with the payer; (b) such right, property or information is used directly by the payer; (c) the location of such right, property or information is in India.
Explanation 6.—For the removal of doubts, it is hereby clarified that the expression “process” includes and shall be deemed to have always included transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar technology, whether or not such process is secret.

3. The last issue is one I shall address in an independent post, that of the amendments to Section 2 and 9 of the Act. Section 2, the definitions clause, saw sub-sections 2(14) and 2(47) amended, the two dealing with the definitions of “capital asset” and “transfer” respectively. To overcome the SC decision, the term “capital asset” has been amended to include any rights of management and the term “transfer” to include:

Explanation 2: For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed always to have included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company incorporated outside India.”

Section 9 (1)(i) has been modified more severely, with a clear eye on the words of the learned Chief Justice in Vodafone, the amendments stating:

Explanation 4: For the removal of doubts, it is hereby clarified that the expression “through” shall mean and include and shall be deemed to have always meant and included “by means of”, “in consequence of” or “by reason of”.

Explanation 5: For the removal of doubts, it is hereby clarified that an asset or a capital asset being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be and shall always be deemed to have been situated in India, if the share of the interest derives, directly or indirectly, its value substantially from the assets located in India.

Mr. Soli Dastur provides an interesting take on how, perhaps the retrospective amendments may not have the desired effect on the Vodafone decision – a video of his analysis of the Finance Bill, 2012, is available over here (the analysis starts from 6 minutes 30 seconds).

A copy of the Finance Bill, 2012 itself is accessible over here.

The Explanatory Memorandum may be read over here.

Informative posts with far more erudite analyses on the budget, by  Nishith Desai Associates (NDA) Hotline may be accessed over here (for a corporate perspective), and by V. Niranjan on the Indian Corporate Law Blog may be accessed over here and here (for an erudite, yet detached, academic perspective).

According to Chinese PM Wen Jiabao, corruption could threaten China’s power structure. (Reuters)

INDIA

EGoM undertook a decision to allow export of additional one million tonnes of sugar over the previously approved two million tonnes for the marketing year through September. This move aims to ease surplus sugar stock and support sugar mills in repaying arrears of INR 8409 crore owed to farmers. According to data released by Indian Sugar Mills Association, sugar output in India increased to 21.16 million tonnes since October 1, up 14% from a Y-o-Y basis. (Financial Express)

According to the Steel Minister, India’s steel production stood at 63.894 million tonnes during the April-February period this fiscal, up 6.8 per cent over the same period last year. He also added that steel production during the entire 2010-11 fiscal was 66.013 million tonnes, up 8.8 per cent over 60.624 million tonnes in 2009-10. (thehindubusinessline)

The lack of clarity in terms of the new General Anti-Avoidance Rule GAAR rules drove the market down on Monday.  According to a brokerage firm IIFL the introduction of GAAR could give powers to the tax department to deny double taxation treaty benefits to foreign funds based out of tax-havens like Mauritius. (Reuters)

According to a CRISIL research report, the new home prices in Mumbai are unlikely to decline, despite a 40 per cent decline in new home sales in 2011. (NDTV)

CIL – In a letter to the Coal Ministry, an UK based hedge fund which holds a minority stake in co. has alleged that co.’s board and top management for not performing adequately and were harming the co.’s growth. (Economic Times/PTI)

Kotak Mahindra Bank – Private equity investor Warburg Pincus LLC has sold 3.6 per cent of its remaining stake in the co. Reports say that the investor sold shares for INR1,400cr through this deal. (thehindubusinessline)

Reliance Gas Transport Infrastructure Ltd - Co. is up for sale and PSU companies GAIL and Oil India have shown interest in buying the co., according to a source. (Economic Times)

IDBI Bank – According to the co. the government has decided to infuse INR 810cr in the bank by way of preferential allotment of shares. (Business Standard/PTI)

Tea Co.’s – According to the Indian Tea Association (ITA), tea production in North India covering Assam and West Bengal for 2012 is set to register a sharp drop due to a prolonged dry spell and rising temperatures across the two States, according to the Indian Tea Association. Data compiled by ITA in respect of its members estimate rainfall deficit for West Bengal to range between 31 and 42 per cent during January-March 2012 as compared to the same period in 2011. (thehindubusiness line)

Infra Co.’s – US Commerce Secretary John Bryson on Monday pitched for U.S. companies to participate in India’s massive private sector-driven push in building infrastructure. However he also warned on the high import tariffs that could hurt long-term ties. (Reuters)

Tata Motors – Co.’s subsidiary Jaguar Land Rover (JLR) yesterday said it has raised GBP 500mn through issue of bonds. (Business Standard/PTI)

Tata Metaliks – Co. yesterday said its board had approved an issue of preference shares worth INR 100cr to its promoter Tata Steel.  (Economic Times/PTI)

EIH Associated Hotels – Shares in co. rose 11 per cent to INR 174.10 on the back of the co.’s proposal of a rights issue as well as merging of the co.’s wholly owned subsidiary Island Hotel Maharaja Ltd with itself. (Money Control)

JSW Steel – Co. yesterday said one of its promoters, JSW Investments, has increased stake in the company to 3.70 per cent by purchasing shares worth INR 1.69cr. (Economic Times/PTI)

Gammon Infrastructure Projects – Co. has bagged a contract from the National Highways Authority of India (NHAI) for four-laning a national highway in Haryana at an estimated cost of INR 934.93cr. (Business Standard/PTI)

Kingfisher – Co. made a tax payment of INR 44cr to the Income Tax Dept. In other news ICICI Bank has sent a loan recall notice to the company asking it to repay the loan or top up the share collateral. The Bank has an exposure of INR 600cr, out of which, INR 170cr is equity and the INR 430cr is debt. In other news the civil aviation minister Ajit Singh issued a warning to the co. saying that the company should pay all its dues to airports and oil companies in order to avoid stoppage of services and fuel. In related news co. owed over INR 5,600cr to public sector banks as on February this year, according to the government. (CNBC TV18/Economic Times/NDTV/PTI)

EUROPE

ECB President, Mr. Mario Draghi, in his speech stated that economy is stabilizing in the troubled Euro zone. He cited that improved lending activities by banks to the financial markets could stabilize the region.  European banks have issued about EUR 70 bn of senior unsecured debt this year, which was above the amount which was issued in 2HY10. (Reuters)

Germany has backed down from its resistance to boosting Europe’s financial firewalls, after Chancellor Angela Merkel said she was open to temporarily boosting the eurozone’s bailout funds to EUR 700bn. But the move still falls short of what may be needed to protect Italy and Spain from collapse. In other news Angela Merkel said that it would be “catastrophic” to allow Greece to leave the eurozone because of its debt problems. (Telegraph/boston.com /AP)

According to ECB’s Christian Noyer, it may not be easy to return to the policies that existed before the financial and debt crises and it was crucial to remain focused on price stability. (Economic Times/Reuters)

Germany’s Ifo index rose in March to 109.8 vs. prev. 109.6, beating the consensus forecast for no change and confounding some expectations of a weaker figure after disappointing economic surveys last week. (Reuters)

HSBC – Co. said it was in talks over a possible sale of its Mauritius retail banking and wealth management division, as the co. sells non-core assets to boost investor returns. (Reuters)

Tullow Oil Plc – Co. discovered oil in the northern part of the country and will undertake further steps to ascertain commercial viability of the well. (Reuters)

RBS – the UK government is in advanced talks to sell a significant stake in the Royal Co. to Abu Dhabi. (BBC)

Royal Mail – UK state-owned postal operator, Royal Mail, is set to launch an IPO by 2013, depending on market conditions. Analysts estimate that the company is valued at GBP 3-4 bn.  The UK Government initially plans a partial sell-off of the company with a complete divestment not ruled out.  The European Commission’s approval of the UK Government taking over Royal Mail’s GBP 9.5 bn pension deficit reduced approximately GBP 1 bn of its GBP 1.7bn debt. (Financial Times)

 NORTH AMERICA

Ben Bernanke, in his speech on Monday stated that labor markets remained weak and that the US Fed could still conduct further quantitative easing if required. For the labor markets to pick up, Mr. Bernanke stated that the economy would still have to grow at a faster rate to create jobs through expansion of production and an increase in demand from consumers and corporations. The decline in US unemployment rate from 9.1 percent to 8.3 percent over the past six months could be stated as a one-off bounce back from the massive layoff witnessed during 2008 and 2009. The April FOMC meeting could reveal the Fed’s policies in terms of whether it plans to continue “operation twist” – buying long-dated Treasury’s and selling short dated ones to keep interest rates low,  or to conduct a third round of asset purchases or QE3. (Financial Times, CNBC)

Schlumberger Ltd – Co. was downbeat on this profits as it said that downward pricing pressure for hydraulic fracturing services, which had now reached North American liquids basins as well. (Reuters)

Anadarko Petroleum Corp – Co. plans to drill six to eight exploration and appraisal wells in the Gulf of Mexico this year, a plan that marks a full recovery from disruption stemming from the government’s 2010 drilling moratorium. (Reuters)

According to a report by Morgan Stanley and consultancy firm Oliver Wyman, investment banks, collectively, are set to reduce their balance sheets by USD 1 tn on account of higher funding costs and increased regulatory pressure to maintain adequate capital. Some of the measures undertaken by the banks include reduction in risk weighted assets by USD 900 bn and USD 10-12 bn in other costs.  (Financial Times)

 Economic Activity

Argentina’s 4Q GDP rises by 7.3 percent on a Y-o-Y basis beating economists’ forecast of 7 percent.  4Q GDP was also up 0.8 percent on a Q-o-Q basis according to data from Argentina’s national statistics agency, Indec. During 2011, the Argentinean economy expanded 8.9 percent, down from 9.2 percent a year before. Argentina’s central bank has forecasted a GDP growth for 2012 at 6 percent even though many economists are less optimistic. (MarketWatch)

German IFO – Business Climate (Mar) at 109.8 vs 109.7 (Previous).

United States Pending Home Sales (MoM) (Feb) data at -0.50 per cent vs 2.0 per cent (Previous)

]]> http://jeffkaye.wordpress.com/2012/03/23/the-moral-tax-maze-what-does-society-want/ Fri, 23 Mar 2012 17:11:06 +0000 Common Threads http://jeffkaye.wordpress.com/2012/03/23/the-moral-tax-maze-what-does-society-want/ …..and General Anti-Avoidance Rules (GAAR)

Following on from the Aaronson report in November, 2011, George Osborne stated in his budget speech to Parliament this week that he has decided (no doubt after Liberal Democrat pressure) to adopt General Anti-Avoidance Tax Rules (GAAR) after due consultation. This is a major departure for the UK and has potentially huge benefits on a world-wide scale.

Osborne stated his abhorrence to excessive tax avoidance and this repeated, in effect, the Aaronson dictum that only excessive tax avoidance should be the subject of any GAAR. Any law should focus, it said, on excesses – where schemes were devised that provided for a “moderate rule” that does not penalize proper tax planning. This would, Aaronson said in November, 2011, not need elaborate clearance systems because it would be clear that centre ground tax avoidance was not likely to be the subject of HMRC wrath. Guidance (rather like that provided with the 2010 Bribery Act, no doubt) could be provided.

Tax and avoiding commitment

Taxation is not an exact science. In the rush to comment on George Osborne’s 2012 budget, the focus has been on how the proceeds of taxation are used by the State. The Moral Maze on Radio 4 this week highlighted this issue. The discussion was not that illuminating but revealed the continuing problem that society has in determining the mix between public and private sector, taxation and philanthropy in a democratic state.  The extremes were in good evidence – at least in the ‘conversation” between Richard Murphy (of Tax Research UK) and Melanie Phillips (Daily Mail).

In the US, the Tea Party and similar Republican and libertarian factions have called for minimum state intrusion in the private affairs of individuals and corporations: to allow them to make their profits and earn their income and spend it however they wish.  Reagan’s opinion that the State was “the problem” is reflected in rightist policy in the US. Here, entrepreneurial spirit takes precedence over the “so-called” needs of those who can’t make it economically or fail through ill-health (or, it is assumed, lack of opportunity – opportunity is what you make yourself). State spending should be for defence (and maybe policing) and little else. The private sector should be responsible for everything and pricing through demand and supply should be responsible for sharing out the needs of the population.

Opposite to this are state run economies – the failed economies of the Soviet Union, for example – which proved that state monopoly failed. The attempt to centralize pricing when the number of SKU’s (stock keeping units) may run into billions was seen to be a huge error. China has awoken to that reality and the market economy is now much more the norm.

So, market economics rules and pricing is, wherever possible, market driven by supply and demand.

The problem is that the “market” (Adam Smith’s “invisible hand”) is not always right and the drive of many individuals and other organisations (the market) coming together is often imperfect on timing, often leading to monopolies of supply and often the result of market imperfections. Of course, there are also wider social issues on which government develops obligations to intervene. Global Warming may be one; re-armament in the UK in 1939 is another – no market would supply the needed response (at least in the latter).

This leads to the need for some societal intervention beyond the market. However, as soon as one section is taken outside the market economy, then the economy is further driven in directions that are imperfect. The requirement for a nation (or city-state or whatever) to defend itself from potential invasion has, throughout civilization, meant that central government has needed to collect tithes or taxes from the population it is defending. Of course, ancient monarchies were defending the monarch rather than the people, but newer, democracies have a similar aspect. Until we reach the perfect state where no-one needs to defend themselves, defence spending will be “allowed” through taxation. This is a basic need and taxation results. Governments (that take on the responsibilities that society gives them through the democratic process) then extend that remit to tax and supply “needs” such as policing, a legal system, health, social security and market intervention. It also has the power to alter the direction that markets take through taxation or incentivisation – e.g. 100% capital allowances or allowances for R&D and geographical location.

The question is no longer whether market economies should exist but the degree of state (on behalf of society) intervention through taxation and the ability of society to accept that taxation and / or devise ways to minimize individual and corporate tax burdens (in the same way that computer hackers attempt to break down IT security defences).

The Moral Taxation Maze

If we believe that democratically elected governments have the right to raise finance through taxation based on the mandate they have been given by society, then it cannot be too far a push to agree that the collection of tax receipts should not be stymied. Tax evasion is a criminal activity; tax avoidance has long been seen as the right of the clever (and the wealthy) to find ways to minimize the tax they (individuals and companies) pay.

This “right” has pitched the seemingly able and spirited against  government bureaucrats and tax inspectors in a battle that the public seemed to want the former to win. After the banking and credit-induced damage inflicted in 2007/8, the “spin” has changed direction. It is no longer just bankers that have questionable business ethics. We are now engaged (world-wide) on a deleveraging project of austerity and public sector cut-backs. This is made much more difficult by those individuals / organisations who are engaged in tax avoidance and try to minimize the tax-take made by government. This impacts directly on the need to save even more public sector spending – impacting directly on those sectors of society that can least afford it.

The fact that tax avoiders inhabit the same off-shore jurisdictions as drug dealers, kleptocrats sending oil and energy wealth into their own accounts and organized crime is maybe a clue  that tax avoidance is not a wholly respectable activity – whether done by individuals or corporations. The debate seems to be changing and the world is now waking up to the debilitating impact of the “legal” flouting of tax laws through manipulative mechanisms and offshore tax havens. Ethical considerations are now allied to the deleveraging process.

Tax: Society’s writ, Government implementation

The moral tax maze may becoming a lot simpler to navigate. Taxation in each country should now be  based on a wide-ranging general anti-avoidance law, which should go further than the Aaronson proposals. While tax will continue to be a competitive issue between nations (within broad guidelines set by trading agreements), tax havens located where value does not arise should be outlawed and value-adding nations (where goods and services are produced, designed and /or sold) should have the sole rights to levy taxes and, through a broad-based anti-avoidance rule, collect those taxes from those operating there (with double taxation only operating between those signing up to the general provisions in operation).

George Osborne’s discomfort with the worst excesses of tax avoidance (based on Aaronson’s GAAR proposals) is a start. But, in a world, which will take a decade or more to rid itself of the excesses that began to unravel in 2007/8 and where economic strength will continue to be more broadly based internationally, governments (where properly representative of society and elected by that society) will need to ensure that society’s wishes are carried out. Taxation is a key to that (as it has always been).  As transparency grows and we know more about tax take and where it is spent (as Osborne is keen to provide information on – or so he stated in his budget speech), the ability of the wealthier and most powerful to manipulate their taxation burden must diminish or the outcry from society will become too loud. In the same budget that reduced the top income tax rate from 50% to 45% (because earners had been able to manipulate the tax take from an estimated £3bn to just £100m!), we are given some hope that the fight back is taking hold.

A few weeks ago, retrospective action was taken against Barclays Bank. Now the consultation is under way on general anti-avoidance rules on tax. Modern economies should not shy away from the essential need of society to see that the governments it elects carries out its wishes. Tax laws (and the ethics behind them) should be implemented and be seen to be implemented. This is an international requirement – the UK may be at the forefront of something transformational – if it does not get too scared by being out in front.

George Osborne’s budget is the first under the budgetary process in full.  This involves an announcement made in budget 1 (in this case the 2011 budget on 23 March) being subject to consultation over the summer, then the draft finance bill measures are published in December for consideration.  If adopted they are included in the budget statement No 2, this year on 21st March and then published as part of the actual finance bill, this year expected on 29 March.  The measures are considered by parliament and the final amended version emerges in the middle of July.

Meanwhile advance announcements in this budget in 2012 will be consulted on this summer, included in a draft bill next December, and then adopted in the Finance Act 2013 after next year’s budget.

One measure which was going to included in this year’s finance bill was the new statutory residence test we discussed in October last year.  This is to be postponed and will now be brought forward for inclusion in next year’s finance bill, the rules becoming operational from 6 April 2013.  We also learn that the concept of ordinary residence is to be largely abolished and it’s effect preserved in connection with certain overseas duties.

A number of measures in this year’s budget have started with consideration by the Office of Tax Simplification – and one of these seems to have backfired on the government. You’re probably aware that the office started off looking at IR35 and redundant tax reliefs.  It then went on to consider small businesses and some it’s recommendations are adopted here including allowing businesses with a turnover below the VAT registration threshold, called ‘Nano’ businesses, to use the cash basis rather than the full GAAP which, in strictness, they should be using.  OTS think that 65% of the smallest businesses, many not using accountancy services, are using this method anyway!

The OTS went on to look at two further areas, issuing initial reports but not final recommendations; one of these concerned employee shares schemes, the other taxation of the elderly. They identified the problem that the tax affairs of elderly people are quite complex, they often have several sources of pensions and income, often dealt with by different districts and, if the taxpayer’s income is below £29,000, they have been entitled to a higher tax allowance when reaching 65 and a higher allowance still on reaching 75, although if their income is just below £29,000 the higher allowance is subject to clawback.

In the meantime the coalition have been pursuing the idea of substantially increasing the normal personal allowance to take increasing numbers of people outside of the scope of IT.  From April 2012, as was announced in 2011, the personal allowance goes up by £630 to £8,105 and to balance this the higher rate threshold is reduced by £630 from £35,000 to £34,370.  This budget provided that next year, from April 2013, the allowance would increase by £1,100 to £9,205, although the higher rate band threshold would reduce by rather more, £2,125, to limit the benefit of the allowance increase to higher rate taxpayers to 25% of what a basic rate taxpayer benefits by.

Now we know that the Lib Dems want to increase the allowance to at least £10,000 and if this allowance eventually exceeded the higher amounts of the age allowance, and of course you can’t have an allowance which is lower that the personal allowance so the age allowance can be done away with then the complexity of the age allowance and the clawback of the additional relief which gives affected taxpayers a marginal rate in excess of 20% could be done away with.

But George has jumped the gun.  Before the OTS makes its final recommendations and before the ordinary personal allowance has caught up with the age allowance George has decided to accelerate its withdrawal – this is the so-called “Granny Tax”.

The age allowance will be restricted now to those who reached the age of 65 before 6 April 1948 and the higher level of the allowance will only be available to those born before 6 April 1938.  It is also going to be frozen, which is the main complaint of the grannies, that in inflation adjusted terms they will be worse off. Although the pension may well be increased next year to compensate those persons who are affected by this ‘granny tax’, the increase in liability of those whose allowance is frozen has been seized upon by the press.  It reminds me of Gordon Brown’s ill-fated attempt to ‘simplify’ the tax system when he controversially eliminated the 10% starting rate for all income other than savings income.

It is made all the worse because George also decided to reduce the 50% rate to 45% on the grounds that the higher rate was counterproductive, it may well be that it is, HMRC figures seem to suggest it, but of course it makes it look as though he is taking from pensioners to transfer to the very wealthy.

In an historical sense this budget will be seen as the one where the government and the revenue finally accepted the need for a General Anti-Avoidance Rule or GAAR; given the number of targeted rules (TAAR) implemented since 2006 when the first one was introduced (concerning capital losses for CT purposes, and was so successful that it was extended a year later to individuals and trusts for CGT purposes) this should enable a significant reduction in the length of taxation legislation and may allow abolition of individual TAARs which now litter the legislation and account for much of the length of recent Finance Acts.

In the past HMRC have been reluctant to introduce this sort of measure, even though it is a potent one in the war against avoidance, because of the need to have a parallel clearance mechanism so that business can achieve certainty before entering into transactions.  It is claimed that Canada – who introduced a GAAR without a clearance mechanism – have suffered as a result.

Graham Aaronson QC, who suggested the GAAR in a report commissioned in last year’s budget, believes that it is possible to have such a rule as a limited GAAR, Sounds like a contradiction in terms which would allow ‘reasonable tax planning’ and so would not require new clearance mechanisms.  It remains to be seen whether it could be effective, as the arbiters of reasonability in the first instance would be – the revenue, although the final decision would be up to the Tribunals and the Courts.

Investors may have a quite unique opportunity in 2012/13 to secure 78% tax relief – it works like this…

Genuine small start-up businesses can use a scheme to raise capital called the Seed Enterprise Investment Scheme or SEIS – this offers investors a tax reducer relief of 50% which they can set against this year or last year’s liability regardless of the rate of tax they actually pay.  But they can do better than this – if they also make gains during the year 2012/13, and they would be advised to do so if they can, these can be matched against the investment into the SEIS and will be exempt from CGT.  Now the ordinary EIS offers 30% relief and deferral of gains, but this is a genuine exemption worth a further 28%.

Middlemen have already started to try to attract investors and match them with suitable small businesses.  It is obviously very high risk but the relief available may make it worthwhile.

Company cars are subject to good news and bad news – lets look at the… good news first.  From April 2013 the current scheme which gives a business 100% relief on the cost of a car which emits less than 100 g/km of CO2 was to come to an end.  It will now be extended to 2015 but at a slightly lower emission limit of 95g/km.

You can still get an Alfa Romeo Mito 1.3 diesel and claim a 100% FYA after April 2013 but if you want an Audi A1 Sportback you’ll need to be quick as it will cease to qualify after April 2013, its emission value is 99g/km – unless the manufacturer improves efficiency even further.

The Bad news? – well there’s rather a lot of it… cars which emit more than 130 g/km but less than 160 g/km will qualify for an 18% WDA until April 2013, but from that time onwards purchasing such a car will give you a writing down allowance of 8% pa only which at the moment only applies to cars with an emission figure in excess of 160 g/km.

In addition between April 2014 and April 2016 several changes are to be made to the company car benefit in kind scheme which will see the benefit in kind, in other words the tax liability, on some vehicles increasing by 25% over this short period, or indeed even more!  If you have a zero emission vehicle, which at the moment has a zero benefit in kind, from April 2015 onwards you will have a 13% benefit and in the following year this will be increased by a further 2% to 15%.  The maximum percentage for company cars is going to go up as well, it is at the moment 35% but will increase to 37%.  From April 2016 onwards you will no longer need to add the extra 3% for a diesel vehicle.

The announced reduction in the rate of corporation tax from 26% down to 24%, where last year we were told that the rate would go down to 25%, was a welcome reduction for larger companies with profits in excess of £300,000, and next year and the year after the rate will go down to 23% and 22% respectively.  But what of the lower 20% rate that applies to profits up to £300,000?  Would that be reduced as well?

The problem is that if this rate is reduced a 40% taxpayer taking a dividend from a company would be liable to a combination of corporation tax and income tax on the dividend which would be less than 40%. This was the mistake made some years ago by Gordon Brown, in reducing the rate to 19%, which he compounded by increasing national insurance so that a self-employed taxpayer was liable at 41% but dividend extraction from a small company attracted a liability of only 39.25%.

In a throwaway comment George indicated that he intended the main rate to fall even further to 20% in the future when there would then be one rate of tax applying to all companies regardless of size and the marginal relief calculation, necessary for profits between £300,000 and £1,500,000 to avoid a large jump in liability would no longer be needed and the complicated Associated Company rules, which were only reformed in last year’s Finance Act would also not be necessary.

In addition to increasing R&D relief further for small and medium sized businesses, a welcome change, he also confirmed the introduction of the idea of a “patent box”.  Originally dreamed up by his predecessor, Alistair Darling, this would mean that profits derived directly or indirectly from the exploitation of patent rights would be charged at an effective rate of 10% from April 2013 onwards and it worth noting here that this is not confined to patent royalties but also the trading profits that manufacturers derive.  As a response to this and the general reduction in CT liabilities Glaxo SmithKline have already announced a half a billion pound investment in UK manufacturing.

The CFC, Controlled Foreign Company, regime is extensively overhauled as announced last year to prevent it falling foul of EU discrimination laws and will only apply where profits are artificially diverted away from the UK by larger companies, rather than applying by default at the moment unless you benefit from an exemption.

A number of VAT anomalies have been removed from 1 October 2012 so that enjoying a hot chicken from your supermarket, drinking sport nutrition drinks, using self-storage facilities, even going to the hairdresser now that self employed stylists will not be able to rent chairs in a salon on an exempt basis could all become more expensive.

When the last government implemented SDLT, Stamp Duty Land Tax, in 2003 a number of bodies suggested they were too hasty in doing so and since then every year has seen further attempts to limit tax losses caused, at least in part, from the revenue’s Stamps Office seemingly not understanding real world property transactions. Of course, before SDLT came in, they were experienced in valuing legal documents but were not required to be aware of other transactions.

Residential properties costing more than £2,000,000 will now be subject to a 7% rate of SDLT and where companies have been used to acquire this sort of residential property there will be a 15% liability on the transfer into the company, because subsequently the shares can be transferred at a much lower Stamp Duty liability of 0.5% or outside the UK with no liability at all – other measures will include charging gains on the sale of property within these offshore companies to CGT and even a version of Vince Cable’s vaunted mansion tax where a company is used as an envelope to avoid liability.

This podcast can only skim the surface of the budget provisions and further information can be obtained from the revenue and treasury websites. There is a 206 page document “Overview of Tax Legislation and Rates” containing details of all of the budgetary changes which can be downloaded from http://www.hmrc.gov.uk/budget2012/ootlar.htm and The Chancellors full budget report, the ‘Red Book’ as it is called is available from http://www.hm-treasury.gov.uk/budget2012_documents.htm

 ·         Vodafone Case

The basis of the Vodafone was whether the assessing officer had jurisdiction to issue the notice under section 201 of the Act. The assessing officer would definitely have power to examine the question whether it had jurisdiction to issue notice. The Supreme Court judgment prevents the assessing officer to examine this issue as according to theApex Courtthe transaction was not liable to tax inIndia.

The government brought retrospective amendments to undo the decision of the Supreme Court. The review petition before the Supreme Court has been dismissed. It is doubtful that a retrospective amendment contained in the Bill could be the ground for review. However, as and when the Bill becomes an Act, a further question may arise whether another review petition would be maintainable on the ground of change in law with retrospective effect i.e. there is an error apparent on the face of the record.

It has been held by Courts that change in law with retrospective effect affecting an order or judgment can be ground for the review. In Mohammad Azamat Azim Khan, v. Raja Shatranji and others AIR 1963 All 541 it was held that review is possible in light of the altered law. In Re Cauvery Water Disputes Tribunal AIR 1992 SC 522 : 1993 Supp (1) SCC 96, the Supreme Court held that legislature cannot set aside an individual decision inter-parties, though it can change the basis of such decision. It would be unjust and contrary to all sense of equity to hold overturn Vodafone.

• Overcoming Vodafone

The Bill has adopted two approaches to overcome Vodafone judgment:

(i)           First by addition of an Explanation to section 2(14) to expand the meaning of “property” to include rights of management or control, etc. However, to determine cost of acquisition of these rights would be difficult and therefore, ratio of CIT v. B. C. Srinivasa Setty 128 ITR 294 (SC) would still be helpful. And also by addition of second Explanation to section 2(47) to expand the scope of “transfer”; and

(ii)               Addition of Explanations 4 and 5 to section 9(1)(i).

• Royalty

Intended insertions of Explanations 4, 5 and 6 to section 9(1)(vi) are not justified. These provisions are aimed at undoing various decisions given by the Courts and Tribunals in the favour of assessee such as that of the Delhi High Court in Ericsson AB and Asia Satellite Telecommunications Co.

• Specified Domestic Transaction

The new provision regarding Specified Domestic Transaction is fall out of the observations made by the Chief Justice in CIT & Anr. v. Glaxo Smithkline Asia (P) Ltd. (2010) 236 CTR (SC) 113 : (2010) 195 Taxman 35 : 47 DTR 65. Accordingly, Transfer Pricing provisions shall be applied to arrive at Fair Market Value (“FMV”) in case of a Specified Domestic Transaction. These transactions are referred to in sections 40A(2), 80A, 80-IA(8), 80-IA(10), transactions referred to in any other section under Chapter VI-A or section 10AA to which provisions of sub-section (8) or sub-section (10) of section 80-IA are applicable. In a case falling under section 80-IA(8), the officer is empowered to determine the FMV in case goods are transferred from one undertaking to another undertaking of the same assessee, while under section 80-IA(10) two assesses are involved.

The most appropriate method shall be applied to determine the arm’s length price and if there are more than one such prices, then average of all such prices shall be the arm’s length price. Detailed records of all Specified Domestic Transactions are required to be kept. The department can take different view about Specified Domestic Transactions from year to year though the order in earlier years on similar facts and circumstances may be in favour of the assessee.

• 92CA(1) : Necessary or Expedient

The AOs have been making reference to TPO merely on the basis of value of transaction. The Commissioners have been granting approval for reference to the TPO routinely and under a list forwarded by the AO and without exercising his mind to the transaction, which is not in the spirit of the provisions of law. There must be something of relevance in the transaction for it to be referred to the TPO. The AO must satisfy himself of the necessity and expediency before making any such reference.

• Apathy of Courts towards Assessees

The BombayHigh Court in Coca Cola India P. Ltd. v. ACIT [2006] 285 ITR 419 had laid down some principles to be followed by the department to prevent misuse of provisional attachment and coercive recovery of demand. However, today the Court is not willing to use the whip it had created which only adds more woes to a hapless assessee. Is the Court becoming cruel only to be kind?

• GAAR

The Bill intends to incorporate into the Income-tax Act, the most obnoxious part of the proposed Direct Tax Code rightly called GAAR i.e. General Anti-Avoidance Rule. These provisions arms the AO with all the tools required to declare an arrangement as “impermissible avoidance arrangement” and then proceed to deny tax benefit, or a benefit under a treaty in such manner as he would deem appropriate. Inspite of the Supreme Court declaring in Vodafone case that one can only “look at” and not “look through” the transaction, now the AO would look into the transaction and reclassify it the way suits him. Though government is supposed to come out with guidelines and notifications as to how GAAR provisions are to be applied, the experience has shown otherwise. These provisions should never be passed into law. It would be like “giving razor to the monkey”.

For example, in the following cases the AO may deny tax benefit for the reason that the main purpose there is to obtain tax benefit:

Ø      Industry set up in backward area;

• 54EC investment of sale proceeds of property;
• Transaction involving demerger – the real intention is to sell the assets;
• Loss on sale of shares on the stock exchange is not allowed, therefore, any sale under private arrangement was only with purpose to set off loss.
• Dividend stripping;
• Saleand lease back transactions.

All these will go contrary to views taken by theApex Courtin last 50 years.

• CBDT Chairman’s letter dated 7^th February 2012

The letter of CBDT Chairman of 7^th February 2012 puts tax collection above the administration of law, when he sets highest weightage to achievement of revenue collection target while writing Annual Performance Review of the officer and his placement in the coming financial year. This is no good for democracy.

• DTAA

The Bill intends to extend GAAR provisions into the arena of DTAAs. The AO can relocate the place of residence of any party, or of situs of an asset, or of a transaction.  This would amount to empowering the AO to override a treaty entered into between two sovereigns.

Certificate of Residency – Condition of producing the certificate of residency would no longer remain the sufficient proof. The question arises whether CBDT Circular No. 789 dated 13 April 2000 would still be effective.

Explanation 3 to be added to section 90 provides that a term defined in the notification shall be deemed to have effect from the date DTAA came into force. This is virtually empowering the department to rewrite the treaty. A country having self-respect will not enter into a treaty with any country whose officers are empowered to obliterate the promises of the sovereign. A notification issued by the Board defining “may be taxed” is a case on this point. A question arises whether the phrase “may be taxed” is a term at all.  However, by notification it has been defined to mean that the income will be taxed inIndiaand then credit shall be given.

• Dispute Resolution Panel (“DRP”)

It has been representatives’ experience appearing before the DRP that one cannot get any substantive relief before it. The assessees do not get a proper hearing neither all options available to the assessee in terms of relief is allowed. The new to be inserted Explanation after section 144C(8) is only going to make situation worse. Now the DRP can enhance the variation. It can consider any matter arising out of the assessment proceedings relating to the draft order whether or not the assessee raised the issue.

• Miscellaneous Amendments

Ø  Section 2(15): Even if 12A or 12AA registration are not revoked, if first proviso to section 2(15) becomes applicable then sections 11 or 12 benefit shall not be available to the organisation. In such an event it is not clear whether such organisations can still issue 80G certificates to any donor. This will affect the revenue augmentation of charities because such institutions mostly receive their fund in last month of the financial year as such donations are accompanied by tax benefit. If issuing 80G certificate in such an event is held to be illegal then the trustees may personally become liable.

• Alternate Minimum Tax (“AMT”): As per new to be added section 115JC, where the income-tax payable by a person, other than a company, is less than the AMT, he will pay tax @18.5% on his adjusted total income.
• Section 68: The newly to be added proviso to section 68 is intended to overrule Lovely Exports 216 CTR 195 (SC). In the event cash credit consists of share application money, share capital, share premium, etc., the company will have to give proof of the source of such sum credited to the satisfaction of the AO.
•   Section 2(19AA): It has been inserted with an intention to do away with the requirement of issuing shares to itself in a case of demerger.
• Section 50D: Where the value of consideration is not ascertainable or determinate, then FMV shall be taken as the full value of consideration.
• Section 149: The time limit for reopening assessment of income in relation to any asset (including financial interest in any entity) located outsideIndiahas been increased to 16 years.

The Standing Committee has made the following recommendations:

A)        NRI’s Residential Status

The existing Income Tax Act, 1961 (‘IT Act’) grants a relief to the Non Resident Indian. An NRI who does not spend more than 183 days in a year in India is not a tax resident for the purposes of IT Act. In terms of Direct Tax Code – 2010 (‘DTC’) such an exemption has been taken away. The Standing Committee recommends that the said exemption may be extended to NRI’s and an NRI may not be a treated as tax resident unless he has spent more than 182 days in a year in India provided that (i) the NRI declares the jurisdiction he would be subject to tax; (ii) cases where this exemption is misused in such a manner that a person is not subject to tax in any jurisdiction, such cases should be treated severely.

B)        Place of Effective Management

In order to determine the tax liability of companies, the DTC introduces the concept of Place of Effective Management (‘PoEM’). It is recommended that the definition of PoEM should be brought in line with internationally accepted standards and judicially settled principles. The concept of decision by Executive Directors and Officers of the company may be removed as these words would increase uncertainty.

C)        Business Connection

The DTC introduces provisions whereby an indirect transfer of a capital asset situated in India could be brought to tax in India. It is recommended that (i) transfer of small share holdings; and (ii) transfer of shares listed on a stock exchange outside India should be kept out of the purview of these provisions; (iii) intra group transfer may be exempted.

D)        Source of aircraft and shipping business

The DTC spells out the charge to the taxability of freight charges in case of transportation of goods by either aircraft or ship. The Standing Committee recommends that the import freight received by a non resident engaged in shipping business outside India in not deemed to accrue in India.

E)        Classification of Commercial Leasing

The DTC includes income from commercial letting of malls, multiplexes under the head ‘income from house property’ instead of ‘income from business’. It is recommended that the act should clearly bring out the distinction between letting out of commercial and non-commercial property in India.

F)        Business Income

The DTC adopts the income-expense model for computation of income from business. In this regard to reduce litigation in respect of classification of income, the items that would form part of business income are enumerated. The Standing Committee has observed that this also includes receipts that are capital in nature. It is recommended that the amendment to the clause may be made so that only receipts that are revenue in nature are made taxable.

G)        Capital Gain – Demerger / LLP’s

The DTC exempts any from any capital gains arising from transfer of an Indian Company arising out of demerger of a foreign company provided certain conditions are met. DTC seeks to exempt from tax transactions arising out of business reorganization and not intra group transfers. Standing Committee recommends that amalgamations of group companies may also be considered for such exemptions. It is also recommended that such exemption may also be extended in case where a partnership (registered under the Indian Partnership Act, 1932) is converted into Limited Liability Partnership (registered under the LLP Act).

H)        Double taxation in case of dissolution

DTC proposes to levy tax on capital gains in the hands of a shareholder when such asset is received upon dissolution of a company by such shareholder. DTC proposes that in such cases the cost of acquisition shall be the cost at which the asset was acquired by the said company. Standing Committee points out that there would be double taxation in the hands of the shareholder in such cases once at the time of such dissolution and secondly at the time when such asset is sold / transferred by such shareholder. Standing Committee recommends that the cost of acquisition in such cases should be the fair market value of the asset on the date of dissolution or transfer.

I)         Transition Provisions – Carry forward / set off of losses

Standing Committee recommends the introduction of transition provisions in respect of carry forward and set off of losses which remains to be carried forward or set off in accordance with the provisions of the present IT Act.

J)         Income from residuary sources

DTC propose to levy tax on dividends (other than dividends received by a shareholder after deduction of ‘Dividend Distribution Tax’) The Standing Committee has proposed that the existing text of the relevant clause should be amended so that the onus of providing payments in respect of DDT is not on the tax payer.

K)        Insurance Benefits

DTC proposes to exempt proceeds / benefits from life insurance policy where the sum assured is at least 20 times the annual premium paid. At present in order to seek exemption of proceeds / benefits the sum assured is at least 5 times. The Standing Committee noted that the conditions imposed is not reasonable and   may have an adverse impact on the insurance industry. Therefore, it is recommended that the present condition may be replaced by a more reasonable condition.

L)        Controlled Foreign Corporation

DTC introduces the concept of Controlled Foreign Corporation (‘CFC’). CFC is defined to mean a foreign company which satisfies the following conditions; (i) it is a resident of a territory with lower rate of taxation; (ii) the share of such company are not traded on any recognized stock exchange; (iii) one or more person, resident in India, individually or collectively exercises control over the company; (iv) it is not engaged in any active trade or business; (v) income increases by the specified income.

With respect of CFC, the Standing Committee has made the following recommendation;

(a) The DTC defines ‘territory with a lower rate of taxation’ to mean a state where the tax paid by a CFC is less than one half of the tax that CFC would have paid in India. The Standing Committee recommends that the tax paid should include foreign tax credit on actual tax paid.

(b) The DTC defines ‘control of CFC by a resident Indian’. The Standing Committee recommends that the term is very widely defined. The Standing Committee perceives that the terms ‘directly or indirectly’, ‘dominant influence’ and ‘decisive influence’ are not defined appropriately which would lead to litigation. Accordingly, it is recommended that these terms may be defined in order to remove any ambiguities.

M)       Investment Linked Incentives

The Standing Committee proposes investment linked incentives for affordable housing sector, education and health care.

N)        Dividend Distribution Tax

In India Dividend Distribution Tax (‘DDT’) is paid by the company that declares dividend to its shareholders. Such dividend is tax free in the hands of the shareholder. The Standing Committee noted that in case of foreign shareholder, credit of DDT may not be available in his jurisdiction as such tax which is paid is paid by the company and not by the foreign shareholder. The Standing Committee recommends that a suitable amendment may be brought which enables a foreign shareholder to take credit of the DDT paid by an Indian Company before distributing dividend.

O)        Branch Profit Tax

DTC introduces Branch Profit Tax (‘BPT’) on branch offices or permanent establishments of foreign companies in India. The BPT shall be in lieu of DDT. The Standing Committee recommends that the concept of Branch Office and Permanent Establishment should be aligned with the tax treaties so that foreign companies are not put to any disadvantage in case they wish to avail credit of tax paid in their jurisdictions.

P)        Transfer Pricing

The term Associated Enterprise also includes ‘any specified or distinct location of either of the enterprises as may be prescribed’. The Standing Committee has noted that such a provision would put even a genuine unrelated transaction within the four walls of transfer pricing. It is recommended that such purely commercial unrelated transactions should be exempt from the scope of the term Associated Enterprise to minimize hardship for the tax payer.

Q)        Advance Pricing Agreement

The DTC introduces the concept of Advance Pricing Agreement. The Central Board of Direct Taxes (‘CBDT’) would be authorized to enter into an APA with any person with prior approval of Central Government. The APA shall specify the manner in which arm’s length pricing would be determined in relation to an international transaction. Such APA shall be valid for a period of five years. The Standing Committee recommends that an independent agency, constituting of a judicial and technical member, may be appointed to advise CBDT on APA’s.

R)        General Anti Avoidance Rules

The DTC provides a Commissioner of Income Tax (‘CIT’) to invoke General Anti Avoidance Rules (‘GAAR’) to declare any transaction as impermissible and determine the tax consequence in case the transaction is entered into obtaining tax benefit and otherwise lacks commercial substance.

The Standing Committee recommends the following:

(i)           The order of the CIT would be subject to review by a Dispute Resolution Panel. It is recommended that the Dispute Resolution Panel should be an independent body.

(ii)          The tax office should provide for reasons in writing before invoking GAAR;

(iii)        The provisions of GAAR should be applied prospectively;

(iv)         Tax payer should be permitted to take an advance ruling as to whether the transaction fall within perimeter of GAAR;

(v)          The uncertainty with regard to applicability of tax treaty should be removed.

(vi)         It is recommended that any king of fiscal uncertainty or ambiguity should be removed.

S)         Tax Deducted at Source

The Standing Committee has recommended that provisions in respect to TDS should be applied to only those non-residents whose income is subject to tax in India.

T)        Permanent Account Number

The Standing Committee has recommended that the requirement of holding a Permanent Account Number should not be applied to every non-resident;

*——————*—————-*—————–*

In a case called Copthorne Holdings Ltd. v. Canada, the court affirmed that the tax department has the statutory power to deny a taxpayer any benefits that accrue from transactions that are conducted primarily for purposes of exploiting loopholes in the law.

In a unanimous written decision from the nine-judge court, Mr. Justice Marshall Rothstein found that a series of dealings made by Copthorne, a holding company associated with the Li family, was structured to frustrate a provision of the act that sets out the tax treatment for corporate amalgamations. “The transaction was therefore abusive and the assessment based on application of the GAAR was appropriate,” he concluded.

The anti-loophole provision, found in section 245 of the Income Tax Act, is controversial because it generates uncertainty. Some legal commentators have called it a “smell test” that gives the government the power to disallow the tax benefits from clearly abusive transactions.

“This is a reaffirmation of GAAR,” said Donald Bowman, a former chief justice of the Tax Court of Canada who is now counsel in the national tax group of Fraser Milner Casgrain LLP. “It’s a very well written articulation of the concept of GAAR. If things had gone the other way, I don’t quite know where GAAR would stand.”

Gabrielle Richards, a tax practitioner with McCarthy Tetrault LLP in Toronto, described the decision as “clear, sequential and logical,” and said it does much to address the uncertainty that was left in the wake of some earlier decisions that dealt with GAAR. She describes the decision as the court’s way of saying: “Here is the approach to take. You guys go away and apply it. Don’t come back to the Supreme Court again, because we’ve now told you clearly how it works.”

Another McCarthy partner, Chia-yi Chua, said the decision will embolden the Canada Revenue Agency in its efforts to enforce GAAR. “We predict that given the victory that the CRA secured here, 9-0, GAAR will be used more in the coming days to shore up CRA assessments of a technically borderline nature.”

Judge Rothstein’s ruling is alive to concerns over the uncertainty. His decision recognizes that taxpayers are entitled to organize their affairs so as to minimize their tax burdens. He cautions that GAAR is a provision of last resort and that the government should apply it only when transactions are clearly abusive. The analysis should not be guided by “moral opprobrium,” but rather a three-part test for abuse, which is set out in paragraph 72. He puts the onus of meeting the test squarely on the government:

The analysis will then lead to a finding of abusive tax avoidance:  (1) where the transaction achieves an outcome the statutory provision was intended to prevent; (2) where the transaction defeats the underlying rationale of the provision; or (3) where the transaction circumvents the provision in a manner that frustrates or defeats its object, spirit or purpose.  These considerations are not independent of one another and may overlap.  At this stage, the Minister must clearly demonstrate that the transaction is an abuse of the Act, and the benefit of the doubt is given to the taxpayer.

Some observers say the decision is actually pro-business. The tax act does not give the government access to invoke GAAR to deny the tax benefits of transactions which have been made for primarily bona fide purposes. This leaves the door open for tax planners to structure corporate reorganizations that may have tax benefits, said David Spiro, counsel with FMC Law in Toronto:

“Corporate Canada will still be able to engage in tax planning to advance business objectives if the transactions contemplated are adequately supported by non-tax purposes and if the results of those transactions do not circumvent any provisions of the Income Tax Act that are clearly aimed at precluding those results.”

And while the decision offers some clarity on when GAAR can be invoked, there will never be a way to provide perfect certainty when it comes to GAAR says Adrienne Woodyard, associate counsel with Davis LLP in Toronto. “As much as taxpayers desire and require consistency and predictability in planning their affairs, the GAAR is, and remains, a bit of a wild card.”

Copthorne was an entity the Li family used for various purposes over the years. One use was to capture a tax loss on the value of its shares in Calgary-based Husky Oil Ltd. and another use was to shelter a capital gain from the sale of the Harbour Castle Hotel in Toronto in 1989.

The government argued that through a complex series of transactions involving Copthorne and other entities, the family realized a deemed dividend of $58.3-million in 1994. The government therefore claimed it was owed withholding taxes amounting to $8.7-million, plus a 10% penalty.

The Canadian government invoked the GAAR provision to claim the amount it felt it was due. Copthorne challenged this in the Tax Court of Canada, but that federal court sided with the government in 2007. This decision was upheld by the Federal Court of Appeal in 2009. The Supreme Court heard the case early this year and released its decision Friday.

Financial Post

But tax revenues can also be increased by making sure HM Revenue & Customs collect in all the tax that is due.  Here we enter the murky world of tax evasion and avoidance.  Let’s start with some definitions.  Tax evasion is illegal, tax avoidance is legal. I know that usually surprises people, including people who avoid tax!  Tax evasion is basically lying about your income and expenditure and defrauding HMRC of taxes on income or expenditure taxes like VAT.  It is an offence and people can and do go to prison if convicted.

Tax avoidance is legal as it results from tax reliefs and incentives passed by Parliament.  So if you have an ISA, you are avoiding income tax on the interest on your savings.  If you arrange your affairs within your family to take advantage of the tax thresholds available to each person, then you are avoiding tax.  If you make contributions to a pension then you get income tax relief.  So that makes most of us tax avoiders but it’s OK as it’s within the law.  It’s best to think of the vast majority of tax avoidance as sensible and prudent tax planning.

The problem comes with individuals and companies who stretch beyond credibility the rules Parliament has passed.  Unscrupulous wealthy people or corporations exploit loopholes and grey areas.  Rather than engaging in sensible and legal tax avoidance they construct contrived and wholly artificial trust or business structures so as to dodge taxes that would have been paid in normal circumstances.  The result is a loss of tax revenue, the so called tax gap, estimated to run into tens of billions.

So why do people get away with it?  Successive governments have passed legions of clauses in tax legislation trying to close off any room for exploitation of new tax reliefs.  HMRC enter into protracted negotiations with companies and either settle or take the issue to court.  Settlements give HMRC a certain amount of money and are entered into to save time and neutralise the risk of losing the case in court.  But they are controversial as readers of Private Eye will know.

We now have an incredibly complex tax code.  There are lots of tax reliefs to incentivise people and businesses to structure their personal finances (savings, pensions, etc) or business planning (capital investment, research, etc) in a way that is for the greater good of society.  But to stop abuse each relief is accompanied by anti-avoidance rules that try to second guess all potential loopholes.  It hasn’t worked and we need to try a new approach.

The Liberal Democrats promised in our 2010 manifesto that we would tackle tax avoidance problems.  The Coalition Agreement provided for a study into what’s called a General Anti-Avoidance Rule, a rather ugly acronym of GAAR.  The Treasury duly commissioned top tax barrister Graham Aaronson QC to set up an expert group to make a recommendation on whether the UK should have a GAAR.   The basic point of a GAAR is that it would be explicitly stated that personal and business arrangements that are set up purely to avoid tax and for no legitimate commercial purpose, would not be considered legal tax avoidance.  Essentially they would be irresponsible tax planning bumping right into illegal tax evasion.

Aaronson has now published his report and I met him to discuss it last week.  He recommends legislation for a GAAR to cover initially income taxes (incl NIC), capital gains tax, corporation tax and petroleum revenue tax.  It would be a shield against future tax avoidance schemes.

Most other developed economies have a variant of a GAAR.  The USA has its Codification of Economic Substance Rule.  It’s now time that the UK had a tough general rule blocking unfair tax avoidance of the sort that perverts the will of Parliament.  That’s why as co-chair of the Liberal Democrat backbench committee on Treasury and Business I have tabled a Parliamentary motion calling for the Treasury to implement the Aaronson report.  I have secured the support of other senior Lib Dems including Deputy Leader Simon Hughes and former Chief Secretary to the Treasury David Laws.  The full text of the motion is set out below.

Finally, a personal note.  To avoid some smart alec coming along and trying to embarrass me about my professional career before I became an MP, let me confirm what has long been in the public domain that I am a member of the Chartered Institute of Taxation, the country’s premier tax planning body.  I worked for PWC and Grant Thornton as well as in the tax functions of large companies.  The vast majority of the UK’s tax profession, in law, accounting and industry, operate entirely within the law, advising clients on how to structure their affairs in a tax efficient way.  The contrived and artificial schemes pursued by some wealthy people or companies are not approved of by responsible advisers.  Abuse of the tax code gives advisers a bad name and also facilitates the vilification of large companies and wealthy people in general.  Such abuse must be stopped and a GAAR may be the way to do it.

The idea of such a rule is to draw a line akin to a test of what the tax rules are intended to achieve ie their spirit.  If a transaction crosses that line, even though it is within the wording of the legislation, it will be caught.

Any general rule of this nature must be drawn at the right level so as to not impinge on innovative but “within the spirit” planning.

If such a rule was implemented it would be interesting to see whether the specific anti-avoidance rules in the existing legislation will be scrapped.  This would probably more than halve the content of the legislation.

Every man is entitled, if he can, to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.

This principle, at the heart of the tax evasion – tax avoidance impasse, can be called the Westminster principle. It, at least as understood by later decisions, allows for individuals and corporations to structure financial arrangements so as to minimise tax liability, as long as these structures are within the four corners of the black letter law. It must be seen in contrast to the modern Ramsay Principle. Laid down in the famous WT Ramsay v. IRC decision of the House of Lords, (1982) AC 300, it is best stated as:

It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions intended to operate as such, it is the series or combination which may be regarded.

This principle can be placed in contradistinction to the one in Westminster, adopting a seemingly purposive construction method to unravel the ‘true nature’ of transactions entered into with the sole intention of avoiding ones legitimate tax liability. The doctrine emerged in light of the increasingly common practice of self-cancelling transactions being entered into that had no real legal effect except to change the apparent nature of a certain loss, gain or appropriation. It was further affirmed in IRC v. Burmah Shell, (1982) STC 30 and in many ways extended in Furniss v. Dawson, (1984) AC 474.

Nevertheless, in later cases such as Macniven v. Westmoreland Investments 2001 UKHL 6 and Craven v. White, [1988] 3 All ER 495, the two seemingly deviant lines of reasoning and judicial approach were reconciled to retain Tomlin’s dictum while providing for a parallel rule of statutory construction to unravel the true nature of a transaction, but only for the purpose of the relevant statute and to assess whether the transaction fell into the category what the statute intended to tax. This position makes for interesting analysis in the context of the principles of statutory interpretation applicable to fiscal statutes, exemplified by Rowlatt J’s famed dictum in Cape Brandy Syndicate [1921] 1 K.B. 64. This must be taken as the meaning of these cases, given their understanding in later decisions and in the Indian context, Justice Srikrishna’s observations in Azadi Bachao. Palkhivala, in his stimulating work, We The Nation, assumes the same position.

In India, tax avoidance has always been a sticky subject, with the recent apex court decision in Azadi Bachao Andolan v. Union of India, 263 ITR 706 providing some respite by clarifying the position. In Azadi, the Revenue was aggrieved by the Delhi High Court decision to quash a circular 789 of the Central Board of Direct Taxes issued on April 13, 2000, that simply reinforced the anomalous situation whereby the Indo-Mauritian DTAA had prescribed that the country of residence was to tax capital gains and since Mauritius did not levy any capital gains tax, companies were investing in India through colourable devices like shell companies, etc. The Court overruled the decision and upheld the validity of the circular, interpreting the previous Constitution Bench decision (he disregarded O Chinappa Reddy’s concurring judgment, labelling it on coherent legal grounds, a far cry from the majority decision of Ranganatha Mishra) in McDowells 154 ITR 148 to hold that in India, the Westminster principle neccessarily operates to prevent judicial unravelling of such anomalous situations. Being squarely on the point of the avoidance-evasion debate, the decision represents a watershed in the Indian jurisprudence on international taxation.

However, the draft Direct Taxes Code, likely to be enacted next year, now includes within it a specific provision that introduces into Indian direct tax jurisprudence for the first time, what is internationally called a General Anti-Avoidance Rule (GAAR). The provision allows Courts to look through superficial companies and transactions, to assess their true nature and impose a tax liability. This would neccessarily imply an overruling of the seminal decisions on the evasion-avoidance debate in both India and England, ie. Westminster and Azadi Bachao. I intend to thoroughly analyse the nature, worth and scope of such a GAAR in a later post, but suffice it to say that the introduction of such a rule will compromise several colourable transactions and structures that have anyway taken a beating post-Vodafone.