Under the India-Mauritius amended treaty, there is no capital gains tax on profits from sale of grandfathered shares which refer to securities bought before April 1, 2017.
Tax officials have typically used General Anti-Avoidance Rules (GAAR) to quash treaty benefits whenever they suspected that a foreign investor’s outfit in jurisdictions like Mauritius and Singapore lacked ‘commercial substance’. Such offshore investors having a paper office or shell company, with few or no employees, and alleged to have been established primarily to obtain tax benefits.
However, in end-March this year, the apex body Central Board of Direct Taxes (CBDT) issued a notification to clarify that earnings from transfer of stocks acquired before April 1, 2017 would not be impacted by GAAR. This came as a relief to foreign portfolio investors (FPIs) as well as foreign direct investors like private equity and VC funds.
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Against this backdrop the invocation of JAAR, a similar tool in the armoury of the taxman, has stunned many. Even though technically the tax department has the power to invoke JAAR, the recent move was entirely unforeseen following the CBDT assurance and subsequent change in the law to spare grandfathered shares from GAAR.
“This is likely to cause significant uncertainty among foreign investors, whose confidence was already shaken by the Tiger Global ruling. It is hoped that the government will provide greater clarity on this issue in a way that reassures both foreign investors and treaty partners by enhancing certainty around India’s tax regime,” said Keyur Shah, head of tax at Alvarez and Marsal India.Sources told ET that at least three foreign investors, including FPIs, have been served draft assessment orders, mentioning the invocation of JAAR, in the last three weeks. They said some of the officials in the tax department have chosen to slap JAAR as they could no longer resort to GAAR for grandfathered shares.
In the world of tax laws, JAAR and GAAR operate parallelly. However, while GAAR, typically applied when tax benefit exceeds ₹3 crore, is a codified law, JAAR stems from case laws and judicial pronouncements.
A few practitioners, however, think it may be a leap of faith for foreign investors to believe that a protection from GAAR would automatically extend to JAAR. According to chartered accountant Ashish Karundia, “The grandfathering protection (treaty entitlement as well as treaty benefit) for investments made before April 2017 is available specifically in the context of GAAR. But, there is no such statutory protection where treaty entitlement is examined under JAAR. The distinction between treaty entitlement and treaty benefit is important. Entitlement is the first question-whether the taxpayer can invoke the treaty in the first place. Only after that is established does the question of treaty benefit arise. Therefore, if treaty entitlement itself is denied under JAAR, the grandfathering protection cannot be relied upon merely because the investment was made before April 2017.”
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JAAR stems from English common law that backs a taxpayer using a structure to escape tax. However, this stand was questioned by the Supreme Court in a landmark case in 1985. According to the apex court, ‘colourable devices’ like sham deals, artificial arrangements, or dubious strategies cannot be justified as legitimate tax planning.