The government will delay by two years implementation of controversial rules on tax avoidance to 2016, Finance Minister P Chidambaram said on Monday, a decision which earned a positive market reaction and is likely to help attract more capital inflows.
Announcing the decision to defer th GAAR, Chidambaram said the government had "accepted the major recommendations with some modifications" of a high-level committee headed by noted tax expert Parthasarathi Shome.
The finance ministry said GAAR would override the double-taxation avoidance agreement if an arrangement was solely aimed at avoiding taxes but according to this Business Standard report, "experts said those coming under Indo-Singapore tax treaty and having tax residency certificates from Mauritius would escape GAAR. It would, however, not be invoked on those investing in stock markets through participatory notes."
The BSE Sensex rose as much as 1 percent after the news of the delay and after a slower-than-expect rise in inflation cemented hopes for an interest rate cut this month.
"The indication from the government seems to suggest attracting capital flows is imperative for the economy and to fund the current account deficit," said Dhananjay Sinha, co-head of institutional research at brokerage Emkay Global.
Sinha added that the deferral was in line with India's stated objectives and recent policy measures like opening up its supermarket and aviation sectors, which were also aimed at attracting increased foreign capital inflows.
The current account deficit hit an all-time high of 5.4 percent of gross domestic product in the July-September quarter, putting the rupee under pressure and increasing the reliance on volatile capital flows to fund the shortfall.
This reliance on foreign capital inflows to bridge the gap is regarded as a serious fault line in the economy, haunted by memories of a 1991 balance of payments crisis when the central bank sent 47 tonnes of gold to Europe as collateral for a loan to avert a sovereign default.
Chidambaram said the anti-avoidance rules would not apply to foreign funds that were not taking tax benefits from India's various tax treaties with other nations.
The rules would also not apply to non-resident Indians running foreign funds, he told a news conference.
According to the proposed rules, investments made before August 30, 2010, would not attract tax provisions under the rules. However, they would apply to investors who route through tax-havens such as Mauritius for getting tax benefits.
Chidambaram also said officials from India and Mauritius would meet by March to review the provisos of a bilateral tax treaty, signed in 1982.
Since the island nation does not tax capital gains, the treaty has been misused by many investors to evade taxes.
India gets nearly 40 percent of its total foreign direct investment inflows through Mauritius, besides large portfolio investments.
The minister said the minimum threshold to come under the GAAR would be 30 million rupees, and that would mean large number of taxpayers would not be effected.
India's moves to toughen tax collection last year triggered an outcry from global industry groups and were blamed for a fall in investment flows into India.
In response, Prime Minister Manmohan Singh set up a panel to look at ways of addressing concerns that the new laws were arbitrary.
Another issue that displeased investors last year was an amendment to income tax laws that empowers the government to retroactively tax investments.
The government is likely to approach parliament next month to water down the rules that damaged investor confidence, which may help settle British-based Vodafone Group long-running $2 billion tax dispute.