Confusion over GAAR likely to risk sell-off in market

Foreign brokerages are complaining at recent Indian provisions to tax indirect investments and combat tax evasion, saying they are couched in ambiguous language and could also be used to target overseas market investors, risking a sell-off in markets.

Industry body Asia Securities Industry and Financial Markets Association (ASIFMA) published a letter to Finance Minister Pranab Mukherjee on Wednesday, expressing “deep concern,” and asking for the government to clarify its stance.

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At the heart of its concerns are two provisions announced this month. The first gives India power to retroactively tax the indirect transfer of assets, which was widely seen as targeting Vodafone’s contentious $11 billion purchase of Hutchison Whampoa’s Indian assets.

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The second targets tax evaders via the General Anti-Avoidance Rule (GAAR), putting the onus on investors registered in countries with special tax exemptions with India to prove they do not intend to explicitly avoid taxes.

Though ASIFMA and other brokerage officials believe neither was meant to specifically target market investors, they say the unclear language still leaves them on the hook to pay taxes.

“These two provisions are creating a very nervous situation for foreign investors at a time when India really needs their participation,” said Nicholas de Boursac, CEO of ASIFMA, in a phone interview with Reuters.

“This is very dangerous. It has the potential of having serious economic consequences, as well as market consequences.”

ASIFMA called for Indian finance ministry officials to issue a statement clearly stating that market investors would not be liable to either provision, or at least to clearly specify which investments would be subject to taxation.

“We are not averse to paying the appropriate level of Indian taxes, as long as the rules are clear so that investors can plan their affairs with a degree of certainty,” ASIFMA’s letter said.

India’s finance minister has not yet directly addressed ASIFMA’s concerns. On Tuesday Mukherjee said GAAR was not intended to harass honest taxpayers, just tax evaders.

Overseas market investors must be registered as foreign institutional investors (FII) in India. This category of investors holds more than $200 billion in assets, or 17 percent of the capitalisation of Indian equity markets, according to ASIFMA.

Most investors end up buying indirectly into Indian securities via funds or other products such as participatory notes - derivatives mimicking an underlying domestic security - sold by registered foreign financial firms.

These end-investors, as well as some FIIs, also tend to invest via countries with tax exemptions with India, such as Mauritius, making them eligible to GAAR.

The BSE Sensex has lost more than 1 percent this week to stand at its lowest in two months, with traders citing the uncertainty behind these provisions as a main reason after broker notes were widely disseminated starting on Monday.

The uncertainty prompted brokerage CLSA to stop selling participatory notes this week.

Still, foreign selling this week has been limited so far, with net sales of about $10 million as of Tuesday, according to the latest available data, though brokerage officials say investors are waiting for more clarity.

“Our phones and those of all the foreign institutions are ringing off the hooks. We are getting calls from literally hundreds of different funds asking for clarification on this,” said a senior tax specialist at a foreign bank in Hong Kong.

“Foreign investors have many billions of dollars of investments that would need to be unwound because it’s too much of a risk.”

Reuters