gaar edel

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1 EdelweissSecuritiesLimited

Wehad

organized

aconference

call

today

with

ALMT

Legal

to

seek

its

views

on

implications of the major amendments to the Direct Tax law proposed in the recent

budget. Post the concall, we are of the view that transactions of FIIs routing money

through tax havens like Mauritius (with or without PNotes), which lack commercial

substance,willbe liableto tax in IndiaunderGAARw.e.fApril01,2012.Thetaxation

ratesare15%onshorttermgainsandNILon longtermgains,subject topaymentof

STT.Since taxationwillbe imposedonFIIs,weexpect its impact tobepassedon the

ultimatebeneficiary(PNoteholders).

Anoption toescape impositionofGAARcouldbemigrating operations toSingapore,

since the Singapore treaty requires an FII to have a fullfledged commercial

establishment. While for Bank FIIs who are already having significant operations in

Singapore,it

will

be

relatively

easier

to

justify

commercial

substance

vis

vis

non

bank

FIIswhoarenothavingsignificantoperationsthere.

Further, the probability of direct taxation of gains arising out of PNote transactions

underSection9amendments(overseastransactionslikeVodafone)looksremotesince

PNotesarecontractualinnatureanddonotconstituteanytransferofshares/interest

inanyentityregisteredoutsideIndia.SinceSection9isnotapplicable,thequestionof

retrospectivetaxationisalsoruledout.

ManojBahety,CFA

+912266233362

[email protected]

SandeepGupta

+912240635474

[email protected]

AshishGupta

+912266233488

[email protected]

March26,2012

EdelweissResearchisalsoavailableonwww.edelresearch.com,

BloombergEDEL,ThomsonFirstCall,ReutersandFactset. EdelweissSecuritiesLimited

ANALYSISBEYONDCONSENSUSTHENEWABCOFRESEARCH

ThePNotedilemma

AnalysisbeyondConsensus(ABC) isour initiativetoprovideadifferentiatedperspectivetoourclientson

various nonroutine and intricate issues. This unit of research works independent of the sector/stock

researchteamandviewsexpressedinthisreportmayvarywiththatofrespectivesector/stockanalyst.

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AnalysisBeyondConsensus

KeyhighlightsofGAARprovisions:

GeneralAntiAvoidanceRule(GAAR)provisionsshallbeapplicablefromApril01,2012,andwillbeinvokedif:

1) Oneofthemainpurposesofthearrangementisavoidanceoftaxand2) Transaction lacks commercial substance. However, the essence of commercial

substancehasnotbeendefined.

Theonusofprovingthatthereisnolackofcommercialsubstanceisonthetaxpayer. GAARprovisionswillprevailovertheDoubleTaxAvoidanceAgreements(DTAA). However,theprocedureforinvokingGAARisproposedtobemadeverystringentasit

requires concurrence of Approving Panel comprising three Commissioners of Income

Tax.Further, the taxpayercanappealagainst theGAARorderdirectly to the Income

taxTribunal.

Section9provisions:IncomedeemedtoaccrueorariseinIndia

The definition for transfer of an asset or capital asset has been amended to includetransactions such as Vodafone in the tax ambit. As per the proposed provisions,

transfer of a share/interest in any entity registered or incorporated outside India

derivingsubstantialvaluefromassetsinIndiashallbetaxableinIndia.

Threshold fordetermining substantial,whichwas51% in theearlierdirect taxcode,hasnotbeendefined.

WilltheaboveamendmentleadtodirecttaxationofPNotes?

WeareoftheviewthatGAARwill leadto indirecttaxonPNotes.FIIs investing in Indian

equities through tax heavens (without commercial substance) will be taxed@ 15% for

shorttermcapitalgainandnilfor longtermcapitalgainwhich inturnwillbepassedonto

thePNoteholder.

Inourviewthere isaremotepossibilityofdirecttaxationofPNotesconsideringthatthey

arecontractualinnatureanddonotconstituteanytransferofshares/interestinanyentity

registered outside India. The imposition of direct taxation of PNotes would have been

furtherdetrimentalasononehanditwouldhavebeenretrospective(w.e.f.1stApril1962)

andonother itwillbe taxedatmuchhigher rates (20% forshorttermgainsand40% for

longtermgains),

Tounderstand the impact of impactof taxationonPNotes, letus consider the following

illustration:

P

Note

holder

based

out

of

US

enters

into

a

contract

to

invest

through

a

P

Note

issuer

based

outoftaxheavensayMauritiusinIndianEquities(TransactionA).ThePNoteissuertrades

inIndianequitiesonbehalfofthePNoteholderandderivesgain(TransactionB).

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AnalysisBeyondConsensus

EdelweissSecuritiesLimited,EdelweissHouse,offC.S.T.Road,Kalina,Mumbai400098.

Board:(9122)40094400,Email:[email protected] Head InstitutionalEquities [email protected] +912222864206

NischalMaheshwari CoHeadInstitutionalEquities&HeadResearch [email protected] +912266233411

Recentresearch

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