Saturday, April 7, 2012

GAAR fear: PEs trying hard to shield exit gains from tax sword

MUMBAI: The hullabaloo over the anti-avoidance rule and tax on short-term stock gains has largely centred around foreign institutional investors (FIIs) for the immediate and visible impact they make on markets.

But the proposed changes in law are a bigger concern for the private equity (PE) club - the largest foreign direct investor group that predominantly puts money in unlisted shares of local companies.

With IPOs failing to take off in a dismal market and many PEs looking for exits, these investors are thinking of ways to protect their long-term profits from tax, which is as high as 20%. In this context, PEs are at a disadvantage over FIIs, who trade in listed securities and, therefore, do not have to pay tax on long-term capital gains.

Having invested nearly $20 billion in 2006 and 2007 in various closely-held Indian firms, several PEs are currently talking to possible buyers to sell their holdings.

Even though gains from these exits will be long-term in nature, PEs that fail to demonstrate "substantial presence" in Mauritius will have to pay tax on profits, as per the proposed General Anti-Avoidance Rule (GAAR) that will override the India-Mauritius tax treaty and target aggressive tax planning through smart financial structures.

"Several PE investors are re-examining their structures to be GAAR compliant. They are also exploring the possibility of establishing the structures in a jurisdiction where they can demonstrate substance better to comply with the GAAR provisions," said Punit Shah, partner (tax & regulatory services), KPMG.

Like FIIs, PEs route their investments through Mauritius. The fund they pool in from wealthy investors across the world is based in tax havens like Cayman or Jersey, but they invest into Indian firms through a special purpose vehicle formed in Mauritius.

"Shifting the fund pool from Cayman to Mauritius may have tax implications as it will be construed as share transfer of an entity that derives its value from India or Indian assets. But even if there is a way to take care of that, there is no guarantee that tax officials will approve it," said a PE firm's senior official refusing to be named. He said given the flexibility of operations and fund formation, Mauritius is the best location. "It will be ideal if we can meet GAAR conditions and continue to invest from Mauritius."

Indian Venture Capital Association President Mahendra Swaroop said it has requested the government to allow grandfathering of investments as on March 31. This, if allowed, would mean that GAAR will be applicable only on exits from investments made on and after April 1, 2012.

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