Indian Economy, 5th edition (74 page)

•
The
total investment
in SEZs till September 30, 2012 was app. Rs. 2,18,795.41 crore.

•
As per the provisions of the SEZ Act 2005,
100 per cent FDI
is allowed in SEZs through the automatic route.

•
A total of 160 SEZs are exporting goods and services – of this 93 are IT/ITES, 17 multi-product and 50 other sector-specific SEZs.

•
The total number of units in these SEZs is 3308.

GAAR

The GAAR (General Anti-Avoidance Rules), originally proposed in the
Direct Taxes Code 2010
, are targeted at arrangements or transactions made specifically to avoid taxes. The government had decided to advance the introduction of GAAR and implement it from the financial year 2013-14 itself. More than 30 countries have introduced GAAR provisions in their respective tax codes to check such tax evasion.

The
objective
of the GAAR provisions is to codify the doctrine of
‘substance over form’
where the real intention of the parties and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure of the concerned transaction or arrangement. It essentially comes into effect where an arrangement is entered into with the main purpose or one of the main purposes of obtaining a
tax benefit
and which also satisfies at least one of the following
four tests
:

(i)
The arrangement creates rights and obligations that are not at arm’s length,

(ii)
It results in misuse or abuse of provisions of tax laws,

(iii)
Lacks commercial substance or is deemed to lack commercial substance, or

(iv)
it is not carried out in a bona fide manner.

Thus, if the tax officer believes that the main purpose or one of the main purposes of an arrangement is to obtain a tax benefit and even if one of the above
four tests
are satisfied, he has powers to declare it as an impermissible avoidance arrangement and re-characterise the entire transaction in a manner that is more conducive to maximising tax revenues. There are many troubling aspects of this provision that will make doing business in India even more
challenging
, than what it already is from a tax perspective –

•
It is presumed that obtaining tax benefit is the main purpose of the arrangement unless otherwise proved by the taxpayer. This is an onerous burden that under a fair rule of law should be discharged by revenue collector and not the taxpayer. In fact, the
Parliamentary Standing Committee on DTC
has specifically recommended that the onus of proving the existence of a tax-avoidance motive and a transaction lacking commercial substance, should rest with the revenue invoking GAAR and not shifted to the taxpayer. This is essentially to ensure that the revenue authorities exercise proper discretion, proper application of mind and gather enough credible data and evidence before attempting to invoke far-reaching provisions such as GAAR.

•
An arrangement will be deemed to lack commercial substance under GAAR if it involves the location of an asset or of a transaction or of the place of residence of any party that would not have been so located for any substantial commercial purpose other than obtaining tax benefit. This again is an amazingly wide provision that provides a great weapon in the armoury of the tax authorities to challenge almost every inbound or outbound transaction with respect to India, made through any of the favourable tax treaties that India has entered into. The government intention becomes visibly clear by one of the finance ministry replies to the
Standing Committee on DTC
, where it has made it clear that the GAAR provisions will check
treaty shopping
by the taxpayer for avoidance of payment of tax in India’.

•
GAAR allows tax authorities to call a business arrangement or a transaction ‘impermissible avoidance arrangement’ if they feel it has been primarily entered into to avoid taxes. Once an arrangement is ruled ‘impermissible’ then the tax authorities can deny tax benefits. Most aggressive tax avoidance arrangements would be under the risk of being termed impermissible. It has a provision according to which the onus to prove that an arrangement is ‘impermissible’ will lie with the tax department. The GAAR panel, the final body that will decide on the applicability of the law, will include an independent member. The rule can apply on domestic as well as overseas transactions.

•
GAAR is a very broadbased provision and can easily be applied to most tax-saving arrangements. Many experts feel that the provision would give unbridled powers to tax officers, allowing them to question any taxsaving deal. Foreign institutional investors are worried that their investments routed through Mauritius could be denied tax benefits enjoyed by them under the Indo-Mauritius Tax Treaty. The proposal
(announced in on May 8, 2012)
had spooked stock market as FII inflows dropped on concerns, and the rupee hit a low of Rs. 53.47 to the Dollar.

Meanwhile,
the government has postponed GAAR to the next financial year (i.e., 2014-15). This will give a breather to tax payers and also allow the government time to frame clear rules after consultations with stakeholders.

Euro Zone Crisis & India

The unfolding of Euro Zone Crisis, the austerity measures in advanced economies, recession in many euro zone countries, risk on/risk off behaviour of investors and the uncertainty surrounding the future of euro zone have adversely affected the global economy. The fallout for the Indian economy has been as given below –

•
A sharp deceleration in
exports
and a slowdown in GDP growth;

•
Import
demand, however, has remained resilient because of the continued high international oil prices that did not decline, unlike what happened after the
Lehman meltdown
of September 2008.

•
The high value of
gold
imports, driven mainly by the ‘safe haven’ demand for gold that has led to a sharp rise in prices, contributed to the high import bill and widening of the trade deficit.

•
As per the
Economic Survey 2012-13
, the trade deficit, as a result, increased to US$ 189.8 billion in 2011-12, which was 10.2 per cent of the GDP. The signs of
strain on BoP
continued in the first half of 2012-13 (April–September 2012) with the trade deficit increasing to 10.8 per cent of GDP and CAD (current account deficit) at 4.6 per cent of GDP. The CAD peaked to
‘an all-time high’
of
6.7
per cent by
end-March 2013
( as per the MoF and the RBI).

•
The CAD
is estimated to be
5.1
per cent for 2012-13 as per the latest document
‘Review of the Economy 2012-13’
(released on
April 23, 2013
by Dr. C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister). The document has estimated the CAD for fiscal
2013-14
at
4.7
per cent.

The high CAD has had implications for rupee volatility and business confidence in the economy. A positive development is that high CAD has lately been financed by capital inflows, which explains why the downhill movement of rupee, witnessed till July 2012, has been largely arrested. There has, however, been high dependence on volatile portfolio flows and external commercial borrowings. This makes capital account vulnerable to a ‘reversal’ and ‘sudden stop’ of capital, especially in times of stress.

The foreign
investment environment
of India has been directly affected by the crisis – the main fallout of the euro zone crisis is global uncertainty. This has led to investors’ alternating between
risk-on
and
risk-off
behaviour, with consequent implications for surge and reversal of capital to emerging economies. A risk-on, prompted by new policy initiatives, creates a favourable disposition towards emerging economy investment, leading to surge in FIIs flows and vice versa –

•
While change in investor attitude is generally observable in the long-run, the fallout of the euro zone crisis has been quick shift between risk-on/risk-off behaviour that has immediate implications for capital flows. An additional factor has been quantitative easing in the US. This increases the supply of liquidity in the system and together with low interest environment and better growth prospects in emerging economies, contributes to increase in capital flows.

•
A closer look at the global risk-on/off events and FII flows to India shows strong correlation between such events and surge and reversal of capital. For example, the US credit rating downgrade in early August 2011, together with worsening of euro crisis, created a risk-off environment. As a result, there was net withdrawal of FII investment of US$ 3.7 billion during August-October 2011.

•
The
Long Term Refinancing Operation
(LTRO) of European Central Bank that injected more than Euro 1 trillion in the banking system in two tranche in December 2011 and February 2012 again created a risk-on environ. As a result, there was a net FII inflow of US$ 16.9 billion during December 2011–February 2012. The investor euphoria soon evaporated as the euro crisis worsened and the spectre of Greek exit loomed. Consequently, the investor behaviour again became risk-off, leading to net FII outflow of US$ 2.3 billion during March–June 2012.

The
investment climate began improving
in
July 2012
with –

(i)
Announcement by European Central Bank President that the euro would be saved at all cost;

(ii)
Proposal to set-up Banking Union in the euro zone;

(iii)
Launch of permanent European Stability Mechanism; and

(iv)
Launch of QE3 in US. The resulting risk-on atmosphere has seen a net FII inflow of US$ 10.8 billion during July–October, 2012.

FDI Liberalization

Foreign Direct Investment (FDI) is preferred to the foreign portfolio investments (PIS) primarily because FDI is expected to bring modern technology, managerial practices and has a long–term nature of investment. The government has liberalized FDI norms overtime. As a result,
only a handful of sensitive sectors now fall in the prohibited zone
and FDI is allowed fully or partially in the rest of the sectors.

Despite successive moves to liberalize the FDI regime, India is ranked
fourth
on the basis of
FDI Restrictiveness Index (FRI)
compiled by
OECD
. FRI gauges the restrictiveness of a country’s FDI rules by looking at the
four
main types of restrictions:

(i)
Foreign equity limitations;

(ii)
Screening or approval mechanism;

(iii)
Restrictions on the employment of foreigners as key personnel; and

(iv)
Operational restrictions.

A score of
1
indicates a closed economy and
0
indicates openness. FRI for India in 2012 was
0.273
(it was 0.450 in 2006 and 0.297 in 2010) as against OECD average of
0.081
.
China
is the most restrictive country as it is ranked number
one
with the score of 0.407 in 2012 indicating that it has more restriction than India. As there is moderation in FDI inflows to India in 2012-13 tahn the last year it is imperative therefore to
rationalize FDI norms
further (as is suggested by the
Economic Survey 2012-13
). The Survey further adds –

•
At present,
defence sector
is open to FDI subject to 26 per cent cap. It also requires FIPB approval and is subject to licensing. Within the 26 per cent cap, FII is also permissible subject to the proviso that overall cap is not breached. India needs to open up the defence production sector to get access and ensure transfer of technology. The existing FDI policy for defence sector provides for offsets policy. The offsets policy has been revised recently but its direct and indirect benefits have not had visible impact on the domestic defence industry. By beginning to produce defence goods that advanced countries currently produce, there is scope for productivity improvement, strengthening of manufacturing, generation of employment and lowering of imports in the country.

•
There is need to review increasing of FDI cap in
insurance
. By raising cap to 49 per cent in the insurance sector, there is scope for substantial growth in the coming years. Competition and adoption of best practices could strengthen this sector, reduce premium and expand the services to the vast untapped rural India. This sector could be one of the major sources of long-term investment in infrastructure.