Shome Committee sends out positive signal
Senior tax professional
The Shome Committee report is a triumph of democracy over tax bureaucracy. The Committee’s recommendations to severely restrict the scope of GAAR, and to abolish tax on gains from transfers of listed shares are bold and far reaching. They are a breath of fresh air in an environment of despondency and gloom surrounding unprecedented retrospective and retrograde tax changes enacted in the last Budget. They establish supremacy of rule of law over indiscriminate tax bureaucracy. The Committee describes GAAR as “an extremely advanced instrument of tax administration”, meant to deter misuse or abuse of tax law through complex and contrived arrangements. However, without adequate safeguards, it could become an instrument of abuse in the hands of inapt tax officials, deterring voluntary compliance by law-abiding taxpayers.
GAAR has been discussed and debated extensively ever since it was first proposed in the White Paper on Direct Taxes Code (DTC). Industry has been crying hoarse ever since about the wide scope of the provisions, and the great discretion given to tax administrators. These concerns were addressed in the Report of the Parliamentary Standing Committee on DTC, 2010, which made useful recommendations to deter abuse / misuse by the bureaucracy. However,the provisions introduced in the Budget completely negated the suggestions of the Parliamentary Committee.
The Shome Committee’s suggestions are similar to those of the Parliamentary Committee, and go beyond. It recommends significant pruning of the scope of GAAR, approval by an independent Advisory Panel before it is invoked, a three-year deferral of its implementation, an exemption for mutual funds and other pooling vehicles making investments through low-tax treaty jurisdictions like Mauritius and Singapore, and grandfathering of investments made prior to its implementation. These elements aim to restore investor confidence in Indian democracy and provide certainty to taxpayers. The Committee’s proposal to abolish the tax on gains from transfer of listed shares (whether by way of capital gains or business income) is a pleasant surprise. The exemption would apply to both residents and non-residents of India. The Committee supports this recommendation on the grounds that many other jurisdictions do not tax non-residents on their share capital gains. In the interest of tax equity, India should also not tax gains from shares.
Interestingly, the former finance minister, Mr Pranab Mukherjee, had viewed the absence of capital gains tax in other jurisdictions as the primary consideration for taxing such gains in India, and that too with retrospective effect. Dr Shome turns around the same logic to reach an opposite conclusion.
As discussed in my column in Business Standard on April 30, the former FM’s logic was flawed. Capital gains tax is actually a third tier tax on corporate earnings over and above the corporate income tax and the dividend distribution tax. Taxation of capital gains in addition to the corporate income tax and dividends amounts to triple taxation, which is contrary to the principle of tax neutrality. This is one of the reasons that several international jurisdictions cited in the Committee report do not apply tax to share capital gains. Even if there were any logic in applying tax on the share capital gains, the tax should apply in the country of residence of the shareholders and not in the country of source of income (i.e., where the underlying assets are located). This is indeed the case in virtually all countries around the world, with the notable exception of India. In most international tax treaties, the right to taxation of share capital gains is given to the residence country, except for capital gains on shares of companies holding mainly real property. Both OECD and UN model tax agreements reflect this principle.Even though many countries apply capital gains tax on the residents, the Committee recommends an exemption for both the residents and non residents – a view also shared by the Kelkar Committee Report of 2002. It may be appropriate to tax capital gains on residents where personal tax is substantially higher that the corporate tax rate on earnings. In India, that is not the case, as the personal and corporate tax rates are the same.
The recommendations would go a long way in bringing certainty in the application of law and encouraging voluntary compliance by the taxpayers. Most importantly, at a time when India is already grappling with an economic slowdown and the global investors are looking askance about the certainty in its policy decisions, the recommendations would send out a positive signal to them. It is unfortunate that an intervention by the Shome Committee was needed for India to come to this point. We wish the bureaucracy’s wisdom and maturity were reflected in GAAR, retrospective taxation of capital gains, and such other provisions at the time of their enactment in the last Finance Bill.