The Foreign Educational Institutions Bill of 2010, and The Universities for Research and Innovation Bill of 2012

By Vandana Shroff and Ashish Jejurkar

The education sector in India is characterized by an ever growing gap between supply and demand. With a population of about 587 million below the age of 25 years and almost 144 million between the ages of 18 to 23, India has a huge demand for quality education. The supply, however, is woefully inadequate.

According to reports by Ernst & Young (Private Sector Participation in Indian Higher Education, 2011), Grant Thornton (Education in India: Securing the Demographic Dividend, 2010) and PWC (Emerging Opportunities for Private and Foreign Participation in Higher Education, 2010), the value of the Indian pre-school and primary education sector is expected to reach $50 billion in 2015. The higher education sector is expected to grow to over $52.5 billion. Despite the size of the potential market, India is currently unable to meet the demand for education in all sectors. For example, enrollment in public sector schools and colleges (government funded education) is only 219 million children (37%) in primary, secondary and higher education, and roughly 11 million students (0.01%) in college.

The enormous gap between supply and demand in education services in India makes education a sector with considerable potential for growth. This, in turn, presents lucrative investment opportunities for foreign direct investment (“FDI”), in the form of private equity and strategic investing. Investors, however, will face certain regulatory challenges.

The (Over) Regulated Landscape Implications under the FDI Policy

Recognizing the need for greater investment in education, by way of Press Note 2(2000), the Government of India allowed 100% FDI under the automatic route in the education sector. (FDI under the automatic route does not require prior approval either of the Government or the Reserve Bank of India.) Furthermore, the Consolidated FDI Policy (effective from April 10, 2012) issued by the Department of Industrial Policy and Promotion, which sets out the prevailing policy of FDI into India, continues to permit 100% FDI in the education sector subject to compliance with the applicable sectoral regulations.

Since October 2011, education has been exempted from prior requirements for minimum acreage for facilities, minimum capitalization, and restrictions on repatriation of the original investment (all of which are still required of hotels, hospitals, SEZs and construction projects).

Constitutional Right To Education
The regulatory framework pertaining to the education sector in India and the manner in which the regulations are drafted need to be considered in light of the provisions of the Indian Constitution. Whilst Article 21 of the Constitution, which provides that that no person shall be deprived of his life or personal liberty except according to procedure established by law, does not expressly include the right to education, the right to education has been expansively read into the right of “personal liberty” under Article 21 by the Indian Supreme Court.
This interpretation was first expressed by the Indian Supreme Court in the case Mohini Jain v. Union of India [(1992) 3 SCC 666]. Although this expansive interpretation was later narrowed by the Supreme Court in the case of Unnikrishnan v. State of Andhra Pradesh [1993 SCC (1) 645] to the limits of the economic capacity of the state and its development, the right to education remains a fundamental right.

In 2002, the 86th Amendment to the Indian Constitution introduced Article 21-A, which imposed an obligation on the State to provide free and compulsory education to all children of the age of 6 to 14 years in the manner in which the State may by law determine. This fundamental right was given effect by the Right to Education Act, which is enabling legislation that came into force in 2010, to discharge the constitutional obligation of the State, as envisaged under Article 21A.

The right to education is reinforced by Part IV of the Constitution which sets out the directive principles of state policy and provides that the State is obligated, within the limits of its economic capacity, to make effective provision for securing the right to education. The State is also obligated to promote the educational interests of the weaker sections of society.

Although Article 21 provides the foundation for the right to education, the right to establish and administer educational institutions is guaranteed under the Constitution under Articles 19(1)(g), 26, and 30. Article 19(1)(g) guarantees as a fundamental freedom to all citizens, the right to practice any profession, or carry on any occupation, trade or business. Article 26 gives the right to every religious denomination to establish and maintain an institution for religious purposes, which would include an educational institution. In addition, Article 30(1) recognizes the right to religious and linguistic minorities to establish and administer educational institutions of their choice.

The Supreme Court, in the celebrated cases of Unnikrishnan v. State of Andhra Pradesh and T.M.A. Pai Foundation v. State of Karnataka [AIR 2003 SC 355] recognized the right to establish an educational institution under Article 19(1)(g) of the Constitution. However, the Court also recognized that education is regarded as an activity that is per se charitable in nature. This position was later reiterated and reinforced by the Supreme Court in P.A. Inamdar v. State of Maharashtra [AIR 2005 SC 3226].

Sectoral Regulations
With a view to ensuring education for all, the regulation of “education” including technical education, medical education, universities, and vocational and technical training of labour have been placed under the concurrent list (List III) of the Constitution, i.e. educational institutions will be subject to the regulations and governance of both the Central Government as well as State Governments.

Multiplicity of Regulators
Since education comes under the concurrent list of the Constitution of India and is subject to regulations framed by the central government as well as the state governments, the education sector is governed by multiple bodies. As a consequence, educational institutions are required to obtain multiple approvals and accreditation. To illustrate, in the case of schools, pre-school, primary and secondary education is regulated by the state in which the school isorganized. In addition, the school must be affiliated to either of the two central boards (i.e., the Central Board of Secondary Education [“CBSE”] or the Central Council for the Indian School Certificate Examinations [“ICSE”]) or the state education board of the state in which the school is set up.

Higher education is primarily regulated by the University Grants Commission (“UGC”) which enforces minimum standards. Apart from the UGC, the All India Council for Technical Education (“AICTE”) is responsible for the maintenance of standards of institutions providing technical education (e.g., engineering, architecture, and management) in India. Professional bodies such as the Bar Council of India, the Medical Council of India, the Indian Council for Architecture Research (“ICAR”), among many others, grant approval for the establishment of institutions providing professional courses for law, medicine and architecture, respectively.

“Specified Entity” Restrictions and Not-for-Profit Requirements

Under current regulations, only certain types of entities are permitted to create educational institutions. In relation to schools, the applicable regulations (including the bye-laws of CBSE, the ICSE and the state specific regulations) and the various state laws require that schools be incorporated by a trust, society or a company registered under Section 25 of the Companies Act, 1956 (a “Section 25 Company”), all of which have a “not-for-profit” character.

In relation to universities and colleges, under the UGC’s Establishment of and Maintenance of Standards in Private Universities Regulations, 2003, a private university must be established under a Central or State Act and by a society registered under the Societies Registration Act, 1860, or any other corresponding law in force, in the state where the university is proposed to be set up or by a public trust or a by Section 25 Company. Similarly, under the AICTE Regulations for Entry and Operations of Foreign Universities in India Imparting Technical Education, 2005, an institution seeking an approval from AICTE to establish an educational institution is required to be registered as a society or trust and must be of a not-for-profit character.

These requirements present a peculiar problem for potential foreign investors. Under the FDI Policy, FDI up-to 100% under the automatic route is permitted in the education sector. However, whereas Indian companies can issue shares against FDI, FDI in trusts and entities other than those specified in the FDI Policy is prohibited (with the exception of venture capital funds established as trusts). By implication, entities established as societies would also be prohibited from receiving FDI.

Hence, potential foreign investors are faced with a situation where on the one hand FDI up to 100% is permitted under the automatic route in the education sector, and on the other hand the sector specific regulations applicable to schools/universities provide that entities engaged in the education sector must be organized either as a trust, society or a Section 25 Company, and FDI is not permitted in trusts and societies.
Given the above restriction on societies/trusts, potential investors have sought to explore the option of using a Section 25 Company to invest in the education sector. However this route is fraught with its own set of difficulties.
The sole purpose of a Section 25 company is to promote commerce, art, science, religion, charity or any other useful purpose, and the license granted it by the Central government recognizes it as such. However, any profit generated by a Section 25 Company must be used to promote its purpose and not any other purpose. Moreover, a Section 25 Company is not allowed to distribute its profits as dividend to its members. Compliance with such requirements is likely to restrict the use of a Section 25 company as an investment vehicle because such an entity would not be able to apply its profits towards returns on investment.

Furthermore, the Indian judiciary has upheld, from time to time, the not-for-profit nature of entities established as educational institutions. Indian courts have held that fees charged by an educational institution cannot exceed a reasonable revenue surplus, and should be utilized for promoting education and developing the institution. With the focus being on better accessibility of education for all, the regulations relating to higher education also prescribe various restrictions on the fees that can be charged to students by educational institutions. These further restrict bona-fide investments in the education sector.

Remedial Measures Proposed Bills and their Flaws

With a view to remedy some of the difficulties faced by foreign investors investing in the education sector, particularly in higher education, the government has recently proposed two important bills – the Foreign Educational Institutions (Regulation of Entry and Operations) Bill 2010 (“FEI Bill”) and the Universities for Research and Innovation Bill 2012 (“Universities Bill”) – which were expected to relax the regulatory framework for establishing an educational institution in India and thus ease the entry norms for foreign investors in the education sector in India.

The FEI Bill
The FEI Bill lays down a detailed procedure which has to be followed by a foreign educational institution (“FEI”) for establishing its campus in India.
First, there are stringent minimum requirements for a FEI to establish itself in India. The key requirements, which are aimed at ensuring that only reputed and financially stable FEIs meet the criteria, are that the institution have provided educational services for at least 20 years since its establishment or incorporation. The foreign university must maintain a corpus fund of not less than Rs. 500 million ($10 million). A maximum of 75% of any income generated by the fund must be utilized for developing the institution, with the rest being reinvested in the fund.

Second, there is a three-step application process: an application must be made to the Registrar endorsed by the Embassy or High Commission of India in the country where the institution is established. A report must be obtained from the Registrar (Secretary of the UGC) on the fitness of the institution. And notification must be made by the Central Government of the FEI as a foreign education provider. The time frames prescribed under the FEI Bill for completion of each of these steps is cause for concern. The Embassy or High Commission has three months to respond; and the Registrar must submit his report within six months, after which the UGC has 30 days to respond with recommendations to the Central Government as to the fitness of such institution to be recognized and notified as a foreign education provider. The Central Government has a further period of 30 days from the date of receipt of the report of the UGC to issue the notification.

Third, in addition to the cap on the amount that can be utilized from the corpus fund, the FEI Bill prohibits any repatriation outside India of any revenue generated by the FEI in India. Although the FEI Bill gives the Central Government wide powers to grant exemptions, the Central Government is not permitted to exempt any institution from conforming to the requirements of the FEI Bill relating to the prohibition on revenue repatriation.

The Universities Bill
The Universities Bill provides for the setting up of new universities by the government, or by domestic or foreign private bodies or to classify some of the existing universities as research and innovation universities.
The Universities Bill permits only non-profit companies, societies or trusts, and foreign universities of repute that are least 50 years old, to establish a university in India.

In addition to the requirement of being a not-for-profit legal entity, the Universities Bill also states that the surplus in revenue must be used only for the development of the university established in India.

The Bill also prescribes operating conditions including the requirement that at least half of the students admitted need to be citizens of India. New intellectual property created by the university vests in the Central Government if it is in the public interest, for the security of the nation, or if the university fails to disclose its creation.

Neither the FEI Bill nor the Universities Bill contains any measures to do away with the multiplicity of regulatory authorities. Both the Bills have created a number of bureaucratic hurdles and the proposed timelines are likely to cause delays in the establishment of educational institutions. Furthermore, the conditions prescribed under the FEI Bill regarding non-repatriation of profits and the condition relating to ploughing back of income from the corpus fund also raises concerns. The Universities Bill is also characterized by similar difficulties. Restrictions on the types of sponsoring entities, the not-for-profit condition and the requirement for ploughing back profits are unlikely to encourage significant foreign investment.

Notwithstanding the criticism to the FEI Bill and the Universities Bill, one significant implication of both Bills is that the government appears to have recognized the importance of FEIs in developing India’s education sector. Presently, the Bills are still under discussion and it is hoped that the provisions of the Bills are revised with a view to providing necessary impetus to FDI in the education sector.

Structuring Considerations
Given the social imperatives and the need to ensure accessibility of education to all strata of society, any move by the government to liberalize investments into the education sector by making necessary changes to the applicable regulatory framework has thus, far been met with public and political outcry. Despite the enormous potential of India’s education sector, the prevailing regulatory framework deters foreign investors (including private equity investors) from investing in India’s education market, primarily because of the not-for-profit conditions and the restrictions on the types of entities which can establish educational institutions (restricted to trusts, societies and Section 25 Companies). Furthermore, the two Bills appear to contain similar restrictions and have failed to address the long-standing concerns of foreign investors.

Presently, the usual structure for foreign investment in education involves the use of two-to-three different entities. The sponsoring entity that would actually establish and run the school/university would need to be a Section 25 Company (the “Sponsoring Entity”). The other entities would own the brand, provide the management know-how and other services as well as the infrastructure required for operating the school (the “Project Entity”).
The Project Entity would need to be incorporated as a company and would receive the foreign investments. Since the service sector comes under the 100% automatic route, the prior approval of the Foreign Investment Promotion Board (“FIPB”) would not be required. The Project Entity would then enter into various contracts with the Sponsoring Entity, to provide various services such as management services, training services etc. to the educational institution and, in return, the Sponsoring Entity would pay for the services being provided by the Project Entity. Where the proposed foreign investment is a strategic investment, the brands associated with the educational institution abroad would also be owned by the Project Entity and licensed to the Sponsoring Entity for appropriate licensing fees/royalty payments.

The accreditation rules require that the educational institution have possession of the land. However, since ownership of such land is not mandated, the Project Entity could opt to construct the school premises itself or establish an entity which would hold the land and buildings required for establishing the educational institution (“Property Entity”). The Property Entity would thus provide the required land to the educational institution by way of a long term lease agreement with the Sponsoring Entity.

The services contracts entered into between the Project Entity and the Property Entity on the one hand and the Sponsoring Entity on the other hand are typically exclusive in nature with a view to ensure a captive arrangement. In light of the oversight by regulatory bodies such as the AICTE, CBSE, UGC, the transactions between the Sponsoring Entity and the Project Entity should be conducted on an arms-length basis and all regulatory and corporate approvals required under applicable law should be obtained. Since there are no restrictions on repatriation of profits in relation to the Project Entity, the profits earned by the Project Entity can be distributed to shareholders. Investors, however, would need to bear in mind the tax implications of adopting such structures.

Even a cursory glance at India’s education statistics shows that an enormous amount of investment is required in order to meet its people’s demand for quality education. The government seems to be ill-equipped to close this huge gap between supply and demand. Although 100% FDI is permitted in India’s education sector, the present regulatory framework does little to make the sector attractive for private investment (including foreign investors). In order to enhance investment into India’s education sector, there needs to be a sea change in the thinking of regulators who must recognize that they need to afford investors the opportunity of earning a reasonable return on investment, particularly as the education sector is capital intensive and has a long gestation period. India must revise its laws and regulations, particularly the FEI and Universities Bills, to permit foreign investors to repatriate reasonable profits. While it is appropriate to keep the fee structure for students subject to regulatory scrutiny to ensure that social objectives and constitutional imperatives are met, there should also be sufficient incentives for private investment in the education sector.

Under the prevailing framework, foreign and domestic investors in the education sector are hamstrung by onerous regulatory requirements and must structure investments in innovative ways. The suggested amendments will bring about transparency and provide the necessary impetus for greater investment in this vital sector.

Vandana Shroff is a Senior Partner at Amarchand & Mangaldas & Suresh A. Shroff & Co. and specializes in M&A, Private Equity and General Corporate law. She can be contacted at vandana.shroff@amarchand.com

Ashish Jejurkar is a Partner at Amarchand & Mangaldas & Suresh A. Shroff & Co. and specializes in M&A, Private Equity and General Corporate. He can be contacted at ashish.jejurkar@amarchand.com

By Krishan Malhotra and Surabhi Singhi

With the recent increase in mergers and ac-quisitions activity in India, there has been a concurrent increase in the use of “earn-out” provisions in share purchase and business transfer agreements. An earn-out is an agreement stating that the seller of a business shall get additional compensation based on the sold business achieving certain future financial goals. Those goals could be an expectation of future earnings, business performance, or some other yardstick, such as turnover. In short, an earn-out is a form of deferred compensation or income for the sale and transfer of a business or its shares.

Taxation of earn-outs in India is based significantly on the “deeming” fiction created by statute, and poses several challenges including: the characterisation of income, year of taxability, quantification of deferred payments and revisions to purchase price depending on final amounts received.

”Deemed” connotes a circumstance where a particular receipt is not income but the law says that it shall be regarded as income; that is, the law departs from reality, constituting a fiction of law. The legal fiction may also relate to place, person or year of taxability.

Thus, under India’s Income Tax Act of 1961 income tax is levied on income received, ac-crued, or deemed to accrue or arise in India. The definition of “income” has been the sub-ject of considerable judicial scrutiny and in-terpretation, but there are two main schools of thought. One is that an essential attribute of income is that it is received on a periodic basis; the other focuses on the value the tax-payer receives or may derive.

One method for structuring earn-outs is for the seller to receive the earn-out payment under the aegis of an employment agreement with the Indian company, after the transfer of shares. In In Re Anurag Jain (277 ITR 1), the Authority for Advance Rulings (AAR), affirmed by the Madras High Court in 308 ITR 302, held that, in such cases, the contingent payments have a real nexus with the employment agreement and not with the purchase agreement, and that the contingent payments are nothing but an incentive remuneration for achieving a target. The periodical payment of consideration was regarded as salary income in the hands of promoters and was not regarded as payment received towards the sale of shares which would be taxable as capital gains. Therefore, in a circumstance where the deferred consideration is linked to services being performed, it is regarded as “ordinary income,” and where the deferred consideration is relatable to the shares, it is taxable as capital gains.

Section 45(1) of the Act provides that profits or gains arising from the transfer of a capital asset made in the previous year is subject to taxation under the capital gains tax, and shall be deemed to be the income of the previous year in which the income transfer took place. Thus, in the context of earn-outs, the Act creates a “deeming” fiction in order to tax such amounts in the year of transfer, irrespective of whether such gains have accrued to the taxpayer.

Recently, the Delhi High Court, in Ajay Guliya v. Ass’t Comm. of Income Tax (ITA No. 423/2012), held that in view of the “deeming fiction,” deferred consideration to a share-holder is taxable in the year of transfer. The decision seems to conflict with the general principles of accrual set forth by the Supreme Court in Comm. of Income Tax v. Ashokbhai Chimanbhai (56 ITR 42), where it was held that unless a right to profits comes into existence, there is no accrual of profits and no tax may be imposed. Section 45 of the Income Tax Act, however, imposes a tax on transfer of capital assets, through the fiction of “deeming” the gains as accrued and subject to taxation in the year of transfer. Moreover, as the failure to meet conditions or pre-agreed thresholds for payment of deferred consideration does not result in reversion of title of shares, the general principles of accrual are not applicable in the case of earn-outs.

Therefore, because the statute requires de-ferred consideration in respect of the transfer of shares or the business to be taxable as capital gains in the year of the transfer, the next and most immediate question that arises concerns the quantification of such gains. Certain M&A deals specify an amount as deferred consideration, which makes it easy to identify the taxable deferred income. However, where the deferred consideration is not specified, but depends on a future event such as performance of the company and future profits, the full value of consideration for computing capital gains is unascertainable.

Until 2012, if capital gains were indetermina-ble, the provisions for computing the capital gains would fail and provisions relating to capital gains would not apply. Comm. of In-come Tax v. B.C. Srinivasa Setty, 128 ITR 294. The Finance Act of 2012, however, has intro-duced a new provision for the taxation of earn outs, where, if the consideration to be paid for any asset is not determinable at the time of transfer of the asset, the fair market value of the asset on the date of transfer shall be considered the full value consideration for the purposes of the Income Tax Act.

Therefore, in case of earn-outs where the deferred consideration is unascertainable, the tax authorities will tax the gains based upon the fair market value of the asset in the year of taxability, even though if it is not certain that the seller will actually receive such an amount. Where the agreed upon conditions are not achieved, however, and the earn-out payments or deferred consideration are not paid, the seller may file a revised tax return (within the statutory time limit) showing the actual full value consideration received, and the consequent capital gains accrued on the transfer. There is no clear guidance on what happens when the time limit for filing a revised return has elapsed.

In conclusion, rules regarding the taxation of M&A-related transfers relating to earn-outs in shared purchase deals, requires greater clarity, as is the case with the law in many countries which have specific chapter(s) de-voted to taxation of earn-outs.

Krishan Malhotra is a partner in the firm Amarchand & Mangaldas & Suresh A. Shroff & Co., in New Delhi. He is the Head of Taxation and can be reached at kri-shan.malhotra@amarchand.com. Surabhi Singhi is an Associate with the tax practice group of the firm. She can be contacted at surabhi.singhi@amarchand.com.

By Mukesh Butani and Rahul Yadav

In the Indian Finance Act of 2012, Parliament made several amendments to the income tax laws, with retrospective effect. The express purpose of the legislation was to overrule the January 2012 judgment of the Supreme Court of India in the Vodafone case. This article discusses whether the retrospective aspect of the legislation undermines the doctrine of separation of powers or compromises “judicial independence” to the extent of making the retrospective law unconstitutional.

The Vodafone case involved a sale of shares from Hutchison Telecom International Ltd. (“HTIL”), a Cayman Islands entity owned by the Hutchison group, to Vodafone Interna-tional Holdings BV, a company incorporated in the Netherlands. HTIL owned Hutchison’s operations in India though a series of compa-nies incorporated in Mauritius. The Indian Revenue authorities contended that as the transaction resulted in the sale of business assets located in India from Hutchison to Vodafone, Vodafone was liable to pay tax on the transaction even though the shares were purchased from HTIL and not Hutchinson. Vodafone challenged the decision. The Supreme Court of India ruled that the wording of section 9 of the Income-Tax Act does not permit a “look through”(piercing the corporate veil). Hence, the sale of shares of a foreign company by a foreign company to another foreign company could not be brought within the scope of taxation in India.

The Indian Parliament, to counter the Su-preme Court judgment, introduced retrospective substantive amendments to sections 9 and 2(47)of the Income Tax Act in the form of clarifying explanations to amend the scope of section 9,so as to bring within the ambit of Indian taxation the sale of shares of a foreign company, if such shares have derived substantial value from Indian assets. The legislation had the effect of retroactively making the Vodafone transaction taxable in India. Many have argued that overruling the Supreme Court by retroactively effective legislation undermines the rule of law and the separation of powers.

Parts I, II and III of the Constitution of India provide for separation of powers among the Executive, Parliament and Judiciary. Indian courts have consistently upheld the doctrine of separation of powers, and that each branch of the government must operate within the limits set forth in the Constitution. There must be no transgression or attempt by one branch to supplant, derogate or encroach upon the designated space of the other branches.

THE CONSTITUTIONALITY OF RE-TROACTIVE LEGISLATION

The power to enact laws lies within the exclusive domain of the legislature. The power to legislate includes the power to legislate retrospectively, including within the field of taxation:

“Legislative power conferred on the appro-priate legislature to enact laws in respect of topics covered by several entries in the three lists can be exercised both prospectively and retrospectively. Where the legislature can make a valid law, it may provide not only for the prospective operation of the material provisions of the said law, but it can also provide for the retrospective operation of the said provisions.”Rai Ramkrishna v. State of Bihar (1963) 50 ITR 171 (SC).

While legislative power to introduce amend-ments for the first time or to amend an enacted law with retrospective effect tis rec-ognized, it is nevertheless subject to constitu-tional limitations. Judicial principles require that amendments made retrospectively (a) should use words expressly providing for or clearly implying retrospective operation; (b) must be reasonable and not excessive or harsh, otherwise they run the risk of being struck down as unconstitutional; and (c) where the legislation is introduced to over-come a judicial decision, the power cannot be used to subvert the decision without remov-ing the statutory basis of the decision.

It is also a settled principle that legislative actions are subject to judicial review by the Indian High Courts and Supreme Court. There is no doubt that the legislature is empowered to enact laws retrospectively as well as prospectively. No such enactment, however, should result in an alteration of the basic structure of the Constitution. KesavanandaBharti v. State of Kerala AIR 1973 SC1461). The general rule is that any amendment or enactment which violate fundamental rights may be struck down by the courts as unconstitutional.

Accordingly, pursuant to the writ jurisdiction conferred upon under Articles226and 32of the Constitution, the High Courts and Supreme Court act as a ‘watchdog’ to safeguard fundamental rights. Such powers have been exercised with great caution by Indian courts. On numerous occasions, when the courts have been called upon to consider the validity of legislation, the courts have shown great restraint. Unless the legislation patently violates fundamental rights and there is no recourse to prevent such a violation but to declare the law unconstitutional and strike it down, the courts will find the legislation constitutional.

LIMITS ON RETROSPECTIVE LEG-ISLATION

The power to legislate includes the power to validate a law which has been held invalid by the courts by making retrospective amendments. This can be done by removing the infirmities in the law or by filling the lacuna therein. The obvious question is whether by exercising such power the legislature violates separation of powers by limiting the power of judicial review.

A retrospective amendment to overcome a judgment does not, by itself, render the amendment invalid or unconstitutional, even if it has the effect of neutralizing the judgment of a court, making the judgment virtually ineffective. Such amendments do not amount to the statutory overruling of judicial decisions. I.N Saksena v. State of M.P (1976) IILLJ 154 SC.

“A competent legislature can always validate a law which has been declared by courts to be invalid, provided the infirmities and vitiating factors noticed in the declaratory judgment are removed or cured. Such a validating law can also be made retrospective. If, in the light of such validating and curative exercise made by the legislature granting legislative competence the earlier judgment becomes irrelevant and unenforceable, that cannot be called an impermissible legislative overruling of the judicial decision. All that the legislature does is to usher in a valid law with retrospective effect in the light of which the earlier judg-ment becomes irrelevant.” Ujagar Prints v. Union of India [1989] 179 ITR 317 (SC)

Accordingly, the judiciary accepts that the legislature is competent to render a judgment ineffective, provided that the legislature removes the statutory basis of the judgment with retrospective effect. However, such retrospective amendment must satisfy the test of constitutional validity, including inter alia, the test of reasonableness. Taxing statues, like any other statues, are subject to amendment with retrospective effect.

THE DOCTRINE OF “SMALL REPAIRS”

Legislative power to enact retroactive legislation has to adhere to constitutional limitations, of which the most important is the “principle of small repairs,” which is an index of whether the law is harsh and oppressive, or a valid exercise of the power to enact retrospectively. The “principle of small repairs ,”is an expression that originated in an article in the Harvard Law Review where it was observed that “it is necessary that the legislature should be able to cure inadvertent defects in statutes or their administration by making what has been aptly called ‘small repairs.’” This prin-ciple was subsequently adopted by the Indian Supreme Court(Assistant Commissioner of Urban Land Tax v Buckingham and Carnatics Co Ltd 75 ITR 603 (SC); Virender Singh Hooda And Ors v State of Haryana AIR 2005 SC 137), and has been applied by Courts in determining the constitutional validity of retrospective legislation. The doctrine seeks to provide a touchstone by which the limits of legislative power to enact retrospective legislation, including tax legislation, may be tested.

A close analysis of the relevant jurisprudence, specifically in relation to tax legislation, demonstrates that retrospective legislation has been upheld by courts principally in two situations, cumulatively reflecting what amounts to “small repairs:”(a) the imposition of a tax, where the intention to impose the tax was always clear but such imposition failed due to a formal defect; or (b) the imposition of a tax, where the intention to impose the tax was always clear, but the imposition originally failed due to sheer inadvertence.

The doctrine of “small repairs” also assumes importance against the backdrop of the “legi-timate expectations of the taxpayers.” Lord Scarman in R v Inland Revenue Commissioners ex p. Preston (1985) AC 835(House of Lords, England) laid down emphatically that unfair-ness in the purported exercise of power can amount to an abuse or excess of power. Thus the “doctrine of legitimate expectations” is applied in the contexts of reasonableness and natural justice.

The doctrine of small repairs permits retros-pective amendment where the aim of such amendment is to convey the meaning or to clarify the intent of the provision as it always was meant to be; to remove a patent defect which, but for the modification, would result in absurd results; to supply an obvious omis-sion in a former statute; or to explain a formal statute. Therefore, retrospective legislation which does not satisfy the requirement of “small repairs” but in fact leads to substantive amendments which are neither clarificatory nor declaratory in nature, may be struck down by the Courts as ultra-vires and unconstitutional on the grounds that it is unreasonable, harsh or oppressive.

THE QUESTIONABLE CONSTITUTION-ALITY OF THE RETROACTIVE LEGISLA-TIONIN VODAFONE

The amendments made to section 9 of the Income Tax Act by the Finance Act of 2012, which outlines the “deemed source” rule of taxation, cannot be said to have been made to rectify a formal defect or an inadvertent error. Further, the severity and magnitude of these amendments does not appear to be clarificatory even though they have been introduced in the statute under the garb of clarificatory explanations. They clearly seem to fall outside the four corners of the “doctrine of small repairs.”

The constitutional validity of these amend-ments has yet to be tested in a court of law. Nevertheless, we are of the opinion that the amendments cannot rationally be held to be clarifying the intent of the Income Tax Act so as to include the off-shore sale of shares by one foreign company to another foreign company (such as Vodafone) within the ambit of section 9 of that statute. This does not seem to be a valid exercise of legislative power, as it amounts to a substantive amendment levying a fresh charge, which cannot be given retrospective operation as per settled legal principles. Not only are these amendments unreasonable, they fasten substantive liability insofar as their retrospective operation is concerned, and they are also harsh and oppressive. While the amendments may stand the test of constitutional validity insofar as their prospective operation is concerned, whether or not Courts uphold their retrospective operation remains to be seen (writ petitions have been filed challenging the constitutional validity of section 9 by McLeod Russel (India) Limited (an Indian company) in the Calcutta High Court and SABMiller Limited (an Australian Company)before the Bombay High Court).

To conclude, while the legislature has the power to render a court’s verdict ineffective by removing the statutory basis of itsjudg-ment, the exercise of such power has to con-form to constitutional requirements, and the limitations are even more rigorous in the case of a retrospective enactment. A practice whereby the legislature, in an attempt to remove the basis of the judgment, ushers in substantive amendments retrospectively (which do not qualify as “small repairs”) in the garb of clarificatory or declaratory amendments is not a valid exercise of legislative power. Such an attempt by the legislature not only undermines the independence of the judiciary but also disturbs the critical balance between the three branches of government.

Judgments and decisions of the Supreme Court, being the highest court in India, are the “law of the land” as expressly provided for under Article 141 of the Constitution of India. Thus, it remains to be seen whether the retroactivity of section 9 will stand up to judicial scrutiny if and when the McLeod Russell and SABMiller cases wind their way to the Supreme Court.

Every democracy aspires to achieve the goal of good governance in accordance with the “Rule of Law.” For the Rule of Law to prevail it is imperative that there exists a sense of responsibility and mutual respect among the three branches of government. Therefore, no branch should be surprised when its attempt to usurp the power of another in derogation of the constitution is challenged until defeated.

Mukesh Butani is the Managing Partner of BMR Legal and specializes in International Tax and Transfer pricing with over 25 years’ experience in advising Fortune 500 multinationals and Indian business houses on a wide range of matters. He is a member of the Advisory Group on International Tax and Transfer Pricing constituted by the Indian Ministry of Finance. He is also a member of the OECD Business Restructuring Advisory Group, the International Fiscal Association’s Permanent Scientific Committee and the OECD-BIAC committee. Mukesh can be reached at Mukesh.Butani@bmrlegal.in.

Rahul Yadav is an Advocate and interna-tional tax dispute expert at BMR Legal and has worked extensively on several cross border transactions. Rahul can be reached at rahul.yadav@bmrlegal.in

A Discussion of HSIIDC v. Mawasi
By Vivek Kohli and Shivambika Sinha

In 1994, the Government of Haryana acquired over 1,765 acres of land for the purpose of developing an Industrial Model Township (“IMT”) in Manesar, Haryana,through compulsory acquisition under the Indian Land Acquisition Act, 1894.Possession of the acquired land was handed over to theHaryana State Industrial and Infrastructure Development Corporation Limited (HSIIDC) which was entrusted with the task of demarcating the land into plots and allottingthe same to prospective investors, industrialists and entrepreneurs.

Even as HSIIDC commenced the allotment process and the development of the IMT progressed, litigation was initiated by the original landowners of the acquired land challenging the fairness of the compensation awarded by the state government in consideration of the compulsory acquisition. The present article analyzes the outcome of the litigation initiated by the landowners seeking an increase in the quantum of compensation payable by the stategovernmentfor theacquired land. The litigation,spanning over 15 yearsand traversing all layers of judicial hierarchy, culminated in a 400% increase in the compensation amount payable by HSIIDC to the landowners. While considering the claims of the landowners, the Supreme Court of India recapitulated the law regarding the criteria for assessing the compensation payable to private landowners and the duty on the state to ensure that such compensation is fair and reasonable. Since the burden of the enhancementof the compensation waspassed on by HSIIDCto the allottees of the land in IMT Manesar, the present article also analyzesthe extent of the contractual liability of the allottees to bear that burden.

SCHEME OF THE ACT
The purpose of the Act is to enable the state to compulsorily acquire lands required for undertaking projects of public importance. The power of compulsory acquisition has an inbuilt element of duty upon the state to pay compensation which is just and fair, and to do so without delay. The Special Tahsildar v. M.Sowdammal, (2010) 5 SCC 708.

The first step in the initiation of land acquisition proceedings by the stateis publication of a notification under Section 4 of the Act whichacts as a public announcement of the Government’s intention toacquire the land for a public purpose. Land that is subject to a notification under Section 4 may or may not become subject to acquisition.Within a year of publishing a notification under Section 4 andupon being satisfied as to the need and suitability of the lands under consideration, a declaration is required to be madeby the appropriate Government under Section 6 of the Act, statingwhether the landsare required for a public purpose or for a Company.

Thereafter, the concerned Land Acquisition Collector (“LAC”) is required to take measurements of the land and invite the persons interested in the land to state the nature of their interestsand the particulars of their claim for compensation. After hearing all parties, and within two years of a declaration under Section 6, the LAC must pass an award declaring the compensation payable for the acquired land. Thereafter, the LAC is entitled to take possession of the land which vests free of all encumbrances with the appropriate Government.

Courts in India have consistently held that the assessment of compensation under the Act, and review of the same by the Courts, must be based upon its ‘fair market value’, it being the price which a willing seller might be expected to obtain in the open market from a willing buyer. The Act also provides guidance as to the aspects that should be taken into account by the LAC and the reviewing Courts while determining the compensation payable to the landowners.The Actprovides that the compensation payable should be determined on the basis of the market value of the land on the date of publication of the notification under Section 4 of the Act (“Relevant Date”).While determining the market value, it shall not be relevant to take into consideration any increase in the value of the acquired land that is likely to accrue from the use to which it is put once it is acquired.

Considering that such acts of compulsory acquisitions, usually of agricultural lands, deprive the original landowners of their source of livelihood and means of production, the Act confers a statutory right on the persons aggrieved by the award of the LAC to challenge the same before Courts of law. The burden to demonstrate that the compensation awarded falls below the true market value of the property, as also to establish the correct market value, lies with the landowner. The landowner has to set up a claim for compensation on the basis of cogent evidence and once the initial burden is discharged, the burden shifts to the State to show that the claim made by the landowner is overvalued and ought not to be granted.

FACTS OF THE CASE
The acquisition of land for IMT Manesar was undertaken in two phases. In the first phase, about 256 acres of land were acquired in village Manesar. The Notification under Section 4 of the Act with respect to the acquisition was issued on 30 April 1994 (“First Notification”) and the declaration of purpose was made under Section 6 of the Act on 30 March 1995. The acquisition was completed and an award was passed by the LAC on 28 March 1997 (“First Award”) fixing the market value of the land at INR 367,400 per acre.

In the meanwhile, an additional 1,490 acres of land were notified for acquisition by way of another Notification under Section 4 of the Act, dated 15 November1994 (“Second Notification”), followed by a declaration under Section 6, dated 10 November1995. The second phase of the acquisition notified lands in village Manesar, as well as, in some adjoining villages. The second phase of the acquisition was completed andan award, dated 3 April 1997 (”Second Award”), was passed by the LACfixing the market value at INR 413,600 per acre. Significantly, the Second Award assessed the fair market value of similarly situated lands higher than the First Award basis the increase in land value in the area following issuance of the First Notification.

Landowners affected by both phases of the acquisition challenged the awards before the Additional District Judge, Gurgaon(“Reference Court”) and produced various sale instances by way of evidence to support their claim for enhanced compensation. The Reference Courtfailed to appreciate the evidence and adopted a location-based criterion for determining the market value of the lands. Pursuant to appeals filed by the landowners, the High Court of Punjab & Haryana set aside the order of the Reference Court and enhanced the market value of the lands covered by the First Award to INR 1,200,000 per acre and of those covered by the Second Award to INR 1,500,000 per acre.

On appeal, the Supreme Court, by order dated 17 August, 2010 [(2010) 11 SCC 175], rejected HSIIDC’s plea against the enhancement of compensation and further increased the compensation payable to the landowners to INR 2,000,000. Review Petitions filed by HSIIDC against the said order were also dismissed by the Supreme Court and the grant of enhanced compensation attained finality on 2 July, 2012 [(2012) 7 SCC 721; (2012) 7 SCC 200].

DECISION OF THE LOWER COURTS
In the instant case, the landowners produced various sale instances by way of evidence before the Courts in order to support their claims for enhanced compensation.Instead of determining which sale instance was the most appropriate indicator of the true market value of the acquired land, the Reference Court adopted a location-based criterion for assessing compensation payable to the landowners and divided the entire acquired portion into two blocks.
Block A was classified as properties situated within 500 yards of a National Highway connecting New Delhi to Mumbai, and the remaining lands were included in Block B. While market value of Block B was not altered significantly, considering proximity to the National Highway, market value of Block A properties was enhanced by the Reference Court to INR 651,994 per acre for lands covered under the First Award and to INR 689,333 for lands under the Second Award.

On appeal, the location-based methodology adopted by the Reference Court was rejected by the High Court which, in fixing the quantum of compensation, placed reliance on a sale deed, dated 16 September 1994, produced by the landowners, on the ground that it reflected, as nearly as possible, the market value of the acquired land.
The Sale Deed had beenexecuted between two companies and the sale consideration, at the rate of INR 2,003,103 per acre, had been paid by way of bank drafts. Taking judicial notice of the fact that sale transactions between private individuals are often undervalued with a view to save stamp duty and registration charges, the High Court relied on the Sale Deed, to the exclusion of all others, on the ground that,since it had been entered into between two companies, it was more likely to reflect the true market value of land as compared to sales between private individuals. The High Court, however, imposed a 20-25% cut in the market value assessed by it on account of development cost of the acquired land, which was far greater in size than the one covered by the Sale Deed.
It is noteworthy that, while fixing the compensation payable to the landowners, the High Court retained the distinction drawn by the Reference Court between the properties notified under the First Notification and those notified under the Second Notification. This distinction was presumed to be a given in light of the requirement that compensation should be based on the market value of the acquired land as on the Relevant Date.

DECISION OF THE SUPREME COURT
The High Court’s rejection of the location-based assessment was upheld by the Supreme Court in light of precedents laying down the principle that where different categories of land were acquired for the same purpose, differential valuation ought to be avoided and a uniform rate of compensation should be awarded for all lands acquired under the same notification. Subh Ram v. State of Haryana,(2010) 1 SCC 444. Further, the Supreme Court upheld the settled principle of law that whenever direct evidence in the form of sale instances is available for consideration, the comparable sales method ought to be applied to the exclusion of all other methods while determining the market value of acquired lands.

The Supreme Court upheld the High Court’s order to the extent it relied on the comparable sales method and it was a question of evidence as to whether the Sale Deed had been validly accepted as the appropriate indicator of the fair market value.On appreciating the evidence led by the landowners, the Supreme Court found that the High Court was right in relying on the Sale Deed for ascertaining the market value of the acquired land and accepted the position of the High Court that judicial notice can be taken of the fact that prices in sale transactions between private individuals are usually undervalued.

However, the Supreme Court modified the High Court’s decision in two ways. First, the Supreme Court rejected the distinction made by the lower Courts between lands acquired under the First and Second Notifications and awarded a single rate of compensation to all landowners basis the principle evolved by the Courts that, for the purpose of appreciating evidence, the date of the sale instance under consideration must be in reasonable proximity to the Relevant Date [(2010) 5 SCC 708].In the instant case, the First Notification was issued in April 1994 while the Second Notification was issued in November 1994. The Sale Deed produced by the landowners was registered in September 1994 and was preceded by an agreement to sell, dated 31 May 1994. Thus, the Sale Deed reflected the market value of the underlying property during the period May-September 1994, which was reasonably proximate to the Relevant Dates of both the First and Second Notifications.

Second, the Supreme Court held that the 20-25% deduction allowed by the High Court in the sale price reflected in the Sale Deed was incorrect. The Supreme Court noted that it cannot be ignored that the land under consideration was acquired for setting up an IMT at Manesar and after developing the land HSIIDC was bound to sell the plots at much higher price to the prospective industrial entrepreneurs andwould recover the development cost of the land proportionately from the allottees.

In this context, it is appropriate to note that while a post-acquisition increase in land value cannot be considered while assessing market value of acquired land, by deducting 20-25% in the instant case, the post-acquisition expense of development costs was sought to be transferred onto the landowners. In such a scenario, the Supreme Court held that the High Court committed an error by applying a 20-25% cut on market value determined on the basis of the Sale Deed, and assessed the compensation at a uniform enhanced rate of INR 2,000,000.

HSIIDC then filed review petitions assailing the enhanced compensation on the ground that the Sale Deed was not a reliable indicator of the true market value as it had been executed between two companies belonging to the same management with a view to artificially inflate the price of the land. On appreciating the evidence placed on record, the Supreme Court found that HSIIDChad presented no evidence to challenge the veracity of the Sale Deed and that HSIIDC was attempting to file a second appeal in the garb of review petitions.In this view of the matter, the Supreme Court dismissed the review petitions and imposed a further cost of INR 25,000 against HSIIDC to be paid in each case filed before the Supreme Court.

In view of the dismissal of the review petitions by the Supreme Court, the question of payment of compensation has now attained finality.

FINANCIAL BURDEN
Under the Act, as well as the order of the Supreme Court, the liability to compensate the landowners dispossessed by compulsory acquisition lies with the concerned State. However, under the terms of the allotment, this burden has been shifted by HSIIDC onto the industrialallottees who have been allotted plots in IMT, Manesar. The financial impact of the Supreme Court’s judgment is, therefore, being borne by industrial allottees.
An attempt made by the IMT Industrial Association to be impleaded in the review petitions filed by HSIIDC was rejected by the Supreme Court on the ground that they did not have locus standi to be heard in this matter. The extent to which the cost of additional compensation can be reasonably transferred by HSIIDC on the allottees of industrial plots was not an issue before the Supreme Court and, therefore, there was no occasion to make a group of industrial allottees a party to a dispute between the State and the landowners. However, the fact that the industrial allottees have already paid an allotment price significantly higher than the cost of the enhanced compensation was duly noted by the Supreme Court.

It may well be possible for HSIIDC to absorb the impact of the enhanced compensation. HSIIDC, however, may seek to recover the enhanced compensation rom industryallottees. In that event, the allottees’ contractual liability to bear the impact of the enhancement would be limited to the difference between the initial compensation awarded by the LAC and the compensation now payable as per the orders of the Supreme Court. While the rights of the landowners against HSIIDC are protected by the Act, the rights of allottees against unjust claims made by HSIIDC are to be found within the terms of the allotment.

CONCLUSION
The Supreme Court’s decision follows a trend of decisions where the Courts have been liberal in awarding compensation for acquisition of land with a view to ensure just and fair compensation for persons affected by compulsory acquisition, without exceeding the scope of law. What was unique in the HSIIDC v. Mawasicase was that the Sale Deed was accepted by the Supreme Court as a true indicator of the market value for the entire acquired land even though it was entered into after the date of the First Notification and an increase in price may have resulted from the said acquisition.

The Supreme Courtwas influenced by the difference in price paid by the allottees to HSIIDC and the price LAC paid to the original owners. Allottees paid HSIIDC at the rate of INR 2,200 per square yard, whereas LAC acquired the land at the rate of INR 82.64 per square yard. Though it is settled law that the purpose of acquisition is not a relevant factor for determining the true market value of acquired property, the potential profit accruable to HSIIDC from further allotment of the acquired land was found to be a relevant consideration for reviewing the reasonableness of the compensation awarded to the original landowners.Even then, the effective increase in compensation to the landowners (from INR 82.64 to INR 413.2 per square yard) is still meager as compared to the profits received and receivable by HSIIDC from the allotment of the acquired land.

From the above analysis of the case, it is apparent that the LAC defaulted in ascertaining the appropriate compensation payable to the landowners as per the Act and the law laid down by the Courts in India. The enhancement of compensation by the Supreme Court was merely to rectify the errors committed by the Courts below in applying the law and appreciating evidence produced by the landowners in support of their claims.
VivekKohliis co-founder and Senior Partner at ZEUS Law Associates. A practicing lawyer for over 20 years, he oversees the indirect tax, regulatory, litigation and dispute resolution practices of the firm in New Delhi. ZEUS is a corporate commercial law firm. One of its areas of specialization is real estate and infrastructure- related advising and litigation.

ShivambikaSinha is an Associate at ZEUS Law Associates. She enrolled with the Bar in New Delhi, India, in 2010 and is part of the litigation and dispute resolution practice of the firm.Both authors may be contacted at zeus@zeus.firm.in.

By Aseem Chawla and Shweta Kapoor

General Anti-Avoidance Regulations (“GAAR”) are aimed at targeting complex and/or peculiar tax avoidance arrangements that take advantage of inadvertent loopholes in tax laws. Such tax avoidance arrangements are generally artificially constructed and have no underlying commercial substance.

GAAR has been termed as the codification of the doctrine of substance over form whose objective is to deter tax avoidance arrangements rather than per se generate revenue. Thus, GAAR regulations aim to deal with tax avoidance arrangements rather than tax mitigation or tax evasion. Tax evasion is forbidden by law, while tax mitigation is permissible and allows a taxpayer to take advantage of a fiscal incentive provided through tax legislation.

The following illustrations show the differ-ence between mitigation and evasion. A company that incorporates its manufactur-ing division in a Special Economic Zone (SEZ) that provides tax incentives such as tax holidays for fixed periods under tax statutes is a company that mitigates its tax obligations. A company that manufactures in a non-SEZ zone and then diverts the manufactured products to a SEZ, but where no further value is added to the product, is a company that evades its tax obligations. The evasion is in the misrepresentation of facts to make it seem as if goods had been manufactured in a SEZ, when, in fact, they were not. Tax avoidance, like tax evasion, affects economic efficacy, fiscal justice and revenue productivity.

The concept of GAAR was first introduced in India through a draft Direct Tax Code (“DTC”) in 2009. The DTC was introduced with a view to replace the Indian Income Tax Act, 1961 (the “Act”). It aimed to achieve simplification of the language and structure of existing direct tax provisions. The DTC, along with a discussion paper, was released on August 12, 2009 for public comments. Subsequently, based upon initial feedback from stakeholders, a Revised Dis-cussion Paper was released in June 2010, which was, again, open for public com-ments. Thereafter, the Draft of Direct Taxes Code, 2010 (“DTC 2010”) was placed by the Government of India before Parliament on August 30, 2010. The DTC 2010 retained most of the GAAR provisions proposed by DTC 2009, but also included certain enabling provisions to effectuate the proposed GAAR provisions.
THE GAAR EVOLUTION PROCESS
The DTC 2009 introduced GAAR with the prime objective of deterring tax avoidance. It failed, however, to clearly distinguish between legitimate tax mitigation and illegal tax evasion. The DTC 2009 proposals did suggest that there will be a presumption that an arrangement would have been entered into, or carried out, for the main purpose of obtaining a tax benefit, unless the person obtaining the tax benefit proves otherwise. The sweeping nature of such a presumptive provision would have caused undue hardship to the taxpayers entering into genuine transactions and accordingly the entire GAAR scheme was viewed as being counterproductive for commercial efficiency. There was also justifiable concern that such provisions would lead to a plethora of litigation, inconsistent with the objective of deterring tax avoidance arrangements. There was widespread consensus that the initial burden of invoking GAAR and proving tax avoidance should be upon the tax authorities.

The DTC 2010, which, based on several representations from stakeholders was re-ferred to the Standing Committee on Finance headed by former Finance Minister, Yashwant Sinha, which issued its report on March 9, 2012 with suggested amendments to the DTC 2010. Eventually, in March 2012, the tax proposals for that year were set forth in the Finance Bill 2012, which introduced GAAR provisions under the existing Act. These provisions became effective on April 1, 2012 and were enacted into law on May 28, 2012 (the “GAAR Provisions 2012”).
SALIENT ASPECTS OF
THE GAAR PROVISIONS

Chapter X-A of the Income Tax Act, 1961, now encapsulates the GAAR Provisions 2012. Like DTC and DTC 2010, the GAAR provisions provide wide discretionary powers to the revenue authorities in taxing tax avoidance arrangements. These powers include the power to disregard entities in a structure, reallocate income and expenditure between parties to the arrangement, alter the tax residence of such entities and the legal situs of assets involved, as well as treat debt as equity and vice versa.

The GAAR Provisions 2012 were once again criticized for providing wide discretionary powers to tax authorities, resulting in an onerous burden on the taxpayers. The GAAR Provisions 2012, along with the retrospective amendments on taxation of indirect transfers, became the subject of intense debate. In view of uproar, implementation of GAAR Provisions 2012 was delayed by one year.

Subsequently, another committee under the chairmanship of the Director General of Income Tax (International Taxation) was constituted (the “New Committee”). It was asked to give recommendations to create guidelines for the proper implementation GAAR provisions. The Committee was also asked to provide clarity on the provisions to safeguard taxpayers against a potential abuse of power on the part of the tax authorities.

The New Committee released its draft rec-ommendations in June 2012. A summary of some of the most important sugges-tions/recommendations are as follows. The burden of proving that an arrangement leads to “tax avoidance” should be on the revenue authorities and not on the taxpayer. In order to provide relief to small taxpayers there should be a monetary threshold before invoking GAAR provisions. For the sake of consistency and transparency in the procedures, the New Committee also prescribed statutory forms, inter-department references and time limits within which office actions should be completed under the GAAR provisions.
Further, it was clarified that GAAR would only apply to cases not covered by Specific Anti Avoidance Rules (“SAAR”). (SAAR relate to “specific” rules to close specifically defined loopholes, as distinct from “gener-al” rules that give the tax authorities wide powers to close what they perceive as loo-pholes. SAAR rules are seen as providing certainty to taxpayers whereas GAAR, un-less crafted carefully, may be open to arbi-trary enforcement and abuse.) The New Committee clarified that in the event only a part of the arrangement is found to be im-permissible, the tax consequences under GAAR will be limited to only that part of the arrangement. The New Committee recommendations also contain many useful illustrations to help determine whether an arrangement would attract GAAR provi-sions or not.

The New Committee recommendations were issued when the Finance Minister’s portfolio was temporarily taken over by the Prime Minister. It was somewhat of a surprise to observe the reaction of the Prime Minister’s Office to the public circulation of the new committee recommendations. The Prime Minister’s office suggested that the rules were merely “draft guidelines to seek wide ranging feedback and for discussion purpose”. Finance Ministry officials countered: “Do not read too much into the release of PMO. The PM has not applied his mind on GAAR issues.” Following these developments, the Government of India constituted an Expert Committee on GAAR to undertake stakeholder consultation to revisit and finalize the New Committee’s recommendations for GAAR.
THE EXPERT COMMITTEE
The expert committee convened under the chairmanship of the distinguished interna-tional economist, Parthasarathi Shome, Ph.D. The Experts Committee’s mandate was to engage stakeholders in consultations and obtain suggestions from them as well as from the general public on the new committee recommendations for GAAR. The Committee received suggestions from stakeholders, tax advisory professionals, chambers of commerce and industry, foreign investor associations, industrialists, and policy makers in relation to the above recommen-dations. Based on such feedback, the Expert Committee issued revised recommendations for GAAR.

The Expert recommended that implementa-tion of GAAR be deferred by three years due to administrative reasons. The reasons included the fact that it would require time to train tax officers to enforce the GAAR. Moreover, the delay would cause no harm as the GAAR seeks to deter tax avoidance arrangements rather than generate revenue.

Further, the committee in its draft report emphatically took an “investment ap-proach” and suggested that tax on gains arising from the transfer of listed securities and tax on business income of foreign investors in India be abolished. However, in order to make good lost revenues if this were implemented, the Expert Committee recommended that the rate of the securities transaction tax be increased. It recommended that tax officers be required to give detailed reasons before invoking GAAR in order to satisfy the government’s prima facie burden of proving incidents of tax avoidance.

In order to avoid ambiguity and uncertainty the committee further recommended that until the tax is abolished, if the government of Mauritius issues a Tax Residency Certificate to any entity, India should not invoke GAAR provisions to examine the genuineness of the residency of that entity in Mauritius. Similarly, where a tax treaty itself has anti-avoidance provisions, for instance, under the India–Singapore tax treaty, the treaty provisions ought not to be substituted by GAAR provisions under the treaty override provisions. The Expert Committee has also opined that tax avoidance should be distinguished from tax mitigation and suggests that there should be an exhaustive negative list (that sets forth precisely what does not constitute avoidance) for the purposes of GAAR.

The Expert Committee has suggested that the negative list be non-exhaustive and in-clude:

• Amalgamations and demergers (as de-fined in the Act) as approved by the High Court.
• Intra-group transactions (i.e. transactions between associated persons or enterpris-es) which may result in tax benefit to one person but overall tax revenue is not af-fected either by actual loss of revenue or deferral of revenue.
• Selection of one option, when the law offers two or more options, should not be considered to be tax avoidance. For instance, payment of payment of dividend or buy back of shares by a company, setting up of a branch or subsidiary, setting up of a business unit in a SEZ or any other place, funding through debt or equity, and purchase or lease of capital.
• Timing of a transaction, for instance, sale of property in loss while having profit in other transactions.

To ensure fairness and lack of ambiguity the Expert Committee has recommended existing investments by residents or non-residents on the date of commencement of GAAR should not brought under the scrutiny of GAAR.
Some of the other salient recommendations of the Expert are:

• The GAAR provisions should become applicable only after a monetary threshold of Rs. 30 million ($500,000 approximately) in tax benefits has been reached.
• GAAR should cover only those arrange-ments which have the main purpose of obtaining a tax benefit and not those where a tax benefit is merely incidental.
• An arrangement lacking “commercial substance” shall be deemed to include arrangements not having significant busi-ness risks or net cash flows apart from tax benefits.
• In order to ensure a high level of inde-pendence, the GAAR Approving Panel should have five members including a chairman. The chairman should be a re-tired judge of a High Court, while the other members should include two mem-bers from outside the government or persons of eminence from the fields of accountancy, economics or business and two chief commissioners of income tax.
• GAAR provisions should not be invoked while processing applications for lower tax deductions at source where the tax-payer gives an undertaking to pay taxes in case it is found that GAAR provisions are applicable during the course of tax assessments in the future.
• The tests set forth under the GAAR provisions of the Finance Act, 2012, should not be discarded as totally irrelevant and may be considered in addition to other aspects while determining commercial substance of an arrangement. Nevertheless, the fol-lowing factors must not be deemed irrelevant: the time period an arrangement has existed, the fact of payment of taxes, directly or indirectly, under the arrangement, and the fact that an exit route is provided for by the arrangement.

In other words, the tax avoidances schemes would be required to be reported in the taxpayer’s voluntary tax filings. At the same time, the committee recommended that for reporting purposes a tax avoidance scheme be deemed more likely than not to be an impermissible avoidance arrangement.

RECOMMENDATIONS ACCEPTED

The Government of India, after considering the Expert Committee’s recommendations, has accepted its major recommendations with some modifications. The final report of Expert Committee, with modifications, was put on online on January 14, 2013. The following decisions have been taken by Government of India:

The provisions of GAAR will come into force with effect from April 1, 2016.
An arrangement with the main purpose of obtaining a tax benefit will be considered to be an impermissible avoidance arrange-ment.

As recommended by Expert Committee, GAAR provisions will be invoked when the tax benefit exceeds the monetary threshold of Rs. 30 million ($500,000 approximately).
Investments made before August 30, 2010, i.e., the date of introduction of the DTC 2010, will be grandfathered and not subject to the GAAR provision.

The GAAR provisions will not apply to for-eign institutional investors (“FIIs”) that do not take treaty benefits under section 90 or 90A of the Act. Further, GAAR provisions will not apply to non-resident investors in FIIs.

Where a part of the arrangement is an im-permissible avoidance arrangement, GAAR will be restricted to tax consequence of such impermissible part of the arrangement.

Either GAAR or SAAR will apply to a given case where both are in force, and guidelines will be issued regarding the applicability of one or the other.

A show cause notice, stating grounds, must be issued by the tax authority to the assessee before implementing the provisions of GAAR.

Time limits will be enacted within which proceedings under GAAR may be com-menced.

The Approving Panel shall consist of a chairperson, who is, or has been, a judge of a High Court; a member of the Indian Revenue Service, not below the rank of chief commissioner of income tax; and a member who shall be an academic or scholar having special knowledge of matters, such as direct taxes, business accounts and international trade practices.

The Approving Panel may consider the length of time for which an arrangement has existed, the fact of payment of taxes, directly or indirectly, under the arrangement, and the fact that an exit route is provided for by the arrangement. Such factors may be relevant but not sufficient in and of themselves, to determine whether the arrangement is an impermissible avoidance arrangement.

The directions issued by the Approving Panel shall be binding on the taxpayer as well as the tax authorities.

A tax auditor will be required to report any tax avoidance arrangement.

CONCLUSION

The acceptance of major recommendations of the Expert Committee by Government of India is a welcome step towards assuring investors a fair and just tax system. More so, when the need of the hour is to achieve an increase of net Foreign Direct Investment flows into India.

However, there are still some concerns among stakeholders with respect to the actual application of GAAR provisions. It remains to be seen whether the tax administration will apply GAAR provisions arbitrarily or upon a predictable rules-based regime.

Mr. Aseem Chawla is a Partner, and Ms. Shweta Kapoor is an Associate, of MPC Legal, based out of New Delhi, India. Mr. Chawla leads the tax practice group of the firm and can be contacted at aseem.chawla@mpclegal.in. Ms. Kapoor is an Associate with the tax practice group of the firm and can be contacted at shweta.kapoor@mpclegal.in.