Foreign investors and managers of Indian assets worry that draft guidelines governing controversial anti-tax evasion rules are too simplistic and could be used indiscriminately by tax officers.

But for the first time since the proposal on general anti-avoidance rules (GAAR) was announced in March, say tax experts, the government has given more clarity on how investors buying Indian securities through an entity incorporated in Singapore could be affected by the new rules.

Yet some argue the situation is less clear for other jurisdictions under the draft guidelines issued late last week. The draft outlines, using 21 case studies, how GAAR may be invoked on anyone who invests in Indian assets via an offshore entity sitting in low-tax jurisdictions. 

The guidelines were released slightly later than the market expected, but come on the heels of the recent stepping-down of finance minister Pranab Mukherjee – the architect of GAAR – to contest the presidency. Prime Minister Manmohan Singh took over the finance portfolio last week.

GAAR seeks to impose a 15% capital gains tax (CGT) on investment gains made within a 12-month period, if a transaction is deemed an “impermissible tax avoidance arrangement” lacking “substantial commercial substance”.

The rules are closely tied to the double taxation avoidance agreement (DTAA) – bilateral tax treaties that India has signed with 82 countries, including Mauritius and Singapore. Foreign investors and asset managers have long been buying Indian securities from these countries to gain tax efficiencies.  

In one example (example 16), while the committee did not specifically relate the illustration to any of the 82 DTAA jurisdictions, tax experts agree it refers to the one signed between India and Singapore.

The Lion City is a popular jurisdiction for international portfolio managers to incorporate an entity to claim zero CGT treaty benefit. Keyur Shah, a partner at KPMG in Mumbai, says the example is applicable to private equity investors or long-only fund managers incorporated in Singapore.

But portfolio managers investing in India through any of the DTAA jurisdictions might still be unsure whether GAAR would be invoked on their investment gains. This is because, apart from Singapore, the guidelines fall short on shedding more light on what constitutes “substantial commercial substance”, say tax experts.

Some argue the approach is over-simplistic, citing that the 21 examples seem to ignore the complexities of how financial transactions are done by cross-border portfolio managers, institutional investors and their financial intermediaries.

Experts suggest that if a tax officer were to judge that a transaction they were assessing did not resemble one of the examples, they would deem it as "lacking commercial substance" or a bona fide purpose and deem it impermissible under GAAR.

As more details on GAAR become available, private equity investors or hedge fund managers may need to evaluate whether an investing entity of theirs that is located in a tax-efficient jurisdiction has substantial commercial substance, notes Anish Sanghvi, associate director of financial services at PwC in Mumbai.

Depending on the comments submitted on the guidelines (the consultation is open until July 20), the minister of finance may give further clarity, given that Prime Minister Singh wants to simplify the policy on foreign investments into India, says Sanghvi. “Otherwise, the overhang on India’s investment environment might cause the rupee to depreciate further.”

Indeed, the market hopes the continued fall in the rupee (54.81 to the dollar at press time, down 23% from one year ago) will cause GAAR to be dropped altogether. Mukherjee in May had already delayed its implementation to April 2013, amid strong investor opposition and a drop in foreign investment inflows.