What is GAAR?

General Anti-Avoidance (GAAR) is introduced by our finance minister in the last budget session to avoid the tax evasion of the foreign investors. At present situation, there is no Know Your Customer (KYC) formalities for the foreign investors. The money which is invested in the stock market is coming from a foreign entity, but our government has no rights to ask or verify the person name or identity to check the source of the money.

This leads to the huge amount of black money in India routes via hawala  and coming back to the Indian market. General Anti-Avoidance (GAAR) is proposed to tap the tax evasion and puts the strict rules on foreign investors. It has been postponed due to the strong protest by the foreign investors and Indian entrepreneurs (it has some negative rules against the Indian start ups to tax their invested money).

If you want to understand the reason why foreign investors are not asked for any details, we need look back and understand the concept of  P-Notes issued by the Indian govt. to encourage the foreign investors to invest in India.

What is P-Notes?

Participatory notes or P-Notes are issued to the foreign investor on 1992 to invest in the Indian market. The primary reason why they need P-Notes is that, the foreign investors need not register them self  to the Security Exchange Board of India (SEBI) and having the P-Note, they will participate in the Indian exchanges. It means that without SEBI knowing them (the true identity), they can invest in our stock markets (see how our laws are flawed). Take an example, if you are a businessmen or politician accumulated lot of black money, then you send that black money via hawala to outside India and trying to take back to India through the stock markets.

As defined clearly by Wikipedia as fallows:

In the Indian context, foreign institutional investors (FIIs) and their sub-accounts mostly use these instruments for facilitating the participation of their overseas clients, who are not interested in participating directly in the Indian stock market. For example, Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors.

Important points to note about the P-Notes are:

• The entity using the P-Notes need not be registered with the SEBI. It is an anonymous investment.
• Trading using the P-Notes are easy.
• When investors using the P-Notes, they take advantage of the tax laws in their country.
• P-Notes become favorite for the money launderers. They first take money out of India and then bring back them using the P-Notes.

P-Notes Crisis in 2007

In fact, SEBI is not happy with the P-Notes, because they are not known about the underlying investors. In 2007, SEBI issued a proposal to curb the issuing of P-Notes to the foreign investors which roughly 50% of the Indian share  market invested via P-Notes. However, SEBI’s proposals were very strict and the next day market opened with a knee-jerk reaction. The market went down 1744 points or about 9% of its value. After this crash, his proposals have been suspended and they clarified that India welcomes the P-Notes and the foreign investors participation. So, P-Notes continued the domination in the Indian market. In the current situation, they become a huge investors and cannot be controlled because of the market reaction.

When GAAR will be implemented?

I hope now you have understood why there is such a strong voice against the GAAR proposal. In this budget, it is announced by the finance minister that GAAR would be postponed to the next financial year. That is unlikely happen, the reason is that next budget would be voters budget keeping mind about the 2014 general elections (!!). So, it is very difficult to pass a most controversial bill in that situation.  It is planned to release with the Direct Tax Code (DTC). Another fact is that, GAAR is part of the DTC. But, they tried to bring it early before DTC is implemented. We have to wait and watch when it will be implemented.

Share your thoughts and understanding about the P-Notes. If you are a foreign investors, share your ideas on the GAAR implementation.