Just a Mood Lifter Won’t Do

Fireworks Unlikely on Street Euphoria over postponement of GAAR may be short-lived in the absence of big-bang economic reforms As many downers prevail, brokers stick to earlier forecast

The deferment of controversial tax avoidance rules will lighten spirits and improve investor sentiment that has reached a nadir because of policy paralysis, but India will regain its standing as a preferred investment destination only if the government pushes through marketfriendly policy measures, according to an ET poll of top brokers and fund managers. 

On Saturday, a government-appointed panel headed by economist Parthasarathi Shome recommended that the General Anti-Avoidance Rules (GAAR) should be implemented only from 2016-17, cheering portfolio investors and drawing accolades from industry leaders such as Deepak Parekh and KV Kamath. 
All of the 10 brokers and fund managers who participated in our poll said the proposals would significantly improve the mood of the market, but they stuck to their previous Sensex targets for the year-end in the absence of fundamental economic reforms such as cutting diesel subsidies andintroducing FDI in multi-brand retail. Five expect the Sensex to be in the range of 18,000-19,000 by December 31 while two see the index trade between 19,000 and 21,000. The Sensex closed at 17,429.56 on Friday. 
"The move will act as a catalyst for the revival of Indian equities if followed up by other actions such as FDI liberalisation, aligning of diesel prices to the market and other pro-growth measures," said Nilesh Shah, director, Axis Direct. 
Nonetheless, the overwhelming consensus — among those polled, 90% were of this view — was that the postponement of GAAR would boost investor sentiment. The market participants were contacted by phone on Saturday evening and Sunday. 
"By delaying GAAR, the government will substantially reduce the uncertainty among investors, and reduce the overhang that has been there since its announcement," said Ajay Srinivasan, chief executive-financial services, Aditya Birla Group. 
"As India is today dependent on foreign capital in capital markets, the announcement of a three-year window will give all stakeholders enough time to deal with the complexities surrounding GAAR," he said. 
GAAR was introduced by then finance minister Pranab Mukherjee in his budget speech in March 2012. But the ambiguity surrounding some of its provisions spooked foreign institutional investors, with several of them threatening to pull out of India as some of the proposals gave the tax authorities power to scrutinise deals that had been structured to mitigate taxes. In particular, investors based in Mauritius would have had to prove that their presence in the island nation had substance, a stipulation that may have been difficult for most to meet. GAAR Expected to Die a Natural Death 
Mauritius has been a base for many foreign investors to route money to India because it has a treaty with India that stipulates a "tax resident' of the country need not pay tax in India. 
The uproar forced Prime Minister Manmohan Singh to set up a committee headed by Shome. 
While the panel suggested GAAR be implemented from 2016-2017, many in the market feel these tax measures may be allowed to die a natural death as India relies on foreign money to fund its current account deficit, which reached 4.2% of GDP for the year ended March 31, 2012, the highest since 1991. 
"The recommendations will provide a huge boost to the markets, as GAAR was the single-most negative factor for foreign investors and created lots of uncertainty for them," said Motilal Oswal, chairman and MD, Motilal Oswal Financial Services 
"The proposals bode well for the market and investors as they convey the government's seriousness about attracting foreign capital," said Suresh Mahadevan, managing director, head of India equities, UBS. "Though the impact of such moves may not be seen immediately, they are certainly good in the long term for a capital-deficient country like India," he added. 
Foreign institutional investors have pumped in close to Rs 63,000 crore, or $12.30 billion, so far in 2012, driving up the Sensex by almost 13%. Indian equities have been the best performing in Asia so far this year. They have risen 1.1% since P Chidambaram was switched to the finance ministry at the end of July because of expectations that he would be able to push through reforms Most poll participants believe that the proposal by the Shome committee to do away with taxes on capital gains on listed securities could reduce the prominence of Mauritius. "In the listed securities space, the proposal to abolish tax would not only be a great positive sentiment for the markets, but could also eliminate the need for foreign investors to evaluate Mauritius as an investment platform," said Gautam Mehra, executive director-tax and regulatory services, PricewaterhouseCoopers. But, Mauritius may continue to be relevant for investors looking to put money in unlisted companies, he said. Seventy per cent of the respondents to our poll felt that Mauritius would continue to be relevant. Regardless of the ultimate fate of the Mauritius route, the Shome committee has called upon the government to recognise the validity of a circular that says Indian tax officers should recognise 'tax residency' certificates issued by the Mauritius authorities. 
"The GAAR panel has very clearly brought out that till the CBDT circular 789 of 2000 about Mauritius tax residency is in place, the attack on such companies is not warranted; in a sense, the GAAR panel has brought out the point (without mentioning it in those words) of tax mitigation or maybe, even an avoidance, blessed by the government itself — and that may be due to larger considerations," said Ketan Delal, joint tax leader, PwC. 
However, the committee's proposal on increasing the securities transaction tax, which is collected at the time of a stock purchase, will be less welcome for market participants. The committee has recommending raising STT to make up for the shortfall in revenue for the government if capital gains tax is completely scrapped, but the move may squeeze domestic traders and jobbers, who operate on wafer-thin margins. 
Foreign institutions are also cheering a provision to unambiguously exempt all their investors from tax. The finance ministry in the budget of 2012-13 had brought in an amendment allowing the government to tax overseas deals in which assets located in India change hands. While the amendment was widely seen as a move to target Vodafone, which has been engaged in a legal battle with the Indian tax authorities over taxation of its purchase of Indian telecom company Hutch Essar that was executed overseas, foreign institutions have been concerned that the end investor would also be taxed under this rule. "This will result in removing an apparently unintended consequence where an end investor of an FII was potentially liable to be taxed under the provisions as earlier enacted," said Mehra. 
"The recommendation to grandfather existing investments from GAAR is awelcome departure from the retroactive changes made earlier — this one gives enough time to taxpayers and investors to react to the changes and the committee has statedly adopted a very fair international practice of 'pre-announcement'," he said.