The finance ministry on Wednesday tried to soothe the nerves of foreign institutional investors (FIIs) over the tax treatment of their investments. Finance secretary R S Gujral told FIIs the General Anti-Avoidance Rule (GAAR) would be invoked only in case of impermissible arrangements.

If they are in a permissible arrangement, clearly they are governed by the particular treaty and GAAR does not get invoked at all. If it is an impermissible arrangement, then GAAR gets invoked and the treaty does not help them, Gujral told reporters after a meeting with FIIs, which comprised Goldman Sachs, Morgan Stanley, JPMorgan, CLSA and Credit Suisse, among others. GAAR is a component of the proposed Direct Taxes Code proposed in the Budget.

GAAR is essentially aimed at deals whose purpose is tax avoidance. The fear in the market is the new rule could apply to participatory notes issued by FIIs, through which entities not registered in India could invest in the stock markets.
GAAR provisions will be announced by the government after the passage of the Finance Bill in Parliament. The finance secretary assured that the interests of genuine investors would be protected and their concerns would be taken on board.

We told them well take those points (FIIs concerns) on board and try and clear those in our rules or even before that through a clarification, he explained.

Last week, finance minister Pranab Mukherjee had indicated the government was ready to bring changes in GAAR based on the parliamentary standing committee recommendations on the Direct Taxes Code (DTC), if required. The standing committee, chaired by BJP leader and former finance minister Yashwant Sinha, had recommended the onus of proving tax avoidance should rest with the department and not the assessee. It also said the approving panel that would decide on tax avoidance should have a minimum of three members.

Meanwhile, the government is likely to reduce the lock-in period under the Rajiv Gandhi Equity Scheme for new equity investors to one year against three years proposed in the Budget. The scheme is aimed at boosting retail investment in the capital market.We discussed the issue of reduction of the blanket lock-in period to one year. We will meet the stock exchanges again and finalise the modalities, an official said after the meeting with representatives of bourses, comprising Bombay Stock Exchange, National Stock Exchange and MCX-SX.

The scheme will allow 50 per cent tax deduction for those whose annual income is below Rs 10 lakh and who invest up to Rs 50,000 in stocks. However, this scheme can be used only once in a lifetime.