Tax planning is not tax evasion!

The authority for advance ruling has said that tax planning, tax efficiency and tax avoidance by companies is not equal to tax evasion. What impact will this have on India Inc?

It's a transaction that created the country's largest cement maker and, as some thought, a large tax liability for the Aditya Birla Group .

In October last year, group company Grasim demerged its cement business into a wholly owned subsidiary Samruddhi cements, which was then to be merged with another group company Ultratech.

This transfer of assets was undertaken to bring the group's cement operations under one legal entity and is structured as a court-approved scheme of arrangement. Had Grasim's cement business been sold to Ultratech it would have been taxed capital gains at 22%. But by choosing the amalgamation route the transaction could avail of a capital gains tax exemption under section 47 of the Income Tax Act.

An exemption that some experts thought would not pass muster with revenue. Would the tax efficiency be interpreted as tax evasion?

Kumar Mangalam Birla, Chairman, Aditya Birla Group
We believe that there is no tax liability. The finest brains in the country have looked at this. There's no question of a capital gains liability in this transaction.

The Birla position is backed by case law.

Whether it's the Supreme Court judgment in 1967 in the A Raman & Co case, or the Gujarat Hiigh Court decision in 1977 in the case of Wood Polymer, courts have held that
"Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited."

Mukesh Butani, Partner, BMR Advisors

All of these case laws dealt with a situation that under what circumstances can the tax administration lift the corporate veil? Under what circumstances can it look at a tax evasion device being resorted to by the taxpayer to plan its affairs? And there, all of these decisions which were rendered by the supreme court between 50 to 80 years back were referred to-and it said a combined reading of all these decisions suggests that the taxpayer is well within his right to organize the affairs of his business such that he is able to claim benefits under the provisions of the law. You cannot attribute a motive to the taxpayer that he is claiming this exemption with a view to evade taxes.

This section 47 exemption for schemes of arrangement, got a shot in the arm earlier this month, thanks to a ruling by the Authority for Advance Rulings or AAR

Here's what happened

Star's Indian entertainment channels-Star plus, Star Gold, Star One and Star Utsav - are owned by overseas entities based in the British Virgin Islands and the UAE.

The global parent wanted to merge these entities with its Indian company Star India Private Limited or SIPL and claim the section 47 capital gains tax exemption
But the dept held that Star had "taken resort to the scheme of amalgamation for the mere purpose of availing the benefit of exemption under Section 47 by putting on the mantle of amalgamation on transfer of shares of channel companies to the Indian companies." And therefore, the transaction should be liable to tax.

The matter went to the Authority for Advance Rulings and AAR disagreed with the dept. Its ruling says "It is within the legitimate freedom of the contracting parties to enter into a transaction, which has the effect of extending to the party the benefit of exemption under the taxation statute. The contracting party is not bound to enter into a transaction in such a way that it results in tax liability while foregoing the benefit of exemption under law."

That's good news, not just for Star but across India INC.

Mukesh Butani, Partner, BMR Advisors

A ruling by the AAR is binding on the taxpayer who is seeking this ruling. So in a nutshell, the ruling is binding on star TV and the group that has sought the ruling with respect to exemption available on a transaction of this kind. Having said that, sometimes, rulings have a persuasive impact if the facts of the case of that particular taxpayer are similar. So if you bring forth another taxpayer whose facts are similar to the star TV case, this ruling will impact them positively.

No wonder corporate houses are breathing a little easier S Gayathri, direct tax head at the Essar Group explains that the AAR's ruling, by clarifying the Revenue's position, helps in planning future transactions or mergers between group companies

S Gayathri, Group Head- Direct Tax, Essar

Of course it a lot of comfort, makes us a little more upbeat because in the backdrop of recent decisions, pointing to a situation where the department has been very aggressive in looking at or evaluating certain transactions, it is a very nice calming effect! That's what this ruling is. We are confident therefore that if the facts support us and the context supports us whatever is valid in the eyes of law cannot become invalid merely because it also results in tax being saved!

Girish Vanvari, ED, KPMG

After the Vodafone dispute has erupted, there has been a fear in tax circles that everything is going to be questioned for tax evasion. And whatever you do, the tax officer will go behind you and recover taxes. This ruling actually addresses that fear. This ruling analyzes the fact that tax evasion and tax planning is different. If there is a genuine business transaction and tax planning happens because there are ways to structure the transaction in tax laws and land up paying no tax, then one cannot say it is tax evasion. And those things are still valid under law.

But the celebration may not last for long. The new Direct Tax Code, proposed last year, has suggested the inclusion of General Anti Avoidance Rules or GAAR in the income tax regime. Rules that corporate India worries would put a whole host of legitimate business transactions under the tax scanner-and rules that would, of course, bring an end to the comfort brought in by this AAR ruling

In fact, with the timelines for introduction of the DTC still unclear, some experts believe that GAAR could even come into force in this year's budget! And if that happens, the fine line between tax planning and evasion could become an easy one to cross.