GAAR Draft 2: A Course Correction!
By: Sunil Jain, JSA
September 07, 2012 / 21:44 IST
By: Sunil Jain, Partner, JSA
General anti-avoidance rules (GAAR) have already seen many attempts of refocus and streamlining beginning with first draft of Direct Taxes Code 2009 to the actual assimilation in Chapter X-A of extant Income-tax Act 1961 (extant income-tax laws).On September 1, 2012 a committee under the chaired by Dr. Parthasarathi Shome (Shome Committee) has outlined its recommendation on GAAR for further public discussions by way of a (Report). The Report develops on the draft GAAR guidelines that were issued by the tax department on June 28, 2012.Stakeholders such as business enterprises i.e. taxpayers and tax advisors have welcomed the approach outlined by the Shome Committee. Shome Committee has adequately distinguished tax avoidance from tax evasion and tax mitigation. Tax mitigation is a situation where the taxpayer uses a fiscal incentive available to him in the legislation subject to satisfaction of prescribed conditions.Key recommendations of expert committee are as under:Overarching principle for applying GAAR - Tax mitigation should be distinguished from tax avoidance before invoking GAAR. An illustrative list of tax mitigation or a negative list specifying as to what are permissible arrangements should be specified for applying GAAR. Examples are payment of dividends, setting up of branch or subsidiary amalgamations and demergers. Overarching principle should be that GAAR will apply only in cases of abusive, contrived and artificial arrangements.Monetary threshold - INR 3 crores of tax benefit including tax only and not interest) to a taxpayer in a year should be used for the applicability of GAAR. In case of tax deferral, tax benefit should be determined based on the present value of money.Implementation issues - Implementation of GAAR should be postponed for three years and should apply in relation to income arising or accruing on or after April 1, 2016 i.e. assessment year 2017-18 to provide a longer period of preparation, training to the tax department and also to the taxpayer community.Tax Officers to be trained in the area of international taxation including GAAR, retained for longer periods in their positions. A manual of GAAR cases to be maintained in an encrypted manner and hosted on the intranet to provide an additive log of guidelines for future application.The concept of large taxpayer units to be made compulsory for a specified class of taxpayers as it is also expected to deal with GAAR issues in view of a high threshold of INR 3 crores of tax benefit for invocation of GAAR.Concerns of foreign institutional investors (FIIs) - GAAR will not apply to a FII choosing to be governed by the domestic tax laws instead of applicable tax treaty. Irrespective of the choice made by FIIs, non-resident investors who have invested in the FIIs and where such investment has an underlying asset in the form of investment in listed securities by the FIIs will not be subjected to GAAR.Abolition of capital gains/business income from listed securities - Government should abolish capital gains/business income earned on transfer of listed securities. Securities Transaction Tax (STT) may be increased appropriately In order to make the proposal tax neutral. Alternatively, Circular 789 of 2000 in relation to Mauritian tax residency certificate should be continued.Circular No. 789 of 2000 - Circular #789 provides that wherever a certificate of residence is issued by the Mauritian Authorities, such certificate will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the India-Mauritius tax treaty.Shome Committee has recommended that GAAR provisions should not be applied to examine the genuineness of the residence of an entity set up in Mauritius and tax residency certificate as mentioned in the circular should be respected.Specific rule v/s general rule - where a specific anti-avoidance rule is applicable, GAAR should not apply. Also where such rules are provided in a tax treaty such as a limitation of benefits (LOB) GAAR will not override the tax treaty. If there is avoidance of violations of such provisions, treaty itself should be revisited but GAAR should not override the tax treaty itself.India-Singapore tax treaty has a LOB clause, thus where it applies, GAAR will not be invoked. In other words, investments made through a Singapore holding company, will enjoy capital gains tax exemption if the LOB clause is adhered to and complied with.Limitation of treaty override - GAAR seeks to override tax treaties. However, in case any tax treaty provide for mechanism to deal with tax avoidance, such provisions should prevail over GAAR.Tax withholding and GAAR - Tax department will not invoke GAAR at the time of considering issuance of a tax withholding certificate if the taxpayer (applicant) concerned submits a satisfactory undertaking to the effect that tax and interest will be duly paid if GAAR is indeed found applicable at the time of assessment proceedings. In case such undertaking is not provided, GAAR may be invoked by the Tax Officer with the prior approval of Commissioner of Income-tax._PAGEBREAK_In the absence of an undertaking it is expected that GAAR will be applied and more often tax withholding will be advised. Approval of the Commissioner will impact the timelines involved in obtaining such order as part of overall transaction timelines.Grandfathering of existing investments - All investments (not the arrangement itself) made by a resident or non-resident and existing as on the date of commencement of the GAAR provisions should be grandfathered so that on exit (sale of such investments) on or after this date, GAAR provisions are not invoked for examination or denial of tax benefit.Advance ruling - administration of authority for advance rulings should be strengthened so that a ruling on applicability of GAAR may be obtained within the time frame of GAAR.Commercial Substance - definition of ‘commercial substance’ along the lines of definition provided in Direct Taxes Code Bill 2009 should be provided in the Income-tax laws. This could be achieved by way of legislative amendment in the next budget.Main purpose should be tax benefit - GAAR should apply only where main purpose of an arrangement is tax benefit and not where obtaining tax benefit is one of the main purposes. This could be achieved by way of legislative amendment in the next budget.Part of an arrangement to be impermissible - In case only a part of an arrangement is impermissible, tax consequences under GAAR should be limited to such portion of the tainted arrangement.Connected person - ‘Connected person’ is a term used in the context of consequences of an impermissible arrangement. However, the definition is too broad and ambiguous. Accordingly, definition of ‘connected person’ may be restricted to cover only ‘associated enterprise’, ‘associated person’ as defined in the Income-tax laws.Relevant factors for determining substance - following relevant factors should be taken into account in forming a holistic assessment to determine whether an arrangement lacks commercial substance:(i) the period or time for which the arrangement (including operations therein) exists;
(ii) the fact of payment of taxes, directly or indirectly, under the arrangement;
(iii) the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement.Corresponding adjustments - while determining tax consequences of an impermissible avoidance arrangement, corresponding adjustment should be allowed in the case of the same taxpayer in the same year as well as in different years, if any. However, no relief by way of corresponding adjustment should be allowed in the case of any other taxpayer.Constitution of Approving Panel - as the objective of GAAR is deterrence rather than revenue collection, it is recommended that:(i) The Approving Panel should be a permanent body with a secretariat, with a 2 year term and consist of five members including Chairman;
(ii) The Chairman should be a retired judge of the High Court;
(iii) Two members should be from outside Government and persons of eminence drawn from the fields of accountancy, economics or business, with knowledge of matters of income-tax; and
(iv) Two members should be Chief Commissioners of Income-tax; or one Chief Commissioner and one Commissioner.Procedure for invocation of GAAR - statutory forms for making reference to the Commissioner and to the Approving Panel have been prescribed. Similarly, suitable timelines have been suggested for various actions under GAAR.
Reporting requirement - Tax auditor to report tax avoidance schemes which are more likely than not expected to be held as an impermissible avoidance arrangement in the tax audit report.Shome Committee has an unenviable task of issuing final GAAR guidelines and submission of roadmap for implementation of GAAR by September 30, 2012 as per the original plan behind its formation. It is expected that by the time final guidelines are in place, GAAR will solely focus on undesirable fiscal behavior which leads to growth of black money in the Indian economy. Examples are ‘round tripping financing’ and arrangements involving ‘accommodating parties’ which participates in any arrangement only for according undesirable tax benefit to the main transacting parties. There are not many recommendations regarding these two aspects indicating that the two aspects may become primary focus of GAAR.Similar good news is expected in respect of controversial offshore-indirect transfer provisions made retrospectively. Finance Minister’s statements - both in the aftermath of the Shome Committee recommendations and earlier upon assuming office are definite harbinger of hope. Constitutional validity of the indirect transfer provisions is already under challenge in the high courts of Calcutta and Bombay respectively. Shome Committee is now going to take a look at such provisions affecting ‘Vodafone’ type transactions as regards their scope (read constitutional validity of retroactivity) as well as the subjective manner in which the said provisions seek to tax indirect transfers consummated offshore India. Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
