Indian GAAR Story

By: Dipanshu Singhal, Symbiosis Law School

The paper aims at understanding the implications of GAAR (General Anti Avoidance Rules). GAAR is an anti avoidance measure which empowers tax authorities to call a business arrangement or a transaction 'impermissible avoidance arrangement' and thereby denying tax benefits to the parties. Avoidance is legal provision which allows investors to legally reduce their tax liability. Concept of avoidance has been an area of debate and Supreme Court in the latest Vodafone judgment has held it to be valid provided it is allowed by the law and also opining that India has room to enact GAAR. Introduction of GAAR was announced in the Finance Act 2012. And the first draft of GAAR when published received heavy criticism and thereby Shome committee was formed to come up with recommendations and guidelines. The instant paper discusses ramification of GAAR into two parts. First part discusses the ramifications of first draft of GAAR in a general manner without going into detail and second part discusses the ramifications of recommendations given by the Shome committee. The introduction of GAAR is inevitable but it has to be reasonable to facilitate conducive investment environment.

No one can predict the future similarly no law can anticipate all the circumstances, neither it can be said with surety that the law so enacted has only one interpretation. In case of dynamic and complex commercial world it is virtually impossible to enact laws that ensure that the law is not misused or bypassed. It is the instances and foreseeable events that prompt new legislations or laws. Similar is the case of GAAR, Mr. Pranab Mukherjee’s (then finance ministers) budget speech on introduction of GAAR in India through Finance Act 2012 created a great tension with market forces reacting negatively. It forced Mr. Mukherjee to bite the bullet and defer the introduction of GAAR by one year to 2013. The first draft of the GAAR was introduced and it created further more tension than its announcement. The draft was heavily criticised by the people citing it will have adverse implications. Meanwhile the Mr. Manmohan Singh (Prime Minister) approved for constitution of an Expert Committee headed by Dr. Parthasarathi Shome to study the provisions of GAAR. Committee received comments from stakeholders and general public till July-end and they timely published second draft of the GAAR by August 31st and they will publish the GAAR guidelines by 30th September.  Recommendations of Shome committee were well received.

Understanding of GAAR is critical to understand its implications. The term GAAR means General Anti-Avoidance Rules and it is an anti avoidance measure. Avoidance is legal means to avoid or reduce tax liability, which is incurred by taking advantage of some provisions or lack of provisions in law. GAAR is based on the doctrine of “substance over form” which means that the tax authorities ignore the legal form of an arrangement and they look into its actual substance to prevent artificial structures form being used for tax avoidance purposes. The doctrine was studied in detailed by the Supreme Court while during the Vodafone case.

Apex Court during the Vodafone issue discussed 3 landmark cases to ascertain the situation:

• In English case IRC v Duke of Westminster [1]  it was held that it is the taxpayer’s legal right to attract least amount of tax and it will construe a situation of tax avoidance. Thus, declaring that tax avoidance is different from tax evasion.

• In McDowell & Co. V. CTO [2]  the Honourable court held that tax avoidance is bad. The case blurred between the provisions of tax avoidance and tax evasion.

• In Union of India v. Azadi Bachao Andodal [3]  , the honorable court while disagreeing the judgment of McDowell case held that tax avoidance is valid and legally right provided that the scheme is within the parameters of law.

Supreme Court overruling the judgment of Bombay High Court held that principles lead down in Azadi Bachao Andolan were correct and court while judging such situation should give priority to legal form of the transaction and that in application of judicial anti-avoidance rule, the revenue may invoke the “substance over form" principle or "piercing the corporate veil" principle only after it is able to establish on the basis of the facts and surrounding the transaction that the impugned transaction is a sham or tax avoidant. The observations of Supreme Court in the context of Anti-Avoidance are also in line with Canada Supreme Court ruling on GAAR.

On careful analysis it is realized that GAAR was desired by the tax authorities much earlier than the present financial year with the intention to tackle the problem of tax avoidance, the concrete process began with the first draft of the Direct Taxes Code 2009 where the introduction of GAAR was proposed for the first time. Thereby to expedite the process of introduction of GAAR, Finance Bill 2012 proposed a new Chapter X-A in the extant income tax law- Income Tax Act 1961. The purpose of chapter would be examination of transactions from the point of view of anti-avoidance and to ascertain whether it is ‘impermissible avoidance agreement’.

GAAR versus SAAR

In addition to GAAR there also exists SAAR- Specific Anti-Avoidance Rules which specifically aim at certain arrangements of tax avoidance. SAAR have many points to its favour, since its specific there is no scope of confusion, it doesn’t provide taxation authorities any discretion and from the point of view of tax payer it provides certainty regarding the nature of his arrangement. Provisions of SAAR are there in Chapter X of the Income Tax Act 1961 and some of the provisions pertaining to SAAR are in various other chapters of Income Tax Act.

Under the Code, GAAR will be invoked if the following conditions are satisfied:

1. The taxpayer should have entered into an arrangement.
2. The main purpose of the arrangement should be to obtain a tax benefit and the arrangement:

i. has been entered into, or carried out, in a manner not normally employed for bonafide business purposes
ii. has created rights and obligations which would not normally be created between persons dealing at arm’s length
iii. results, directly or indirectly, in the misuse or abuse of the provisions of this Code or
iv. lacks commercial substance, in whole or in part [4].

The paper divides implication of GAAR into two parts. First part understands the implication of first draft of the GAAR. And second part deals with the implications of recommendation of the Shome committee and second draft.

Reason given by tax authorities for introducing of GAAR was that it is a codification of already existing principles and doctrine of ‘substance over form' [5] . And its invocation would restrict the abuse of the extant laws and will keep a check on arrangements claiming to be of nature of tax avoidance when in reality they are of tax evasion and also cover the areas which lead to the abuse of the treaties.

1. Ramification of first draft.

The first draft suffers from many lacunas:

1.1. LACK OF CLARIFICATION

The lack of clarification in the guidelines is a double edged sword as it can be used by the tax authorities to question transactions which are not tax evasion in nature and it may lead to the instances of tax avoidance by its abuse.
The discussion on basic and fundamental issues is very limited thereby providing room for interpretation of guidelines and discretion to the Tax Authorities few instances of such issues are treaty shopping wherein a party seeks to the jurisdiction of a country having favourable tax treaty, thin capitalisation, arbitrage transactions and the circumstances in which the corporate veil can be pierced.
The idea of codification of the doctrine of “substance over form” didn’t quite appear as a wise move because it already exists in the legal system as well as it was always considered both by the tax authorities and courts while adjudicating the matter. In reality the codification aims at widening the doctrine to the benefit of authorities so that to they can question an arrangement and thereby declare it as tax avoidance even when it is not so.
It is stated in the guidelines that GAAR will not impact tax mitigation exercise supported by fiscal incentives. But it doesn’t clarify that when a taxpayer for reasons of tax efficiency, opts for one of the two permissible methods or ways of completing a transaction, regardless of whether taxpayer is or is not concerned with a specific fiscal incentive in the law, whether it will constitute tax avoidance. Clarification of this nature will just be an extension in the list of illustrations.
The first draft of GAAR is very ambiguous on the important point of what constitutes ‘main purpose’ for obtaining tax benefit. Though in context and spirit it intends, that only the arrangement which aims at tax benefit without there being a real commercial purpose would be targeted, but absence of clarification on the same point has added to the confusion. And this is one of the few points on which the tax authorities decide as to a scheme is of tax avoidance or of tax mitigation or tax benefit. Further, the test for the presence of tax benefit should be conducted by taking into account all connected parties involved in an arrangement.

1.2. LARGE POWER

GAAR provides large power to the tax authorities but these provisions might lead to the initiation of arbitrary actions and at the same time negligence in the form of not enquiring where there should have an enquiry and the same might cause exchequer a huge loss. GAAR provides that the Commissioner Income Tax will have the power to look into a business arrangement or a transaction and declare it to be ‘impermissible avoidance arrangement’ and thereby denying tax benefits to the parties. GAAR borrows this provision from the South African model of GAAR where the post of Commissioner is very high but in India we have more superior positions than that of Commissioner and also to be noted here is that we have more than 700 Commissioners.
The Tax Authorities will look into the arrangement to ascertain the ‘substance’ but this approach will lead to the enquiries in the tribunal or appellate tribunal by the parties involved to exactly know how they have been indicted for tax avoidance.

1.3. Foreign Institutional Investment (herein after FII)

GAAR provides for denial of exemption for capital market transactions and it was not taken well by the investors and hence, it proved to be a let-down for the FII community. It had a negative impact on the investments in India as investors sold off their investments which lead to the crash of stock markets. Tough  some comfort is provided through safe harbour rules applicable to the FIIs, provided payment of domestic taxes is made, further it is desirable to have a simple provisions of GAAR which can be applied for all portfolio investments including the FIIs and promissory note holders.

1.4. COMMERCIAL INTEREST

GAAR ignores one important factor which tax authorities should have taken into consideration i.e. commercial interest of the parties. For example, in some international jurisdictions, the tax authority invoking GAAR are expected to provide reasons in the form of comparable counterfactuals of the proposed arrangement and they are also liable to suggest that how the arrangement should have been accomplished, with the interest of the parties secured by showing that the commercial and business advantages has not been compromised of the taxpayer arrangement. But there is no provision in the GAAR on this point thereby providing a point of appeal to the parties involved and also making it as a negative legislation which does not taken into consideration best interest of the parties.
Enforcement of first draft of GAAR will lead to the situations where earlier investors/industry could obtain a tax benefit but enforcement would lead to GAAR being invoked. The draft created a negative outlook regarding the future policies of India which caused great concern amongst foreign investors, prompting the Prime Minister’s Office to set up a committee to review the rules. The committee published its modified rules and recommendations and after a second round of consultation, will suggest final rules to the Government by September 30.

2. Ramifications of Shome Committee’s Report

The Shome committee by their report have recommended to the Government to remove the ambiguous and unclear provisions in the proposed GAAR. Their recommendations were well received both by domestic and international markets and financial systems. One of the most important recommendation of the committee is that the 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 from the proposed April 1, 2013 i.e. assessment year 2014-15 so as a time is provided for preparation, which can be utilized by tax department to understand GAAR and it also helps taxpayer community by providing time to understand the law and thereby act accordingly.

2.1. Training of tax officers
Shome committee makes one interesting recommendation which is of training of tax officers. This is a good recommendation and a welcome change in the ideology of the policy makers because particular recommendation aims at a well informed and updated tax department competent enough to take decisions on complex arrangements because the committee recommends training in international taxation particularly GAAR. This is a very positive step as it will ensure that the GAAR provisions are properly applied by the tax authorities.

2.2. Detailed report of reasons

The Committee recommended that the tax officer who declares that an arrangement is against the policies should set out a detailed report explaining as to how arrangement is ‘impermissible avoidance agreement’. This is an important provisions and it is of fundamental nature as it as it affords the party to know the reasons from the tax authority and it also puts pressure on the authority to discharge their function in an efficient manner.

2.3. Relief to FII

FII are also given relief by the Shome committee as the GAAR provisions will not apply to non-resident investors who have invested in the FIIs provided such investment has an underlying asset in the form of investment in listed securities. And GAAR will not apply when a FII chooses to be governed by domestic law against the applicable treaty.

2.4. SAAR versus GAAR

In case of conflict between both SAAR and GAAR are applicable, SAAR will apply and GAAR will not apply. This provision is a salutary provision as it helps in building a favourable image of India in international circuit as it shows that policies and tax structure framed before GAAR are stable and its introduction does not affect the their working.

Similar provision is recommended in case of treaties that where specific rules are provided in the tax treaties in form of Specific Anti-Avoidance Rules and Indian Double Tax Avoidance Agreements(DTAA) popularly known as limitation of benefits(LOB), GAAR will not apply and the provisions of treaty will apply. Further in case the tax treaty provides for procedure to deal with tax avoidance then such provisions would prevail over GAAR.

2.5. Grandfathering

To protect the existing arrangements they will be grandfathered. Grandfather clause is a situation whereby an old rule continues to apply to old existing situations, while the new rule will applies to all the future situations. Thereby ensuring the current transactions are not disturbed by introduction of GAAR. This also provides an important safeguard to the present investors and parties who have their interest in the money market.

2.6. Monetary Threshold

A monetary threshold has been set by the Shome committee of Rs. 3 crores (3 Million INR) in a given year for a taxpayer. It includes tax benefits accruing to only tax and does not include interest and penalties. Any transaction above this amount will come under scrutiny there by safeguarding the interest of small and medium investors.

These provisions help in smooth implementation of GAAR as possible areas of conflict have been oozed out by the committee’s recommendation and it helps in tackling the issue of tax avoidance in much better way, as implementation of GAAR will address the loopholes in the earlier policies and the present tax treaties and SAAR continue to work in efficient manner thereby both complimenting each other.

Conclusion

GAAR provisions have been in our law for quite some time and judiciary has fostered its evolution to keep it up to date but still tax authorities come across arrangements in the name of tax avoidance which actually aim at tax evasion. In a case like this it is reasonable to change the law or enact new law as there is problem with the tax system and its operation and there is also a problem or gap with the way judiciary interprets law and the way Government wants it to be. Therefore a specific enactment pertaining to anti-avoidance arrangements will act as an additional muscle to tax authorities to weed out fancy and sham schemes. Enactment of GAAR in harmony with the existing policies will help a capital deficit nation like ours by minimizing the tax evasion and exchequer also gains with the increase in investment and development in the country. In addition to the criticism of GAAR for being another layer of legislation superimposed to an already complex system, the first draft of GAAR lacked clarity. The recommendations given by the Shome committee are very reasonable and realistic in nature, which are well received by industry experts. If accepted and implemented will help in achieving the desired results. Their final and second rules are awaited and it may happen that it could replace the earlier draft thereby entrusting the committee with a tough task.  Enactment of a clear and viable GAAR will send a clear message to the investors and stakeholders of the intentions of India and it will put rest to all the speculations and thereby provide conducive business environment.

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[1]  [1935] All ER 259 (H.L.).
[2]1985 154 ITR 148 SC
[3] 2003 132 Taxmann 373 SC
[4]Deloitte General Anti Avoidance Rules, India and International perspective
[5](para 1.1, Annexure D) the GAAR

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