GENERAL ANTI AVOIDANCE RULE BY: DHARANI SUNDARAM
GENERAL
ANTI AVOIDANCE RULE
AUTHORED BY:
DHARANI SUNDARAM
B.COM., LL.B(Hons).,
LL.M
Assistant
Professor In Law
Mother
Teresa Law College, Mettu Salai, Illupur, Pudukottai,
ABSTRACT
We know that utmost of the profit
which the government generates is from levies which they collect from
individualities, associations, etc. Everyone wants to profit from the duty
assessed on them. numerous times they indulge in malpractice to get saved from
levies. The General Anti Avoidance Rule (GAAR) was brought about by the Indian
government to check duty elusion and avoid duty leaks. In India, the GAAR
provision was brought by the government after the notorious case of Vodafone
International.
WHAT IS
GENERAL ANTI AVOIDANCE RULE
General Anti Avoidance Rule (GAAR) is an anti-tax
avoidance law for keeping a check on the businesses that entered into an
agreement with the ideal of avoiding duty. Chapter X-A of the Income Tax Act,
1961 of India deals with the conception of GAAR. GAAR was introduced in the
time 2012 during the budget session in 2012 by also Finance Minister Pranab
Mukherjee. Composition 265 of the Constitution of India gives power to the
government to levy or collect duty from the people of India. It's generally
presumed that every citizen is liable to pay reasonable duty within the vittles
of duty bills. The person escaping from paying duty generally would be liable
for elusion under Indian laws. occasionally associations try to lower their
liability to pay duty to the government which is known as duty avoidance. GAAR
was introduced by the Finance Act, 2012[1]
with the end that any planning or arrangement which involves any duty benefit,
whether done directly or laterally, would be taboo and liable under the
provision of said law. Black Law’s wordbook defines ‘duty avoidance’ as
minimization of one’s duty liability by taking advantage of fairly available
duty planning openings.
NEED FOR
GENERALANTI-AVOIDANCE RULES (GAAR)
Ample of legal doctrines and judicial
precedents recommended and stressed the need for General Anti-Avoidance Rules (GAAR),
especially, in the case of Union of India v. Azadi Bachao Andolan[2]
and Vodafone International effects B.V. v. Union of India stated the
significance of legalistic daises and expressed the significance of policy
decision in a matter of General Anti-Avoidance Rules (GAAR). Justice Kapadia
and Justice Swatantra Kumar expressed the need for General Anti-Avoidance Rules
(GAAR) in following words “duty policy certainty is pivotal for taxpayers (including
foreign investors) to make rational profitable choices in the most effective
manner. Legal doctrines like Limitation of Benefits and look Through are
matters of policy. It's for the Government of the day to have them incorporated
in the covenants and in the laws so as to avoid disagreeing views. Investors
should know where they stand. It also helps the duty administration in
administering the vittles of the exacting laws.”
In durability to the below- mentioned
compliances, Justice Radhakrishnan1 also observed the significance for
legislation as follows:
“duty avoidance is a problem faced by
nearly all countries following civil and common law systems and all partake the
common broad end, that's to combat it. numerous countries are taking colorful
legislative measures to increase the scrutiny of deals conducted by non-resident
enterprises. Australia has both general and specific anti-avoidance rule (GAAR)
in its Income duty Legislations. In Australia, GAAR is in Part IVA of the
Income Tax Assessment Act, 1936, which is intended to give an effective measure
against duty avoidance arrangements. South Africa has also taken action in
combating about duty avoidance or duty harbors. Countries like China, Japan
etc. have also taken remedial measures.
Direct Tax Code Bill (DTC) 2010,
proposed in India, envisages creation of an economically effective, effective
direct duty system, proposing GAAR intends to help duty avoidance, what's
inequitable and undesirable.”
As with the courts' above- mentioned
views and compliances, there are number of compliances across the world about
the significance and need for anti-avoidance rules to help abuse of Double
Taxation Avoidance Justice K.S. Radhakrishnan stated in the Judgment of
Vodafone International effects B.V v. Union of India & Anr[3] Covenants
(DTAT). The points and objects of anti-avoidance rules linked by the number of
experimenters are distributed and presented below
·
To
help the taxpayer from indulging in any ingenious scheme or device in order to
exclude or reduce their taxability;
·
To
discourage taxpayers from entering into vituperative arrangements;
·
To
offset the vituperative duty advantage which a taxpayer attempts achieving; and
·
To
include a number of safeguards that ensure that any reasonable choice of a
course of action is kept outside the target area of the anti-avoidance rules.”
The significance of General Anti-Avoidance
Rules (GAAR) was explained by numerous courts of foreign countries, especially,
in the court of New Zealand in CIR v. BNZ Investments case[4]
the significance of the General Anti-Avoidance Rules (GAAR) was explained as
follows
“GAAR is an essential pillar of the duty
system designed to cover the duty base and the general body of taxpayers from
inferior duty avoidance bias. By discrepancy with specific anti-avoidance rules
which are directed to particular defined situations, the council through GAAR
has raised a general anti-avoidance mark by which the line between licit duty
planning and indecorous duty avoidance is to be drawn.
Line
delineation and the setting of limits fete the reality that commerce is legitimately
carried out through a range of realities
and in a variety of ways; that duty is
an important and proper factor is business decision timber and family property planning;
that commodity further than an actuality of a duty benefit in one academic situation compared with another is needed to justify attributing a lesser duty liability; that what should nicely be stuck at are sleights and other arrangements which
have duty convinced features outside the range of respectable practice, utmost tax avoidance involves a false transaction; and that certainty and
pungency are important but not absolute values. ”
OVERVIEW OF
GENERAL ANTI-AVOIDANCE RULES (GAAR) 2012
The Explanatory Memorandum to
the Finance Bill, 2012 outlines the reasoning behind the introduction of the
General Anti-Avoidance Rule (GAAR) as follows:
While
there are specific anti-avoidance provisions within the Act, general
anti-avoidance has typically been addressed only through judicial decisions in
specific cases. Some courts have ruled that the legal form of a transaction can
be disregarded in favour of considering its true substance for tax purposes,
while others have insisted on upholding the form. In the context of moderate
tax rates, it is essential to ensure the correct tax base is taxed in the face
of aggressive tax strategies and the use of low-tax jurisdictions for residence
and capital sourcing. Many countries have codified the 'substance over form'
principle through the General Anti-Avoidance Rule (GAAR). In this context,
there is a need for a statutory provision to enshrine the 'substance over form'
doctrine, where the real intention and effect of a transaction are considered
for tax purposes, regardless of any legal structure designed to conceal the
true intent. Thus, GAAR has been introduced in the Income-tax Act to address
aggressive tax planning.
KEY FEATURES OF THE GENERAL ANTI AVOIDANCE
RULE (GAAR)
The
Government of India's 2012[5]
memorandum explains the core features of GAAR, which include:
i)
An arrangement designed with the main purpose, or
one of the main purposes, of obtaining a tax benefit and meeting at least one
of four criteria may be deemed an "impermissible avoidance arrangement."
ii)
These four
criteria include:
·
Creation of rights and obligations not normally
found in arm's-length dealings.
·
Misuse or abuse of tax laws.
·
Lack of commercial substance, or being deemed to
lack it.
·
Conducted in a manner not typically used for bona fide
purposes. iii) An arrangement is considered to lack commercial substance if:
·
The overall substance or effect contradicts the
form of individual steps or parts.
·
It involves round-tripping or financing through an
accommodating party.
·
It includes offsetting or cancelling elements.
·
A transaction is carried out through
intermediaries, obscuring the value, location, source, ownership, or control of
the funds involved.
·
The location of assets or transactions, or the
residence of any party, is shifted for reasons other than substantial
commercial purposes.
The
provision also clarifies that certain factors, such as the duration of an
arrangement, taxes arising from it, or an exit strategy, are not to be
considered when determining if commercial substance is lacking. Once an
arrangement is deemed impermissible, the tax consequences related to the
arrangement can be assessed, taking into account the specific case
circumstances. Possible actions include:
- Disregarding or combining
steps of the arrangement.
- Ignoring the arrangement for
tax purposes.
- Disregarding or combining
parties involved.
- Reallocating income and
expenses among the parties.
- Relocating the residence of a
party or the location of a transaction or asset.
- Disregarding corporate
structures.
- Recharacterizing
transactions, such as converting equity to debt or capital to revenue.
These
provisions can be used alongside other anti-avoidance measures or tax liability
rules. To prevent treaty abuse, a limited treaty override is also provided.
GAAR UNDER INCOME TAX ACT 1961[6]
- Section 95: Describes the
application of GAAR and specifies that an arrangement can be deemed
impermissible, with tax consequences determined based on the case details.
- Section 96: Defines
"impermissible avoidance arrangement" and outlines the
conditions under which an arrangement may be presumed to have been made
primarily for tax benefit.
- Section 97: Specifies
situations where an arrangement may lack commercial substance, including
round-tripping financing, accommodating parties, and transactions designed
to obscure critical details like asset location or ownership.
- Section 98: Sets forth the
GAAR provisions, detailing how arrangements can be disregarded, combined,
or restructured to prevent tax avoidance.
- Section 99: Allows the tax authorities
to treat connected parties as one for tax benefit assessments.
- Section 100: Clarifies that
GAAR provisions supersede other methods of determining tax liability.
- Section 101: Specifies that
the guidelines and conditions for applying GAAR will be prescribed.
- Section 102: Provides
definitions for terms like "arrangement," "asset,"
"tax benefit," and "connected person.
INCOME TAX RULES, 1962[7]
|
Rules
|
Description
|
|
Rule 10U
|
GAAR not to apply in
certain cases
|
|
Rule 10UA
|
Determination of
consequences of impermissible avoidance arrangement
|
|
Rule 10UB
|
Notice and Forms for
reference under Sec. 144BA
|
|
Rule 10UC
|
Time limits for various
stages of assessment procedure in GAAR cases
|
|
Rule 10UD
|
Reference to the
Approving Panel
|
|
Rule 10UE
|
Procedure before the
Approving Panel
|
|
Rule 10UF
|
Remuneration of
Approving Panel
|
The
Central Board of Direct Taxes (CBDT) has released Circular No. 7 of 2017, dated
27.01.2017, which provides crucial clarifications regarding the implementation
of GAAR provisions under the Income-tax Act, 1961, in the form of 16 Questions
and Answers.
IMPERMISSIBLE AVOIDANCE AGREEMENT (IAA)
- Section 96(1) defines an IAA
as an arrangement where the primary goal is to secure a tax benefit, in
addition to involving one of the four elements listed in Section 96.
- The term
"arrangement" is defined in Section 102(1).
- GAAR will apply to a step or
part of an arrangement if the primary purpose is to obtain a tax benefit,
even if the overall arrangement's primary purpose isn't tax avoidance.
CONDITIONS FOR IAA
- As per Section 96(1), an IAA
is an arrangement with the main purpose of obtaining a tax benefit and
includes one of the four tainting elements.
- Section 96(2) presumes that
if a step or part of an arrangement's main purpose is to gain a tax benefit,
the entire arrangement is deemed to be aimed at obtaining a tax benefit,
unless proven otherwise by the taxpayer.
- Section 97 lists conditions
that indicate an arrangement lacks commercial substance, such as if the
arrangement's form is inconsistent with its substance, involves round trip
financing, or manipulates the location or ownership of funds to secure a
tax benefit.
- If the arrangement meets the
conditions under Section 96, it can be declared an IAA by the Assessing
Officer following the process outlined in Section 144BA. The tax
consequences of an IAA, including denial of tax benefits or benefits under
a tax treaty, will be determined by the Assessing Officer as specified in
Section 98.
MAIN PURPOSE – NEW CONSIDERATIONS
- As per Section 96[8],
an arrangement can only be classified as an IAA if the main purpose is tax
avoidance.
- "Arrangement" has a
broad definition, including transactions, schemes, or agreements, which
can be unilateral or bilateral. It doesn't have to be enforceable.
- The burden of proving that
the main purpose is to secure a tax benefit lies with the tax authority.
However, as the taxpayer is familiar with the arrangement's objectives,
the tax authority will likely need to gather basic evidence from the
taxpayer. The taxpayer must provide tangible evidence to substantiate
their claimed purposes.
- Unlike the pre-GAAR approach,
which focused on "what" the taxpayer did, GAAR examines
"why" the taxpayer did it.
- If the arrangement’s primary
purpose isn't to obtain a tax benefit, GAAR won't apply, and no further
inquiry will be required. Proper documentation and explanation of the
commercial purpose behind an arrangement will be beneficial for the
taxpayer.
- Codified GAAR is different
from judicial GAAR (JAAR) in that it allows for the examination of
individual steps within an arrangement, rather than only the arrangement
as a whole. For instance, merging profit and loss-making businesses may be
driven by commercial goals, but individual steps, like the merger of
loss-making entities with profit-making ones, could be motivated by
tax-related reasons.
- To determine the
"main" purpose of an arrangement, the revenue must consider
relevant factors and determine if other purposes can be disregarded in
favour of focusing solely on the tax benefit. These factors must be
examined carefully when applying GAAR to an arrangement.
ANTI-AVOIDANCE RULES: SAARs AND GAAR
Anti-avoidance
rules are primarily categorized into two types: General Anti-Avoidance Rules
(GAAR) and Specific Anti-Avoidance Rules (SAARs). SAARs, also referred to as
Targeted Anti-Avoidance Rules (TAARs), are designed to address specific tax
avoidance strategies through clearly defined tests that taxpayers must meet.
Indian tax laws include several SAARs such as Transfer Pricing regulations[9],
Section 40A (2), Section 64, Section 93, Section 94(7), Section 94B, and
Section 80-IA(3).
SAARs
focus on particular areas of tax law, introduced by the government to counter
known tax avoidance methods through specific legal provisions. However, the
complexity of tax legislation has allowed for ‘creative compliance,’ where
taxpayers exploit these rules, making it challenging for courts to curb such
practices due to their specific nature.
A major
drawback of SAARs is that taxpayers can structure their affairs to technically
comply with these rules without adhering to their intended purpose, leading to
continuous amendments to close legal loopholes. This reactive approach has made
tax laws more complex and provided opportunities for new avoidance schemes. Since
frequent amendments and new SAARs proved insufficient to prevent tax avoidance,
the government introduced GAAR as a comprehensive statutory measure.
GAAR, as
per Section 100 and the overriding clause in Section 95, supersedes SAARs and
other tax provisions.[10] That
while SAARs address specific tax abuses, a general anti-abuse framework like
GAAR is essential. Both GAAR and SAARs can coexist and be applied as required
based on the facts of a case. An OECD GAAR expert affirmed that no GAAR
restricts its application due to the presence of specific anti-avoidance
provisions.
GAAR IN THE CONTEXT OF BEPS
From the
government's standpoint, both the General Anti-Avoidance Rules (GAAR) and the
Base Erosion and Profit Shifting (BEPS) initiative aim to achieve similar objectives.
However, taxpayers and businesses seek legal frameworks that ensure certainty,
consistency, and ease of compliance. As highlighted in the Finance Minister’s
speech during GAAR’s introduction, its primary purpose was to curb black money
generation and prevent treaty abuse. While black money pertains more to tax
evasion than tax avoidance, treaty abuse is effectively addressed by BEPS
Action Plan 6. Additionally, measures such as the retrospective taxation of
indirect share transfers, exemptions for Foreign Institutional Investors (FIIs)
not claiming treaty benefits, and the gradual elimination of tax exemptions and
deductions limit GAAR’s scope.
Notably,
some BEPS reports advocate for the inclusion of GAAR-like provisions,
recognizing that anti-abuse clauses in tax treaties alone cannot fully prevent
tax avoidance that exploits domestic tax laws. For example, BEPS[11]
Action 6 introduces the Principal Purposes Test (PPT), which denies treaty
benefits if one of the main purposes of a transaction is to gain such benefits,
unless aligned with the treaty’s objectives. However, BEPS primarily recommends
Specific Anti-Avoidance Rules (SAAR) for targeted BEPS issues, rather than
broad-based anti-avoidance measures like GAAR.
While
addressing tax evasion and aggressive tax avoidance is essential, the
government must avoid excessive legislation that hampers business operations,
increases litigation, and creates complexity and uncertainty. GAAR in India,
despite procedural safeguards, is often criticized for its complexity such as
the numerous defined terms under Section 102—and the broad authority it grants
tax authorities to recharacterize transactions, which could elevate business
costs and uncertainty. India's reputation as a challenging tax jurisdiction,
particularly due to inconsistent enforcement at lower levels, may further deter
foreign investment.
The 2016
Budget is expected to implement BEPS measures in line with OECD guidelines
while addressing taxpayer concerns about the uncertainty in Indian tax laws,
especially in cross-border transactions. Given that BEPS covers many of India’s
tax concerns, it may be prudent for India to reassess GAAR’s implementation.
Taxpayers need adequate time to adapt to BEPS changes, and introducing GAAR in
alignment with global best practices, after assessing BEPS impact, would be
preferable. In conclusion, implementing GAAR in its current form may ultimately
do more harm than good.
VODAFONE INTERNATIONAL HOLDING BV VS UNION OF
INDIA[12]
In this
landmark 2012 case, the Revenue argued that the judgment in the Azadi Bachao
Andolan case should be overruled to the extent that it deviated from the
principles established in McDowell & Co. Ltd. However, the Supreme
Court disagreed and made several key observations:
- The Westminster Principle
asserts that if a document or transaction is genuine, the court cannot
disregard it in favor of an assumed underlying substance. This principle
has been reaffirmed as a fundamental doctrine in subsequent judgments by
English courts.
- The Ramsay case did
not reject the Westminster Principle but instead contextualized it,
holding that any transaction deemed a colorable device must be treated as
a fiscal nullity. Thus, Ramsay provides a framework for statutory
interpretation rather than establishing a broad anti-avoidance rule in tax
law.
- The Court clarified that the
binding ratio in the McDowell & Co. Ltd[13].
case is the opinion expressed by Justice Mishra, with whom three other
judges concurred, and supplemented by Justice Reddy’s observations on tax
avoidance.
- It was emphasized that the
Revenue cannot impose taxes without explicit statutory authority. Moreover,
taxpayers are within their rights to structure their financial affairs to
minimize tax liability and are not obligated to adopt arrangements that
maximize revenue for the state. The Revenue’s argument that the McDowell
ruling contradicts the Azadi Bachao Andolan judgment was deemed
unsustainable by the Court, which found no need for reconsideration by a
larger bench.
INTERPLAY BETWEEN GAAR AND THE ANTI-ABUSE RULE (PPT RULE) IN TAX
TREATIES
The
interaction between the General Anti-Avoidance Rules (GAAR) and the Anti-Abuse
Provisions in tax treaties under the Multilateral Instrument (MLI) an OECD
initiative to implement Base Erosion and Profit Shifting (BEPS) measures merits
consideration, particularly in relation to the Principal Purpose Test (PPT
Rule) and GAAR.
LIMITED SCOPE FOR CONFLICT BETWEEN PPT AND GAAR
In
practice, GAAR should not deny treaty benefits when the PPT Rule does not apply
to an arrangement. However, there may be instances where both PPT and GAAR
could be applicable, or where PPT applies but GAAR does not. This ensures that
if a taxpayer successfully satisfies the PPT requirements, GAAR will not
override those treaty benefits. In India, with the MLI effective from April 1,
2020, for 28 countries,[14]
the likelihood of disputes over GAAR overriding tax treaties is minimal,
provided that the MLI is applied only to Covered Tax Agreements notified by
both India and its treaty partners.
DIFFERENCES IN CONDITIONS FOR PPT RULE AND GAAR APPLICABILITY
Under the
PPT Rule, treaty benefits can be denied if obtaining such benefits is one of
the principal purposes of a transaction, not necessarily the sole or dominant
purpose. This "one of the principal purposes" standard, as stated in
Article 7(1) of the MLI, sets a lower threshold compared to GAAR, which requires
the “main purpose” to be tax avoidance. Thus, the PPT Rule may have a broader
scope than GAAR. Additionally, GAAR is triggered only when certain elements such
as non-arm’s length rights or obligations, misuse of tax provisions, lack of
commercial substance, or arrangements not undertaken for bona fide purposes are
present. Therefore, GAAR is unlikely to apply if a taxpayer meets the PPT
requirements.
GAAR also
includes a de minimis threshold, applying only when the combined tax benefit
exceeds Rs. 3 crores in a financial year, while the PPT Rule has no such limit.
Furthermore, GAAR does not apply to income from investments made before April
1, 2017, but no such grandfathering exists for the PPT Rule.
Notably,
Sections 90(2A) and 90A (2A) of the Income Tax Act provide that GAAR overrides
tax treaties, even when treaty provisions are more favourable to taxpayers.
CONCLUSION
Tax
collection from organizations is crucial for funding government initiatives
like infrastructure development, which benefit society. GAAR was introduced to
prevent tax avoidance through deliberate arrangements. While beneficial for the
country, GAAR has certain loopholes that need addressing. Many companies fear
harassment by tax authorities under GAAR, even when they comply with tax laws,
highlighting the need for balanced and fair implementation by the government.
REFERENCE
STATUTES REFERED
INCOME TAX ACT, 1961
INCOME TAX RULES, 1962
FINANCE ACT, 2010
FINANCE ACT, 2012
WEBLIOGRAPHY
[1] https://www.indiabudget.gov.in/budget2012-2013/ub2012-13/mem/mem1.pdf
[2] 263 ITR 706 (SC)
[4] (2001) 20 NZTC 17,103 (CA).
[5] OM.F.NO.500/111/2009-FTD-1 Dated 27
February, 2012
[6] Income-tax Act, 1961 was amended by Finance Bill, 2012 to add Chapter X-A titled 'General Anti- Avoidance
Rule'
[7]https://pib.gov.in/PressReleasePage.aspx?PRID=1481279#:~:text=The%20necessary%20procedures%20for%20application,the%20Income%20Tax%20Act%2C%201961.
https://www.scconline.com/blog/post/2023/03/06/critical-analysis-of-gaar-in-light-of-the-constitution-of-india-and-dtaa/
[9] The Finance Act, 2001 introduced
Transfer Pricing Regulations.
[11] https://www.oecd.org/en/topics/policy-issues/base-erosion-and-profit-shifting-beps.html
[12] 2012 (6) SCC 757, at 68
[MANU/SC/0105/2009]
[13] McDowell & Co. Ltd. v. CTO (1985) 3 SCC 230
[14] On 25th June,
2019, India has deposited the Instrument of Ratification to OECD, Paris along with
its Final Position in terms of Covered Tax Agreements (CTAs), Reservations,
Options and Notifications under the MLI, as a result of which MLI will enter
into force for India on 01st October, 2019 and its provisions will have effect
on India’s DTAAs from FY 2020-21 onwards.