General Anti-Avoidance Rules (GAAR) in India

Reducing the amount of payable tax while complying with tax laws is known as Tax Avoidance. Tax avoidance has not been defined under any Tax Laws in India. It is the result of various activities carried out by the taxpayer, none of which is illegal or forbidden by the law.

As per International literature, Tax Avoidance is described as the following:

• Tax avoidance comprises of legal exploitation of tax laws by the taxpayer for their own advantage.
• All attempts made legally to prevent or reduce the payable tax by leveraging certain legal provisions for the taxpayer’s own benefits.
• It is an arrangement entered into for the sole purpose of gaining certain tax advantages.

Taxpayers often consider it their right to adjust their monetary dealings in such a manner that they have to pay the least amount of tax.

Tax authorities across the globe deem aggressive tax planning schemes to be damaging the defined tax bases exponentially, even when the tax rates have been reduced significantly. Numerous countries have, therefore, adopted and implemented provisions under the ‘General Anti-Avoidance Rules (GAAR)’ to prevent tax avoidance and fight against ‘impermissible tax avoidance’.

Several countries such as the United Kingdom, China, South Africa, Australia, Canada, Brazil. and India have integrated GAAR in their country’s tax laws to deal with aggressive tax planning and tax avoidance.

GAAR in India

India introduced the concept of GAAR primarily in the Direct Taxes Code Bill, 2009 (DTC Bill, 2009). A revised discussion paper was released at a later point. The Direct Taxes Code Bill, 2010 (DTC Bill, 2010) planned to implement GAAR from 1April 2012 onwards. The provisions stated under GAAR were introduced in the Income Tax Act, 1961 vide the Finance Act, 2012 by adding a new Chapter X-A. This Chapter X-A was substituted by the Finance Act, 2013.

It was clarified by the Central Board of Direct Taxes (CBDT) via a press release dated 27 January 2017 that the GAAR provisions shall be applicable from the financial year 2017-18 onwards.

Provisions of GAAR have been stated under Chapter X-A of the Income Tax Act, 1961. The mandatory procedures for the application of GAAR and conditions where it may not be applied have been stated in Rules 10U to 10UC of the Income Tax Rules, 1962.

GAAR Applicability

When it comes to applicability of GAAR, Section 95 of the Act states that a taxpayer’s arrangement may be declared to be an ‘impermissible avoidance arrangement’ and the consequences that must be determined shall be subject to the provisions of Chapter X-A of the Income Tax Act, 1961. The section further states that this Chapter’s provisions may be applied to any step or a part of a taxpayer’s arrangement as they are applicable to the entire arrangement.

This specific section starts with a non-obstante clause, according to which, if this clause is in conflict with other clauses, this clause shall prevail and be preferred over all the others.

The provisions stated under GAAR would be applicable for everyone irrespective of the other provisions of this Act.

Note: In instances where the Income Tax Act provides certain incentives to taxpayers for fulfilling certain conditions, the provisions of GAAR shall not be applicable.

Note: In instances where Specific Anti-Avoidance Rule (SAAR) deals with various methods to stop tax avoidance, GAAR provisions shall not be applicable.

Impermissible Avoidance Arrangement (IAA)

IAA refers to arrangements that satisfy both of the following conditions:

• Obtaining a Tax Benefit

The main purpose or one of the main purposes is to receive tax benefits. As per Section 102 clause (10), tax benefit is defined as (related to the concerned previous year or any other previous year):
    - Reduction or avoidance or deferral of tax or other amount payable under this Act.
    - Increase in a refund of tax or other amount under this Act.
    - Reduction or avoidance or deferral of tax or other amount that would be payable under this Act, as a result of a tax treaty.
    - Increase in a refund of tax or other amount under this Act as a result of a tax treaty.
    - Reduction in total income.
    - Increase in loss.

• Satisfies Tainted Element Tests

Test 1: Refers to a non-arm’s length dealings where an arrangement establishes rights and obligations that are not formed normally between parties involved in dealings at arm’s length. As SAAR is applicable in cases of international transactions and some specified domestic transactions, this tainted element is to be examined only in these specific transactions that are not covered by Transfer Pricing Regulations and where the main goal of the arrangement is to avail tax benefits.

Test 2: Refers to arrangements that lead to misuse or abuse of the Act’s provisions. This means in cases where the law is adhered to in letter but not in spirit or substance, or where the arrangements result in consequences that are not envisioned by the legislation, revealing the desire to misuse or abuse the law.

Test 3: Refers to arrangements that lack any commercial substance or are deemed to lack any commercial substance. Section 97 states that certain arrangements have been deemed to lack any commercial substance as under:

• The substance or effect of the arrangement as a whole is inconsistent with, or differs significantly from, the form or fits individual steps or a part, or
• It involves or includes:
      - Elements that have effect of offsetting or cancelling each other,
      - An accommodating party,
      - Round trips financing, or
      - A transaction that is conducted through one or more individuals and hides the value, source, location, ownership, or control of funds that is the subject matter of such transactions, or
• It involves an asset’s or a transaction’s location or of the place of residence of any party that is without any substantial commercial purpose other than receiving certain tax benefits for a specific party.
• It does not have a substantial effect on the business risks or net cash flows or any party to the arrangement apart from any effect attributable to the tax benefits that shall be received.

Basically, the above provision implies that where substance of an arrangement is different from what is intended to be shown by the form of the arrangement, tax consequence of a particular arrangement should be assessed based on the substance of what took place. To put it simply, it reflects the inherent ability of laws to look beyond form by removing the corporate veil.

Test 4: Refers to arrangements that are entered into or carried out by means of or through a way that is not usually used for bona fide purposes. In simple terms, it refers to an arrangement that possesses abnormal features. Basically, this is not a purpose but a manner test.

IAA: Consequences

Any arrangement declared to be an IAA shall face consequences that may include denial of tax benefits or the benefits under a tax treaty. These consequences shall be determined in a way which is deemed adequate in the circumstances of each case. Some illustrations of the ways have been mentioned below:

• Treating the IAA as if it had not been entered into or carried out.
• Disregarding any associated party or treating any associated party and any other party as one and the same person.
• Disregarding, combining or recharacterizing any step in or a part or whole of the IAA.
• Stating individuals who are connected individuals in relation to each other to be one and the same person for the purposes of determining tax treatment of any amount.
• Treating the place of residence of any party to the arrangement or the situs of an asset or of a transaction at a place other than the place of residence, location of the asset or location of the transaction as provided under the arrangement.
• Reallocating any accrual or receipt of a capital or revenue nature or any expenditure, deduction, relief or rebate amongst the parties to the arrangement.
• Disregarding any corporate structure to consider or look through any arrangement.

Furthermore, it has also been stated that:

• Any equity may be treated as debt, or vice versa.
• Any accrual or receipt of a capital nature shall be treated as of revenue nature or vice versa. In addition, any expenditure, deduction, relief or rebate may be recharacterized.

GAAR: Exemptions

A few exceptions where the provisions of GAAR are not applicable are mentioned below.

• GAAR provisions are only applicable for the financial year 2017-18 and thereafter.
• Grandfathering is available in respect of income from transfer of investments made before 1April 2017, i.e., provisions under GAAR shall not be applicable on any investment made before 1 April 2017.
• GAAR is not applicable on arrangements where tax benefits in the relevant assessment year arising in aggregate to all the parties to the arrangement does not exceed a sum of INR 3 crores.
• A Foreign Institutional Investor who:
      -Is an assessee under the Act,
      -Has not taken advantage of an agreement referred to in Section 90 or Section 90A, depending upon the case, and
      -Has invested in listed securities or unlisted securities after getting the permission of the competent authority beforehand, in accordance with the Securities and Exchange Board of India (Foreign Institutional Investor) Regulations, 1995 and other such regulations may be applicable with respect to such investments.
• An individual, who is a non-resident, in relation to investment made by them through offshore derivative instruments or otherwise, directly or indirectly, in a Foreign Institutional Investor.

Conclusion

Although Tax Avoidance is not an illegal approach to reduce the payable tax, tax authorities do not deem it to be appropriate, as it can extensively degrade the tax slabs set by them. While it is imperative to pay your taxes, it is equally important to ensure you do not violate any law while trying to pay a lesser amount than what is expected.


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