Introduction: Income taxes are a significant cost for successful firms, frequently accounting for 25% or more of pretax income. In order to examine rival agency-based and risk-based explanations of corporate tax planning, this study takes advantage of a setting—the market for corporate control. We find a considerable decrease in tax evasion after the introduction of the takeover law by utilising the staggered enactment of M&A laws across nations that enhanced the danger of takeover as an exogenous shock that permits a potent difference-in-differences design. Our research indicates that the most likely mechanism by which takeover regulations affect tax avoidance is reduced management private benefit consumption (i.e., rent extraction), not managerial effort aversion or elevated risk aversion related to aggressive tax techniques. Collectively, our research adds to the body of knowledge by emphasising the influence of the corporate control market on cross-sectional variation in corporate tax evasion.
Corporate cross-listing and accounting conservatism: How corporate governance acts as a mediator: From a different angle, cross-listing increases a company’s demand in the financial market, its liquidity, and its risk level. Listing in multiple marketplaces at once improves the company’s financial status by improving capital and liquidity raising but requires a high level of risk management suggested by conservatism.
Investors in the global financial markets will then give conservative companies more credibility because they are more likely to be regarded as more reputable and deserving of trust there. Furthermore, these investors view conservatism as a tool that encourages management to choose investments that are better for shareholders. Parallel to this, some recent research demonstrates a favourable relationship between conservatism and the accuracy of financial statements.
Parallel to this, empirical data demonstrates that conservatism is linked to better investment choices since losses from unsuccessful initiatives are realised sooner than earnings from successful ones. A. S. Ahmed and Duellman (2011), for instance, discovered that companies with more conservative accounting practises have better operating cash flows and gross profit margins. Francis and Martin (2010) uncover proof that managers are more likely to make successful investments when conservatism is present. According to Louis et al. (2012), conservatism is linked to more effective cash investment. Kravet (2014) also discovers that conservatism can deter management from investing in a hazardous project, even if it is profitable.
According to the information disclosure theory, businesses that operate in international markets are subject to the strictest disclosure regulations (Dodd, 2013). This is because enhanced disclosure drives trade, which raises the cross-listed company’s market worth. Thus, the more information is disseminated and the company is visible on the foreign market, the more money a cross-listing company would make (Abdallah, 2008). As a result of increasing brand awareness and recognition in international markets, increased investor recognition leads into increased firm value, claim Eng and Ling (2012).
The potential of reverse causality might then be assumed. For instance, a company might wish to cross-list because the managers believe it will boost the company’s worth, maximise their remuneration or wealth, etc. The company engages in a number of pricey actions intended to signal their type in order to reap the greatest benefits from cross-listing (i.e., differentiate themselves from “bad” enterprises in their native country). One such action might be to adopt a more conservative approach to accounting.
Risk Of Poor Governance To Investors In India: A governance structure with a set of rules is necessary for institutions like states and companies to operate efficiently and distribute rewards to all of its stakeholders. When these organizations are run by individuals with diverse cultural backgrounds, governance becomes more complicated. While no culture will ever condone crime, such as fraud, the lack of understanding in certain sectors and strong cultural prejudice in others may make it simpler to maintain bad governance. For instance, passing a firm down down the generations to the male family members may be possible, but if there are other shareholders, governance concerns may arise.
Corporate governance refers to the set of guidelines, practices, and procedures that regulate and control a business. It generally entails striking a balance between the interests of a company’s numerous stakeholders, including shareholders, senior management staff, clients, vendors, financiers, the state, and the local community. Poor corporate governance can raise questions about a business’s operations, eventual profitability, and profit distribution. Investors that disregard governance in favor of chasing such businesses’ returns are thereby incurring an unnecessary risk. India needs strong institutions and effective governance if it is to expand economically and draw in investment.
In the US, companies like WorldCom and Enron as well as Volkswagen in Europe come to mind as examples. Enron declared bankruptcy in 2001 when it was unable to conceal significant trading losses.
Executives lied about earnings and altered the balance sheet to show good performance using the company’s complicated business strategy and unscrupulous activities. An internal audit of WorldCom in 2002 found a plan to falsify earnings to boost the stock price of the business.
WorldCom was eventually compelled to acknowledge that it had inflated its assets by almost $11 billion. Over $200 billion in estimated investor damages resulted from just these 2 lawsuits. These problems prompted the US to enact new laws like Sarbanes-Oxley, which protects investors from accounting fraud by raising the calibre of financial reporting and accounting standards.
In the Volkswagen crisis, often known as “Dieselgate” or “Emissions Gate,” it was discovered that the firm had placed devices on purpose to evade the US-mandated car emissions testing. The controversy caused a 46-billion-dollar loss of value for shareholders.
Investors in Indian markets may be reminded of the Satyam Computer Services scam, which was exposed in the wake of the global financial crisis caused by the US Lehman collapse. The company was discovered to have claimed profits that had never occurred, and PwC, its auditor, was unaware of the deception. The majority of the lost money was used to buy real estate. When the real estate market in a south Indian city crashed in late 2008, a trail leading back to Satyam was left.
In July 2018, two of IL&FS’s companies failed to repay loans and intercorporate deposits to certain banks and lenders, exposing the greatest corporate fraud in India. This exposed intentional accounting fraud, including loan “evergreening.” At the time of the scam, ILFS had a balance sheet of USD 12 billion, and its collapse had a significant effect on the credit market.
These are only a few worldwide instances of actual economic losses that are mostly due to brazen fraud. With the right governance frameworks, the majority of these and comparable incidents might be avoided. A genuine independent board of directors, shareholder committees, accounting and audit monitoring, and openness regarding corporate operations are all important.
Some of the biggest, most recognisable indexes in India featured names without these fundamental features. Some of them have relied on the so-called Crony Capitalism for years, when commercial contracts are won or approvals are obtained entirely based on the connections they have to the government. Additionally, they rely on a number of intricate corporate structures and accounting procedures that might temporarily boost their revenues and therefore, stock values. The frameworks conceal huge financial risks. When such organizations encounter financial difficulties, their collapse might appear swift and violent, but in retrospect, the warning indicators were always present, as we have learned by studying prior poor-governance related collapses, of which we just provided a few examples.
Effective corporate governance helps to ensure that a company is managed in the best interests of its shareholders and stakeholders. It involves the establishment of policies and procedures to guide the decision-making process and the monitoring of management’s actions to ensure that they align with the company’s overall goals and objectives. Strong corporate governance promotes transparency and accountability, reduces the risk of fraud and mismanagement, and enhances the overall performance of the company. Without it, a business may lack direction, fail to achieve its objectives, and ultimately, fail.
Effects of Poor Governance:
1) Loss of trust and confidence among shareholders:
A company’s shareholders are informed when it departs from its corporate governance approach that it cannot be trusted. This makes the shareholders feel deceived or misled and undermines any faith they may have had in the company. In order to avoid any prospective loss, shareholders may leave the company if they think terrible business decisions are in the near future.
2) Difficulty Obtaining Finance:
Investors may also turn away due to a company’s failure to follow its corporate governance strategies. The degree of application of corporate governance principles (public disclosure of information, protection of shareholder rights, and equal treatment of shareholders) and profitability, which ensures return on investment, are among the factors that investors consider most important when making an investment decision.
3) Enhanced Government Supervision:
Companies having a bad reputation for failing to follow corporate governance guidelines may face more regulatory scrutiny from agencies checking to see whether they are following the law. In the event that something were to go wrong, this puts the company in the public eye.
Even the finest companies might suffer from poor corporate governance. When corporate governance fails on a systemic level, it also fails on a regulatory, market, stakeholder, and internal level. Businesses must make sure they maintain their integrity, openness, independence, responsibility, and fairness. Companies without efficient governance will undoubtedly suffer financially, legally, or have their reputations damaged. The integrity and effectiveness of businesses, as well as the financial markets in which they trade, are greatly improved by good corporate governance. A company’s potential is diminished by bad corporate governance, which also leaves room for fraud and financial problems.
The Mediating Effect Of Corporate Governance: The empirical research on the connections between information dissemination and governance mechanisms confirms that various governance mechanisms are related to voluntary information disclosure. According to Lara et al. (2007), more cautious accounting decisions are made when there is stronger governance. Strong corporate governance is linked to a higher level of conservatism, according to A. Ahmed and Duellman’s 2007 research. In the context of Indian companies, Sharma and Kaur (2021) investigated the connection between accounting conservatism and corporate governance. Their findings suggest that the features of the audit committee and board of directors have a considerable impact on the firm’s accounting conservatism policy.
The presence of conservatism is explained by the idea that it promotes firm value by restricting management’s opportunistic payments to itself or other parties, which benefits users of financial reporting. Corporate governance is crucial to putting conservatism into practise. John and Senbet (1998) and Fama (1980), in particular, contend that the board’s qualities can affect the calibre of financial reporting. John and Sebnet (1998) assert that the qualities of the board of directors that may affect the information quality include its size, composition, and mix of functions. Similar to this, Klein (2002) asserts that the composition of the board of directors has a substantial impact on the disclosure of reliable and pertinent financial information. This suggests that the boards of directors would want extensive financial information with greater conservatism the more effectively they wield control.
In terms of board size, Zahra and Pearce (1989) claim that the largest boards have the best ability to successfully oversee managers. It would be more difficult for the CEO to control the board the bigger the board gets. Similar to this, other writers, such Charreaux and Pitol-Belin (1985), have confirmed that the size of the board of directors represents the degree of power that directors have over the company. The directors’ control will be more tightly knit the more significant it is. In light of this, Alves (2021) discovered a non-linear link between board size and the degree of conservatism. More specifically, their findings supported the notion that smaller boards may be increasing efficient than larger boards in observing managers’ behaviour because the firms in the sample showed more conservatism as the number of boards increased up to 8 members. Board size and accounting conservatism are inversely correlated when board size is greater than 8.
The bulk of empirical research on leadership structure view the combination of functions as an inadequate means of adding value at the business level (see, for example, Jensen, 1993; Godard and Schatt, 2004). According to this point of view, the CEO, who also serves as the board’s chairman, will have a disproportionate amount of power, enabling him to make decisions that are detrimental to shareholders’ interests. Therefore, it is in favour of using two distinct structures for the two functions. In this manner, control is appropriately exercised by the board because power is no longer concentrated in the hands of a single person. Function duality can reduce the efficacy of the governance systems and can lead to conflicts of interest between managers and owners, according to Jensen and Meckling (1976) and Jensen (1993).
Rechner and Dalton (1991) discovered that companies with distinct management structures perform better than those with mixed management structures by looking at the accounting measures. Therefore, we could anticipate discovering a strong relationship between conservatism and the structure of the board if the separation of the functions, the independence, and the size, increase the efficiency of control of the board.
Rechner and Dalton (1991) discovered through analysis of accounting indicators that organisations with distinct management structures perform better than those with mixed management structures. Accordingly, if the independence, size, and separation of the functions increase the effectiveness of the board’s control, we could anticipate discovering a strong correlation between conservatism and the board’s structure. Song (2015) states that ownership concentration reduces accounting conservatism on the same Order. Because majority shareholders will be more likely to expropriate small shareholders and be more eager to conceal their actions by manipulating income, the requirement for accurate information will decline as ownership concentration increases. However, Alves (2020) demonstrates that concentrated ownership is positively and significantly related to accounting conservatism. This finding raises the possibility that large shareholders may have strong incentives to use conservative accounting in order to lower potential litigation costs and agency costs.
Wan Ismail et al. (2012) discovered that public enterprises are not conservative when putting together their financial reports with regard to State ownership. This finding is in line with allegations that managers at state-owned businesses engage in aggressive financial reporting due to poor governance, strong incentives to maximise salary, and worsening agency issues.
When accounting conservatism and managerial ownership are taken into consideration, Ryan and Sugata (2008) demonstrate that the separation of ownership and control leads to agency issues between managers and shareholders, supporting Jensen and Meckling’s (1976) contention that as manager participation rises, managers’ interests become more closely aligned with those of external shareholders and vice versa. Conservatism Financial reporting is therefore acknowledged to handle these agency issues. Therefore, there is a negative correlation between managerial ownership and accounting conservatism as managerial ownership declines and the severity of the agency problem rises, raising the demand for conservatism. However, at both low and high levels of managerial ownership, Alves (2020) demonstrates a significant positive association between managerial ownership and conservatism accounting.
Tax Avoidance And Corporate Governance: A Relationship: For the advantage of the explorer, it is advisable to add a warning before exploring the connection between tax avoidance and corporate governance. In order to define the boundaries of the relationship, a multidisciplinary analysis is necessary. This is only due to the fact that taxation is a special arena where economic factors and legal philosophy interact. Fiscal laws have their own set of interpretive guidelines and a well defined enunciation in the legislation. On the other hand, economic taxation has a significant part in defining the corporate attitude toward the tax-positions established by the firm, even while it affects corporate performance and is a cost of doing business in a jurisdiction.
Legal realists believe that the issue of tax avoidance is related to the fiscal statutes’ strict construction and the importance of “certainty” in fiscal policy. Every individual is entitled, if he can, to arrange his activities in such a way that the tax attaching under the respective Acts is less than it otherwise would be. Moral and equitable considerations are foreign to fiscal enactments. 5 These principles are the cornerstone for judicial evaluation of fiscal disputes in the majority of civilised nations, even though they have been used inconsistently in the United Kingdom and India. In the absence of any tax avoidance provisions, the tax payer is legally allowed to manage his affairs to lower the tax due thanks to this judicial bent. 8 Thus, citizens (which includes corporations subject to taxation) are allowed to organise their business dealings in a way that would reduce their tax liabilities, i.e., they have the legal right to engage in tax minimization. This fiscal statute’s interpretative assumption is the source of disagreement and is thought to be the main motivator behind individuals with financial resources’ indulgence in aggressive tax planning.
The Economic Approach: The urgency to maximise shareholder returns and boost managerial incentives lies at the heart of appropriate behaviour adopted by corporations, according to economists who view the entire exercise of minimization from an agency-conflict perspective. This is in contrast to legal luminaries who challenge the legitimacy of tax-avoidance structures based on legal theory and precedents. According to an economic analysis, shareholders in well-run businesses gain from tax shelters. Financial innovations, the integration of capital markets, and an increasingly complex corporate tax code give businesses opportunities to take advantage of variations in tax rates, tax preferences, and tax status in increasingly sophisticated ways, making tax-avoidance activities appear to be central to corporate financial decision-making.
There is an alternate explanation for why company management would use aggressive tax tactics rather than the desire to enhance shareholder return. It is claimed that in order to serve the interests of management rather than shareholders, tax avoidance “demands obfuscatory operations that might be packaged with diversionary activities, including profits manipulation.” According to empirical research, “individual executives play a considerable effect in deciding the extent of tax evasion that corporations engage in incremental to the characteristics of the firm,” Therefore, management determine the practical tax decisions even if shareholders provide general recommendations regarding the corporation’s tax attitude toward risk.
Additional economic research also supports the following conclusions:
(a) “higher levels of corporate social responsibility activities of the corporation, lower levels of corporate tax aggressiveness, therefore, more socially responsible corporations appear to deter tax aggressive activities; and
(b) outside director membership has a positive impact on debt policy, and further, that it strengthens the negative association between tax aggressiveness and debt by reducing the agency costs.” Empirical data that “individuals’ political attitudes influence their decisions on tax avoidance practises” emphasises this feature even more. Therefore, the political inclinations and connections of corporate managers play a crucial role in determining the tax strategy they choose.
These arbitrary yet precise research evaluating the function of CEOs offer resounding proof that corporate governance affects a corporation’s tax-aggressiveness. In terms of the aggressiveness of the tax strategy to be adopted, a number of factors, including:
(a) direct costs,
(b) exposure to risk of sanctions,
(c) implicit taxes,
(d) compliance costs, etc., influence corporate decision-making.
These studies clearly confirm by economic analysis the hypothesis that “tax laws can influence corporate governance dynamics directly (i.e. as a direct consequence of specific tax policy choices) or indirectly” (i.e. as an indirect consequence of the way the tax system operates).
Methods Applied By The Government To Deal With Tax Evasion And Corporate Frauds: Corporate fraud refers to the intentional manipulation and concealment of crucial information by a business or organization in order to present a false impression of its financial stability and performance. This can be achieved through a variety of methods, such as providing false information in prospectuses, falsifying financial records, hiding debt, and other deceptive practices. Some specific examples of corporate fraud include falsifying accounting entries to inflate profits, conducting false trades, disclosing price-sensitive information in violation of insider trading laws, and creating false transactions to attract additional investors and funding. Such actions are illegal and can have serious consequences for both the company and its shareholders. It’s important for companies to have adequate systems in place to detect and prevent such frauds.
There are several reasons why businesses engage in such fraud, including increasing the amount of counterfeit money they make, fabricating the company’s reputation in the marketplace, and misleading the government to perpetrate tax evasion.
There are many different forms of fraud, including financial statement fraud, employee fraud, vendor fraud, customer fraud, investment fraud, bankruptcy fraud, and other scams. Among the frequent scam types are:
1) Financial Frauds: Manipulation, falsification, manipulation of accounting records, deliberate misrepresentation or omission of quantities, etc.
2) Misappropriation of Assets: includes selling confidential information, making erroneous payments, and stealing physical assets by internal or external parties.
3) Corruption: Making or accepting inappropriate payments, providing bribes to public or private authorities, accepting bribes, etc.
One of the major types of corporate fraud is Tax evasion.
Tax evasion is when a person or business intentionally avoids paying their fair share of taxes. It includes fabricating or disguising revenue, falsifying deductions without supporting documentation, failing to declare cash transactions, etc. Tax evasion is a severe crime that carries harsh punishments and criminal prosecution. The fact that taxes are a significant source of revenue for the government makes advocating for them difficult since most people find it difficult to comprehend parting away a portion of their income. This sum of money is used to fund a number of development initiatives aimed at enhancing the status of the business. However, tax avoidance has been a major issue for the nation. The country’s revenue has allegedly suffered as a result of those who should be paying taxes but in turn had found ways to avoid doing so.
In order to control the corporate frauds and tax evasions government has imposed various penalties on the same.
Anyone found guilty of avoiding or dodging taxes is subject to a number of penalties from the income tax department. Companies who fail to declare and pay their own taxes or that do not properly withhold taxes at source may also be subject to these fines.
Some of these may be:
- When income is not revealed, tax collection might range from 100% to 300%.
- The assessing officer may apply a penalty amount in the event that the tax is not paid when due, but the penalty cannot be more than the tax owed.
- If a person does not submit their tax returns by the deadline, a penalty of Rs. 200 may be assessed for each day the return is not submitted.
- The fine can be between 100% to 300% of the tax owed if someone hid information about their income or any taxable fringe benefits.
- If a person or business fails to maintain their accounts as required by section 44AA, they may be subject to a fine of Rs. 25,000.
- A firm may be fined up to Rs. 1.5 lakhs or 0.5% of its annual sales turnover if it fails to get itself audited or to submit the audit’s report.
- A punishment of Rs. 1 lakh may be imposed if a report from an accountant is not submitted as required.
- The penalty might be the payment of the tax owed if an organisation doesn’t deduct tax from payments where it should.
Corporate Frauds are governed by Companies Act,2013
S.447 of the Companies Act of 2013 clearly defines fraud in relation to the operations of a company or any other corporate body. According to this section, fraud encompasses any act, omission, concealment of any fact, or abuse of position that is carried out by an individual or group with the intention of deceiving, gaining an unfair advantage over, or harming the interests of the company, its shareholders, its creditors, or any other person. This definition encompasses a wide range of actions and behaviors and emphasizes the intent to deceive or harm as a crucial component of fraud in the context of corporate governance.
- PUNISHMENT FOR FRAUD (Section 447) : Individuals found guilty of committing fraud in accordance with the Companies Act of 2013 may face severe penalties. The punishment for fraud includes a minimum prison sentence of six (06) months and a maximum sentence of ten (10) years. Additionally, they may be subject to a fine that is at least equal to the amount involved in the fraud, but can go as high as three times that amount. It’s worth noting that if the fraud in question affects the public interest, the minimum prison sentence increases to 3 years.
- PENALTIES FOR UNTRUE EVIDENCE (SECTION 449): According to the Companies Act of 2013, an individual who provides deliberately misleading evidence in any examination on oath or solemn affirmation, or in any affidavit, deposition, or solemn affirmation in relation to the winding up of a company or any other matter arising under the Act, shall be subject to severe penalties. The punishment for this offense includes a prison term of a minimum of three years and a maximum of seven years, as well as a fine of at least Rs 10 Lacs. This serves as a strong deterrent against providing false evidence and promotes integrity and honesty in the corporate world.
- ADJUDICATION OF PENALTIES (SECTION 454): The Central Government, as per the Companies Act of 2013, has the authority to appoint Adjudicating officers for imposing penalties for non-compliance of the Act’s provisions. These officers have a specified jurisdiction, which is also determined by the Central Government. The Adjudicating officer may impose penalties on the company and the officer who is in default for non-compliance of the Act. In case a person is not satisfied with the order, they have the right to appeal to the Regional Director who has jurisdiction in the matter.
Few steps that government entities can take up to control fraud are as follows:
- Set a positive precedent at the top:
Writing a code of conduct is a great method for governing bodies and top management to foster an environment of responsibility. The entity’s viewpoint on corporate ethics, a definition of fraud, and a description of the repercussions should all be made explicit in this code. The code might be as brief as a three-sentence explanation of how the government interacts internally, with vendors, and with its constituents in order to comply with legal obligations.
- Put internal controls in place:
Effective internal controls are essential for protecting assets, accurately recording transactions, and achieving organizational goals and objectives, including compliance with regulations. To focus on the most important internal controls, it is recommended to prioritize the following:
Duties segregation: Assign distinct responsibilities for recordkeeping and physical custody of assets to different individuals to reduce the risk of errors and fraud.
Access monitoring: Monitor employee access to recordkeeping systems to ensure that duties are being properly segregated as intended.
Management review: Conduct regular reviews of access and exception logs, as well as detailed reviews of non-standard journal entries, reconciliation details, transaction records, and monthly financial information to identify and address any potential issues.
- Create a hotline for reporting fraud:
An essential component of preventing and spotting fraud is being able to inform staff members, customers, contractors, service providers, and other third parties that you have a hotline. Working to ensure that reports may be made without worrying about reprisal is a crucial aspect of a hotline. Having a structured procedure in place will ensure that every tip is looked at and dealt with fairly. This aids in defending the government in court. Hotlines are often inexpensive. There is often a little monthly hosting price beyond the initial setup expense.
- Determine and quantify the risks. Determine the risk of fraud that the entity is exposed to, how likely it is that fraud will occur, and put the right controls in place. With such measures the risk of fraud can be lowered. Maintaining financial integrity, detecting and quantifying risk, streamlining procedures, and proactively combating fraud should all be the main goals of an evaluation.
- To not be dependent upon Financial Audit:
The quality and completeness of the financial accounts utilised by other parties are attested to through audits, which offer a quantifiable advantage. However, financial audit is not sufficient enough to uncovered a fraud. Audit methods aren’t meant to find fraud because they only cover a small portion of activities.
These actions are a component of a larger risk management procedure. The company should at least do two things: develop an ethical tone and build robust internal controls, even if it might not be able to adopt all of these suggestions. The foundation of all other policies and procedures is comprised of these two activities.
General Anti-Avoidance Rules (GAAR): The constitutional and administrative restrictions governing how these rules are applied have a significant impact on corporations because the availability of legal defences allowing them to successfully avoid the application of these restrictions affects how corporate managers view the adoption of aggressive tax-evasion strategies. After evaluating the interrelated nature of tax avoidance and corporate governance, it is appropriate to evaluate the anti-avoidance laws individually as well as the legislative framework in which they are implemented in each country.
GAAR, or the “General Anti-Avoidance Rules,” are regulations intended to combat attempts at tax evasion, as their name suggests. However, the obvious question is why GAAR is necessary given tax rules already offer penalties and prosecutions for failure to pay taxes. The policy premise that tax avoidance is economically undesirable and unfair, along with the practical realities of tax avoidance being used as a negotiating tactic to lower the biggest expense to business—taxes— provide the answer to this question. Ambiguity is considered against the tax administration in terms of the letter of the law, regardless of the legislation’s spirit. Even when the tax-payer has complete knowledge of and control over all the facts, the tax administration is nonetheless under pressure to prove that the taxpayer engaged in avoidance tactics. The capacity of tax payers to route money flows through multiple countries, including tax havens, thanks to professional skill also works against the tax administration’s efforts to fairly collect taxes.
Tax administrations frequently arm themselves with these almighty regulations with the goal of bridging the gap between the letter and spirit of the law in order to tip the scales in their favour and to deter tax payers from using artificial means to evade paying taxes. Thus, tax administration can deter sophisticated company structures by exposing their lack of commercial substance and empowering itself by enforcing repercussions for illegal avoidance strategies.
Even the judiciary has created anti-avoidance regulations like the substance-over-form test to combat simply avoidance strategies, but the execution of these laws is arbitrary and dependent on the posture that the judiciary will take on a case-by-case basis. Thus, GAARs give the tax administration legal authority to combat tax avoidance by opposing transactions that appear to follow the text of the law but have no clear goal other than to lower or eliminate tax liabilities. These factors, which are universally shared by tax administrations around the world, provided the motivation for GAAR legislation.
GAAR Under Direct Tax Code Bill: The idea of including anti-avoidance provisions in tax legislation is therefore not new to India at all. “Targeted Anti Avoidance Rules” (TAAR) or “Specific Anti Avoidance Rules” (SAAR) have previously been popular for a long time. Anti-avoidance laws pertaining to transfer-pricing, securities transactions, transactions with non-residents, etc. are already provided by Chapter X of the Income Tax Act of 1961, which is titled “Special Provisions Relating to Avoidance of Tax.” Anti-avoidance regulations created by judges have been included as a supplement to these statutory rules.
However, the Direct Taxes Code Bill sparked a previously foreign debate in India about the implications and details of “General Anti-Avoidance Rules” (GAAR) under the nation’s direct tax legislation.
When it released the initial draught of the Bill 40 for public comment in 2009, the Government of India recognised the urgent need for implementing legislative laws against tax evasion.
GAAR Under Income Tax Act, 1961: The Direct Taxes Code Bill, 2010, after its introduction in the Parliament, was referred to the Standing Committee on Finance of the Parliament. In its Report evaluating the nuances of the Bill44 the Committee noted various fallouts of GAAR being invoked, both on equitable as also pragmatic considerations. These were:
(a) the “provisions to deter tax avoidance should not end up penalizing tax- payers, who have genuine reasons for entering into a bonafide transaction”;
(b) the “proposals should not lead to any fiscal uncertainty or ambiguity”; and
(c) “it should be ensured that any of the proposals does not pave the way for avoidable litigation, which is already at a very high level in tax matters.
The Government of India moved ahead and introduced GAAR in the Income Tax Act, 1961, in the unaltered and somewhat expanded form notwithstanding the request to ensure built-in protections in the draught GAAR proposed in the Direct Taxes Code Bill. The Supreme Court’s then-recent decision in Vodafone International, which revisited the entire discussion of the substance versus form of transactions in the context of tax-avoidance transactions to reaffirm its earlier position in favour of the tax-payers adhering to the Duke of Westminster principle, served as the catalyst for the same.
Despite the proposal to include built-in protections in the draught GAAR suggested in the Direct Taxes Code Bill, the Government of India proceeded through and included GAAR in the Income Tax Act, 1961, in the unmodified and somewhat expanded form. The catalyst for the same was the Supreme Court’s then-recent decision in Vodafone International, which revisited the entire debate over the content of transactions versus their form in the context of tax-avoidance transactions to reaffirm its prior position in support of the tax-payers adhering to the Duke of Westminster principle.
Success Of GAAR: The next question is whether anti-avoidance regulations have an effect on raising corporate governance standards. The first question to be answered is whether these anti-avoidance provisions are effective in preventing tax evasion, which is their limited aim. Retaining these regulations in the statutes for unrelated purposes will not be helpful unless they are successful in preventing tax avoidance, which is their declared goal. Given that these policies have antecedents, although in wealthy nations, an evaluation of how they have performed in other jurisdictions will have a considerable impact on how well they may perform in the Indian setting.
GAAR Lessons For Corporate Managers: We can gain valuable lessons from past corporate failures. On the one hand, there are the factors that encouraged Enron to engage in tax-motivated transactions, such as “Enron’s aggressive interpretation of business purpose, the cooperation of accommodation parties, the protections provided by tax opinions, and the complex design of transactions,” and on the other, there is the Satyam case, where external approval of the fictitious financial position adopted by the corporation gravely misled the stakeholders. These instances “demonstrate the need for robust anti-avoidance rules to combat transactions that may meet the technical requirements of the tax statutes and administrative rules, but that are conducted for little to no purpose other than to generate income tax or financial statement benefits,” according to the report.
Since the introduction of anti-avoidance provisions in tax legislation is mostly due to firms’ failure to uphold qualitatively laudable norms, GAAR have an impact on the current corporate governance standards. The fundamental element in the tax administrations’ decision to respond with stricter and more deterrent anti-avoidance policies is the persistence with which firms implement tax-avoidance methods that challenge the positions taken by tax administrations. The case of South Africa, which replaced its 1941 GAAR with a new one in 2006, serves as a powerful illustration of the difficulty tax administration may face in successfully combating tax avoidance even with GAAR. However, it also serves as a reminder that, no matter how cunning, tax avoidance is unacceptable to tax administrations and will continue to be attacked.
The business decision-makers’ first and most important course of action following GAAR will be to review their tax positions since such positions will be evaluated for compliance with GAAR and will thus need to be changed on the corporate level. For instance, courts have ruled that in the absence of anti-avoidance regulations, the tax administration lacks the authority to challenge a number of corporate structures that are disfavored internationally, such as round-trip financing, thin capitalization structures, dividend-stripping transactions, etc. As “a GAAR which comprises a number of principles, including, but not limited to, directions about the significance of economic substance and of the manner of carrying out a scheme, may be able to operate, in conjunction with new approaches to legislation, to support the judiciary better in their task of statutory interpretation,” this stance will change.
Additionally, in light of GAAR, corporations planning to continue making changes to structures that appear to be tax-efficient will be in a precarious position because a strict GAAR envisages higher professional fees changed by intermediaries and tax advisors to develop models that can withstand the attacks of tax administrations. The importance of tax intermediaries in encouraging aggressive tax preparation by taxpayers has already been established, and the fact that some rulings, notwithstanding the statutory GAAR, do in fact favour taxpayers may be a strong enough incentive to maintain the practise of aggressive tax positions.
There is yet another corporate governance lesson to be learned. Judges frequently make harsh judgements about the conduct of the corporation when such cases are litigated and the judicial authorities are tasked with making the final decision, even though they are required to make decisions objectively. This happens when they notice socially unacceptable behaviour on the part of the corporation. This factor is very important to the current governance norms. For instance, in a contentious dispute between various players in the telecommunications industry and the tax administration, the Bombay High Court did not just side with the tax administration; it also made disparaging remarks about the corporations for concealing material information and providing false information to the tax administration. In truth, there are numerous instances in Indian law where the judiciary has ruled on “allegations of subterfuge” and “fictitious arrangements” to escape taxes by taking into account business decisions and economic realities. It goes without saying that these actions have an impact on governance standards and consequently call for correction because they throw a clear indictment on unacceptable company behaviour.
However, even if the tax administration successfully invokes the GAAR, the non-imposition of corresponding penalties may play a substantial role in preventing the GAAR from having the desired impact. The application of GAAR is only an exercise in interpretation because it indicates that the tax payer and the tax administration have different viewpoints on the nature and impact of the transaction. Therefore, even if GAAR is used against the tax payer, the tax administration can only ask for the tax that is legally owed and nothing more. Even with the adoption of GAAR, the Income Tax Act of 1961 was amended, but those changes did not include any new criminal obligations that might be placed on the tax payer even after a successful application of GAAR.
According to established Indian law, assessments of tax liabilities based on the tax payer’s disclosures and statutory best judgement do not indicate concealment on the part of the taxpayer (as will be the case under GAAR). Therefore, from a purely commercial perspective, even GAAR simply increases the corporation’s risk of paying higher taxes, and it may not have a long-lasting impact on corporate managers who are prone to take aggressive tax stances.
Conclusion: A review of the economic and legal factors influencing how tax evasion and company governance interact reveals a strong connection between the two. In reality, there is a concave relationship where, on the one hand, unchecked tax evasion results in a decline in corporate governance standards and, on the other hand, an overemphasis on tax administrations’ efforts to combat it can lead to the impression that these administrations are dictating what constitutes good corporate governance. In this confluence of events, the statutory adoption of anti-avoidance regulations lends legitimacy to the acts of the tax administration, which is focused on reshaping commercial reality in a way that would increase tax collection. Therefore, the GAAR has been correctly criticised as acting as a magic wand to nullify the effects of other provisions of tax law, weakening the predictability of the tax system—which is essential for any organisation operating in the modern business climate.
Even GAAR “would not fix every problem with the tax system,” according to academic consensus; rather, it can only direct taxpayers toward “reasonable exercise of choices of behaviour under the relevant tax regulations.” Therefore, even after GAAR, the question in terms of corporate decision-making would come down to whether the tax-structure would likely pass the test of anti-avoidance. The extensive experience of GAAR in other jurisdictions has clearly demonstrated that opportunistic tax avoidance has not decreased in spite of GAAR. In any case, there is no disputing that GAAR serves as a deterrent to opportunistic tax behaviour, and corporate choices do certainly take this risk into consideration. Therefore, it is possible that GAAR will result in a change in corporate managers’ perspectives on tax-planning, specifically the adoption of aggressive tax-strategies, especially for closely-held firms, and as a result, add a new chapter to the body of knowledge on corporate governance. The question of whether GAAR can function as a statutory corporate governance norm to support corporate decision-making nevertheless continues to be raised.
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