This article is all about General Anti Avoidance rules (GAAR). These rules come into effect when any transactions are undertaken by being within the provisions of the Income tax Act but the sole purpose of such transaction is to avoid tax. So in order to develop the better understanding about our current topic, let us first understand what Special Anti-Avoidance Rules (SAAR) is and how they differentiate from GAAR. The scope of SAAR is predefined which prescribes the applicability of such rules under certain situations. For example-When any person receives loan from a closely held company, such loan received will be treated as Deemed Dividend and it will be chargeable to tax under section 2(22)(e). This case is one of the few examples of SAAR because it attracts the rules of Income tax for undertaking certain activity. Whereas in case of GAAR, as the name suggests the provisions will attract when the arrangements are made in order to avoid tax by being within the limits of Income Tax Act. So in order to put it in simple words, GAAR will apply when efforts are being made to show “Form over Substance” i.e. Legality over Reality. Therefore can be said that GAAR overrules Income Tax Act.
GAAR provisions are made applicable from AY: 2018-2019. Therefore any investments made before the aforesaid period to avoid tax will not attract the provisions of GAAR. But it shall be noted that any agreements made before the said period to avoid tax can be brought under the scope of GAAR. One more condition for applicability of GAAR states that when the saving of tax by both the parties to the transaction aggregately exceeds Rupees Three Crores, GAAR can be made applicable.
Where GAAR is invoked the particular transaction will be termed as Impermissible Avoidance Arrangement. So in order to term any transaction as impermissible avoidance arrangement, two following conditions should be satisfied.
1. The main purpose of undertaking the transaction is to avoid tax.
2. It creates rights, obligations which are not created when dealing in Arm’s length Price.
It results directly or indirectly into the misuse of the provisions of Income Tax Act.
It is not for bona fide business purposes
It lacks commercial substance partly or wholly
Let us briefly go through few cases where GAAR can be made applicable.
1. As per the DTAA between India and Kenya, any Kenyan company which holds more than 10 % of the shares of the Indian Company if sells such shares, the profit arising from such sale transaction will be made taxable in India. In order to overcome this, Kenyan company incorporates two fully owned subsidiary companies holding 9.95% shares each in the Indian company. So it can be said that the sole purpose of incorporating the subsidiaries was to split the holding of shares in order to remain within the provisions of the DTAA. Therefore in such case GAAR will be made applicable. It shall be noted that GAAR overrules Double Taxation Avoidance Agreements (DTAA’s).
2. An Indian Company buys goods from Singapore and sells in Dubai. So being an Indian Company, it’s world income will be made taxable in India. In order to avoid the levy of tax in India, the Indian company incorporates another company in Cyprus which is a Zero Tax Jurisdiction. This is basically done in order to show that such sale is undertaken through the company in Cyprus and the Place of effective management of business (POEM) is Cyprus. Since there is no commercial reason of undertaking the sale through the company in Cyprus, the status of the company incorporated in Cyprus will be dissolved and the provisions of GAAR will be invoked. Thus GAAR overrules POEM.
3. X Ltd an Indian Company is intending to provide a loan to Y Ltd also an Indian Company. But in order to avoid the taxability of interest income on such loan in the hands of X Ltd, it incorporates a subsidiary A Ltd in Cayman Islands (Zero Tax Jurisdiction) and such company provides a loan to Y ltd. Since there is no bonafide purpose of creating a subsidiary and the sole purpose was to avoid tax resulting into misuse of provisions of Income Tax Act. This is the classic case of Round Trip Financing and hence the provisions of GAAR will made applicable.
This was an attempt made by me to explain GAAR in short. Hope it serves your purpose.