GAAR- General Anti Avoidance Rules

If any transaction is treated as Impermissible Avoidance Arrangement under GAAR then in such case accommodating party will be disregarded.

But again to invoke the provision of GAAR, the Tax Benefit to all accommodating party shall exceed Rs 3 Crore. This gives the window of Tax planning i.e., overall tax benefit in the relevant previous year is upto Rs 3 Crores.

Further law also states that transaction has not to be seen in isolation i.e., Substance over form in order to arrive at a position that transaction is merely done for the Tax benefit.

General Anti Avoidance Rule (“GAAR”) is made to codify the “Substance over Form” doctrine and it is based on the principle that transactions have to be real and are not to be looked at in isolation. When there is no business purpose and no commercial expediency, except to obtain a tax benefit. Such tax benefits arise from arrangements that are ‘impermissible avoidance arrangements’.

Applicability of GAAR

GAAR provisions apply where aggregate Tax benefits in relevant assessment year arising to all the parties to the arrangement exceed Rs 3 Crores.

Important Definitions

1. Relative: – As per Section 56(2) of income tax act, In case of an individual: –

a. Spouse of the individual

b. Brother or sister of the individual

c. Brother or sister of the spouse of the individual

d. Brother or sister of either of the parents of the individual

e. Any lineal ascendant or descendant of the individual

f. Any lineal ascendant or descendant of the spouse of the individual

g. Spouse of the person referred to in above points

2. Tax Benefit: – It includes

a. Reduction/avoidance/deferral of tax or other amount payable under this Act. (Income Tax Act 1961)

b. Increase in refund of tax or other amount under this Act.

c. Reduction/avoidance/deferral of tax or other amount that would be payable under this Act, as a result of Tax Treaty.

d. An increase in refund of tax or other amount under this Act as a result of tax treaty.

e. Reduction in total income.

f. Increase in loss.

Impermissible Avoidance Arrangement

An arrangement is an Impermissible avoidance arrangement if following twin conditions are fulfilled: –

If primary condition along with any of the above tainted condition is fulfilled then such arrangement will be called as an Impermissible Avoidance Arrangement.

Arrangement that deemed to lack commercial substance

It involves or includes: –

1. Round Trip Financing

2. An accommodating party

3. Elements that have effect of offsetting or cancelling each other.

4. Transaction which is conducted through one or more persons and disguises the value, location, source, ownership and control of funds which is subject matter of such transaction

Examples for Reference

1. Round Trip Financing

X ltd., an Indian Company incorporates a subsidiary company Z Ltd in Cyprus (No Tax Jurisdiction) with equity of UDS 100 million. Z Ltd gives a loan of USD 100 million to another Indian company Y Ltd at a rate of 10% p.a.

Y Ltd claims the deduction of interest payable to Z Ltd from the profit of business and there is no activity other than this.

This arrangement appears to avoid the payment of tax on interest income by X ltd in case loan is directly provided by X ltd to Y ltd. The arrangement involves round tripping of funds even though the funds emanating from X ltd are not traced back to X ltd. Hence arrangement deemed to lack commercial substance.

In such case Z Ltd may be disregarded and interest income will be taxed in hands of X ltd.

2. Transaction which is conducted through one or more persons and disguises the value, location, source, ownership and control of funds which is subject matter of such transaction

Dubai X is a banking institution in Dubai (No Tax Jurisdiction). There is a closely held company Y in Dubai which is wholly owned subsidiary of another closely held Indian company of Z.

Y has reserves and if it provides loan to Z, it will be treated as Deemed dividend under section 2(22)(e) of the Act.

To avoid this Y made a term deposit with Dubai X bank and such bank on the basis of security provides a back to back loan to X.

This is an arrangement whose main purpose is to bring money out of reserves in Y subsidiary to India without payment to due taxes. The tax benefit is saving of taxes on income to be received from Y subsidiary by way of dividend or deemed dividend. The arrangement disguises the sources of funds by routing it through Dubai Bank. Dubai bank may also be treated as accommodating party. Hence such arrangement shall deemed to lack commercial substance.

Conclusion

Since as stated above, any arrangement fulfilling above conditions would be treated as the Impermissible Avoidance Arrangement and in these cases accommodating party will be disregarded and every income will be taxable in the hands of real originator i.e., Substance over form.

But again to invoke the provision of GAAR, the Tax benefit (as defined above) to all the accommodating party shall exceed Rs 3 Crores in the relevant previous year. This also gives the window for the tax planning i.e., whose overall tax benefit to all the accommodating parties is upto Rs. 3 Crores in the relevant previous year. In such scenario, GAAR would not be invoked and no accommodating party will be disregarded.

Further, law also states that transaction has to be real which will not be seen in isolation. This means that the any party who in real sense is transacting in any way which might lead to tax benefit but a normal business transaction which is done not to gain the tax benefit (i.e., Primary objective is not tax benefit) may be looked on case to case basis whether the party will become the accommodating party or not and whether GAAR would be invoked in such case or not.