Understanding basics of General Anti-Avoidance Rule (GAAR)

Anuranjan Sahni*

Introduction

The General Anti-Avoidance Rule (GAAR) is an anti-tax avoidance law in India to curb tax evasion and avoid tax leaks. It came into effect on 1st April 2017. The GAAR provisions come under the Income Tax Act, 1961. GAAR is a tool for checking aggressive tax planning especially that transaction or business arrangement which is/are entered into with the objective of avoiding tax. It is specifically aimed at cutting revenue losses that happen to the government due to aggressive tax avoidance measures practiced by companies. The Vodafone case, the biggest sensation of Indian Taxation history is one of the main reasons for the framework of GAAR.

GAAR is effective from assessment year 208-19. It is meant to be applied to transactions which are prima facie legal but result in tax reduction. Broadly tax reduction can be of following three categories:

> Tax Mitigation

> Tax Evasion

> Tax Avoidance

We have explained these further to understand which type of tax reduction invoke GAAR.

Concept of Tax Evasion, Tax Avoidance and Tax mitigation

Tax mitigation is a ‘positive’ term in the context of a situation where taxpayers take advantage of a fiscal incentive provided to them by a tax legislation by complying with its conditions and taking cognisance of the economic consequences of their actions. Tax mitigation is permitted under the Act. This tax reduction is acceptable even after GAAR has come into force.

Tax evasion is when a person or entity does not pay the taxes that is due to the government. This is illegal and liable to prosecution. Illegality, wilful suppression of facts, misrepresentation and fraud—all constitute tax evasion, which is prohibited under law. This is also not covered by GAAR as the existing jurisprudence is sufficient to cover tax evasion/Sham transactions.

Tax avoidance includes actions taken by a taxpayer, none of which are illegal or forbidden by the law. However, although these are not prohibited by the law, they are considered undesirable and inequitable, since they undermine the objective of effective collection of revenue. GAAR is specifically against transactions where the sole intention is to avoid tax. In this the taxpayers used legal steps which results in tax reduction, which steps would not have been undertaken if there was no tax reduction. This kind of tax avoidance planning is sought to be covered by GAAR.

With GAAR there is no difference between tax avoidance and tax evasion. All transactions which have the implication of avoiding tax can come under the scanner of GAAR.

Now let’s see when can GAAR apply and in which cases GAAR is exempt in the forgoing paragraphs.

When can GAAR Apply?

As per the provision of the Income Tax Act, GAAR would apply to an arrangement entered into by the tax payer which may be declared to be an impermissible avoidance agreement (IAA).

This provision starts with a non-obstante clause. Thus, it has an overriding applicability.

Now we will understand what does Impermissible Avoidance Agreement mean.

What is Impermissible Avoidance arrangement (IAA)

The provision of GAAR is to codify the doctrine of ‘substance over form’ where the real intention of the parties and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure of the concerned transaction or arrangement.

Therefore, GAAR provisions are applicable to “Impermissible avoidance arrangement” (IAA) for which following two conditions have to be satisfied :

1. The main purpose of entering into such arrangement is to obtain tax benefit, and

2. If the arrangement:

• • Creates rights or obligations, which are not ordinarily created between persons dealing at Arm’s Length Price (or)
  • Results, directly or indirectly, in the misuse or abuse of the provisions of The Income Tax Act (or)
  • Lacks or deemed to lack commercial substance in the whole or in part (or)
  • Is entered or carried out by means or in a manner which is not ordinarily employed for bona fide purpose.

Onus on whom?

Under GAAR the onus is on the revenue to declare an arrangement as IAA. If the revenue considers that the arrangement is an IAA, the assessee will be given an opportunity to be heard. Based on the response of the assessee further action will be taken.

Thus there is no suo-moto application of GAAR. It has to be specifically applied by the revenue by declaring the arrangement as IAA. Having declared an arrangement as IAA, the onus shifts to the assessee to rebut the declaration or agree with the revenue’s view.

The decalation of an arrangement as IAA has to be under specified process u/s 144BA

Now we have discussed few cases where GAAR we will see whether GAAR would apply or not.

Case A :A business sets up an undertaking in an under developed area by putting in substantial investment of capital, carries out manufacturing activities therein and claims a tax deduction on sale of such production/ manufacturing. Is GAAR applicable in this case?

There is an arrangement and one of the main purposes is a tax benefit. However, this is a case of tax mitigation where the tax payer is taking advantage of a fiscal incentive offered to him by submitting to the conditions and economic consequences of the provisions in the legislation e.g., setting up the business only in the under developed area.

Therefore, Revenue should not invoke GAAR as regards to this arrangement.

Case B :A business sets up a factory for manufacturing in an under developed tax exempt area. It then diverts its production from other connected manufacturing units and shows the same as manufactured in the tax-exempt unit (while doing only process of packaging there). Is GAAR applicable in this case?

There is an arrangement and there is a tax benefit, the main purpose of this arrangement is to obtain a tax benefit. The transaction fails to have a commercial nature and there is misuse of the tax provisions.

Therefore, revenue should invoke GAAR as regards to this arrangement.

Case C :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 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 Place of effective management.

Case D :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 bona fide purpose of creating a subsidiary and the sole purpose was to avoid tax resulting into misuse of provisions of Income Tax Act and hence the provisions of GAAR will made applicable.

Conclusion

The conditions and tests are very elaborate. Almost any situation which will have the effect of tax reduction, can be covered within GAAR. Therefore, one must analyse the tax implication of any transaction very carefully before undertaking the same.

Also, there is many criticism regarding GAAR since anti-tax avoidance regulations are difficult to implement as it is hard to differentiate between different types of avoidance practices. Many provisions of GAAR have been criticised by various thinkers. However, the basic criticism of GAAR provisions is that it is considered to be too harsh in nature and there was a fear that tax authorities will apply these provisions regularly and torture the general honest tax payer too.

*(Author ‘Anuranjan Sahni’ is associated as Analyst-Direct Tax with ‘International Business Advisors, Delhi’)