By Gautam Chopra, Principal Associate, Vaish Associates Advocates, Gurgaon Haryana, India
Domestic tax laws of countries generally contain specific anti-avoidance regulations, i.e. regulations which provide for disregarding of a transaction or any part thereof if the conditions specified in the regulations are met. Such examples in the Indian context include disallowance of loss in case of bonus/ dividend stripping transactions, prohibition on carry forward of losses in case of change in shareholding, giving loans and advances to closely held companies, clubbing of income of minors etc.
The rationale for an anti-avoidance law is to prevent taxpayers from taking unintended benefits of the provisions of tax laws. Over a period it has been felt that specific anti-avoidance regulations do not sufficiently meet the objective of preventing tax avoidance by taxpayers as taxpayers continue to find newer ways to obtain 'tax benefits'. As a result, a general overarching set of regulations seeking to prevent tax avoidance, better known as General Anti-Avoidance rules (GAAR), have been enacted in several countries across the world. The rationale for general anti-avoidance rules is that a transaction's primary driver should be commercial consideration and not tax reduction or avoidance.
In the past, even while GAAR has not been on the statute in India, Courts have, from time to time, invoked the 'substance vs. form' doctrine to disregard the transaction where the primary objective of the transaction has been found to be tax avoidance. A recent example of this is a decision of the Gujarat High Court in case of Vodafone Essar Ltd: [2011] 161 Comp Cas 144 (Guj). In this case, the Court declined to accord its approval to a scheme of reorganization under sections 391-394 of the Companies Act, 1956 since the Court was of the view that the transaction was, prima facie, designed to avoid tax.
GAAR- international experience
In the US, GAAR as part of the statute book was introduced in 2010. Prior to 2010, it was a doctrine, more commonly known as 'Economic Substance Doctrine' which the Courts applied to disregard certain transactions or certain steps in a transaction for tax purposes. The UK does not have a statutory GAAR. It has allowed the GAAR to be developed over a period of time through Court rulings based on again, the substance test.
Similar to proposed Indian GAAR [as contained in the proposed Direct Taxes Code (DTC)], Canadian GAAR gave sweeping powers to the Revenue when it was introduced in 1988. However, over a period of time, Courts have interpreted the GAAR in a more reasonable and balanced manner. Another notable feature of Canadian GAAR is that it puts the onus of proving that the transaction is intended for tax avoidance, on the Revenue authorities. Canadian GAAR also has provision for seeking advance rulings to achieve certainty for taxpayers intending to enter into a transaction. Netherlands GAAR also puts the onus of proving lack of substance in a transaction in order to invoke GAAR, on the Revenue.
GAAR- the Indian context
Indian GAAR is modeled to a large extent, on South African GAAR. South Africa itself introduced GAAR in 2006 and there is not much guidance available in the form of judicial precedents which may help in interpreting South African GAAR. It is interesting to note that India has not chosen to base its GAAR on GAAR provisions existing in countries such as Australia, Canada or Netherlands, where GAAR has been in place for much longer period of time.
The proposed GAAR would apply to any arrangement [impermissible avoidance arrangement] which is intended to obtain a tax benefit in a manner not normally employed for business. The 'impermissible avoidance arrangement' is defined to include any arrangement if its main purpose is to obtain a tax benefit in a manner not normally employed for bona fide business purposes. Any transaction lacking commercial substance which results in a tax benefit will also fall within the scope of GAAR. GAAR will also seek to cover cases where round tripping is suspected.
GAAR, as currently proposed, seeks to empower the Revenue (Commissioner of Income Tax) to recompute income and taxes, by disregarding a transaction or any step in a transaction. The onus of proving that the transaction is not entered into primarily for tax benefit would be on the taxpayer. This would put enormous burden on the taxpayers and such a position is also not in line with some of the international best practices [e.g. Netherlands, Canada etc]. To illustrate, proposed GAAR provides for recharacterization of debt into equity or vice versa in certain cases. Therefore, in a case where an investment is made through compulsorily convertible debt instruments, GAAR can be invoked to disallow interest on debt by recharacterizing debt as equity. In such a case, the onus that the arrangement was not entered into to obtain a tax benefit would be on the taxpayer.
In fact, nearly all corporate restructuring activities, including mergers and acquisitions, de-mergers, debt restructuring etc may come under the scanner of GAAR. Therefore, it is imperative that detailed guidelines are put in place to exclude from the purview of GAAR, transactions of a routine nature, unless there is overwhelming evidence of tax avoidance.
Advance Ruling mechanism, as currently proposed under the DTC, provides for seeking a ruling by a non-resident or a resident in respect of a transaction with a non-resident. It appears that once an advance ruling is obtained, the transaction in respect of which such ruling is obtained will not be subject to GAAR, since advance rulings would be binding on the Commissioner and the authorities below him. However, this route is available only for transactions which involve non-residents or certain specified class of assesses, that may be notified for the purpose by the Board. In respect of all other assessees, advance ruling mechanism is not available. It would be important to have a similar mechanism for all assesses across the board to achieve certainty in business transactions. It is proposed that forum of DRP will be available in cases of GAAR. However, past experience has shown the practical limitations of DRP in granting any substantial relief to the assessees. Therefore, the need to have an AAR mechanism is absolutely important.
At present, there is no clarity on applicability of GAAR to transactions which have taken place before the introduction of GAAR, which may continue to have effect during the post GAAR period. There is a case to specifically exempt such classes of transactions from applicability of GAAR in the interest of fair play and to avoid litigation which may ensue otherwise.
GAAR and Treaty interplay
Almost all Double Taxation Avoidance Conventions ('Treaties') concluded by India have in-built anti-avoidance rules as regards items of income dealt with under the treaties, the foremost being the concept of 'liable to tax'. The concept seeks to restrict availability of treaty benefits to bona fide residents of a Contracting State, who are liable to tax in that Contracting State. Then there is a concept of 'beneficial ownership' which enables the legal and beneficial owner of passive incomes like royalty, interest etc to receive the same subject to lower tax withholding rate in the source State. Sometimes, entitlement to treaty benefits may be subject to satisfaction of prescribed conditions –essentially substance tests. An example of this is India Singapore Treaty, which was amended in 2005 to restrict the benefits of capital gains exemption to entities which passed the prescribed 'substance' test.
While GAAR provides for treaty override, it appears that entities, which may otherwise be eligible under the substance tests prescribed in the Treaty, would be disentitled to the Treaty benefits if GAAR is invoked. This aspect also needs to be looked into critically and perhaps there is a case to make some exceptions at least in cases where Treaty itself contains detailed 'Limitation of benefits' conditions.
Conclusion:
While the need for GAAR is well-recognized, there needs to be adequate safeguards in the regulations, otherwise there is a risk that such regulations may become an oppressive tool in the hands of the Revenue to indiscriminately disallow genuine transactions and lead to business uncertainties. There is urgent need for issuing detailed guidelines on GAAR, which should seek to address the concerns of the taxpayers, while allowing the Revenue, its fair share of taxes. Perhaps, there is also a case for formulating draft guidelines on implementation of GAAR and opening up such draft guidelines for public comments before they are finalized, which would go a long way in allaying fears , if any, about the potential misuse of the provisions.
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