Edited by Hitender Mehta
General Anti-avoidance Rules (GAAR) were introduced in the Income Tax Act, 1961 by the Finance Act, 2012 to apply with effect from April 1, 2013. Subsequently, based on numerous representations, an Expert Committee was constituted by the Prime Minister to advise on roadmap for implementing GAAR.
The said Committee has made several far reaching recommendations in its report, some of which are summarized as follows:
- Implementations of GAAR may be deferred by 3-years.
- GAAR approving panel should consist of 5 members, with a Chairman being a retired High Court judge, and 2 independent representatives comprising prominent personalities from the field of finance and accounting.
- A negative list of transactions should be prescribed wherein GAAR will not be invoked. This will ensure that genuine forms of tax planning and tax savings scheme are protected.
- It is recommended that Circular no. 789 should be reinstated and if a Mauritian company possesses valid Tax Residency Certificate (TRC), treaty benefit should not be denied.
- Where specific anti-avoidance rules apply, GAAR should not be invoked.
- In order to invoke GAAR, monetary threshold of ` 3 crore should be applied, i.e. transactions leading to a tax benefit of upto ` 3 crore should be excluded from the ambit of GAAR.
- Tax collections from GAAR should not be reckoned as part of targets for the field officers and jurisdictional commissioners by virtue of which department would not invoke GAAR to meet tax collection targets.
- A distinction should be made between tax mitigation and tax avoidance; where a tax payer has a choice of adopting a method to pay less tax, he should be permitted to do so, unless it's not a commercially driven transaction/ action.
- Tax treaties should not be overridden by GAAR.
- Foreign Institutional Investors (FIIs) should not be taxed on gains from sale of listed securities, whether short-term or long-term gains.
- GAAR should not be invoked in respect of intra-group transactions which, if cumulatively considered, are tax neutral.
- Where GAAR is invoked, corresponding adjustments should be allowed to other taxpayers.
- All existing investments should be grandfathered and excluded from applicability of GAAR.
- GAAR should not apply where a resident of a country holds a valid TRC and is not hit by Limitation on Benefits clause, wherever such clause exists in a Treaty.
- Due weightage should be given to tenure of arrangements, payment of taxes and option to exit in deciding whether a transaction lacks commercial substance, while invoking GAAR.
Comments: The recommendation to postpone implementation of GAAR for 3 years is welcome, as the adverse implications that GAAR provisions in their present form, would have had on the economy and business, do not appear to have been well thought through. The recommendation to reinstate Circular no. 789 and provide protection to companies investing in India through Mauritius is also a welcome move and another attempt to restore investors' confidence, which had been adversely affected on account of recent retrospective amendments. The report also makes certain other welcome recommendations particularly relating to minimum monetary threshold to trigger GAAR, need to protect treaty benefits, broad-based approving panel headed by a retired High Court judge, etc. It is expected that GAAR provisions as enacted would be amended taking into consideration the above amendments.
Government notifies Advance Pricing Agreement Mechanism
Provisions relating to Advance Pricing Agreement ('APA') were introduced in the Income Tax Act, 1961 vide Finance Act, 2012. The rules/ mechanics for implementing the same, however, were to be notified by the Government. The Government has vide Notification no. 36/2012 dated August 30, 2012, introduced rules for implementation of APA mechanism, the salient features of which are as under:
- Any person who has undertaken or is contemplating to undertake an international transaction shall be eligible to enter into an APA.
- Every person proposing to enter into an APA can make an application in prescribed form, requesting for a pre-filing consultation, including the following:
- determine the scope of the agreement;
- identify transfer pricing issues;
- determine the suitability of international transaction for the agreement;
- discuss broad terms of the agreement.
- APA shall not be binding on the Revenue or the assessee if there is a change in any of the critical assumptions. "Critical assumptions" mean the factors and assumptions that are so critical and significant that neither party entering into an agreement will continue to be bound by the agreement, if any of the factors or assumptions is changed.
- In case of anonymous pre-filing, the names of the assessee or the associated enterprise ('AE') are not to be given. However, details of the authorized representatives of the assessee who would be appearing before the authorities for the pre-filing discussions would need to be furnished.
- Unilateral, bilateral and multilateral APAs may be entered into. For unilateral APAs, the application has to be filed with the Director General of Income Tax (International Tax) ('DGIT'); whereas for bilateral and multilateral APAs, the application has to be filed before the Competent Authority. The details to be furnished along with the application include the following:
- Corporate background of the assessee and its AEs;
- Transaction flows of the multinational enterprise (volumes, directions and amounts) that may have an impact on the pricing of the covered transactions;
- Detailed functional analysis of the assessee and all relevant entities with respect to the covered transactions;
- Business strategies, including current and future Budget statements, projections and business plans for future period covered by proposed APA etc., general business and industry trends, future direction/ business strategy including R&D, production, and marketing;
- Copies of all relevant intercompany agreements (pricing, cost sharing, licensing, distributorship etc.);
- Detailed analysis of industry and markets for all countries involved;
- Discussion of relevant legal considerations and requirements;
- Discussion of transfer pricing methodologies, policies, and practices used by the assessee and AEs for the covered transactions during the past three years, or business cycle as appropriate;
- Discussion of relevant rulings, APAs and other similar arrangements entered into with foreign tax administrations, for transfer pricing or other valuation bases, or other taxation matters entered into by the assessee.
Comments: The aforesaid Notification has operationalized the provisions relating to APA. Introduction of multilateral APAs is a welcome step as that will mitigate double taxation, as also, anonymous pre-filing consultations, as this will help the assessees to decide whether to go for APA without worrying about the confidential information coming into the knowledge of the Revenue.
The issuance of the aforesaid is a positive development and it is expected that taxpayers at large would benefit from this mechanism, which will not only reduce uncertainty but also costly and time-consuming litigation.
Gujarat High Court holds the scheme of reconstruction of tower business of Vodafone Essar Gujarat Ltd. – not tax Avoidance
The Gujarat High Court, in case of Vodafone Essar Gujarat Ltd. has held that scheme of reconstruction cannot be considered as one for tax avoidance and overruled the decision of single judge, who had not approved the scheme.
In this case, Vodafone Essar Gujarat Ltd. ("transferor") filed a petition under Sections 391 to 394 of the Companies Act, 1956 to transfer its 'Passive Infrastructure Assets' to Vodafone Essar Infrastructure Ltd. ("transferee") free of liabilities and encumbrances. The corresponding liabilities were not to be transferred. No consideration was payable by the transferee nor were any shares to be allotted to the shareholders of the transferor. Post demerger, the transferee was to be made a substantially owned company of a new company to be formed by all or some of the shareholders of the transferee. Thereafter, the transferee was to be amalgamated/ merged into Indus Towers Ltd.
The application was opposed by the Income-tax Department on the ground that since no consideration was involved, the scheme was designed for tax avoidance. The petition was heard by the Company Judge, who came to the conclusion that the sole object of the Scheme was to avoid tax on income in excess of ` 3,500 crore and also stamp duty and VAT to the tune to ` 600 crore, which would have been payable otherwise in case of transfer of assets. He accordingly refused to sanction the arrangement. On appeal by the company, the division bench of the Gujarat High Court sanctioning the scheme held, as follows:
- The Scheme cannot be said to have no purpose or object and that it is a mere device/ subterfuge with the sole intention to evade taxes. While it is true that the Scheme may result in tax avoidance, it cannot be said that the only object of the Scheme is tax avoidance. In Vodafone International Holdings B.V 341 ITR 1 (SC) it was held that the Revenue cannot start with the question as to whether the impugned transaction is a tax deferment/ saving device and that it should apply the "look at" test to ascertain its true legal nature. The business purpose of a transaction is evidence of the fact that the impugned transaction is not undertaken as a colourable or artificial device. It cannot be said that all tax planning is illegal/ illegitimate/ impermissible.
- The Revenue's argument that the transfer is void for want of consideration is not acceptable because it is not a party to the transaction. Even a consideration of one rupee can be said to be a valid consideration and it is not necessary that consideration is always a monetary consideration. In a reconstruction, there is a give and take and mutual/ reciprocal promises and obligations, which can be said to be consideration for each other.
Comments: This ruling reemphasizes the position of law that legitimate tax planning is permissible and cannot be equated with tax avoidance. In other words, every person has the right to arrange its affairs in a manner to achieve tax efficiencies and the transaction cannot be disregarded merely because it leads to a tax benefit. Significantly, the Court has also observed that consideration, in a scheme of reconstruction need not always be monetary consideration and they are mutual/ reciprocal provisions and objectives, would constitute consideration. The scheme could not be said to be for tax avoidance on the ground that it did not envisage a monetary consideration.
Goodwill arising on acquisition of business eligible for depreciation
The Supreme Court, in the case of Smifs Securities Ltd: 24 taxmann.com 222, held that goodwill arising on acquisition of business was eligible for deprecation under Section 32(1)(ii) of the Income Tax Act, 1961.
In the aforesaid case, pursuant to the scheme of amalgamation, the assets and liabilities of amalgamating company vested in the taxpayer. Excess consideration paid by the taxpayer, over and above the value of net assets, was treated as goodwill in the books of the taxpayer. The excess consideration was stated to be paid towards reputation of the amalgamating company's business, which was acquired by the taxpayer. The taxpayer claimed depreciation on such excess consideration, treated as goodwill, under Explanation 3(b) of Section 32 the Income Tax Act, 1961, on the ground that goodwill was in the nature of business or commercial right.
The Supreme Court, holding that depreciation was allowable on such goodwill, observed as follows:
- Explanation 3(b) to Section 32 states that the expression 'asset' shall mean an intangible asset, being know how, patents, copyrights, trademarks, licenses, franchises, or any other business or commercial rights of a similar nature.
- A reading of the words 'any other business or commercial right of similar nature' indicates that goodwill would fall under the expression 'any other business or commercial right' and applying the principle of ejusdem generis, it had to be held that goodwill is an asset under Explanation 3(b) to Section 32.
Comments: The Delhi High Court, in the case of Hindustan Coca-Cola Beverages Pvt. Ltd: 198 Taxman 104 had held that payment on account of goodwill is similar to assets like patents, trademarks, etc. However, diverging views were expressed by the benches of the Tribunal on the issue of allowing of depreciation on Goodwill. The aforesaid decision of the Supreme Court has put to rest this controversy.
Editorial Team: Bomi F. Daruwala, Gautam Chopra, Hemant Puthran, Rupesh Jain and Shilpi Shivangi
© 2012, Vaish Associates, Advocates,
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