India: CBDT Clarifies GAAR Implementation Through 16 Point FAQs

Background

Inarguably one of the biggest tax reforms that the country has ever witnessed, the General Anti-Avoidance Rules (GAAR) inserted in Chapter X-A of the (Indian) Income-tax Act, 1961 (IT Act) are slated to take effect from 1 April 2017. Since the Central Board of Direct Taxes (CBDT) notified the GAAR provisions in the Income-tax Rules, 1962 (IT Rules) on 23 September 2013, uncertainty over their implementation has been a cause of worry for investors. A working group was constituted in June 2016 and based on their comments, the CBDT released a set of sixteen FAQs on 27 January 2017 to clarify the application of GAAR in certain situations.

SAAR v GAAR

The CBDT clarified that the provisions of Specific anti-avoidance rules (SAAR) in the form of the Limitation of Benefit (LOB) test in a tax treaty may or may not adequately address all tax avoidance strategies. If avoidance is 'sufficiently addressed' by the LOB test in the respective tax treaty, GAAR will not be invoked.

Otherwise, SAAR and GAAR both can co-exist and are applicable based on the facts and circumstances of each case.

Grandfathering of investments

The IT Rules provide that income from transfer of investments, which have been made prior to 1 April 2017 will be grandfathered. The CBDT has further issued clarifications regarding applicability of grandfathering provisions for income arising from transfer of following instruments:

  • compulsorily convertible instruments (such as compulsorily convertible preference shares, compulsorily convertible debentures, foreign currency convertible bonds, global depository receipts) from one form to another at terms finalised at the time of issue of such instruments, provided the convertible instrument was acquired prior to 1 April 2017;
  • shares brought into existence by way of split or consolidation of holdings acquired prior to 1 April 2017 in the hands of the same investor; and
  • bonus issuances in respect of shares acquired prior to 1 April 2017 in the hands of the same investor.

It further clarified that lease contracts and loan arrangements are not 'investments' and hence grandfathering for such transactions will not be available.

Applicability to fund structures

If the selection of jurisdiction of the foreign portfolio investor (FPI) is based on non-tax commercial considerations and the main purpose of the arrangement is not to obtain a tax benefit, then GAAR will not apply.

Further, GAAR does not extend to the admissibility of funds claiming tax treaty benefits in one year and opting to be governed by the provisions of the IT Act in another year.

Authority for Advance Rulings (AAR) and court approved structures

The AAR ruling is binding on the income-tax authorities in respect of the applicant and hence GAAR provisions will not apply to those transactions.

While sanctioning an arrangement, if the relevant court or National Company Law Tribunal has explicitly and adequately considered its tax implications, GAAR will not apply to such an arrangement.

Fair and rational application in the GAAR regime

In cases containing highly aggressive and artificially pre-ordained schemes, the proposal to declare an arrangement as an impermissible avoidance arrangement would be vetted by the Principal Commissioner/ Commission of Income Tax and then by an Approving Panel, headed by a High Court judge (Relevant Authorities) and thus, GAAR would be invoked only in deserving cases.

If GAAR provisions are invoked and consequences are applied in the hands of one party to the arrangement, a corresponding adjustment will not be made in the hands of the other. This is because GAAR is an anti-abuse, deterrent mechanism.

Miscellaneous

  • GAAR will not affect the right of a taxpayer to select a method of implementing a transaction.
  • GAAR can expand the scope of charging sections under the IT Act, permit the disallowance of expenditure actually incurred, assess notional income if a transaction qualifies as an 'impermissible avoidance arrangement'. The transaction will be disregarded by applying GAAR provisions, and necessary consequences will follow.
  • The timeline of an arrangement is relevant but not a conclusive / sufficient factor for determining its commercial substance.
  • The tax benefit threshold of INR 30 million is jurisdiction and assessment year specific and cannot be read in respect of a single taxpayer only as GAAR is applicable to an arrangement or part of the arrangement.
  • If an arrangement has been vetted by the Relevant Authorities as permissible in one year and the facts and circumstances remain the same, GAAR will not be invoked for that arrangement in the subsequent years.
  • The levy of penalty under GAAR is not automatic and is based on facts and circumstances of the case. There is no provision in the law for immunity from penalty for a period of five years. The taxpayer can apply for the benefit of a reduction or waiver of penalty, as provided under the law, provided the conditions for such benefit/waiver are met.

Khaitan Comment

While the FAQs clarify the 'SAAR v GAAR' debate and treatment of convertible instruments, it also opens new doors of ambiguity on certain fronts. For instance, the FAQs provide that GAAR will not apply if avoidance is 'sufficiently addressed' by the LOB test in a tax treaty. This standard seems rather vague, leaving room for a lot of subjectivity and litigation. It does not stand to reason as to why GAAR, i.e. the domestic legislation of a contracting state, should be invoked when there is compliance with a specific anti-abuse provision (in the form of an LOB test or otherwise) in a tax treaty, which is a bilateral agreement negotiated between sovereign states.

Similarly, it is stated that GAAR will not be applied in a court-sanctioned arrangement if the court has 'explicitly and adequately' considered its tax implications. Whether the contention has been 'explicitly and adequately' dealt with by the court will need to be assessed on a case to case basis.

The clarification on non-applicability of GAAR for FPI entities established in a treaty jurisdiction for commercial purposes merely affirms the current legal position.

While the CBDT circular on GAAR reinforces the government policy of non-adversarial tax regime but given the inherent risk of subjectivity, it may not be entirely litigation free.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com

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