India: Clarifications On GAAR Implementation

Last Updated: 13 February 2017
Article by SKP  

The provisions of Chapter X-A of the Income Tax Act, 1961 relating to General Anti-Avoidance Rule (GAAR) will be enforced from 1 April 2017. The Central Board of Direct Taxes (CBDT) received certain queries about the implementation of GAAR provisions. The Board constituted a Working Group in June 2016 for this purpose. The Board has considered the comments of the Working Group and has issued certain clarifications.

Key highlights of the clarification issued are summarised below

  • Co-existence of GAAR and Specific Anti-Avoidance Rules (SAAR) provisions depending upon the facts and circumstances of the case.
  • Adoption of anti-abuse rules in tax treaties may not be sufficient to address all the tax avoidance strategies. They are required to be tackled through domestic anti-avoidance rules. If a case of avoidance is sufficiently addressed by the Limitation of Benefit (LOB) clause in the treaty, there shall not be an occasion to invoke GAAR.
  • The taxpayer is entitled to select or choose the method of implementing a transaction.
  • GAAR should not be invoked merely on the ground that the Foreign Portfolio Investment (FPI) is located in tax efficient jurisdiction. If the jurisdiction of the FPI is finalised based on non-tax commercial considerations and the main purpose of such an arrangement is not to obtain a tax benefit, GAAR will not apply.
  • Grandfathering from GAAR will be available to any income arising from the transfer of investments done before 1 April 2017, even with respect to the instruments which are compulsorily convertible, such as Compulsorily Convertible Debentures, Compulsorily Convertible Preference Shares, Foreign Currency Convertible Bonds and Global Depository Receipts. Grandfathering shall be available even in the case of shares received on split or consolidation of holdings or by way of bonus in respect of shares acquired before 1 April 2017, i.e. GAAR shall not apply to such investments.
  • Lease contracts and loan arrangements are not covered under the definition of investments as per the Accounting Standards, and shall not be grandfathered, i.e. GAAR shall be applicable in respect of such arrangements.
  • GAAR shall not apply if a particular arrangement is permitted by the Authority for Advance Ruling in respect of the applicant.
  • GAAR shall not be applicable when the tax implications of an arrangement have been explicitly and adequately considered at the time of sanctioning the arrangement by the Court or National Company Law Tribunal (NCLT).
    It would be crucial maintaining the trail of submissions/discussions on tax implications held/made before the Court while the sanctioning process such as in the case of amalgamation, merger, demerger, etc.
  • There was a specific query on GAAR applicability with respect to opting in treaty benefit by a Fund in year one and opting out of the benefit in year two. A specific example of a fund claiming treaty benefit on gains from derivatives in one year and in another year sets off the losses from derivatives against gains from shares under the Act has been given.
    It has been clarified that the admissibility of a claim under the treaty or domestic laws in different years shall not be decided through GAAR provisions. GAAR is restricted to impermissible avoidance agreements.
  • Adequate safeguards have been implemented to ensure that GAAR is invoked only in deserving cases through a two stage vetting process, once by the Principal Commissioner/Commissioner and then by the Approving Panel headed by a Judge of a High Court.
  • Another specific query was made on the consequences of GAAR. A question was raised whether GAAR can lead to the assessment of notional income or disallowance of real expenses. It was also asked whether GAAR applicability leads to expanding the scope of the taxable base among other things.
    In this regard, the CBDT only mentioned that once an arrangement is disregarded, the necessary consequences may follow. They have remained silent on the specific question. However, one can infer that in that case, the expense could get disallowed and the income could get taxed.
  • With regard to clarity on the non-application of GAAR in respect of arrangements existing for a specific time (5 to 10 years), it has been clarified that the period of time for which the arrangement exists is one of the relevant factors and is not a sufficient factor in determining whether an arrangement lacks commercial substance.
  • In the event of a particular consequence being applied in the hands of one of the participants as a result of GAAR, the corresponding adjustment in the hands of another participant will not be made. In this regard, one of the examples provided in the Shome Committee report has been given below:

Example

Company A Ltd. enters into a ready forward contract with B Ltd., whereby A Ltd. sells some unlisted securities to B Ltd. for INR 1,000 on 1 January 2020 and on 1 January 2021, the company A Ltd. purchases the same unlisted securities for INR 1100 as agreed in advance. The forward contract price was based on a rate of return of 10% p.a. B Ltd. claims the gain of INR 100 as long-term capital gains, which are not taxable at the marginal rate of 30%.

Consequences

The ready forward contract and fixing the price based on the rate of interest clearly suggests that it was given a form of purchase and sale of goods, but in fact, it was a financing arrangement. The sole purpose of the arrangement was to obtain a tax benefit. The substance or effect of the arrangement as a whole is inconsistent with the form of its individual steps. Thus, it may be deemed to lack commercial substance. Hence, GAAR shall be invoked to recharacterise the capital gains in the hands of B Ltd. as interest income and taxed at applicable rates. Furthermore, the corresponding deduction of interest expense would not be allowed in the case of A Ltd.

  • The tax benefit arising due to a certain arrangement or part of the arrangement enjoyed in Indian jurisdiction shall be examined for each assessment year. Furthermore, the threshold limit of INR 30 million for the applicability of GAAR shall not be in respect of a single taxpayer, but it is specific to an arrangement.
  • Based on the principle of consistency, if an arrangement has been held to be permissible in one year, GAAR shall not be invoked in subsequent years if the facts and circumstances are the same.
  • Levy of the penalty shall depend on the facts and circumstances of the case and shall not be automatic. No blanket exemption from penalty proceedings has been provided as per the law. The taxpayer can apply for reduction/waiver of a penalty if it fulfils the requisite conditions listed in the penal provisions.
  • SKP's comments

    The instances and transactions which may come up before the tax authorities during the implementation period will allow the law to evolve. Furthermore, the Final Shome Committee Report issued in 2012 provided a detailed analysis of the provisions along with examples on the applicability and non-applicability of GAAR along with the recommendations on various issues raised by stakeholders. The clarifications issued above, vide Circular No. 7, addresses some of the concerns raised by stakeholders. However, all the aspects of the Final Shome Committee Report have not been taken into consideration in this circular. Perhaps a reference can be drawn from the Final Shome Committee Report with regards to the applicability of GAAR and various other aspects covered therein, along with the examples given for a particular fact or situation. However, the same may not be binding on the tax authorities. Perhaps the court may take cognizance of the same.

    We have highlighted few points below which require some consideration:

    • As per Section 100 of the GAAR provisions, it clearly mentions that these provisions are in addition to or in lieu of any other basis for determination of tax liability. Hence, in accordance with the same and as mentioned in the circular, GAAR shall apply even if a particular transaction fulfils the conditions of SAAR.
    • It is not clear that if the substance test as per the LOB clause is fulfilled, GAAR will apply or not. It may happen that even if the LOB test is fulfilled, GAAR may still apply for other reasons. Furthermore, multilateral arrangement lays down LOB test as well as principal purpose test which need commercial reasoning for the existence of the enterprise, being a resident of a treaty country. Hence, it is necessary for the taxpayers to take cognizance that mere substance assurance will not suffice, but principal purpose test needs to be fulfilled too.
      Furthermore, the term 'sufficiently addressed' in respect of LOB clause has not been explained and has been left to the tax authorities to interpret.
    • As per the Shome Committee recommendations, while determining tax consequences of an impermissible avoidance arrangement, the corresponding adjustment should be allowed in the case of a taxpayer in the same year, as well as in different years, if any. However, no such clarity is given in the circular. This creates doubt whether relief, if any, in the hands of the same taxpayer should be granted in same or subsequent years corresponding to the addition made.
    • It was discussed in the Shome Committee report that while processing an application for lower withholding of taxes, the taxpayer can submit a valid undertaking/indemnity to pay tax along with interest, in case it is found that GAAR provisions are applicable in relation to the remittance during assessment proceedings. In case it is not done by the taxpayer, then the matter can be put up for the approval of the Commissioner by the Assessing Officer (AO) if the AO finds any applicability of GAAR in the proposed transaction. There is no clarity in this regard in the circular.

    To sum up, it is now evident that GAAR would certainly be enforced from 1 April 2017 and that there is no deferral. Based on the current provisions of GAAR, grandfathering is available only for investments made up to 31 march 2017 and not for the arrangement entered into untill 31 March 2017. Thus, it would be advisable for the taxpayers to immediately check their current tax affairs and the arrangements entered into as it might not be grandfathered.

    All in all, due to the amendments made in the Mauritius, Cyprus and Singapore tax treaties, Base Erosion and Profit Shifting (BEPS) Action Plan being adopted, the Automatic Exchange of Information (AEOI) through the Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard (CRS), crack down on black money, The Benami Property Act and now GAAR, the taxpayers are in a difficult position and the need of the hour is to have a close look at the existing structures. Also, the days of aggressive tax planning seems to be over.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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