The debatable principle of tax righteousness is not new, this contentious concept has always been a topic of some persuasive deliberations in the past, when it comes to the principles of tax management, tax planning or an art of paying less taxes. Whether, morality becomes relevant when someone takes some positive action to avoid paying tax, but is it a moral obligation not to try to reduce or avoid paying taxes within the legal framework; this seems a challenging thought.
Repeatedly, the courts have said that there is nothing sinister in so arranging one's affair as to keep taxes as low as possible1. Perhaps, everybody does so, rich or poor, and all do right, for nobody owes any public duty to pay more tax than the law demands: taxes are enforced extractions, not voluntary contributions. The argument is not on tax morality v. tax legality per se, it is the matter of following the principles of morality while applying the tax provisions to reduce the payment of taxes, i.e. to say the focus should be on tax planning and management and not aggressive tax avoidance planning.
The momentum of aggressive tax planning, has been growing for the last few years, High Net Individual(s), Corporates and Multi-National Enterprises have actively engaged themselves in building complicated tax structures to achieve less tax payouts. Though these structures are regarded legally correct but whether they stand within the four walls of morality is a topic of discussion around the world. Discussions of the ethics of tax avoidance are almost pervasive; even the most powerful countries of the word are actively engaged in the discussions and why not, as they are the most affected ones.
Base Erosion and Profit Shifting ('BEPS') project of Organization of Economic Cooperation and Development ('OECD') led by the G20 countries is focused on a coordinated drive by the countries across the world to address the concerns of aggressive tax planning by MNEs by modernizing the current framework of tax treaties and nationally-set-anti-tax avoidance laws. Treaty abuse is one of the chief concerns when it comes to attaining or defining objectives of BEPS Projects. BEPS Action Plan 6 on Treaty Abuse suggests that there is a need to identify the tax policy consideration that, in general, countries should consider before deciding to enter into a tax treaty with another country including carrying out a cost/benefit analysis of the tax treaty. The report prescribes for the development of domestic rules, and treaty provisions, that counter the unintended use of treaties to avoid payment of taxes.
With this background, India in its commitment towards the BEPS project and to protect its tax base, has taken umpteen number of steps, inter alia, enforcement of provisions of General Anti Avoidance Rules ('GAAR')2, Recent Amendments made to the bilateral tax treaty between India-Mauritius, Singapore and Cyprus and the introduction of thin capitalization rules3, marks a beginning of a second generation reforms of the Indian Income Tax code.
GENERAL ANTI AVOIDANCE RULES ('GAAR'): EVOLUTION
In Indian Tax framework, GAAR was first proposed to be introduced in the year 2009 as a part of the Direct Tax Code (DTC). Since, DTC, 2009 faced plethora of representations from the investor and professional community at large, the same was revised in the year 2010.
It was widely felt that the provisions of GAAR under DTC, 2009 did not strike a balance between legitimate tax minimization and abusive tax avoidance. The revised version of DTC, 2010, essentially retained the same provisions of GAAR as provided for in the DTC, 2009, however, some enabling provisions pertaining to safeguards relating to process for invoking of GAAR were introduced. DTC was again revised and another version was presented in the year 2013. However, the new government, while announcing the Finance Budget, 2015, formally discarded the DTC stating that "there is no merit in going ahead with the Direct Tax Code as it exists today."
As the fate of DTC was not definitive, GAAR was introduced as Chapter X-A of the Act vide the Finance Act, 2012 under the existing tax laws (considering that new Direct Tax Code ideation was shelved by the new Modi Government) and was proposed to be implemented with effect from April 1, 2014. In view of the several representations received on the implementation of the GAAR, the Central Board of Direct Taxes ('CBDT'), the apex board administrating Direct Taxes in India constituted a committee to address the concerns of the community at large. The draft guidelines and the recommendations of the committee were released on June 28, 2012.
Post the receipt of the draft guidelines and recommendations, another expert committee under the chairmanship of Dr. Parthasarathi Shome was constituted to address the concerns of the foreign and domestic investors and finalise the draft GAAR guidelines. The first draft report of the Shome Committee was made public on August 31, 2012 and after considering the views and submissions of the public and other stakeholders, Dr. Shome submitted its final report on September 30, 2012. Since the said report was only for consideration of the government and was not binding, the government did accept majority of the recommendations of the Shome Committee, with certain modifications. The Finance Minister on January 14, 2013 announced that the GAAR with the proposed amendments shall be applicable April 1, 2016, rather than the proposed date of April 1, 2014.
The tax proposals for the year 2015, further postponed the introduction of GAAR for two years to the financial year 2017-18, with a grandfathering, that GAAR will not apply to investments made upto March 31, 2017. April 1, 2017 marks the beginning of the Financial Year 2017-18, and enforcement of provisions of GAAR4.
SCHEME OF GAAR REGULATIONS: CHAPTER X-A OF INCOME TAX ACT, 1961
GAAR as a codified law enshrined under Chapter X-A of the Income Tax Act, 1961 ('Act'), hinges in primacy upon the doctrine of "substance over form", where the real intention of the parties, the effect of transactions and purpose of arrangement is taken into account for determining tax consequences, irrespective of legal structure that has been superimposed to camouflage the real intent and purpose.
It inter alia empowers the tax authorities to deny tax benefit, if the transactions or arrangements do not have any commercial substance or consideration other than achieving the tax benefit.
Section 95 and 96 of the Act, further do suggest GAAR as an anti-avoidance measure, which, irrespective of anything laid down under the Act, provides power to the tax officials to treat any transaction or any arrangement as an 'impermissible avoidance arrangement', where the main purpose of entering in such transaction or arrangement is to obtain tax benefit.
The term "impermissible avoidance arrangement" in terms of the provisions of Section 96 of the Act essentially means an arrangement or a transaction whose main purpose is to obtain a tax benefit and lacks commercial substance in whole or in part.
Therefore, the scope of the provisions of Section 96 is very wide and for the purposes of an arrangement to be an "impermissible avoidance arrangement", a primary test of obtaining a tax benefit along with any of the secondary tests, as enlisted below, is to be satisfied.
Secondary Tests as provided under Section 96 of the Act:
- Creates rights, or obligations, which are not ordinarily created between persons dealing at arm's length;
- results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;
- lacks commercial substance or is deemed to lack commercial substance, in whole or in part; or
- is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.
While, the conditions provided in (a), (b) and (d) are subjective, the condition of lack of commercial substances as provided in (d) is defined under Section 97 of the Act.
In terms of the said Section an arrangement shall be deemed to lack commercial substance, where, the substance or the effect of the arrangement as a whole is inconsistent with the individual transactions or steps; or it involves ,round tripping financing, or an accommodating party, or the transaction is concluded or conducted in such a manner that the value, location, source and ownership of funds are disguised; or there lacks any substantial commercial purpose other than obtaining a tax benefit; or it does not have significant effect upon the business risks or net cash flows of any party to the arrangement other than the one attributable to the tax benefit.
The area of concern with respect to the enforceability of the GAAR is with regard to the scope of main purpose test of obtaining tax benefit. Section 96(2) of the Act, provides that the whole of the arrangement shall be deemed to be entered for the main purpose of obtaining a tax benefit, even if a step in, or a part of the arrangement is to obtain a tax benefit. Such deeming fiction shall hold good irrespective of the fact that the whole arrangement is not to obtain a tax benefit. Thus, even if one step in an arrangement or a transaction results in a tax benefit, it can be treated as an 'impermissible avoidance agreement'.
Furthermore, the said Section also casts a significant burden upon the tax payer to prove that the transaction or an arrangement or even a part of such arrangement was not entered into, or carried out, for the main purpose of obtaining a tax benefit. In such a scenario, wherein, even a small part of the whole transaction constitutes tax benefit, such deeming fiction, in all likelihood will lead to unintended consequences and protracted litigation.
GAAR PROVISIONS: APPLICATION FRAMEWORK AND MACHINERY PROVISIONS
The provisions of the Act, provides for sufficient procedural safeguards for the purpose of invoking of GAAR. Although, the proposal of invoking the provisions of GAAR will be initiated by the Assessing Officer, ultimate decision of the application of the same vests in the hands of the Approving Panel constituting (1) one sitting or retired judge of a High Court of India who will also be the chairperson; (2) one member from the Revenue, not below the rank of Chief Commissioner; and (3) one member who will be an academic or scholar having special knowledge of matters such as direct taxes, business accounts and international trade practices.
Rule 10UB of the Income Tax Rules, 1962 ('Rules') prescribe the procedure for invoking the provisions of GAAR to any arrangement or transaction. In terms of the Rules, the Assessing Officer, before making a reference to the Commissioner for invoking the provisions of GAAR, shall provide an opportunity to the assessee seeking his objections to the applicability of the provisions of GAAR.
The notice seeking the objections of the tax payer must elucidate the following details:
- details of the arrangement to which the provisions of GAAR are proposed to be applied;
- the tax benefit arising under such arrangement;
- the basis and reason for considering that the main purpose of the identified arrangement is to obtain tax benefit;
- the basis and the reasons why the arrangement satisfies the condition of considering the arrangement as an impermissible avoidance arrangement.
- and the list of the documents and evidence relied upon by the Assessing Officer.
It is therefore mandatory for the tax officer to make a reference to the Commissioner of Income Tax in all the cases. Post the receipt of any reference from the Assessing officer and considering the reply of the assessee, Commissioner may conclude that the invocation of the GAAR provisions are not warranted and shall issue direction to the Assessing Officer accordingly.
However, if the Commissioner considers that the provisions of GAAR is applicable on the facts and circumstance of the case, a reference shall be made by the Commissioner to the Approving Panel along with his satisfaction regarding the applicability of the provisions of GAAR.
TRANSACTIONS HELD IMPERMISSIBLE: CONSEQUENCES
The tax office has vide powers in term of the provisions of the Act, once the arrangement or the transaction is concluded to an impermissible avoidance agreement.
In terms of Section 98 of the Act, including denial of the tax benefit or treaty benefit to the assessee, the Assessing officer may inter alia recharacterize the transaction or part thereof; treat the arrangement as if the same was never entered; treat the place of residence of any party to the arrangement or the situs of an asset or of a transaction to be at a place other than the place of residence, location of asset or of transaction as provided in the arrangement; or lift the veil and look through any arrangement by disregarding any corporate structure; or treat equity as debt, capital expenditure as revenue expenditure or vice versa.
Considering the vide powers entrusted with the tax authorities, it is most likely that the non-resident assessee's and certain categories of resident assessee's would consider the option of seeking an Advance Ruling, to seek an assurance whether the provisions of GAAR are applicable or not, before entering into any transaction, which may lead to a tax benefit to the assessee. Section 245N, Chapter XIX-B of the Act, provides that an advance ruling may be sought on the aspect of arrangement being an impermissible avoidance arrangement or not, in terms of the provisions of Chapter X-A of the Act. Section 245N(a)(iv) provides that such ruling can be sought either by a resident or a non-resident, however, the same should be sought prior to entering into any such arrangement. Since the ruling of the Authority of Advance Ruling is binding on both the assessee and the revenue, this route may be considered as a safeguard against some consequences, before entering into any arrangement.
GRANDFATHERING AND SAFEGUARDS
In terms of the provisions of Rule 10U of the Rules, provisions of GAAR shall not be invoked in a scenario where the tax benefit in the relevant assessment year, in aggregate, to all the parties in the arrangement does not exceed a sum of INR Thirty Million.
Furthermore, the provisions of GAAR shall not be applicable to a Foreign Institutional Investor, who is an assessee under the Act, has not taken any benefit of a bilateral tax treaty and has invested in India in listed or unlisted securities in accordance with the Securities and Exchange Board of India (Foreign Institutional Investor) Regulations, 1995.
Although, the government has also provided the much-needed relief to the assessee's by providing the grandfathering of the investments made prior to April 1, 2017, in terms of Rule 10U(1)(d) GAAR will not apply to income earned/received by any person from transfer of investments made before April 1, 2017. However, Rule 10U(2) provides thatGAAR will apply to any arrangement, irrespective of the date it has been entered into, if tax benefit is obtained on or after April 1, 2017.
In view of the provisions of Rule 10U(1)(d) read with Rule 10U(2) of the Rules, it can be suggested that the investments made before April 1, 2017 will be grandfathered and not come under scrutiny of GAAR but any arrangement before this could come under the tax department's scanner if a tax benefit from such arrangement is claimed from next year. This means that existing arrangements which are felt to be aggressively structured to escape taxes in India, be it royalty payments, depreciation, interest payments or fees for technical services could come under the tax department's scrutiny irrespective of the date of entering into such arrangements if tax benefits continue to be claimed in Financial Year 2017-18 or after.
However only, income arising from transfer of investments (viz. Capital Gain) made before April 1, 2017 ought not come under GAAR's scrutiny.
GAAR VIS-À-VIS SPECIFIC ANTI AVOIDANCE RULES ('SAAR')
Although, it is widely perceived that GAAR has been incorporated to curb the international arrangements wherein, the treaty benefits are claimed by the assessee's, pertaining to transactions flowing from tax havens of the world, in the absence of any commercial substance with regard to the same. However, the provisions of the GAAR, apart from other specific anti avoidance rules, such as Transfer Pricing, dividend stripping, bonus stripping, etc., also act as a deterrence to the domestic arrangements which are entered for the main purposes of tax benefit and fulfills the secondary tests.
To protect its tax base, India has renegotiated its treaty with Mauritius, Singapore and Cyprus, through which, India has recorded maximum inflow of the foreign investment, because of the favourable tax provisions under the erstwhile treaties between India and such countries. Investments were routed through such countries, without having any substantial presence in such countries, to take the benefit of the tax treaty and the domestic tax provisions of such tax havens. The amended treaty also provides for a detailed out Limitation of Benefit ('LOB') clause, which suggests that the treaty benefits shall not be available, in a scenario wherein, the conditions provided under the LOB clause are not fulfilled.
Albeit, it is widely debated that in the presence and fulfillment of a LOB clause or any Specific Anti Avoidance Rule ('SAAR') the provisions of GAAR should not be applicable, since the specific provision would override the general provision. However, Hon'ble CBDT vide Circular dated January 27, 2017 has inter alia clarified that Specific Anti Avoidance Provisions may not address all situations of abuse. It has been further clarified that the provisions of GAAR and SAAR/LOB can coexist and are applicable, as may be necessary, in the facts and circumstances of the case.
In the contemporary tax environment, business reasoning and commercial rationale is central to any structuring or investment arrangement. That said, the GAAR framework does provide for procedural safeguard before invoking the provisions of GAAR to any arrangement or transaction, however, considering the arbitrary and adversarial approach of the tax officials in the past and the routine manner in which the powers enshrined under the Act are exercised, the standard safeguards appears to be meaningless, unless there is a deliberate conscious effort which is depicted by the tax authorities which is suggestive of the fact that such regulations would be involved in seldom deserving situations and powers are exercised with restrain in a cautious manner.
While general anti-tax avoidance measures are necesary, sufficient cushion should have been provided to the ordinary business transactions or transactions. The provisions of Section 96(2) of the Act, wherein, even if one step in a scheme or plan results in tax benefit, the whole arrangement can be treated as an 'impermissible avoidance agreement', seems draconian and can be considered as something prone and susceptible to being measured by the tax department.
India's tax policy all this while has struggled to bridge the 'trust deficit' between tax department and society at large, which is witnessed with low tax GDP ratio. Implementation of GAAR in a judicious manner is welcome lest the divide further widens and GAAR becomes a bridge too far!!!!
1. IRC v. Duke of Westminster (1936) AC 1; Union of India v. Azadi Bachao Andolan  263 ITR 706 (SC); Vodaafone International Holdings B.V v. Union of India 341 ITR 1 (SC)
2. Chapter X-A: General Anti Avoidance Rules, Income Tax Act, 1961
3. Section 94B of the Income Tax Act, 1961
4. Chapter X-A of the Income Tax Act, 1961 (Section 95 to 102) read with Rules 10U to 10UC of the Income Tax Rules, 1962.
This article was first published in the Conference Journal of IFA- Asia Pacific Tax Conference, New Delhi.
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.