By: Siddharth Dalmia
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GAAR (General Anti-Avoidance Rule), drafted under chapter X-A of the Income Tax Act,1962, applies the substance over form approach in the domain of tax laws. The idea behind GAAR is to tackle an "impermissible avoidance arrangement" (IAA). An IAA means a transaction where the main purpose is to obtain a tax benefit and includes transactions where there is an abuse / misuse of the law or where the transaction lacks commercial substance.

But GAAR provisions can only be seen as an amendment to the Indian domestic law and this point would become significant in the later part of this discussion. The GAAR provisions give tax authorities teeth and claws to enforce the jurisprudence of McDowell's case (AIR 1986 SC 649) in which it was held that tax planning may be legitimate provided it is within the framework of law. However, a colourable device was held to be outside the scope of tax planning.

Various DTAAs became susceptible to BEPS (Base erosion and profit shifting) and tax avoidance. Even though such transactions were held to be legal in Azadi Bachao Andolan V Union Of India (2004) 10 SCC 1, the tax revenue authorities were not happy because approximately, the cumulative inflow from April 2000 to December 2015 from Mauritius alone had been a whopping Rs. 465,163 crores, a sum which could not be taxed. There were other problems which were identified, which includes double non taxation and treaty shopping. This led our legislature to become active in implementing certain safeguards and make treaty amendments in DTAAs.

After this, legislature started becoming active to amend the existing DTAA treaties and introducing LOB clauses. LOB clause refers to the procedural requirements which the tax beneficiary must fulfil to take advantage of benefits under DTAAs. The tax was being avoided between Mauritius and India because the Capital Gains are exempted in Mauritius as per Mauritius tax laws and Capital Gains were exempted in India for a Mauritius resident as per DTAA between India and Mauritius.

On the controversy surrounding the India–Mauritius tax treaty, the SC, in Azadi Bachao Andolan V Union Of India (2004) 10 SCC 1, held that in light of the fact that the treaty does not have limitation of benefit (LOB) clause, the RA cannot at the time of sale, deny treaty benefits on the reasoning that the FDI was only 'routed' through a Mauritius company.

How the problems depicted above were eventually mitigated can be understood through the examples of DTAA amendments and introduction of the LOB clause in the same. The LOB clauses is necessitated so that the companies with the sole intention to avoid the taxes are not able to exploit the Bonafide intention behind DTAAs, i.e., a healthy business environments and expansion of economy through contract between two or more countries. We also need to understand what their interplay with GAAR provisions is but before that we need to understand and analyse the provisions through the following DTAAs amendments examples:


Protocol of 2016 introduced the following LOB clauses:

To avail the various tax benefits and benefits arising out of provisions under DTAA, the Mauritius residents would be required to meet two subjective tests, i.e. LOB clauses, which are as follows:

  1. Main purpose test
  2. Bonafide business test

It was accompanied by a grandfathering provision which states that the LOB clause would not become applicable on the transactions which happened on or before 1 April, 2017. The conditions were accompanied by 2 other objective tests/ deeming provisions:

  1. A Mauritius resident is deemed to be a shell/conduit company, if its total expenditure on operations in Mauritius is less than INR 2.7 million in the immediately preceding 12 months.
  2. A Mauritius resident listed in Mauritius stock exchange will also not qualify as shell/conduit company.

The India-Mauritius tax treaty was one of the DTAAs and tax laws that provided for the taxation based on resident, both for capital gains and income from other sources up until the protocol. But after the protocol, the principal has again shifted to the source based taxation. The said tests provide tax authorities with tooth and claws to get the relevant taxes and objective tests to protect Bonafide taxpayers and residents.

We also have to see that the Mauritius- India treaty has a period between grandfathering and removal of benefits regarding corporate gains. India wanted to slowly change the amendment so that the economies and investors are protected.

Singapore-India DTAA:

The LOB clauses in this treaty are drafted in a slightly different language as follows:

  1. its affairs are arranged with the primary purpose of taking advantage of the benefits provided under the Singapore Treaty, and
  2. it is a shell company with negligible business operations or with no continuous or real business activities.

The wordings under the Mauritius treaty regarding the subjective clause is wider than the ones used in Singapore India DTAA. The tax authorities have wider powers with respect to the companies situated in Mauritius because the Singapore-India DTAA limits itself to the ill purpose regarding the Singapore India DTAA. Though the objective tests remain similar, though the minimum capital requirement is on the higher side. The test specifies that the company shall:

  1. be listed on a recognized stock exchange in Singapore, or
  2. incur total annual expenditure of SGD 200,000 on operations in Singapore in the 24 months immediately preceding the date on which the gains arise.

Although the capital specified is higher, the time period specified is also higher compared to the Mauritius-India DTAA.

Another additional provision is that the grandfathered transactions have also been brought under the ambit of LOB clause so this gives the Income Tax Authorities to tax the transactions even if they took place in the grandfathered period.

The most important LOB clause is Article 28A of the Singapore treaty, which reads as follows:

"This Agreement shall not prevent a Contracting State from applying its domestic law and measures concerning the prevention of tax avoidance or tax evasion."

This makes the intent of the state clear and in the Indian government's perspective, the provisions of GAAR would still be applicable even if some other anti avoidance provision is enacted in the DTAA. This protocol is absent from many other DTAAs which have been signed by India.


Protocol of 2007 made the following amendments:

  1. The requirement when an individual would be considered a 'resident'.
  2. As regards a 'Company', for it to be a resident of UAE, it should be incorporated in the UAE and should be wholly managed and controlled from UAE.

The use of word 'wholly' is very significant and interesting. It has been construed very strictly in India as can be seen in Radha Rani judgment. It means, if the company is not 'wholly' located in UAE, it would not get the relevant tax benefits under the treaty.

Significant LOB clause has been introduced which are as follows:

  1. The LOB clause provides that the benefits of India-UAE DTAA shall not be available if the main purpose or one of the main purposes of the creation of such entity was to obtain the benefits of the DTAA between India and UAE.

This is a very wide clause because of the words 'one of the' which gives a huge power to taxing authority who would only have to prove that a component of business relates to non-bonafide business.

Hong Kong-India DTAA:

The treaty is in alignment with the MLI and BEPS.

The LOB clause is very comprehensive which covers all the Multi Lateral Instruments(MLI) requirements. This also includes the digital economies which has been missing in various jurisdictions.

The problem with GAAR is that it can only be invoked in following circumstances with regards to DTAAs:

  • If the anti avoidance rule is absent in DTAA.
  • If the treaty does not explicitly provide for it to do so.


Even though GAAR would be implementable in domestic law, it would not be applicable regarding the treaty law or DTAAs. "DTAA cannot be overridden by a unilateral legislative amendment by one Country"- CIT (IT) Vs Reliance Infocomm Ltd (Bombay High Court). It can be also gauged from the Singapore treaty explicitly providing for the implementation of domestic law in that regard. If such a provision would be absent, then that would mean that the domestic law has been read into treaty law, which is not allowed. Supreme Court has also held that provisions of tax treaties would prevail over the general provisions to the extent they are beneficial to the tax payer. – Azadi Bachao Andolan. Delhi High Court in New Satellite Case has also held that the amendments made in the act cannot be extended to the treaties and Tax Treaty cannot Be Affected By Retroactive Amendments. This would make the reading of GAAR in the treaties impossible. But, the laying down of GAAR in the Income Tax Act shows the legislative intent and gives India an upper hand on the negotiations. India, being signatory to MLI only strengthens the intent. Although the BEPS and other tax avoidances and evasions have started to be taken seriously and India has made strides through recent amendments, there is still a long road ahead.

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