Recently, the Central Board of Direct Taxes ("CBDT") released a circular1 ("Circular") providing clarifications on implementation of General Anti-Avoidance Rules ("GAAR"). The Circular provides responses to queries raised by various stakeholders in the context of the applicability of GAAR.


The GAAR provisions, which were introduced in the ITA by the Finance Act, 2012, are slated to come into force from April 1, 2017. GAAR confers broad powers on the tax authorities to deny tax benefits (including tax benefits applicable under tax treaties), if the tax benefits arise from arrangements that are 'impermissible avoidance arrangements'

An 'impermissible avoidance arrangement' is an arrangement entered into with the main purpose of obtaining a tax benefit and satisfying one or more of the following: (a) non-arm's length dealings; (b) misuse or abuse of the provisions of the domestic income tax provisions; (c) lack of commercial substance2; and (d) arrangement similar to that employed for non-bona fide purposes.

The CBDT had issued rules, necessary procedures for application of GAAR and conditions under which it shall not apply. These have been enumerated in the Income Tax Rules, 1962 ("ITR") ( Click here for our hotline with insights and analysis of the GAAR Rules that were notified.). The wide-scope of these GAAR provisions and the broad powers conferred upon the tax authorities evoked considerable concern among various stakeholders such as offshore funds, FPIs, legal practitioners, etc. This led to the Central Government appoint an Expert Committee under the renowned economist Dr. Parthasarthy Shome to consult with stakeholders and review GAAR. In its detailed report, the Expert Committee had recommended a substantial narrowing down of the scope of GAAR and other protections in the interest of fairness and certainty. On the recommendation of the Shome Committee these provisions were deferred and the GAAR provisions were redrafted to address the concerns of stakeholders such as various industry bodies, investors, etc. After being deferred again in 2015, the GAAR provisions are finally set to come into force from April 1, 2017.

The Circular

Last year, the CBDT issued a press release3, inviting comments and input from the general public and stakeholders on the provisions of GAAR in respect of which greater clarity was sought. A working group was constituted by the CBDT in June, 2016 to address the queries/comments so received. The Circular, which has been issued by CBDT after considering the comments of this working group, addresses some of the most practical concerns raised by stakeholders.


The Circular clarifies that since Special Anti-Avoidance Rules ("SAAR") may be inadequate to address all situations of tax abuse, invocation to GAAR provisions may be resorted to even in cases were SAAR provisions exist. The same logic has been extended to the application of GAAR to arrangements which are covered under India's Double Taxation Avoidance Agreement ("DTAA") which include a Limitation of Benefits ("LOB") clause as an anti-avoidance measure. The CBDT has expressed its view that there may be cases where the LOB may not be address all tax avoidance strategies and in such a case, it would be open to the Indian tax authorities to apply the GAAR provisions. In situations when the anti-abuse is sufficiently addressed by the LOB provision in the DTAA, GAAR shall not apply. However, what the standard for the LOB to be sufficiently addressed is not provided and may result in additional complexities.

The CBDT has further clarified that the GAAR provisions will not interfere with the right of the taxpayer to select or choose a method of implementing a transaction/ arrangement.

Main Purpose test to be adopted while considering the choice of residence of FPIs

In a significant confirmation, the CBDT has clarified that where a FPI is located in a particular jurisdiction based on non-tax commercial reasons and the main purpose of the choice of location/residence of the FPI is not to obtain a treaty benefit, the GAAR provisions will not be resorted to by the tax authorities. The CBDT has clarified that the choice of the entity, location, etc. decided upon by the FPI would be considered on the basis of the main purpose and other conditions which are mentioned in Section 96 of the ITA.4

Grandfathering of convertible instruments/securities

It has been clarified that any shares which result from the conversion of any compulsorily convertible instrument, at the terms finalized at the time of issue of such instruments, which had been acquired prior to April 1, 2017 will be eligible for the benefit of the grandfathering of investments provided under Rule 10U(1)(d) of the ITR. Further, shares which come into existence as a result of a split or consolidation of share capital or any bonus issue will also be extended this benefit of the grandfathering. This is especially welcoming as it brings the much needed clarity on the treatment of convertible instruments which continues to be ambiguous under the India-Mauritius treaty.

The CBDT, relying upon the definition of "investments" provided under the Accounting Standards, has expressed its view that lease contracts and loan agreements should not be characterized as "investments" and consequently, should not qualify for the benefit of grandfathering. This may be worrisome for certain stakeholders such as the aviation industry where sale and lease back of aircraft is very common.

The Circular also clarifies that where the Authority for Advance Ruling ("AAR") has ruled that an arrangement is permissible the income tax authorities will be barred from invoking the GAAR provisions with respect to such arrangement.

Two-Tier Vetting of Arrangements

To ensure that there is no indiscriminate application of GAAR by the tax authorities, a two-tier vetting process is proposed to be put into place. Under this process, where any proposal is made to treat an arrangement as an impermissible avoidance arrangement, such a proposal will be vetted by the Principal Commissioner/Commissioner of Income Tax and subsequently by an Approving Panel which will be headed by a High Court judge.

It has been confirmed that where an arrangement goes through the two-step vetting process and is adjudged as being a permissible arrangement in any given assessment year, it will not be open to the tax authorities to treat the same arrangement as an impermissible avoidance arrangement in subsequent assessment years. This clarification should being great comfort to taxpayers as tax authorities often resort to an adversarial approach in different assessment years, even in cases where a taxpayer has obtained a favourable order from a competent court such as the ITAT or a High Court in support of its stand in an earlier assessment year.

Mergers / Demergers and re-structuring

Mergers or demergers in India are usually undertaken through a court appointed process. It has been clarified that where any court or authority such as the National Company Law Tribunal ("NCLT") has "explicitly and adequately" considered the tax implication of an arrangement, GAAR will not apply to such an arrangement. While this is welcome clarification the wording of the same may be problematic. For instance, it is possible that in case of a merger, the NCLT does not explicitly opine on the tax implications while granting its sanction to a scheme of amalgamation. Under Section 230(5) of the Companies Act, 2013, a copy of the scheme of merger is required to be sent to various authorities such as RBI, SEB, etc., including the tax authorities. These authorities are required to raise objections/give their comments on the merger scheme within 30 days. In case the tax authorities do not raise objections during this period, it should not be open to them to invoke the GAAR provisions to deny the benefits of the merger/arrangement to taxpayers on the ground that the NCLT did not explicitly deal with the tax implications of the merger.

No exemption to long-standing structures

The CBDT has declined requests to exempt structures which have been in existence for a time period fixed by the CBDT from the applicability of GAAR provisions.

Adjustment in hands of other participants

CBDT has refused to allow corresponding adjustments in the hands of other participant(s) in an arrangement/ transaction which is declared as an impermissible avoidance arrangement and a participant is made the subject matter of the GAAR provisions. The rationale offered by CDBT for this decision is based on its view that the GAAR provisions are meant to deter tax avoidance and allowing corresponding tax adjustments in the hands of other participants in an impermissible avoidance arrangement will dilute the deterrence value of these provisions.

Scope of Review under GAAR

The CBDT has rejected requests to extend the scope of review under the GAAR provisions to other territories and other parties involved in the arrangement under scrutiny. On the contrary it has stated that it considers GAAR to be specific to the Indian tax benefit enjoyed by a taxpayer as a result of the arrangement and the assessment year in question.


A request had been made to that no penalty proceeding be initiated against any taxpayer who is considered to have participated in any impermissible avoidance arrangement for an initial period of 5 years. The CBDT has declined this request and has confirmed that since the levy of penalty is a fact specific consideration, no blanket exemption will be made available to taxpayers in this regard.


Given that GAAR is slated to come into effect from April 1, 2017 it was high time that the Government issued clarifications on its implementation. However, even after providing these clarifications, it still remains unclear as to how GAAR will be practically implemented. Further, even these clarifications do not provide relief to the anxiety caused by GAAR being introduced.

As stated earlier, by using phrases such as 'sufficiently addressed' and not explaining what it actually means, the CBDT has caused more confusion on situations when even if there is an LOB in a treaty, whether GAAR will apply or not apply. Further, the Multilateral Instrument ("MLI") recently released by the OECD as part of its project on Base Erosion and Profit Shifting ("BEPS"), provides that as a minimum standard, countries should implement at least one of the following measures in its treaties – (i) a principal purpose test ("PPT") only, which is a general anti-abuse rule based on the principal purpose of transactions or arrangements (ii) a PPT supplemented with either a simplified or a detailed LOB provision, or (iii) a detailed LOB provision, supplemented by a mechanism to deal with conduit arrangements not already dealt with in tax treaties. Consequently, given its enabling nature and flexible form, the MLI provides various alternatives in its provisions concerning treaty abuse and limitation of benefits. Signatories to the convention may elect to opt in any of these alternatives in respect of their tax treaties. In this context, it would be interesting to see if such principal purpose test 'sufficiently addresses' the abuse as envisaged by GAAR, and whether GAAR would still be applicable to the transaction.


1 Circular No. 7 of 2017.

2 As per Section 97 of the ITA, an arrangement is deemed to lack commercial substance, in case (a) the substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part; (b) it involves or include round trip financing, an accommodating party, elements that have effect of offsetting or cancelling each other; or a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction; (c) it involves the location of an asset or of a transaction or of the place of residence of any party which is without any substantial commercial purpose other than obtaining a tax benefit; or (d) it does not have a significant effect upon the business risks or net cash flows of any party to the arrangement apart from any tax benefit.

3 CBDT Press Release No. F No 370149/89/2016-TPL dated May 27, 2016.

4 Section 96(1): An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain a tax benefit, and it—

  1. creates rights, or obligations, which are not ordinarily created between persons dealing at arm's length;
  2. results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;
  3. lacks commercial substance or is deemed to lack commercial substance under section 97, in whole or in part; or
  4. is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

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.