General Anti-Avoidance Regulations (‘GAAR’) are aimed to target complex and / or peculiar tax avoidance arrangements not dealt directly by the provisions of tax laws. Such tax avoidance arrangements which are artificial i.e. having no commercial substance entered with the main motive of abusing tax provisions.
GAAR has also been termed as codification of the doctrine of substance over form with the objective of deterring occurrence of tax avoidance arrangements rather than per se revenue generation.
GAAR regulations intend to deal with tax avoidance arrangements and not tax mitigation or instances of tax evasion considering that tax avoidance is distinct from tax mitigation and tax evasion. Where, on the one hand, tax evasion is illegal or forbidden by law, tax mitigation is where tax payer takes advantage of a fiscal incentive offered to him by the tax legislation.
The above can be explained by way of an illustration, let us take a situation where Company incorporates its manufacturing division in Special Economic Zone (SEZ) so that it can take benefit of tax holiday offered by the tax statute. It being a fiscal incentive and taking its advantage would amount to tax mitigation. In the same situation, if the company were to manufacture in non-SEZ zone but diverts the manufactured products to SEZ, where no value addition is done, it would be regarded as tax evasion, emanating due to misrepresentation of facts.
Having suggested so, it has been variedly held that tax avoidance arrangements do otherwise affect economic efficacy, fiscal justice and revenue productivity.
With this given conceptual background, the concept of GAAR was first introduced in India through draft Direct Tax Code (‘DTC’), 2009. DTC was introduced with a view to replace the Indian Income Tax Act, 1961, aiming to achieve simplification in terms of language and structure vis-à-vis the extant direct tax provisions. The same along with a discussion paper was released on August 12, 2009 for public comments.
Subsequently, a Revised Discussion Paper was released in June 2010, based upon the initial feedback received and was again made available for public comments.
Thereafter, the Draft of Direct Taxes Code, 2010 (‘DTC 2010’) was placed by the Government of India before the Parliament on 30 August 2010. In specie, DTC 2010 did retain most of the GAAR provisions proposed by DTC 2009. Also other certain enabling provisions were incorporated to effectuate the proposed GAAR provisions.
- GAAR-Evolution Process
The DTC 2009 introduced GAAR with a prime objective of its acting as a deterrent against tax avoidance practices. However, a reasonable distinction between legitimate tax minimization and abusive tax avoidance was conspicuously missing in DTC 2009.
The DTC 2009 proposals, inter-alia did suggest that an arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit unless the person obtaining the tax benefit proves that obtaining the tax benefit was not the main purpose of arrangement. The sweeping nature of such presumptive provision ought to have caused undue hardship to the taxpayers entering into genuine transactions and accordingly the entire scheme of GAAR was viewed as counterproductive vis-à-vis commercial efficiency. Also, such provisions would lead to a plethora of litigation, inconsistent with the objective of achieving deterrence of avoidance arrangements.
It was widely suggested that the initial burden of invoking GAAR should be shifted upon the tax authorities.
After receiving several representations from stakeholders, the revised draft DTC 2010 was issued. The 2010 version of DTC was, thereafter, referred to the Standing Committee on Finance headed by former Finance Minister, Yashwant Sinha, which gave its report on March 9, 2012 recommending amendments.
Eventually, the tax proposals for the year 2012 announced vide Finance Bill 2012 on March 16, 2012 introduced GAAR provisions in the existing scheme of Income Tax Act, 1961 (Act) effective April 1, 2012.
The said proposals enunciated vide Finance Bill 2012 were enacted on May 28, 2012.
- Salient Aspects of GAAR Proposal
Chapter X-A of the Income Tax Act, 1961, now encapsulates the scheme of GAAR.
The said scheme like in DTC 2009, 2010 does provide wide discretionary powers to the revenue authorities in taxing tax avoidance arrangements’ including the power to disregard entities in a structure, reallocate income and expenditure between parties to the arrangement, alter the tax residence of such entities and the legal situs of assets involved, treat debt as equity and vice versa, etc.
The legislated GAAR provisions were once again criticised for providing wide discretionary power to tax authorities resulting in excessive tax and compliance burden on the taxpayer. Also, the said proposal , along with the retrospective amendments on taxation of indirect transfers did become a subject of intense debate.
Considering the same, implementation of GAAR was deferred by one year.
Subsequently, a committee under the chairmanship of the Director General of Income Tax (International Taxation) was constituted to give recommendations for formulating the guidelines for proper implementation GAAR provisions and to provide clarity on the provisions so as to safeguard taxpayers against their indeterminate use and curb abuse thereof.
The Committee released its draft recommendations on 28 June 2012, the following suggestions/recommendations were made by the committee:
Shifting of initial burden to prove, if, an arrangement leads to “tax avoidance” on the revenue authorities from the taxpayer.
Also, in order to provide relief to small taxpayers, it was suggested to provide a monetary threshold for invoking GAAR provisions. For the sake of consistency and transparency in the procedures, the committee also prescribed statutory forms for making references within the tax departments and time limits for completion of various actions under the GAAR provisions.
Further, it was clarified that GAAR would cover cases not covered by Specific Anti Avoidance Rules (‘SAAR’). Guidelines clarified that in case only a part of the arrangement is impermissible, the tax consequences under GAAR will be limited to only that part of the arrangement.
Various illustrative cases were recommended by committee for sake of clarity as to whether an arrangement would attract GAAR provisions or not.
The said guidelines were issued when there was a change of guard at the office of the Finance Minister with the finance portfolio getting vested with the Hon’ble Prime Minister.
It was somewhat a surprise to observe the reaction of the Prime Minister’s Office to the circulation of the draft guidelines in the public domain, suggesting that the rules were merely “draft guidelines to seek wide ranging feedback and for discussion purpose”. Further, the finance ministry officials did state “Do not read too much into the release of PMO. The PM has not applied his mind on GAAR issues”.
The Government of India constituted an Expert Committee on GAAR to undertake stakeholder consultation to finalize the guidelines for GAAR.
- Shome Committee
The expert committee under the chairmanship of Dr. Parthasarathi Shome, noted economist was constituted by Government to undertake consultations and suggestions from stakeholders and general public on the first draft guidelines for GAAR.
The committee did receive suggestions from the stakeholders, professionals in tax advisory, chambers of commerce and industry, foreign investor associations, industrialists, and policy makers in relation to the above recommendations and on based on the feedback issued second draft guidelines for GAAR.
The draft report submitted by Shome committee has suggested deferring the implementation of GAAR by 3 years on the administrative ground as it would require trained tax officers. The tax officers would be required to have specific knowledge since GAAR requires deterrence of avoidance arrangement rather than revenue generation.
Further, the committee in its draft report has emphasized on “investment approach” by suggesting abolishment of tax on gains arising from transfer of listed securities and tax on business income of foreign investors in India. And in order to make good of tax loss, the committee has recommended increasing the rate of security transaction tax.
It recommended that the tax officer would be required to give a detailed reasoning before invoking GAAR, as such the onus of proving shall be of tax authorities.
In order to avoid ambiguity and uncertainty the committee has further recommended that until the tax is abolished as mentioned in the above paragraph, in case a Tax Residency Certificate is issued by government of Mauritius, GAAR provisions shall not apply to examine the genuineness of the residency of an entity set up in Mauritius.
Similarly, where the treaty itself has anti-avoidance provisions, for instance under Indo – Singapore tax treaty, the treaty provisions ought not be substituted by GAAR provisions under the treaty override provisions.
As discussed, the provisions of GAAR envisaged provision of wide discretion & authority to tax authorities, as such it has been constantly feared that it might result in tax exploitation.
It was also felt that tax avoidance should be distinguished from tax mitigation. An exhaustive negative list for the purposes of GAAR should also be specified.
The committee has also recommended introduction of a negative list, not exhaustive, to include:
- Amalgamations and demergers (as defined in the Act) as approved by the High Court.
- Intra-group transactions (i.e. transactions between associated persons or enterprises) which may result in tax benefit to one person but overall tax revenue is not affected either by actual loss of revenue or deferral of revenue.
- Selection of one option out of two or more options offered by law should not be considered to be tax avoidance. For instance:
- payment of dividend or buy back of shares by a company,
- setting up of a branch or subsidiary,
- setting up of a business unit in SEZ or any other place,
- funding through debt or equity, and
- purchase or lease of a capital.
- Timing of a transaction, for instance, sale of property in loss while having profit in other transactions.
To bring more clarity and fairness the committee has in its report has recommended that the investment made by residents or non-residents which are existing as on the date of commencement of GAAR should not brought under the scrutiny of GAAR provisions.
Other salient recommendations of the Shome committee inter alia are:
- Monetary threshold of Rs. 3 crores (equivalent to USD 5,00,000 approximately) of tax benefit to check the applicability of GAAR provisions.
- GAAR to cover only those arrangements which have the main purpose of obtaining tax benefit and not those whose one of the main objective is to obtain tax benefit.
- An arrangement lacking “commercial substance” shall be deemed to include arrangement not having significant business risks or net cash flows apart from tax benefit.
- In order to ensure high level of independence, the Approving Panel for the purposes of GAAR should have 5 members including chairman. The chairman should be retired judge of the High Court, two members from outside government and persons of eminence from the fields of accountancy, economics or business, two chief commissioner of income tax.
- As per the existing legislated provisions of GAAR under Finance Act, 2012, whilst determining the commercial substance of an arrangement following factors are considered irrelevant:
- Time period of existence of an arrangement,
- Fact of payment of taxes, directly or indirectly, under the arrangement,
- Fact that an exit route is provided by the arrangement.
The committee has recommended that these test should not discarded as totally irrelevant and may be considered in addition to the other aspects while evaluating the commercial substance of an arrangement.
- GAAR provisions would not be invoked while processing application for lower tax deduction at source where the taxpayer gives an undertaking to pay taxes in case it is found that GAAR provisions are applicable in relation to remittance during the course of assessment proceedings.
Apart from the above, the committee has also recommended that tax avoidance schemes to be considered for reporting purposes as more likely than not as impermissible avoidance arrangement and be reported in the voluntary tax filing done by the taxpayer.
By and large the Industry and all the stakeholders have hailed the recommendations of the Shome Committee as a welcome relief.
The timing of introduction of GAAR regulations in the given international as well as domestic scenario is viewed regressive. Seemingly, there has been an instantaneous sense of realization that, in the present challenging times, sound tax competitiveness is required.
The policy makers are extremely conscious of flow of International Capital and perhaps have understood that the tax regime has to be conducive with the global environment and the need of the hour is to achieve increase of net Foreign Direct Investment flows into the country. When compared with the 2009 version, significant changes have taken place in the GAAR regulations, which itself suggests that tax policy is being correctly configured at this given juncture.
A variety of measures can be undertaken including initiating structural reforms in the tax system and administration, which can add to revenue productivity.