By Aseem Chawla and Shweta Kapoor
General Anti-Avoidance Regulations (“GAAR”) are aimed at targeting complex and/or peculiar tax avoidance arrangements that take advantage of inadvertent loopholes in tax laws. Such tax avoidance arrangements are generally artificially constructed and have no underlying commercial substance.
GAAR has been termed as the codification of the doctrine of substance over form whose objective is to deter tax avoidance arrangements rather than per se generate revenue. Thus, GAAR regulations aim to deal with tax avoidance arrangements rather than tax mitigation or tax evasion. Tax evasion is forbidden by law, while tax mitigation is permissible and allows a taxpayer to take advantage of a fiscal incentive provided through tax legislation.
The following illustrations show the differ-ence between mitigation and evasion. A company that incorporates its manufactur-ing division in a Special Economic Zone (SEZ) that provides tax incentives such as tax holidays for fixed periods under tax statutes is a company that mitigates its tax obligations. A company that manufactures in a non-SEZ zone and then diverts the manufactured products to a SEZ, but where no further value is added to the product, is a company that evades its tax obligations. The evasion is in the misrepresentation of facts to make it seem as if goods had been manufactured in a SEZ, when, in fact, they were not. Tax avoidance, like tax evasion, affects economic efficacy, fiscal justice and revenue productivity.
The concept of GAAR was first introduced in India through a draft Direct Tax Code (“DTC”) in 2009. The DTC was introduced with a view to replace the Indian Income Tax Act, 1961 (the “Act”). It aimed to achieve simplification of the language and structure of existing direct tax provisions. The DTC, along with a discussion paper, was released on August 12, 2009 for public comments. Subsequently, based upon initial feedback from stakeholders, a Revised Dis-cussion Paper was released in June 2010, which was, again, open for public com-ments. Thereafter, the Draft of Direct Taxes Code, 2010 (“DTC 2010”) was placed by the Government of India before Parliament on August 30, 2010. The DTC 2010 retained most of the GAAR provisions proposed by DTC 2009, but also included certain enabling provisions to effectuate the proposed GAAR provisions.
THE GAAR EVOLUTION PROCESS
The DTC 2009 introduced GAAR with the prime objective of deterring tax avoidance. It failed, however, to clearly distinguish between legitimate tax mitigation and illegal tax evasion. The DTC 2009 proposals did suggest that there will be a presumption that an arrangement would have been entered into, or carried out, for the main purpose of obtaining a tax benefit, unless the person obtaining the tax benefit proves otherwise. The sweeping nature of such a presumptive provision would have caused undue hardship to the taxpayers entering into genuine transactions and accordingly the entire GAAR scheme was viewed as being counterproductive for commercial efficiency. There was also justifiable concern that such provisions would lead to a plethora of litigation, inconsistent with the objective of deterring tax avoidance arrangements. There was widespread consensus that the initial burden of invoking GAAR and proving tax avoidance should be upon the tax authorities.
The DTC 2010, which, based on several representations from stakeholders was re-ferred to the Standing Committee on Finance headed by former Finance Minister, Yashwant Sinha, which issued its report on March 9, 2012 with suggested amendments to the DTC 2010. Eventually, in March 2012, the tax proposals for that year were set forth in the Finance Bill 2012, which introduced GAAR provisions under the existing Act. These provisions became effective on April 1, 2012 and were enacted into law on May 28, 2012 (the “GAAR Provisions 2012”).
SALIENT ASPECTS OF
THE GAAR PROVISIONS
Chapter X-A of the Income Tax Act, 1961, now encapsulates the GAAR Provisions 2012. Like DTC and DTC 2010, the GAAR provisions provide wide discretionary powers to the revenue authorities in taxing tax avoidance arrangements. These powers include 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, as well as treat debt as equity and vice versa.
The GAAR Provisions 2012 were once again criticized for providing wide discretionary powers to tax authorities, resulting in an onerous burden on the taxpayers. The GAAR Provisions 2012, along with the retrospective amendments on taxation of indirect transfers, became the subject of intense debate. In view of uproar, implementation of GAAR Provisions 2012 was delayed by one year.
Subsequently, another committee under the chairmanship of the Director General of Income Tax (International Taxation) was constituted (the “New Committee”). It was asked to give recommendations to create guidelines for the proper implementation GAAR provisions. The Committee was also asked to provide clarity on the provisions to safeguard taxpayers against a potential abuse of power on the part of the tax authorities.
The New Committee released its draft rec-ommendations in June 2012. A summary of some of the most important sugges-tions/recommendations are as follows. The burden of proving that an arrangement leads to “tax avoidance” should be on the revenue authorities and not on the taxpayer. In order to provide relief to small taxpayers there should be a monetary threshold before invoking GAAR provisions. For the sake of consistency and transparency in the procedures, the New Committee also prescribed statutory forms, inter-department references and time limits within which office actions should be completed under the GAAR provisions.
Further, it was clarified that GAAR would only apply to cases not covered by Specific Anti Avoidance Rules (“SAAR”). (SAAR relate to “specific” rules to close specifically defined loopholes, as distinct from “gener-al” rules that give the tax authorities wide powers to close what they perceive as loo-pholes. SAAR rules are seen as providing certainty to taxpayers whereas GAAR, un-less crafted carefully, may be open to arbi-trary enforcement and abuse.) The New Committee clarified that in the event only a part of the arrangement is found to be im-permissible, the tax consequences under GAAR will be limited to only that part of the arrangement. The New Committee recommendations also contain many useful illustrations to help determine whether an arrangement would attract GAAR provi-sions or not.
The New Committee recommendations were issued when the Finance Minister’s portfolio was temporarily taken over by the Prime Minister. It was somewhat of a surprise to observe the reaction of the Prime Minister’s Office to the public circulation of the new committee recommendations. The Prime Minister’s office suggested that the rules were merely “draft guidelines to seek wide ranging feedback and for discussion purpose”. Finance Ministry officials countered: “Do not read too much into the release of PMO. The PM has not applied his mind on GAAR issues.” Following these developments, the Government of India constituted an Expert Committee on GAAR to undertake stakeholder consultation to revisit and finalize the New Committee’s recommendations for GAAR.
THE EXPERT COMMITTEE
The expert committee convened under the chairmanship of the distinguished interna-tional economist, Parthasarathi Shome, Ph.D. The Experts Committee’s mandate was to engage stakeholders in consultations and obtain suggestions from them as well as from the general public on the new committee recommendations for GAAR. The Committee received suggestions from stakeholders, tax advisory professionals, chambers of commerce and industry, foreign investor associations, industrialists, and policy makers in relation to the above recommen-dations. Based on such feedback, the Expert Committee issued revised recommendations for GAAR.
The Expert recommended that implementa-tion of GAAR be deferred by three years due to administrative reasons. The reasons included the fact that it would require time to train tax officers to enforce the GAAR. Moreover, the delay would cause no harm as the GAAR seeks to deter tax avoidance arrangements rather than generate revenue.
Further, the committee in its draft report emphatically took an “investment ap-proach” and suggested that tax on gains arising from the transfer of listed securities and tax on business income of foreign investors in India be abolished. However, in order to make good lost revenues if this were implemented, the Expert Committee recommended that the rate of the securities transaction tax be increased. It recommended that tax officers be required to give detailed reasons before invoking GAAR in order to satisfy the government’s prima facie burden of proving incidents of tax avoidance.
In order to avoid ambiguity and uncertainty the committee further recommended that until the tax is abolished, if the government of Mauritius issues a Tax Residency Certificate to any entity, India should not invoke GAAR provisions to examine the genuineness of the residency of that entity in Mauritius. Similarly, where a tax treaty itself has anti-avoidance provisions, for instance, under the India–Singapore tax treaty, the treaty provisions ought not to be substituted by GAAR provisions under the treaty override provisions. The Expert Committee has also opined that tax avoidance should be distinguished from tax mitigation and suggests that there should be an exhaustive negative list (that sets forth precisely what does not constitute avoidance) for the purposes of GAAR.
The Expert Committee has suggested that the negative list be non-exhaustive and in-clude:
- Amalgamations and demergers (as de-fined in the Act) as approved by the High Court.
- Intra-group transactions (i.e. transactions between associated persons or enterpris-es) which may result in tax benefit to one person but overall tax revenue is not af-fected either by actual loss of revenue or deferral of revenue.
- Selection of one option, when the law offers two or more options, should not be considered to be tax avoidance. For instance, payment of 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 a SEZ or any other place, funding through debt or equity, and purchase or lease of capital.
- Timing of a transaction, for instance, sale of property in loss while having profit in other transactions.
To ensure fairness and lack of ambiguity the Expert Committee has recommended existing investments by residents or non-residents on the date of commencement of GAAR should not brought under the scrutiny of GAAR.
Some of the other salient recommendations of the Expert are:
- The GAAR provisions should become applicable only after a monetary threshold of Rs. 30 million ($500,000 approximately) in tax benefits has been reached.
- GAAR should cover only those arrange-ments which have the main purpose of obtaining a tax benefit and not those where a tax benefit is merely incidental.
- An arrangement lacking “commercial substance” shall be deemed to include arrangements not having significant busi-ness risks or net cash flows apart from tax benefits.
- In order to ensure a high level of inde-pendence, the GAAR Approving Panel should have five members including a chairman. The chairman should be a re-tired judge of a High Court, while the other members should include two mem-bers from outside the government or persons of eminence from the fields of accountancy, economics or business and two chief commissioners of income tax.
- GAAR provisions should not be invoked while processing applications for lower tax deductions at source where the tax-payer gives an undertaking to pay taxes in case it is found that GAAR provisions are applicable during the course of tax assessments in the future.
- The tests set forth under the GAAR provisions of the Finance Act, 2012, should not be discarded as totally irrelevant and may be considered in addition to other aspects while determining commercial substance of an arrangement. Nevertheless, the fol-lowing factors must not be deemed irrelevant: the time period an arrangement has existed, the fact of payment of taxes, directly or indirectly, under the arrangement, and the fact that an exit route is provided for by the arrangement.
In other words, the tax avoidances schemes would be required to be reported in the taxpayer’s voluntary tax filings. At the same time, the committee recommended that for reporting purposes a tax avoidance scheme be deemed more likely than not to be an impermissible avoidance arrangement.
The Government of India, after considering the Expert Committee’s recommendations, has accepted its major recommendations with some modifications. The final report of Expert Committee, with modifications, was put on online on January 14, 2013. The following decisions have been taken by Government of India:
The provisions of GAAR will come into force with effect from April 1, 2016.
An arrangement with the main purpose of obtaining a tax benefit will be considered to be an impermissible avoidance arrange-ment.
As recommended by Expert Committee, GAAR provisions will be invoked when the tax benefit exceeds the monetary threshold of Rs. 30 million ($500,000 approximately).
Investments made before August 30, 2010, i.e., the date of introduction of the DTC 2010, will be grandfathered and not subject to the GAAR provision.
The GAAR provisions will not apply to for-eign institutional investors (“FIIs”) that do not take treaty benefits under section 90 or 90A of the Act. Further, GAAR provisions will not apply to non-resident investors in FIIs.
Where a part of the arrangement is an im-permissible avoidance arrangement, GAAR will be restricted to tax consequence of such impermissible part of the arrangement.
Either GAAR or SAAR will apply to a given case where both are in force, and guidelines will be issued regarding the applicability of one or the other.
A show cause notice, stating grounds, must be issued by the tax authority to the assessee before implementing the provisions of GAAR.
Time limits will be enacted within which proceedings under GAAR may be com-menced.
The Approving Panel shall consist of a chairperson, who is, or has been, a judge of a High Court; a member of the Indian Revenue Service, not below the rank of chief commissioner of income tax; and a member who shall be an academic or scholar having special knowledge of matters, such as direct taxes, business accounts and international trade practices.
The Approving Panel may consider the length of time for which an arrangement has existed, the fact of payment of taxes, directly or indirectly, under the arrangement, and the fact that an exit route is provided for by the arrangement. Such factors may be relevant but not sufficient in and of themselves, to determine whether the arrangement is an impermissible avoidance arrangement.
The directions issued by the Approving Panel shall be binding on the taxpayer as well as the tax authorities.
A tax auditor will be required to report any tax avoidance arrangement.
The acceptance of major recommendations of the Expert Committee by Government of India is a welcome step towards assuring investors a fair and just tax system. More so, when the need of the hour is to achieve an increase of net Foreign Direct Investment flows into India.
However, there are still some concerns among stakeholders with respect to the actual application of GAAR provisions. It remains to be seen whether the tax administration will apply GAAR provisions arbitrarily or upon a predictable rules-based regime.
Mr. Aseem Chawla is a Partner, and Ms. Shweta Kapoor is an Associate, of MPC Legal, based out of New Delhi, India. Mr. Chawla leads the tax practice group of the firm and can be contacted at email@example.com. Ms. Kapoor is an Associate with the tax practice group of the firm and can be contacted at firstname.lastname@example.org.