The India growth story has attracted significant foreign direct investment. Foreign investors have been subject to aggressive tax planning to make arrangements / create artificial structures for tax avoidance. Tax authorities have consistently ignored the legal form of an arrangement and looked at its actual substance. In most countries, the doctrine of substance over form have been programmed as General Anti-Avoidance Rule (‘GAAR’).
However, in India, there are some specific anti-avoidance regulations but the general anti-avoidance has been established only through judicial precedents. Considering the aggressive tax planning with the use of sophisticated tax structures, there was an immediate requirement to look at the real intention of the arrangements and determine the tax consequences.
In view of this, GAAR was introduced into the Finance Act, 2012.
The Story So Far
Vodafone – Hutchison Essar
In 2007, The Indian Government claimed over US$ 2 billion from Vodafone International BV towards transfer of shares of an overseas company between two non-resident companies having no presence in India.
In 2012, the honourable Supreme Court of India (‘SC’) held that the transaction is not taxable in India.
In view of this high-profile cross border tax litigation, various specific anti-avoidance provisions were introduced in Finance Act, 2012 to cover indirect transfers of a capital asset situated in India. Finance Act, 2012 rationalised provisions of international taxation to retrospectively amend Section 2, 9 and 195 of the Income-tax Act, 1961 (‘the Act’) to cover such transfers.
This high-profile litigation highlighted the need of moving from ‘measures based on principles from judicial precedents’ to GAAR.
Direct Tax Code
GAAR was initially proposed in draft Direct Taxes Code (‘DTC’), 2009. Later, revised discussion paper was released in 2010 and a formal bill – DTC 2010 was tabled in parliament. As per DTC 2010, GAAR was supposed to be made applicable from 1st April 2012. Though DTC was deferred, Government planned to introduce GAAR in Union Budget 2012-13.
Union Budget 2012-13
Two months subsequent to the SC ruling in Vodafone International BV, the Finance Minister proposed to introduce a GAAR in order to counter aggressive tax avoidance schemes, while ensuring that it is used only in appropriate cases, by enabling a review by a GAAR panel.
The wait is over…
GAAR has been deferred more than once.
- Initially, GAAR was deferred by a year and later was proposed to be introduced from 1st April 2016.
- In Union Budget 2015, the Finance Minister deferred GAAR furthermore by two years.
- CBDT has issued a clarification dated 27th January 2017 on implementation of GAAR under the Act.
Hence as it stands now, GAAR will be applicable from 1st April 2018 (i.e. AY 2018-19 / FY 2017-18).
Any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding.
In short, anything and everything can be an arrangement.
2. Tax benefit
Tax benefit shall include the following pertaining to any tax year:
(a) Any reduction or avoidance or deferral of tax or other amount payable under the Act (includes even if the sum is as a result of a tax treaty); or
(b) Any increase in refund of tax or other amount under the Act (includes even if the sum is as a result of a tax treaty); or
(c) Reduction in total income or an increase in loss.
3. Connected Person
Connected person shall refer to the persons referred to in Section 40A(2)(b) excluding clause (iv)
4. Commercial substance
An arrangement shall be deemed to lack commercial substance if:
- The arrangement as a whole is inconsistent with or differs significantly from a part of the arrangement; or
- No significant effect upon either the business risks or the net cash flows of that party other than effect attributable to tax benefit; or
- Location of an asset or of a transaction of any party is without any substantial commercial purpose other than obtaining a tax benefit for a party; or
- It involves or includes –
- Round trip financing – means series of transactions through which funds are transferred among the parties and such transactions do not have any substantial commercial purpose other than obtaining tax benefit;
- An accommodating property – means the main purpose of the direct or indirect participation of that party in the arrangement is to obtain a tax benefit for the assessee;
- Elements that have effect of settling or cancelling each other; or
- Transaction which is conducted through one or more persons and disguises the nature of such transaction.
When does it apply?
GAAR will arise when an arrangement is declared to be an Impermissible Avoidance Arrangement (‘IMA’).
Any arrangement shall become an IMA if:
- Main purpose of the arrangement is to obtain a tax benefit; and
- Satisfies atleast one of the following conditions:
- Creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length;
- Directly or indirectly results in misuse or abuse of the provisions of the Act;
- Lacks commercial substance (partly or wholly); and
- Entered into which are not ordinarily employed for bona fide business purposes.
It is further to be noted that, if the main purpose of part of an arrangement is to obtain a tax benefit then it shall be presumed that the main purpose of entering into the arrangement is for a tax benefit.
- GAAR shall not apply to:-
- an arrangement where the tax benefit in the relevant assessment year arising, in aggregate, to all the parties to the arrangement does not exceed rupees three crores;
- a foreign institutional investor – who is an assessee under the Act; who has not availed tax treaty benefit; and who has invested in securities with prior permission of competent authority;
- A non-resident in relation to investment in offshore derivative instrument or in a foreign institutional investor;
- Any income from transfer of investment made on or before 31st March 2017 by such person.
However, it is to be noted that GAAR provisions shall override all tax treaties.
What are the consequences?
Denial of tax benefit under the provisions of the Act or the treaty shall be determined including by way of but not limited to the following:-
- Disregarding, combining or recharacterizing any part of the IMA;
- Treating as if the IMA has not been entered into;
- Disregarding an accommodating party or treating accommodating party and any other party as one;
- Deeming persons who are connected persons in relation to each other to be one and the same person;
- Reallocating, any accrual or receipt; or any expenditure, deduction, relief, or rebate, amongst the parties to the arrangement;
- Treating the pace of residence; or the situs of an asset, at a place other than place of residence, location of the asset as provided in the arrangement.
Where a part of an arrangement is declared to be an IMA, the consequences in relation to tax shall be determined with reference to such part only.
Procedure for invoking GAAR
- To declare an arrangement as IMA, the assessing officer may make a reference in Form 3CEG to the Principal Commissioner or Commissioner (‘Authority’) in this regard;
- On receipt of a reference, if required, the authority may issue a notice to the assessee, setting out the reasons and basis of such opinion, for submitting objections, if any, and providing an opportunity of being heard to the assessee within such period, not exceeding sixty days, as may be specified in the notice.
Proposed Action by the Authority:
- Assessee doesn’t object – Issue such directions as he deems fit in respect of declaration of the arrangement to be an IMA.
- Assessee objects and Authority is satisfied – Pass directions in Form 3CEH to the Assessing Officer with a copy to the assessee.
- Assessee objects and Authority is not satisfied – Make a reference on the matter to the Approving Panel for the purpose of declaration of the arrangement as an IMA.
- A panel shall consist of three members headed by a judge of High Court and the term is ordinarily for one year and may extend up to three years.
- The panel shall have the powers of ‘Authority for Advance Rulings’ u/s 245U of the Act.
- Approving panel may:
- Direct the Authority to make further inquiry and furnish a report containing the result of such inquiry to it; or
- Call for and examine such records relating to the matter as it deems fit; or
- Require the assessee to furnish such documents and evidence as it may direct.
- After providing opportunity of being heard to the assessee and the assessing officer, the panel may issue directions in respect of the declaration of an arrangement as an IMA.
- The directions must be issued within six months from the end of the month in which reference was received from the Authority.
- No appeal shall lie against such directions and shall bind on the assessee and the tax authorities.
- Order of assessment or reassessment shall be passed by the Assessing Officer.
- Prior approval of the Authority is required if any tax consequences have been determined under Chapter X-A of the Act.
Views on GAAR
GAAR is being implemented in a period where Multinational Enterprises (MNE’s) have serious concerns on seemingly endless and protracted litigation on tax issues. The powers provided to tax authorities are open ended and will potentially lead to significant uncertainty and litigation.
Tax mitigation, as distinct from tax avoidance, is allowed under the tax statute. The GAAR provisions do not deal with case of tax mitigation. Hence, a significant shift in the approach to ‘tax planning’ in various cross border transactions will be essential.
It’s critical that GAAR is implemented with adequate procedural safeguards and applied in a uniform, fair and rational manner.
Considering all these and being an unconditional type of tax legislation, bringing GAAR into practice without affecting the business environment will be a huge challenge.
 Vodafone International Holdings BV v. Union of India [2012 – 6 SCC 613]
Note: The article was published in CASC Bulletin - April 2017