Basics on General Anti Avoidance Rule (GAAR) in India

What is GAAR?

Each component of the expansion of GAAR will give some idea about it. GAAR is General Anti Avoidance Rule and hence it is an anti-tax avoidance regulation. As the name suggests, it is set of laws aimed at curtailing tax avoidance in general. GAAR is set of rules under the Income Tax Act (under the proposed Direct Tax Code) which empowers the revenue authorities to deny tax benefits transactions or arrangements which do not have any commercial substance or consideration other than achieving the tax benefit. Thus, in nutshell, we can say that GAAR usually consists of a set of broad rules which are based on general principles to check the potential avoidance of the tax in general.

What is tax avoidance?

Tax avoidance is deliberate measures to avoid or reduce tax burden by an individual or a company. Tax avoidance, is by and large not defined in taxing statutes. Tax avoidance is, nevertheless, the outcome of actions taken by the assessee, which is not illegal or forbidden by the law as such. The purpose here is to reduce tax burden.

Why GAAR?

Tax avoidance is legal; but now, large scale revenue loss is occurring due to aggressive tax planning by corporate using avoidance opportunities. Governments in many countries are introducing anti- avoidance rules to check this revenue loss from excessive avoidance.

What is the difference between GAAR and SAAR?

Anti-Avoidance Rules are generally existing in many countries in two categories, viz, general and specific. In the case of the former, the legislation will be GAAR whereas in the case of the latter, the legislation is in the form of Specific Avoidance (SAAR). Special rules are targeted at individual, case by case specific provisions. Legislations with respect to general rules are known as GAAR and legislations with respect to special rules are known as SAAR.

GAAR in India

In India, the GAAR concept was introduced with the DTC Bill on August 2009. Later, a revised discussion paper was released with provisions containing the GAAR under DTC Bill 2010. The bill aimed to introduce the GAAR involving DTC from 1st April 2012 onwards. The GAAR provisions were introduced in the 2012-13 budget by the then Finance Minister Dr. Pranab Mukherjee. But several of its provisions were criticized because of lack of clarity, lack of safeguards and increased scope for subjective authorization by the tax officials.

The government subsequently set up a panel under Parthasarathy Shome to review the proposals. The Committee, suggested that the rules be deferred by three years to 2016-17, arguing that more time is needed to create administrative machinery for its implementation and called for intensive training of officials.

According to the press release by CBDT (Central Board of Direct Taxes), GAAR provisions shall be effective from assessment year 2018-19 onwards, i.e. financial year 2017-18 onwards. The provisions of GAAR are contained in Chapter X-A of the Income Tax Act, 1961. The procedures for application of GAAR and conditions under which it shall not apply, are enumerated in Income-tax Rules, 1962.

What the new GAAR notification says?

GAAR tries to examine imposition of taxes on those types of arrangements that are primarily aimed to avail a tax benefit or those doesn’t have any commercial substance. Similarly, if some good business principles (like bona fide transaction, arm’s length principle etc.) are not followed with tax avoidance objectivities, GAAR will be invoked on such tax payers. The existing GAAR rules (2015) was amended by the CBDT on 22nd 2016. After the amendment, the applicable date of GAAR has been changed to April 1ST 2017.

For Foreign Investors, GAAR would be applicable to only to those who have not taken the benefit of Double Taxation Avoidance Agreements (DTAA).

How GAAR treats Treaty (DTAA)?

Double Taxation Avoidance Treaties (DTAAs) and GAAR are two set of regulations on the matter of tax administration. If GAAR is limited to the boundaries of a tax jurisdiction, treaty goes beyond the boundaries of a country. Hence when there is a conflict between the two, which one will override is a big matter.

As per the new notification, the treaty provisions will override the GAAR except when there is Impermissible Avoidance Arrangements (IAAs).

The CBDT’s press release about the introduction of GAAR and its implication on treaties says two things about the applicability of GAAR on treaties. First, it says that adoption of anti-abuse rules in tax treaties may not be sufficient to address all tax avoidance strategies. Hence, avoidance through DTAAs should be tackled through domestic anti-avoidance rules. Secondly, the press release says that if avoidance is sufficiently addressed by Limitation of Benefits (LoB) provisions in the treaty (DTAA), there is no need to invoke GAAR in such cases.

What is an Impermissible Avoidance Arrangement (IAA)?

GAAR provisions empower tax authorities to declare any transaction as impermissible avoidance arrangement and determine the tax consequences, if the transaction has been entered into with the main purpose of obtaining a tax benefit and it lacks commercial substance. The concept of impermissible avoidance arrangement is defined under section 124 (15) of DTC. The responsibility of proving that main purpose of particular transaction was not obtaining a tax benefit lies with the tax payers. The GAAR confers wide discretionary powers on the Commissioner of Income Tax (CIT) including the power to invoke GAAR. The new GAAR provisions empower tax authorities to scrutinize an arrangement (a business deal) which gets the protection of a DTAA, if that arrangement is impermissible. An arrangement is any type of transaction, operation, scheme agreement or undertaking.

As per the DTC provisions and amendment by the government after Shome Committee recommendations, an arrangement becomes impermissible avoidance arrangement if it has two conditions. That is if:

(1) the main purpose of which is to obtain a tax benefit.

(2) it is an arrangement, to obtain a tax benefit, with either of the following conditions:

(a) violates arm’s length principle;

(b) results, directly or indirectly, in the misuse, or abuse, of the provisions of DTC;

(c) lacks commercial substance partly or wholly; or

(d) is not for bona fide business purposes (bona fide means with good intentions).

The DTC comprehensively defines ‘impermissible avoidance arrangement’, ‘tax benefit’, ‘commercial substance’, ‘bona fide business purposes’ etc.

What are the major features of the proposed GAAR?

Some of the key recommendations that have found place in the rules are:

  • Threshold of Rs 3 crores in respect of tax benefit to be breached for applicability of GAAR provisions.
  • GAAR not to apply to Foreign Institutional Investors (“FII”) subject to satisfaction of certain conditions.
  • Where a part of an arrangement is declared to be an impermissible avoidance arrangement, the consequences in relation to tax shall be determined with reference to such part only.
  • Investments made before April, 2010, the date of introduction of the Direct Taxes Code, Bill, 2010, would be grandfathered (from GAAR). Grandfathering clause is a situation in which an old rule continues to apply to some existing situations, while a new rule will apply to all future situations. As per the new GAAR notification by CBDT, the investments made before 1st April 2017 will be grandfathered.

What is procedure for invoking GAAR?

For applying the GAAR provisions, a lengthy procedure involving several tax-administration institutions has to be followed. All the GAAR mechanisms start with the GAAR notice issued by a Commissioner of Income tax declaring that a given tax arrangement is an impermissible avoidance arrangement after the reference from an Assessment Officer (AO). Following are the main steps for invoking the GAAR.

1. Assessing Officer makes a reference to the Tax Commissioner about a GAAR potential case.

2. Principal Commissioner of Income Tax/Income Tax Commissioner issuing notice to the tax payer after finding that an arrangement is IAA.

3. Tax payer submits document showing that the arrangement is not IAA:

4. If the Commissioner is not satisfied about the explanation given by the tax payer, he can refer the case to the Approving Panel.

5. The GAAR notice and tax payers’ documents are to be examined by an Approving Panel. Directions of the Approving Panel is applicable to the tax payer and to the tax authorities.

6. Assessing Officer makes an order: Once an arrangement is declared an IAA, the Assessing Officer (AO), should issue an order to the tax payer. Here, the order comes after the ratification by the Commissioner.

What is the difficulty of GAAR implementation?

The GAAR itself is an unconventional type of tax legislation; bringing tax avoidance under the scrutiny of tax officials. Anti-avoidance regulations are tough to implement as it is difficult to differentiate between different types of avoidance practices. The line of difference between an objectionable avoidance and permissible one is very thin. In the present context, it is very difficult to filtrate a permissible arrangement from an impermissible one. Ideally, the approach under GAAAR should be to target arrangements which have the sole or main purpose of achieving a tax advantage.

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