Introduction to General Anti-Avoidance Rule
Internationally and in India, tax avoidance has been a major issue.
Tax avoidance is basically exploiting the loopholes in the law to obtain a tax advantage.
A taxpayer is entitled to conduct transactions in a manner so as to reduce his tax liability. But, these transactions should have economic or commercial substance. They should not be carried out for the sole purpose of avoiding taxes.
General Anti-Avoidance Rule or GAAR is a set of rules to determine whether a set of transactions have commercial substance. It is an anti-tax-avoidance regulation.
GAAR has been made effective in India from 1 April 2017.
Background
General Anti-Avoidance Rule (GAAR) was proposed for the first time in Direct Taxes Code 2009.
It was introduced in the Parliament by then Finance Minister, Pranab Mukherjee in 2012. It became controversial as it was sought to be implemented with retrospective effect.
The Government had to set up a panel under Parthasarathy Shome in 2012 to review the GAAR proposals. The Committee suggested that the implementation of GAAR be deferred by three years to 2016-17.
The discussion of GAAR came to the forefront due to the Vodafone tax dispute.
Vodafone had entered the Indian market in 2007 by purchasing Hutch India at Rs.55000 crores. Hutchinson Hongkong (the parent company of Hutch India) sold Hutch India to Vodafone and hence was liable to pay capital gains tax to Indian tax authorities.
As per the Indian tax law, Vodafone should have deducted the amount of capital gains tax from the final payment made to HTL Hongkong and deposited it with the tax authorities.
But, it did not turn out that way. This is because HTL Hongkong did not invest directly in India. They invested through an intermediary in the Cayman Islands called CGP Investments (Holdings) Ltd., which owned 67% in Hutch India. So, Vodafone purchased CGP investments. It effectively made them the owner of Hutch Essar, India.
Vodafone refused to pay capital gains tax in India as it was a transaction carried out in the Cayman Islands between two foreign firms. (The Cayman Islands is a tax haven and impose no capital gains tax on the sale of assets.)
The tax authorities argued that the transaction involved the sale of Indian assets and was liable to be taxed in India.
On January 2012, the Supreme court gave the verdict in favour of Vodafone. This case was one of the reasons why GAAR was proposed to be implemented with retrospective effect.
Provisions of General Anti-Avoidance Rule
As per the GAAR provisions, an arrangement/ transaction may be declared to be an ‘impermissible avoidance arrangement’. The consequences in relation to the impermissible arrangement will be determined by the tax authorities.
An impermissible avoidance arrangement is defined to mean an arrangement, the main purpose of which is to obtain a tax benefit, and it—
- creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length. (Arm’s length transaction means parties involved in the transaction are not related to each other. Example- Principal and subsidiary firms are related parties)
- results, directly or indirectly, in the misuse, or abuse, of the provisions of the Indian domestic tax law;
- lacks commercial substance or is deemed to lack commercial substance, in whole or in part; or
- is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes
GAAR will not be applied in certain cases:
- An arrangement in which the tax benefit to all parties is less than Rs.3 crores
- GAAR will not be applicable to Foreign Institutional Investors (FII), provided no treaty benefit has been claimed.
- GAAR will not be applicable to non-resident Indians (NRIs) investing in participatory notes. (Read: Participatory notes explained)
- GAAR will not be applicable to any tax benefit derived from an arrangement made before 1 April 2017. This is known as Grandfathering clause.
Grandfathering clause means an old rule continues to apply to existing situation. As per GAAR provisions, old rule will continue to apply to arrangements done before 1 April 2017. GAAR will be applicable only to arrangements made on or after 1 April 2017.
Procedures for applying GAAR
A two-step approval process has been prescribed to invoke General Anti-Avoidance Rule or GAAR to ensure that tax authorities do not misuse their power.
1. If a tax officer considers necessary to invoke GAAR, he makes a reference to the Principal Commissioner/ Commissioner
2. If the Principal Commissioner/ Commissioner is satisfied, he issues a notice to the taxpayer.
3. If the taxpayer raises no objection, the Commissioner declares the arrangement to be an ‘impermissible avoidance arrangement’ issues and issues directions as he deems fit.
4. If the taxpayer raises an objection, he has to submit documents and give explanations proving that the arrangement is not an ‘impermissible avoidance arrangement’.
5. If the Commissioner is not satisfied with the explanation given by the taxpayer, he can refer the case to the Approving Panel.
5. The Approval panel examines the GAAR notice and taxpayers’ documents.
6. The Approving Panel issues directions as it deems fit.
Conclusion
It has to be noted that India has amended tax treaties with Mauritius and Singapore to counter tax avoidance. But, there are other benefits that are available. In this context, GAAR is important. The GAAR overrides the tax treaties with different countries.
(Read: The India-Mauritius Treaty Amendment: Explained)
Although, Central Board of Direct Taxes (CBDT) has clarified that GAAR will not be invoked if the treaty addresses the concerns of tax avoidance.
Lastly, there is a thin line between legitimate tax planning and tax avoidance. Investors fear that General Anti-Avoidance Rule (GAAR) has given greater subjective authority to the tax authorities. It can affect business sentiments. Detailed guidelines, as issued in countries like Canada and UK should be issued to help both the tax authorities as well as taxpayers.
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References:
GAAR India and international experience by Deloitte