GENERAL ANTI-AVOIDANCE RULES

General Anti-Avoidance Rules [GAAR] in India - An Insight into

T. P. Ostwal*, Siddharth Banwat**

1. Introduction
Given the concerns raised by the Revenue relating to the aggressive tax planning by taxpayers and its slow pace of progress in amending certain Double Tax Avoidance Agreements, the Direct Taxes Code Bill, 2010 (DTC) has proposed to introduce anti-avoidance measures in the domestic tax laws themselves by according wide powers to the Revenue to invoke GAAR.
T. P. Ostwal

The proposed GAAR provisions do not envisage that every arrangement for tax mitigation would be liable to be classified as an impermissible avoidance arrangement. It is only in a case where the arrangement, besides obtaining a tax benefit for the assessee, is also covered by one of the four conditions, i.e., it is not at arms length basis, or it represents misuse or abuse of the provisions of the Code or it lacks commercial substance or it is entered into or carried on in a manner not normally employed for bona fide business purposes, the GAAR provisions would come into effect. The various terms such as impermissible avoidance arrangement, tax benefit, lacks commercial substance, bona fide business purposes, etc, have been comprehensively defined in the DTC.

Siddharth Banwat

2. DTC vis-a-vis GAAR

Under DTC, the power to invoke GAAR is bestowed upon the Commissioner of Income-tax. For this purpose the Code empowers him to call for such information as may be necessary. He is also required to follow the principles of natural justice before declaring an arrangement as an impermissible avoidance arrangement. He will determine the tax consequences of such

* T. P. Ostwal, Senior Partner, T.P. Ostwal & Associates. ** Siddharth Banwat, Director international taxation in T.P.Ostwal & Associates

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impermissible avoidance arrangement as if the arrangement had not been entered into and issue necessary directions to the Assessing Officer for making appropriate adjustments. The directions issued by him will be binding on the Assessing Officer and the Commissioner shall comply with other procedural compliance as prescribed under section 154 of the DTC.

For a transaction to be declared as an impermissible avoidance arrangement, it should essentially satisfy two conditions, viz.:

2.3.1 The main purpose of an arrangement, whether looked in part or whole or in any step of such an arrangement therein, is entered into to obtain tax benefit;
For the purpose of analysis and understanding of the overall definition of the term impermissible avoidance arrangement, which, in turn, contains various defined and undefined terms, one need to examine each and every aspect involved in the given definition separately. In the following paragraphs various terms used therein, their basis of origination and issues relating to their interpretation have been discussed. First of all, it is noteworthy that the definition of the term emphasizes on a phrase main purpose which itself is undefined under the provisions of the DTC which can lead to ambiguity. However, for the purpose of this research and understanding of this term and to arrive at a reasonable interpretation, reference can be made to the South African discussion paper on tax avoidance released in November 2005 which explains the word main in similar context as generally construed to mean predominant. It further goes to explain by way of an example that if a transaction has both, a tax and a commercial purpose, then the test of main purpose would be satisfied only if the tax purpose is the predominant one. In light of the above discussion, it is to be appreciated that the main purpose test is a subjective and factual test which may differ from case-to-case. Further, Para 36 of approved Revised Commentary on Article 1 of the UN Model Double Tax Convention to be included in the next version of the UN Model Double Tax Convention, albeit in the context of inclusion of general anti-abuse rules in a tax treaty, expresses the apprehension that the words the main purpose would impose an unrealistically high threshold that would require tax administrations to establish that obtaining tax benefits is objectively more important than the combination of all other alleged purposes, which would render the provision ineffective.

2.1 In the proposed DTC, GAAR can be classified into following three parts:
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Basic provisions - As given in section 123 and section 125. Definitions pertaining to GAAR - As given in various sub-sections of section 124. Fundamental procedural provision As given in section 154 and section 155.

2.2 Analytical insight into various provisions of GAAR in the proposed DTC:
Drawing inference from the international experience towards GAAR, it is attempted to de-mystify the provisions of GAAR in the proposed DTC. GAAR provisions may be invoked once a transaction is declared as an impermissible avoidance arrangement. It, therefore, becomes imperative for the participants to thoroughly review the various definitions contained in various sub-sections of section 124, the satisfaction of conditions of which could ultimately lead the CIT to declare a transaction as an impermissible avoidance arrangement.

2.3 Concept of Impermissible avoidance arrangement:

The term impermissible avoidance arrangement has been defined in section 124(15) of the DTC. The scope of this term extends to transactions which are entered into between parties resulting into any tax benefit and specifically meet any of the conditions laid down resulting into either abuse of law or commercial nature of the transaction. Remarkably, the definition of the term itself contains terminologies which have been defined in various other sub-sections of section 124.

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The term arrangement is defined in section 124(3) of the DTC. The given definition is wide enough to cover any type of transaction, operation, scheme, agreement or understanding, irrespective of whether it is enforceable or not and also extends to include all steps therein or parts thereof. Interestingly, the terminology used in the statute emphatically states that, even though the main purpose of the arrangement may not be to obtain tax benefit, yet, if a step therein has been executed to obtain tax benefit, even then the whole arrangement could be declared as an impermissible avoidance arrangement. This ideology follows from the South African experience wherein the South African Revenue Service while formally introducing legislative GAAR in South Africa, clarified that, even though the purpose of a step in or part of an avoidance arrangement may be different from the purpose attributable to the

avoidance arrangement as a whole, GAAR may be applied to such an arrangement, in order to overcome a previous Courts Ruling. All the aforesaid terminologies have to be read in conjunction with the term tax benefit which has been defined in a wide manner to principally cover: (i) a reduction, avoidance or deferral of tax or other amount payable under the provisions of the DTC or which would have otherwise been payable under the DTC but for a tax treaty; (ii) an increase in a refund of tax or other amount under the provisions of the DTC or as a result of a tax treaty in the relevant or any otherfinancial year. Following chart explains the scope of the term and correlates it with various situations covered by the scope of the term tax benefit;

Definition of the term tax benefit includes even the benefit arising in accordance with the provisions of double tax avoidance agreement entered into by India. The benefit under the tax treaty may be in the form of reduction of the rate of tax, elimination of tax by transferring right of tax to other nation, etc. Another fundamental question which arises is when one can trigger the GAAR provisions at the time when actual tax benefit arises or when tax benefit accrues to the parties or even at the earlier stage, i.e., at the planning stage. Ironically an impermissible avoidance arrangement has been defined to mean a step in (a part or whole of) an arrangement, whose main purpose is to obtain a tax benefit and if it lacks commercial substance or bona fide purpose.

The definition suggests that existence of a tax benefit is a prerequisite to attract GAAR provisions. The definition of tax benefit is wide enough to even include any deferral of tax. Deferral of tax, as understood internationally, means postponement of the payment of tax liability. On many instances, a transaction or an arrangement may not result into an immediate tax benefit or even a deferral of an immediate tax benefit. These instances are well understood in the scenario where overseas inbound or outbound investment structures are planned and created methodically, resulting into no tax benefit at the planning stage. The best example for the same can be setting-up of an International business holding company with the purpose of holding investments in various operating companies. However, in such cases tax benefits may arise at a later stage when

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operating companies start generating profits and surplus funds are repatriated either way of dividends or interests, as the case may be. Now, once the condition of obtaining tax benefit is met, one has to look at the specific conditions laid down hereunder to deem a particular transaction/arrangement as an impermissible avoidance arrangement. If a particular transaction is determined to be covered under the scope of either or one or more of these conditions then the transaction shall be declared as an impermissible one, if it also results into tax

benefit. Here, it is important to note that these criteria of falling under either of these conditions are required to be met along with the basic criteria of obtaining a tax benefit. Each of these conditions along with appropriate situations covered under such conditions and various issues arising out of each of them is discussed in the following paragraphs:

2.3.2 To establish a arrangement as an impermissible avoidance arrangement, tax benefit is to be looked at in conjunction with the either of the given four conditions:

Under the first criteria, if any unreasonable right(s) or obligation(s) are created between the parties to the arrangement, which normally would have not been created between two persons dealing at arms length basis then such an arrangement shall be deemed to be an impermissible one. The criteria laid down in this condition aims at testing the motive of the parties getting into an arrangement. However, the word arms length is too subjective. Inferences can be taken from the existing transfer pricing regulations where globally still there is no consensus as to what is arms length. Perhaps, an interesting comparison can be made on the scope of the term arms length when used in the context of transfer pricing provisions (which are SAAR) whereas it is in the context of GAAR. Under the transfer pricing, arms length principle is applicable where arrangement is between two associated enterprises, whereas in light of the present definition even the arrangement between parties (unassociated), dealing in normal commercial terms, may be construed

to be not at arms length. The effect of clause (a) of section 124(15) can be understood from the following example:
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The second criteria emphasizes on the use of the provisions of the Code to effectively reduce the tax liability. Section 124(15)(b) uses the term misuse or abuse of the provisions of the DTC which cover under its scope any arrangement which results into misuse or abuse of the provisions of the Code. In order to understand the difference between the word misuse and abuse reference can be had to Canadian ruling in case of OSFC Holdings wherein the Court stated that: the misuse analysis looks to specific provisions in isolation from the broader scheme of the ITA, while the abuse analysis looks to the purpose, scheme or policy reflected in the provisions of the ITA as a whole The phrase misuse or abuse of the Code has not been defined in the GAAR. It is an irony that originally it was claimed that DTC would simplify the tax laws in India,

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but here is another instance wherein confusion has been increased in the name of simplification.
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In the third criteria, lack of commercial substance has been addressed. Section 124(15)(c) states that an arrangement, either in part or whole, shall be treated as an impermissible one, if it lacks commercial substance. Further, the term lacks commercial substance has been defined in the section 124(15)(19) as a step in, or a part or whole of an arrangement shall be deemed to be lacking commercial substance if it falls under any of the following paragraphs: If it does not have a significant effect upon the business risks, or net cash flows, of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained but for the provisions of section 123 of DTC. The first deeming situation given above uses the word significant. It is unclear as to what is the meaning of the word significant as it is used in connection with effect on the business risk or net cash flow. The overall concept of the aforesaid provision is to cover within its scope the arrangements or transactions which are internationally known as sham transactions and are essentially articulations of the economic substance doctrine. If the legal substance, or effect, of the arrangement as a whole is inconsistent with, or differs significantly from the legal form of its individual steps. This condition is essentially an articulation of the internationally known substance over form doctrine, where the legislative intent is to prevent transactions entered into merely to avail of the tax benefit with no legal substance, thereby resulting into abuse of provision of the law. If it includes, or involves any of the following:

i. round trip financing without regard to whether or not the round tripped amounts can be traced to funds transferred to, or received by any party in connection with the arrangement; or the time, or sequence, in which round tripped amounts are transferred or received; or the means by, or manner in which round tripped amounts are transferred or received; ii. an accommodating or tax indifferent party (For example: Use of conduit entity/person) iii. any element that has the effect of offsetting or cancelling each other; or iv. a transaction which is conducted through one or more persons and disguises the nature, location, source, ownership, or control, of the fund; (For Example: Use of colourable devices or use of sham entities or hiding behind the corporate veil) The term Round Trip Financing is used since past few years in the context of Foreign Exchange Management Act, 1999. However it has been nowhere defined. It is a term which is coined by the professional fraternity to denote a particular type of an arrangement used for circulating ones own funds in a way that it gets reinvested from where they originated. It is the first time that in DTC, Sec 124(21) defines the term Round trip Financing. The definition is an inclusive one which includes financing in which funds are transferred among the parties to the arrangement and the transfer of the funds would result in, directly or indirectly, a tax benefit but for the provisions of section 123 of the DTC or significantly reduce, offset or eliminate any business risk incurred by any party to the arrangement. From the analysis of definition of the term Round Trip Financing given under the DTC it is understood that the aim of the definition is to prevent transactions entered into between parties

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merely for the purpose of availing of tax benefit. One can take a simple example to understand the basis of the round trip financing. X Ltd., an Indian company, invests US $ 10 Million in newly set-up Singaporean wholly owned subsidiary which, in turn, invests back in India either directly into X Ltd. or indirectly through investment in another Indian company which invests in X Ltd. The term accommodating party is also defined in the DTC. Sec 124(1) defines Accommodating party to mean a party to an arrangement who, as a direct or indirect result of his participation, derives any amount in connection with the arrangement, which shall (a) be included in his total income which would have otherwise been included in the total income of another party; (b) not be included in his total income which would have otherwise been included in the total income of another party; (c) be treated as a deductible expenditure, or allowable loss, by the party which would have otherwise constituted a non-deductible expenditure, or non allowable loss, in the hands of another party; or (d) result in pre-payment by any other party;
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in support of its claim that GAAR does not apply. Thereafter, the Commissioner shall pass an order declaring whether the arrangement is an impermissible avoidance arrangement or not. It is not clear whether it would be mandatory for the Commissioner to state reasons as to why GAAR could be applicable to a particular arrangement, while issuing notice to a taxpayer. Once the arrangement is declared to be an impermissible avoidance agreement, the Commissioner issues directions to the Assessing Officer (AO), the first level tax authority, for making appropriate adjustments. The AO is bound to follow these directions and issue a draft order to the taxpayer. The taxpayer can, on receipt ofthe draftorder from the AO, within a period of 30 days, file objections before the Dispute Resolution Panel (DRP), a collegium of three Commissioner-level tax officers, constituted by the CBDT. The DRP may call for and examine the record of any proceeding relating to the draftorder and make such further inquiry, as it thinks fit. Thereafter, the DRP, after giving an opportunity to both the taxpayer as well as the AO, may confirm, reduce or enhance the variations proposed inthe draftorder. The direction of the DRP is binding on the AO. The taxpayer can appeal against this directly with the secondappellateauthority, i.e., theIncome TaxAppellateTribunal.

The fourth criteria relates to the test of Bona fide Business Purpose. The term Bona fide purpose has been defined in the section 124(10) to include the purpose which creates rights or obligations that would normally be created between persons dealing at arms length basis and would not result, directly or indirectly, in the misuse, or abuse, of the provisions of this DTC. Interestingly, one wonders what could have been the purpose of re-iterating the two conditions laid down in the definition of the term impermissible avoidance arrangement identically once again in the definition of bona fide purpose.

3.1 Burden of proof

The burden of proof vests in the taxpayer to establish that thetax benefitwas not the main purpose of the arrangement. Furthermore, an arrangement is presumed to have been entered into/carried out for the main purpose of obtaining atax benefit, if the main purpose of a step or part of the arrangement is to obtain atax benefit, even if the main purpose of the whole arrangement may not be to obtain thetax benefit.

4. Conclusion
After going through the procedural provisions, it is felt that the powers conferred on the Commissioner are alarming in the sense that it could result in an abuse of power. For instance, the Commissioner could re-characterize any

3. Procedures in applying GAAR:

DTC 2010 provides for the Commissioner to serve notice on the taxpayer to provide any evidence or particulars on which it may rely on

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avoidance arrangement or step therein/ thereof, to his own interpretation (thereby classifying such avoidance arrangement as an impermissible one in nature) even if such an interpretation is not in accordance with the taxpayers interpretation or intention. Such an interpretation could lead to grave consequences for the taxpayer, should he not be able to satisfy the Commissioner during the applicable notice period, as a lengthy and costly Court battle could ensue. In our opinion, such power on the side of the Commissioner could disturb the equilibrium between the power of the taxing authorities and the right of the taxpayer

to conduct his business according to the principles laid down in the case of Azadi Bachao Andolan. Apart from a few specific anti-abuse rules in the Income Tax Act, 1961, the development of antiabuse or anti-avoidance principles in India in general has been by way of judge-made laws. In India, the Courts have drawn a thin line of distinction between tax evasion and tax avoidance. However, in the legal position as of today, form over substance still prevails in India wherein the legal character of the transaction should not be disregarded in pursuit of substance, unless tax is sought to be avoided by adopting colourable devices wherein lifting of corporate veil would nonetheless be permitted by authorities.

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