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GAAR India and International perspective

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  • 1. General Anti-Avoidance Rules India and International perspectivewww.deloitte.com/in
  • 2. 2
  • 3. ContentsExecutive summary 4Pre GAAR concept 6Pre GAAR concept – India experience 8GAAR concept 10International experience 11India Regime 17Way forward 23 General Anti-Avoidance Rules India and International perspective 3
  • 4. Executive summary“Tax avoidance like tax evasion, seriouslyundermines the achievements of the publicfinance objective of collecting revenues in anefficient, equitable and effective manner1.” Internationally, tax avoidance has been recognized as an provision may undermine the common denominator area of concern and several countries have expressed in determination of a tax avoidance scheme, i.e., the concern over tax evasion and avoidance. This is also principle that though the taxpayer is free to choose the evident from the fact that either nations are legislating most tax efficient method, the commercial justification the doctrine of General Anti-Avoidance Regulations in for the choice taken and tax consideration (benefit) is their tax code or strengthening their existing code. not the only reason. In India, the proposed Direct Tax Code 2010 (DTC Considering the goals of tax avoidance legislation, 2010 or Code) seeks to address the issues relating namely, deferral, re-characterization, elimination and to tax avoidance and evasion by bringing in General shifting, India would need to address the issue in the Anti-Avoidance Rules (GAAR) in addition to various proper perspective so that the provisions and their transaction-specific Special Anti-Avoidance provisions. implementation do not become a law onto themselves. In the circumstances, one should be aware of some The Discussion paper issued along with the proposed issues relating to the promulgation of a General Anti- new tax code states that tax avoidance arrangements Avoidance Rule, in terms of it being receptive to: adopted by taxpayers span across several tax jurisdictions, and it is desirable to introduce GAAR that • Providing a robust framework based on sound legal would serve as a deterrent to the use of increasingly jurisprudence and principles to address the issue sophisticated forms of tax avoidance by taxpayers. of abusive transactions, which tend to ride on the The paper also states that the appellate authorities shortcomings of the tax system. As indicated by and Courts have cast a heavy onus on the revenue many international tax theorists and practitioners, authorities for dealing with matters of tax avoidance, the design of GAAR should be by reference to ‘busi- especially when the relevant facts are in the exclusive ness-purpose test’ with emphasis on the different knowledge of the taxpayer who chooses not to reveal concepts of the economic substance associated with them. the categories of tax avoidance behavior, such as tax evasion, acceptable tax avoidance and abusive The introduction of GAAR regulation recognizes that it tax avoidance rather than narrow the scope to the may not always be feasible for the judiciary to address aspect of a tax benefit test. the unforeseen implications of transactions carried out • Incorporate a substance over form rule where a for tax purposes and also the need to provide some transaction or a series of transactions are entered semblance on the matter of tax avoidance. However, into to judge the authenticity and purpose of the where tax benefit is to be considered as the sole transaction rather than teleologically apply the tax1 Discussion paper on Direct criterion (as is currently recognized under the proposed benefit provision, surpassing all other aspects of the Taxes Code 2009 new Code) for determining tax avoidance, such a transaction.4
  • 5. • The issue of bilateral tax treaty override by way of This paper outlines some of the nuances relating to bringing the same under the relevant treaties in General Anti-Avoidance Rule by examining the historical terms of limitation of benefits clause. In the absence perspective for tax avoidance generally and in India. The of the same, it may result in violation of international concept of GAAR, international experience on GAAR principles of treaty interpretation. legislation in some jurisdictions, the proposed provisions• Striking a balance between wide coverage and under the Direct Tax Code followed by a comparison uncertainty – it is imperative that the Government with other countries, few instances on the applicability issues detailed guidelines on inherent principles and of the GAAR provisions, and the way forward for both on the type of transactions/arrangements they may the authorities and the taxpayers have been covered in consider as ‘avoidable transaction’. A mechanism the paper. similar to an advance ruling may be considered to avoid uncertainty, protracted litigation and disputes. General Anti-Avoidance Rules India and International perspective 5
  • 6. Pre GAAR conceptInternationally and in India, a constant debate has ‘Legal substance’ would refer to characterization which 2 Carter Commission in Canadabeen raging over the issue of tax avoidance. Over emerges from a close study of the rights and obligations 3 Lord Nolan in IRC v.the years, the term ‘tax avoidance’ has come to be in a legal relation whereas ‘Economic substance’ has Willoughbyunderstood as arranging affairs with the main object different interpretations as propounded by various 4 Lord Templemanor purpose of obtaining tax advantage while prima jurisdictions: 5 Simon in Latilla v. I.R.C. (11facie fully intending to comply with the law in such • ‘Real economic substance’ – This is the American ITR Suppl. 78, 79) (HL)respect. Some principles underlying the meaning of notion under which the Economic substance‘tax avoidance’ are: is determined by looking at both objective and subjective factors to see if there is any potential• The expression ‘tax avoidance’ is used to describe for profit other than tax savings, or if there is any every attempt by legal means to prevent or reduce meaningful change in the economic position of the tax liability, which would be otherwise incurred, taxpayer. Under this doctrine, a transaction lacking by taking advantage of some provision or lack of economic substance will be ignored. In Gregory provision in the law. It pre supposes the existence vs Helverig (1934) - US, the Court outlined that of alternatives, one of which would result in less “it does not follow that Congress meant to cover tax than the other. Moreover, motive would be an such a transaction. The meaning of a sentence essential element of tax avoidance. A person who may be more than that of the separate words, as adopts one of the several possible courses to save tax a melody is more than the notes, and no degree of must be distinguished from a taxpayer who adopts particularity can ever obviate recourse to the setting the same course for business or personal reasons2. in which all appear, and which all collectively create.• A course of action designed to conflict with or defeat If what was done here was what was intended by the evident intention of Parliament3. [the statute], it is of no consequence that it was all• Where it reduces the incidence of tax borne by an an elaborate scheme to get rid of income tax, as it individual taxpayer contrary to the intentions of certainly was… [But] the purpose of the section is Parliament4. plain enough; men engaged in enterprises… might• Tax planning may be legitimate, provided it is within wish to consolidate, or divide, to add to, or subtract the framework of law. Colorable devices cannot be from, their holdings. Such transactions were not to part of tax planning and it is wrong to encourage or be considered as realizing any profit, because the entertain the belief that it is honorable to avoid the collective interests still remained in solution. payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay their taxes In other words, the benefit of the objective tax result honestly without resorting to subterfuges5. would be denied, where the transaction did not• Further, Courts in India have broadly indicated change the economic position, apart from the tax that if some device has been used by a taxpayer to benefit, nor did it reflect any facet of the business, conceal the true nature of the transaction, it is the which could be considered as lacking economic duty of the taxing authority to unravel the device substance, and was not “the thing which the statute and determine its true character. However, the legal intended”.” effect of the transaction cannot be displaced by probing into the ‘substance of the transaction’. • Step Transaction plus business purpose – This UK version combines step transactions doctrine andConsidering these continuing difficulties of classifying business purpose doctrine and enables the courts totransactions as being acceptable within the framework overlook the step transactions that serve no businessof law or not, a need is being felt to move towards a purpose. This could be evolved from the variousstructured approach to address the issue of avoidance juridical pronouncements made by the UK courts withboth from a legal and economic point. regard to transaction considered as entered into with the objective of tax avoidance.Thus, ‘tax avoidance’ could be said to transact betweensubstance over form of a transaction, the issue being of In Duke of Westminster vs IRC, their Lordships held thatwhether it is legal or economic substance. the Act is to receive a strict or literal interpretation and6
  • 7. that a transaction is to be judged not by its economic or commercial substance but by its legal form. In Ramsay vs IRC, their Lordships watered down the economic substance theory on the ground that it could be invoked only when the purposive Further, the OECD leaves it to the individual countries interpretation approach is adopted. The principle to introduce anti-abuse legislation, which they consider outlined herein came to be considered as a general could be applied without interference by the Model rule of statutory construction, not a separate judicial Convention or the bi-lateral tax treaty between the doctrine. countries inter-se. However, the OECD Commentary on Article 1 of the Model Tax Convention also clarifies thatThe common denominator which can be found in most a general anti-abuse provision in the domestic law incountries is that if a taxpayer has multiple avenues the nature of ‘substance over form rule’ or ‘economicavailable to structure his transaction, he is free to substance rule’ would not be in conflict with the treaty.choose the most tax-efficient avenue, provided a level In other words, the general anti-abuse rule wouldof commercial justification for the same exists, and tax is override the provisions of the tax treaty.not the only reason. Hence, the underlying principle emanating fromIn respect of international recognition to the concept, international experience in respect of tax avoidance andthe Vienna Convention provides that international where GAAR legislation has not been enacted is theagreements are to be interpreted in ‘good faith’. In case recognition that the contentious issue of determining/any international agreement/treaty leads to unintended establishing the doctrine of substance over form wouldconsequences like tax evasion or flow of benefits to have to be established through an examination of theunintended person, it is open to the signatory to take legal substance, the legal form, or the real economiccorrective steps to prevent abuse of the treaty. Such substance of the transaction. This has also been dulycorrective steps are consistent with the obligations adapted under Indian jurisprudence as outlined in theunder the Vienna Convention. section below. General Anti-Avoidance Rules India and International perspective 7
  • 8. Pre GAAR conceptIndia experience6 v. A. Raman and Co, CIT Indian tax laws, though providing for specific anti- Westminster, and took the view that tax planning was [1968] 67 ITR 11 (SC) avoidance measures, do not have any general anti- legitimate so long as it was strictly within the four corners7 ank of Chettinad Ltd. v. B avoidance rules or regulations. The Courts have over the of the law and any ‘colorable’ device or dubious methods CIT [1940] 8 ITR 522 (PC) years drawn out the general parameters and principles to minimize tax incidence were not legally permissible.8 McDowell and Co. Ltd. v. Commercial Tax Officer, in outlining whether a transaction or scheme would be [1985]154 ITR 148 (SC) considered as tax avoidance/tax evasion or tax planning It appears that there is no single approach towards the9 Union of India v. Azadi under the tax laws, as outlined below, though the issue of substance over form. A clear tendency exists Bachao Andolan, [2003] 263 ITR 706 (SC) uncertainty continues. for Revenue authorities to try and counter any kind of undesired outcome (in their eyes) of a certain piece of The Hon’ble Supreme Court (SC) in A Raman’s case6 legislation by applying the substance over form doctrine. observed that: However, while examining a legally valid transaction, the “...the law does not oblige a trader to make the maximum Revenue authorities should proceed objectively and not profit that he can get out of his trading transactions. hypothetically attribute ‘motives’ behind the taxpayer’s Income which accrues to a trader is taxable in his hands. action. Income which he could have, but has not earned, is not made taxable as income accrued to him. Avoidance We have witnessed a contentious journey for of tax liability by so arranging commercial affairs that determining whether the affairs planned by the taxpayer charge of tax is distributed is not prohibited. A taxpayer were legitimate to be strictly within the four corners of may resort to a device to divert the income before it the law or was a colorable device or dubious method accrues or arises to him. Effectiveness of the device entered into with a purpose to minimize tax incidence depends not upon considerations of morality, but on the leading up to the decision9 wherein the SC reiterated operation of the Income-tax Act. Legislative injunction and continued to enshrine the principles as laid out in in tax statutes may not, except on peril of penalty, be Duke of Westminster as under: violated, but may lawfully be circumvented....” “...With respect, therefore, we are unable to agree with Further, in Bank of Chettinad’s case7, the Hon’ble Privy the view that Duke of Westminster’s case (1936) Council (PC) stated that: AC 1 (HL); 19 TC 490 is dead, or that its ghost has been “...the tax authority is entitled and is indeed bound exorcised in England. The House of Lords does not to determine the true legal relation resulting from seem to think so, and we agree, with respect. In our a transaction. If the parties have chosen to conceal view, the principle in Duke of Westminster’s case (1936) by a device the legal relation, it is open to the tax AC 1 (HL); 19 TC 490 is very much alive and kicking in authorities to unravel the device and to determine the the country of its birth. And as far as this country is true character of the relationship. But the legal effect of concerned, the observations of Shah J. in CIT v. Raman, a transaction cannot be displaced by probing into the (1968) 67 ITR 11 (SC) are very much relevant even substance of the transaction...” today...” and Another important Indian case8 addressing the substance “...It thus appears to us that not only is the principle over form question reiterated the principles laid down in Duke of Westminster’s case (1936) AC 1 (HL); 19 TC by the House of Lords in the decision of Duke of 490 alive and kicking in England, but it also seems toWhile examining a legally valid transaction, theRevenue authorities should proceed objectively and nothypothetically attribute ‘motives’ behind the taxpayer’saction.8
  • 9. have acquired judicial benediction of the Constitutional shares in an Indian company. In the matter beforeBench in India, notwithstanding the temporary the Bombay High Court, it was observed that theturbulence created in the wake of McDowell’s case domestic tax law recognizes the right of a taxpayer to(1985) 154 ITR 148 (SC).” plan his transactions to reduce the incidence of tax. In the absence of statutory provisions to the contrary,Further, the SC in Azadi Bachao Andolan’s case observed instruments and legal structures which are utilized for athat: bonafide business purpose do not permit an enquiry by• The contention that the Double Taxation Avoidance the authorities into the underlying economic interest. Convention (DTAC) between India and Mauritius However, the parties cannot conceal the nature of is ultra vires is not acceptable — even if the DTAC their legal relationship by adopting a structure which is is susceptible to ‘treaty shopping’ on behalf of the different from the legal character assumed by them. residents of third countries.• A tax treaty or convention must be given a liberal Considering the background to the ongoing tussle, the interpretation. A holistic view has to be taken in this intention of the Government in proposing to legislate regard. GAAR provisions could be drawn from the principle• An act, which is otherwise valid in law, cannot be for recognizing the continuum of Courts addressing treated as non-est merely on the basis of some unforeseen implication of transactions under the tax underlying motive (supposedly resulting in some provisions and in the circumstances, to provide a vision economic detriment or prejudice to the national to an assumed obscure state of affairs. interest, as perceived by the respondents). However, it needs to be seen how the principlesHowever, the Revenue authorities have over the years enshrined through judicial pronouncements (beingchallenged various forms of transactions entered into principle based or purposive) would continue to beby taxpayers, specifically with regard to cross-border followed under the proposed GAAR regime as istransactions. The recent example being in the case proposed under DTC 2010, wherein the distinctionof the purchase of shares by Vodafone International between tax avoidance and tax evasion is being soughtof a foreign company, which held directly/indirectly to be obliterated. General Anti-Avoidance Rules India and International perspective 9
  • 10. GAAR concept “A broad spectrum GAAR carries a real risk ofundermining the ability of business and individuals tocarry out sensible and responsible tax planning and thaton the other hand introducing a moderate rule whichdoes not apply to responsible tax planning, and istargeted at abusive arrangements would be beneficial.”Legislatures in various countries are moving towards better legislation, giving clearer signal to taxpayers, 10 Edgar: ‘Designing and T Implementing a Targetpromulgating General Anti-Avoidance Rules to address better tools to the judiciary and an improved basis for Effective General Anti-the ongoing debate between illegal evasion and ‘legal’ enhanced cooperation between taxpayers and revenue Avoidance Competence’avoidance, or what is termed as ‘acceptable’ and authorities. Further, the only true solution to avoidance 11 David Duff-Relationships,‘unacceptable’ avoidance of tax. is to have a more principle based tax system, but this Boundaries and Corporate Taxation: Compliance requires more than mere changes to wording and that and Avoidance in Era ofAccording to legal experts, the implementation of further work is clearly needed on forms of drafting GlobalizationGAAR has led to difficulties in various jurisdictions. In (rather than just pick and implement), both at the 12 ditorial Comment: Beyond Espite of that, none of the jurisdictions have shown signs specific and meta levels. Boundaries: Developing Approaches to Taxof dispensing with the provisions; in fact, they have Avoidance and Tax Riskrevised the concept when judicial pronouncements have Further, in the recently released “A study to consider Managementrefused to recognize the same. whether a GAAR rule should be introduced into the UK Tax System”, it has been stated:However, GAARs should not be relied upon to address “....that introducing a broad spectrum GAAR wouldforeseeable methods of tax avoidance occasioned not be beneficial for the UK tax system. This wouldby statutory difference in the tax treatment of similar carry a real risk of undermining the ability of businesstransactions or relationships10. In these circumstances, and individuals to carry out sensible and responsibleto the extent that the avoidance is considered tax planning and that on the other hand introducingunacceptable, the preferred response for legislature a moderate rule which does not apply to responsibleis to either amend the specific provisions at issue or tax planning, and is targeted at abusive arrangementsintroduce a specific anti-avoidance to preclude their use would be beneficial for the UK Tax system....”for unacceptable tax avoidance11.In dealing with the issue of tax avoidance through alegislative code or judicial principles, it is imperative toprovide clarity in dealing with the situation. This may bethrough a purposive interpretation of legislation so asnot to offend the rule of law where such a general rulecould be considered to be on the boundary of havingno limits.As stated by Judith Freedman12 in summarizing thefindings in the stated publication, there is a need for10
  • 11. International experience Canada following principles to guide the interpretation of the GAAR: General • While the economic substance of a transaction A taxpayer is entitled to structure affairs so as to might be relevant at various stages of GAAR analysis, minimize tax within the confines of the law. However, ‘economic substance’ has little meaning in isolation tax planning (or tax minimization) must be contrasted from the proper interpretation of specific provisions with tax evasion, which may render the taxpayer liable of the Act. Accordingly, any argument that is to fines or imprisonment. Some forms of tax planning based on notions of ‘economic substance’ must be are restricted through the use of specific anti-avoidance considered in light of the specific provisions being provisions, more generally abusive planning, is checked examined. through a statutory GAAR. • A finding of misuse or abuse is possible in the following situations: Background of legislation – taxpayer uses specific provisions of the tax the Canadian tax laws contain GAAR provisions since 1988. laws in order to achieve an outcome that those Explanatory notes issued by the Federal Department of specific provisions seek to prevent; Finance in 1988 stated that the rule: – transaction defeats the underlying rationale of a the provisions that are relied upon; or “....is intended to prevent abusive tax avoidance – arrangement circumvents the application of an transactions or arrangements but at the same time is certain provisions, such as specific anti-avoidance not intended to interfere with legitimate commercial and rules, in a manner that frustrates or defeats the family transactions. Consequently, the new rule seeks to ‘object, spirit or purpose’ of those provisions. distinguish between legitimate tax planning and abusive • Abuse is not established if it is reasonable to tax avoidance and to establish a reasonable balance conclude that an avoidance transaction was within between the protection of the tax base and the need for the ‘object, spirit or purpose’ of the provisions that certainty for taxpayers in planning their affairs....“ confer the tax benefit. Trigger event Recently, the Canadian Supreme Court had, in the case If a transaction is an ‘avoidance transaction’, the Canada of Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, Revenue Agency (CRA) may deny the tax benefit that observed that the general anti-avoidance rule scheme would otherwise result. An avoidance transaction is set out in the Act and requires that three questions is any transaction that would otherwise result in a be decided: (1) was there a tax benefit; (2) was the direct or indirect tax benefit, or that is part of a series transaction giving rise to the tax benefit an avoidance of transactions that would otherwise result in a tax transaction; and (3) was the avoidance transaction benefit. For GAAR purposes, a transaction includes an giving rise to the tax benefit abusive. arrangement or event. However, a transaction will not be considered to be an avoidance transaction if it can The Court further observed that “in order to determine reasonably be considered to have been undertaken or whether a transaction is an abuse or misuse of the Act, arranged primarily for bonafide purposes other than to a court must first determine the object, spirit or purpose obtain the tax benefit. of the provisions that are relied on for the tax benefit, having regard to the scheme of the Act, the relevant Even if a transaction is an avoidance transaction, GAAR provisions and permissible extrinsic aids. will apply only if the transaction results in a misuse or an abuse of the provisions of tax laws. In other words, While an avoidance transaction may operate alone to GAAR applies only to transactions that lack a bonafide produce a tax benefit, it may also operate as part of non-tax purpose and that result in a misuse or abuse of a series of transactions that results in the tax benefit. the tax laws. While the focus must be on the transaction, where it is part of a series, it must be viewed in the context of the The Canadian Supreme Court in the case of Canada series to enable the court to determine whether abusive Trustco Mortgage Co. [2005] SCC 54 established the tax avoidance has occurred. In such a case, whether a General Anti-Avoidance Rules India and International perspective 11
  • 12. transaction is abusive will only become apparent when Further, where corporate reorganization takes place, it is considered in the context of the series of which it is the GAAR does not apply unless there is an avoidance a part and the overall result that is achieved. transaction that is found to constitute an abuse. Even where corporate reorganization takes place for a tax The analysis will lead to a finding of abusive tax reason, the GAAR may still not apply. It is only when avoidance: (1) where the transaction achieves an a reorganization is primarily for a tax purpose and is outcome the statutory provision was intended done in a manner found to circumvent a provision of to prevent; (2) where the transaction defeats the the Income Tax Act that it may be found to abuse that underlying rationale of the provision; or (3) where the provision. And it is only where there is a finding of transaction circumvents the provision in a manner that abuse that the corporate reorganization may be caught frustrates or defeats its object, spirit or purpose. These by the GAAR. considerations are not independent of one another and may overlap”. Procedural requirements In Canada Trustco, the Canadian Supreme Court laid Providing further guidelines, the Court emphasized that down the following procedural principles: the transaction may have a tax purpose, but that does • The onus is on the taxpayer to refute the following not necessarily mean that the tax purpose will always be (on a balance-of-probabilities basis): the primary reason for the transaction. – assertion that a tax benefit results from the the transaction. It is not permissible, however, for the However, where a transaction takes place primarily for a CRA to take the position that more tax would non-tax purpose, there will be no avoidance transaction. have been paid if the taxpayer had engaged in In the absence of an avoidance transaction, the fact that some other transaction or that the amount of tax a transaction may have a secondary tax benefit purpose paid is less than some notional amount that the will not trigger the GAAR. Whether the transactions are CRA believes should have been paid; and between parties at arm’s length or not at arm’s length – assertion that the transaction was an the should be immaterial (Stubart Investments Ltd. v. The avoidance transaction. The taxpayer might be able Queen, [1984] 1 S.C.R. 536). to refute this assertion by showing a bonafide and primary non-tax purpose for the transaction. • If there is a tax benefit and an avoidance transaction, the burden then falls on the CRA to establish that there is abusive tax avoidance. Australia General Tax avoidance generally involves a series of artificial or contrived transactions undertaken with the objective of reducing a taxpayer’s tax liability without committing either criminal or taxation offences. Tax avoidance can take a variety of forms, such as reducing or diverting assessable income, increasing deductions and offsets, deferring the payment of tax, manipulating business structures, or altering the type and nature of transactions. Background of legislation Australia’s GAAR was introduced in 1981 and is contained in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936).12
  • 13. John Howard, the then Treasurer, described the Is there a scheme?objective of GAAR in these terms: A ‘scheme’ for these purposes is defined broadly as: a) any agreement, arrangement, understanding,“The proposed provisions embodied in a new Part promise or undertaking, whether express or impliedIVA seek to give effect to a policy that such measures and whether or not enforceable, or intended to beought to strike down blatant, artificial or contrived enforceable, by legal proceedings; andarrangements but not cast unnecessary inhibitions on b) any scheme, plan, proposal, action, course of actionnormal commercial transactions by which taxpayers or course of conduct.legitimately take advantage of opportunities availablefor the arrangement of their affairs.” It may comprise many steps or parts and is not necessarily limited to the step that produced the taxIn his speech, the then Treasurer reaffirmed the limited benefit. Furthermore, for any given scenario, it isscope of the new legislative solution “In order to confine possible that a number of schemes may be identifiedthe scope of the proposed provisions to schemes of within the total steps undertaken.the “blatant” or “artificial” variety, the measures in thisBill are expressed so as to render ineffective a scheme Is there a benefit?whereby a tax benefit is obtained and an objective A tax benefit is obtained in any of the following casesexamination, having regard to the scheme itself and to where the event would not have occurred but for theits surrounding circumstances and practical results, leads scheme:to the conclusion that the scheme was entered into for • an amount is not included in assessable income,the sole or dominant purpose of obtaining a tax benefit.” including amounts which are converted from assessable income to capital gains eligible forThe Australian GAAR is a provision of last resort, i.e. it discount treatment;should not apply unless the taxpayer’s claim is otherwise • a deduction is allowed;allowable. It, therefore, counters schemes that strictly • withholding tax is not payable;satisfy the technical requirements of the tax law, • property is disposed off under a dividend strippingincluding the ordinary provisions and SAAPs, but when scheme;objectively viewed, are considered to be conducted • a foreign tax offset is allowed; oror carried out with the sole or dominant purpose of • a capital loss is incurred.obtaining a tax benefit. What is the purpose?If certain conditions are met, the provisions allow the The GAAR will only apply where at least one personCommissioner to cancel all or part of any tax benefits who entered into or carried out the scheme did so forwhich a taxpayer derives from the scheme. the sole or dominant purpose of enabling a taxpayer to obtain a tax benefit. In order to ascertain the purposeThe three key conditions which must be satisfied for Part of the scheme the following eight matters should beIVA to apply are: (i) there must be a ‘scheme’, (ii) there considered:must be a ‘tax benefit’ obtained in connection with the 1) the manner in which the scheme was entered into orscheme, and (iii) it must be reasonable to conclude that at carried out;least one person entering into the scheme did so for the 2) the form and substance of the scheme;‘sole or dominant purpose’ of obtaining a tax benefit. 3) the time at which the scheme was entered into and the length of the period during which the schemeOn 18 November 2010, the Australian Government was carried out;released for public comment a Discussion Paper that 4) the income tax result that, but for Part IVA, would bedeals with the review of the existing anti-avoidance achieved by the scheme;rules. The paper deals with possible improvements to 5) any change in the financial position of the relevantboth the general and specific anti-avoidance provisions taxpayer that has resulted, will result, or maywith a view to simplify as well as improve the operation reasonably be expected to result, from the scheme;of these provisions. General Anti-Avoidance Rules India and International perspective 13
  • 14. 6) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;7) any other consequence for the relevant taxpayer, or for any person referred to in (6), of the scheme This provision does not apply where the right to having been entered into or carried out; and income is transferred for a period of less than 7 years; 13 S LA 2005/24 ‘Application P of General Anti-avoidance8) the nature of any connection (whether of a business, the parties to the transfer are associated and the Rule’ family or other nature) between the relevant taxpayer consideration for the transfer is less than an arm’s length 14 Section 102CA ITAA 36 and any person referred to in (6). consideration; the transfer is then disregarded for tax 15 ection 102B ITAA 36 S purposes and so the transferor remains assessable on 16 ection 46A and B ITAA 36 SProcedure for applying GAAR the income15.The Commissioner of Taxation has released PracticeStatement13 which provides detailed guidelines for tax Foreign tax credit schemesofficers on the practical application of Part IVA. Schemes entered into after 13 August 1998 to acquire or generate foreign tax credits that can beInteraction between the GAAR and other provisions used to shelter low-taxed foreign-sourced incomeof the Taxes Acts from Australian tax. A specific power is providedThe operation of Part IVA of ITAA 1936 is not limited to the Commissioner to amend a foreign tax creditby any other provisions of ITAA 1936, ITAA 1997, or determination.the International Tax Agreements Act 1953 (ITAA 53),wherein all tax treaties are enacted as schedules. Dividend stripping Dividend stripping is not defined in the legislation. TheSpecific Anti-Avoidance Rules essence of dividend stripping is that value is taken outThere are a number of specific rules in the ITAA of a company in the form of a dividend, normally an1936 and ITAA 1997 targeted at certain schemes abnormally large dividend which clears all the currentthat are regarded as impermissible by the Australian and accumulated profits out of the company, in order toGovernment. Examples of these (on a non-exhaustive achieve a tax benefit.basis) are outlined below: In case of dividend stripping arrangement, theAlienation of income Commissioner is allowed to cancel the tax benefitsA right to income arising out of the ownership of derived by shareholders who sell their shares beforeproperty can be transferred. Where the right to income a dividend is declared. The share-dealing company inis transferred but the property giving rise to the income such a situation is also denied a rebate in respect of theis retained by the transferor, the consideration received dividend. A rebate is also denied where the purchaser offor the transfer of the right to income is assessable as the shares is not a share-dealing company but seeks toincome14. claim the loss on the shares as a capital loss16.14
  • 15. Dividend streaming GAAR audits and adjustments must be reported level The scope of Part IVA includes franking credit trading by level up to the State Administration of Taxation for and dividend streaming schemes where one of the approval. purposes of the scheme is to obtain a franking credit benefit17. Franking credit schemes involve the disposition Specific Anti-Avoidance Rules of shares or an interest in shares where the elements Apart from GAAR, China has specific rules concerning: described in the provision exist. • Transfer pricing • Thin capitalization Where the company and the person receiving the • Controlled foreign companies dividend or distribution are parties to the scheme, the • Recognition of a beneficial owner for treaty purposes Commissioner has a choice as to whether: • to post a debit to the company’s franking account; Impact on treaty usage or Under Article 58 of the EITL, treaty provisions prevail in • to deny the franking credit benefit to the recipient of case there is a conflict with the provisions of the EITL. the dividend or distribution. Accordingly, absent any provision in a particular treaty to the contrary and depending on the specific application The amount of debit to franking account is the amount of the GAAR provision to the particular transaction, that the Commissioner considers reasonable in the this could be read to mean the provisions of that circumstances, i.e. not being an amount larger than treaty will prevail over the GAAR provisions of the EITL. the debit to the franking account occasioned by the However, this issue has not yet been tested to date, and payment of dividend. accordingly, whether such a reading of the law will be accepted remains unclear. China However, it may be noted that in many, if not most Time since in statute cases, it is likely that GAAR would be applied to alter the The new EITL18, which came into effect on 1 January facts to which Chinese law would be applied, and as 2008, includes a general anti-avoidance provision such a conflict in so far as the treaty is concerned would (Article 47 of the EITL). not arise. What are the trigger events It should be noted that the more recent treaties Article 47 of the EITL provides: “If an enterprise engages concluded by China include provisions specifically in a business arrangement without bonafide commercial stating that domestic GAAR would operate to counter purposes that results in reducing its taxable revenue or transactions without justified commercial purpose but to taxable income, the tax bureau has the right to make take advantage of the treaty benefits. adjustments based on reasonable methods.” South Africa The tax authorities may initiate a GAAR audit of enterprises that enter into the following arrangements: General • abuse of tax incentives; GAAR operates as one of the measures to counter tax • abuse of treaties; avoidance, and is generally considered as a residual • abuse of the corporate structure; measure, which may apply in addition to or as an • use of tax havens for the avoidance of taxes; and alternative to any other or specific anti-avoidance • other business arrangements without bonafide provision. commercial purposes. Background of legislation Procedure for applying GAAR During 2006, the Income Tax Act 50 of 1962 was Tax authorities identify potential cases for investigation amended to enable the South African Revenue Service17 Section 177EA ITAA 36 based on the information submitted by taxpayers or (SARS) to more effectively combat tax avoidance in18 Enterprise Income Tax Law gathered through their own channels. South Africa. Section 103(1), the general anti-avoidance General Anti-Avoidance Rules India and International perspective 15
  • 16. provision, was repealed and the GAAR was introduced. • the presence of round trip financing;The GAAR is contained in Part IIA of Chapter III of the • the presence of an accommodating or tax-indifferentIncome Tax Act and specifically applies to impermissible party (described as a party for whom the amountsavoidance arrangements as defined. received from the arrangement are not subject to normal tax, or the tax liability is significantly offset byA provision against tax avoidance applies where: an expenditure incurred by that party in terms of the• an impermissible avoidance agreement has been arrangement); entered into with its sole or main purpose being to • the presence of elements which have the effect of obtain a tax benefit; and offsetting or cancelling each other.• in the context of business: – was entered into or carried out in a manner it Further developments that would not normally be employed for The SARS have recently released a ‘Draft Comprehensive bonafide business purposes other than for Guide to the General Anti–Avoidance Rule’ which obtaining a tax benefit; or provides for guidance to revenue authorities on – lacks commercial substance; it interpretation and application of GAAR.• in the context other than business, it was entered into or carried out by means or in a manner not Broadly, in interpreting the provisions relating to GAAR, normally employed for a bonafide purpose, other the guideline provides that a tax benefit may be denied than obtaining a tax benefit; or under the GAAR if such tax benefit would misuse or• it has created rights or obligations which would not abuse the object, spirit or purpose of the provisions normally be created between persons dealing at of the Income Tax Act that are relied upon for the arm’s length, or it would result directly or indirectly tax benefit. It would require a purposive approach in the misuse or abuse of the provisions of the to interpret the provisions of the Income Tax Act, Income Tax Act. which is already the accepted approach to legislative interpretation in South Africa. The introduction of theTax consequences misuse or abuse test is specifically directed at ensuringIf the above requirements are met, South African that the remedy provided by the section is advanced andrevenue authorities may: that the mischief against which the section is directed is• disregard, combine or re-characterize the suppressed. As a result, a mere literal interpretation of arrangement or any step thereof; the provisions will no longer safeguard a taxpayer who• disregard any accommodating or tax-indifferent applies the provisions in the Income Tax Act in a context party or treat this party and any other party as one or manner which is not intended by the Income Tax Act. and the same person;• deem the parties who are connected persons in Although it is accepted that where the substantive tax respect of each other as one and the same person; provision is clearly articulated and free from ambiguity,• re-allocate any income, receipt or accrual of a capital a departure from the ordinary meaning of the language nature or expenditure; used is not required. The misuse or abuse requirement• re-characterize any income of a capital nature as in the GAAR nevertheless requires that the intention of income of a revenue nature; the legislator is considered in determining whether the• treat the transaction as if it has not been carried out, provisions of the Income Tax Act are applied in a manner or in any other manner that in ‘revenue authorities’ which is intended. view is adequate for the prevention or diminution of the tax benefit. Further, the purpose test under the GAAR is a more objective test, wherein the sole or main purpose of theTrigger event arrangement itself is the relevant purpose and no longerThe presence of certain criteria is considered as the subjective purpose of the taxpayer.indicative of tax avoidance. These include:• the legal substance of the arrangement as a whole is inconsistent with, or differs significantly from, the legal form of its individual steps;16
  • 17. India Regime Proposed GAAR – DTC 2010 d) transaction which is conducted through one or a Under the Code, GAAR will be invoked if the following more persons and disguises the nature, location, conditions are satisfied: source, ownership or control of funds; or a) The taxpayer should have entered into an e) expectation of pre-tax profit which is an arrangement. insignificant in comparison to the amount of the b) The main purpose of the arrangement should be to expected tax benefit. obtain a tax benefit and the arrangement: i) been entered into, or carried out, in a manner has The concepts of ‘round trip financing’ and not normally employed for bonafide business ‘accommodating party’ will be defined in the Code. purposes; ii) created rights and obligations which would has Tax consequences of impermissible avoidance not normally be created between persons dealing arrangements at arm’s length; If the conditions specified above are satisfied, iii) esults, directly or indirectly, in the misuse or r the Commissioner will be empowered to declare abuse of the provisions of this Code; or the arrangement as an impermissible avoidance iv) acks commercial substance, in whole or in part. l arrangement and determine the tax consequences of the taxpayer as if the arrangement had not been Meaning of arrangement entered into. For this purpose, he may: An ‘arrangement’ will mean any transaction, conduit, i) disregard, combine, or re-characterize any steps event, trust, grant, operation, scheme, covenant, in, or parts of, the impermissible avoidance disposition, agreement or understanding, including all arrangement; steps therein or parts thereof, whether enforceable or ii) disregard any accommodating party or treat any not. Therefore, if the motive behind individual steps is accommodating party and any other party as one to obtain a tax benefit, but the overall scheme is not so, and the same person; the individual steps will nevertheless be treated as an iii) deem persons who are connected persons in relation arrangement and the GAAR may be invoked. to each other to be one and the same person for purposes of determining the tax treatment of any An arrangement will also include any interposition of an amount; entity or transaction where the substance of such entity iv) re-allocate any gross income, receipt or accrual of a or transaction differs from the form given to it. capital nature, expenditure or rebate amongst the parties; Lack of commercial substance v) re-characterize any gross income, receipt or accrual The lack of commercial substance, in the context of an of a capital nature or expenditure; arrangement, shall be determined, but not limited to, by vi) re-characterize any multi-party financing transaction, the following indicators: whether in the nature of debt or equity, as a i) The arrangement results in a significant tax benefit transaction directly among two or more such parties; for a party but does not have a significant effect vii) re-characterize any debt financing transaction as an upon either the business risks or the net cash flows equity financing transaction or any equity financing of that party other than the effect attributable to the transaction as a debt financing transaction; tax benefit. viii) reat the impermissible avoidance arrangement t ii) The substance or effect of the arrangement as a as if it had not been entered into or carried out whole differs from the legal form of its individual or in such other manner as the Commissioner in steps. the circumstances may deem appropriate for the iii) The arrangement includes or involves: prevention or diminution of the relevant tax benefit; a) round trip financing; or b) ‘accommodating party’, as defined; an ix) disregard the provisions of any agreement entered c) elements that have the effect of offsetting or into by India with any other country under section cancelling each other; 265. General Anti-Avoidance Rules India and International perspective 17
  • 18. An arrangement declared as an impermissible avoidance GAAR – Tax Treaty arrangement shall be presumed to have been entered It has been provided that the GAAR provisions would into or carried out for the main purpose of obtaining apply to a taxpayer notwithstanding that the treaty a tax benefit unless the party obtaining the tax benefit provisions are more beneficial. Considering the proves that obtaining a tax benefit was not the main approaches as outlined before (under the Vienna purpose of the avoidance arrangement. Convention and the OECD wherein the underlying principle would be that GAAR could override the provi- Procedure for applying GAAR sions of a treaty), it is important to note that OECD The power to invoke GAAR is bestowed only upon the Commentary on Article 1 of the Model Tax Convention Commissioner of Income Tax (CIT). For this purpose, the also clarifies that a general anti-abuse provision in the Code empowers him to call for such information as may domestic law in the nature of ‘substance over form rule’ be necessary. He is also required to follow the principles or ‘economic substance rule’ would not be in conflict of natural justice before declaring an arrangement as an with the treaty. impermissible avoidance arrangement. He will determine the tax consequences of such impermissible avoidance However, as enshrined in the Vienna Convention19, arrangement and issue necessary directions to the “every treaty in force is binding upon the parties to it Assessing Officer for making appropriate adjustments. and must be performed by them in good faith”, ‘Pacta The directions issued by him will be binding on the sunt servanda’ is based on good faith. This entitles states Assessing Officer. to respect obligations. This good faith basis of treaties implies that a party cannot invoke provisions of its Key issues domestic law as a justification for a failure to perform. The key issues / implications under the proposed GAAR are: Thus, if a legislature unilaterally enacts new domestic tax • Tax avoidance has been widely defined with the laws which are contrary to an existing treaty, without objective to encompass a number of circumstances the treaty having been amended or terminated, such and instances of tax avoidance, leading to action is violation of international law and also violates uncertainty and extensive litigation. the principles of ‘pacta sunt servanda’. This type of • GAAR can be invoked where obtaining a tax benefit treaty violation is known as ‘treaty override’. is the ‘main purpose’, and it is not clear as to what is meant by ‘main purpose’; the courts would be left to Further, according to rules of legislative interpreta- decide whether in the given facts the main purpose tion, specific legislation overrides general legislation. of the transaction/arrangement was to obtain tax Therefore, changes of a domestic law generally, which benefit. could be the case with GAAR, may not affect the treaty. • Where an adjustment is made (invoking GAAR), it is Considering the same, in the absence of an anti-avoid- not clear whether the full effect of the same would ance provision under the treaty, it remains to be seen be given to ensure that there is no double taxation. whether the provisions would be able to override the • The onus of proving that an arrangement has not been treaty. carried out for the main purpose of obtaining a tax benefit is with the taxpayer, while the tax authorities Specific anti-abuse rules may not have any evidence of tax avoidance. In addition to the GAAR provisions, the Code provides • There is no cut-off date for applicability of GAAR for specific anti-avoidance rules to deal with some of provisions to any arrangement and, therefore, where the following circumstances. These are similar to the the impact of past arrangements continues in Direct provisions under the Income-tax Act, 1961: Tax Code regime; the same may still be covered by i) Certain payments deemed to be dividend [Clause GAAR irrespective of the fact that the arrangement 314(4) r.w 314(81)]; has been approved by the tax officer or subjected to ii) Clubbing of income arising to other person by virtue judicial review. of a transfer without transfer of the asset [Clause 8(1)];19 Article 27 iii) Denying tax benefits to a business formed by18
  • 19. splitting up, or the reconstruction or a business vis-à-vis other countries (discussed in the preceding already in existence [Schedule 11, 12 13]; sections) indicates that the provisions are broadly oniv) Denying tax benefits to a business formed by the lines incorporated by South Africa. However, the transfer to a new business of machinery or plant South African draft guidance indicates that “in essence, previously used for any purpose [Schedule 11, 12, a tax benefit may be denied under the GAAR if such 13]; tax benefit would misuse or abuse the object, spirit orv) Expenditure incurred in relation to income not purpose of the provisions of the Income Tax Act that includible in total income [Clause 18]; are relied upon for the tax benefit. This clearly requiresvi) Payment to associated persons in respect of expend- a purposive approach to interpreting the provisions iture [Clause 115]; of the Income Tax Act, which is already the acceptedvii) Transfer of shares to a firm or closely held company approach to legislative interpretation in South Africa”. without or for inadequate consideration [Clause 58(2)(j)]; Further, as indicated under South Africa GAAR, theviii) Carry forward and set off of losses in the case of purpose test is a more objective test, wherein the sole certain companies [Clause 66]; or main purpose of the arrangement itself is the relevantix) International transactions not at arm’s length purpose and no longer the subjective purpose of the [Clause 116]; taxpayer.x) Transactions resulting in transfer of income to non- residents [Clause 119]; Thus, in implementation, one would need to adapt thexi) Avoidance of tax in certain transactions in securities principle that the “tax benefit” would misuse or abuse the [Clause 120]. object, spirit or purpose of the provisions of the Income Tax Act. However, under the proposed law in India, evenComparison of the proposals with legislation in where the main purpose of a step in the transaction, orother jurisdictions the part of a transaction is to obtain a ‘tax benefit’, theA comparison of the proposed Indian GAAR provisions arrangement would be presumed to be carried out with General Anti-Avoidance Rules India and International perspective 19
  • 20. the main purpose of obtaining a tax benefit. Though the two-part inquiry.provisions indicate the establishment of main purpose, it • The first is to interpret the provisions giving rise tois unclear as to the methodology of determining the main the tax benefit to determine their object, spirit andpurpose. Further, the absence of simultaneous business purpose which would be the question of law.purpose or a bonafide purpose test and the mere • The second is to examine the factual context of apresence of a tax benefit give rise to the presumption that case in order to determine whether the avoidancethe avoidance arrangement was designed and entered arrangement defeated the object, spirit or purposeinto solely or mainly to obtain a tax benefit. This may also of the provisions under consideration. This wouldlead to greater onus on the taxpayer to establish that generally be a question both of law and fact, inthe main purpose was not the ‘tax benefit’. Hence, it is which the onus will be upon the Commissioner toimperative that the criterion of ‘tax benefit’ should not assess the factual element of the case.be made the sole purpose and object of invoking GAARprovisions. Further, it may also be relevant to consider the recent report on introduction of GAAR in the UK for some of theAs such, it may be appropriate to adopt the approach methodologies and rules being suggested in this respect.adapted under the Canadian provisions wherein itis stated that an avoidance transaction means any Hence, considering the intent of introducing GAAR,transaction there is a likelihood in implementing the provisiona) that, but for this section, would result, directly or by underplaying the object, spirit and purpose of the indirectly, in a tax benefit, unless the transaction provisions and the arrangement based on the facts may reasonably be considered to have been of the case. In the circumstances, it may be advisable undertaken or arranged primarily for bonafide to appreciate and adapt the two part inquiry in terms purposes other than to obtain the tax benefit; or of the provisions and the arrangement rather thanb) that is part of a series of transactions, which restrict it to determining whether the main purpose of series, but for this section, would result, directly or the arrangement was a ‘tax benefit’. Further, a single indirectly, in a tax benefit, unless the transaction objective test may undermine the importance of looking may reasonably be considered to have been into the objective and purpose of the legislation, which undertaken or arranged primarily for bonafide may not be the intention of the legislation itself. purposes other than to obtain the tax benefit. Case study in respect of applicability of theIt is further provided that the provisions would be proposed provisionsapplicable to a transaction only if it may reasonably be (Cases considered from the Canadian authoritiesconsidered that the transaction would result directly or circular)indirectly in a misuse of the provisions of any one ormore of the Act, treaty etc., or would result directly or Case 1indirectly in an abuse having regard to those provisions. • A corporation transfers property used in its business to a related corporation to permit the deduction ofThus, under Canadian law and as even interpreted by non-capital losses of the related corporation. All oftheir Courts, the misuse or abuse test would involve a the shares of the two corporations have been ownedIt may be advisable to appreciate and adapt the two partinquiry in terms of the provisions and the arrangementrather than restrict it to determining the whether mainpurpose of the arrangement was a ‘tax benefit’.20
  • 21. by the same taxpayer during the period in which the Case 4 losses were incurred. • A taxable company has agreed to purchase all of• Where the transaction could be considered as consistent the shares of an operating company, which is also a with the scheme of the Act, it may be argued that the taxable Indian company The purchaser incorporates GAAR provisions would not be infringed. However, if a a holding company which borrows the purchase transfer of a property or other transaction is undertaken price and pays the vendor for the shares. The holding to avoid a specific rule, such as a rule designed to company and the operating corporation amalgamate preclude the deduction of losses after the acquisition of so that the interest payable on the monies borrowed control of a corporation by an arm’s length person, such to acquire the shares can be deducted in computing a transfer would be a misuse of the provisions of the the income from the business of the amalgamated Act and be subject to provisions of the Act. corporation.• Thus, genuine corporate reorganization should not • Generally, leverage of debt by Indian companies and be affected. subsequent amalgamation should not be considered as abusive under GAAR. However, the implicationCase 2 of provisions of Section 14A could be considered to• A company has property with an unrealized capital bring the same under a ‘tax benefit’ and hence under gain that it wishes to sell to a third party. A related GAAR provisions. corporation, a wholly owned subsidiary has a net capital loss. Instead of selling the property directly to Case 5 the third party and realizing a capital gain, the person • A taxable Indian company merges with another transfers the property to the related corporation. The taxable Indian company that is a shell company. related corporation sells the property to the third Upon merger, the shareholders who controlled the party and reduces the resulting taxable capital gain predecessor receive common shares of the merged by the amount of its net capital loss. company and the minority shareholders of the• Where the provisions of the Act provide that the sale predecessor receive redeemable preferred shares to a related corporation should be at arm’s length, that are immediately redeemed. The sole reason it could be argued that the transaction may not that the minority shareholders receive shares instead infringe the provisions as in determining the cost in of cash is to cause the merger to comply with the the hands of the related corporation, the cost to the requirements of the Act. company would be considered. • Structuring of company reorganization through• Thus, the transfer of property by holding company redeemable preference shares should not be covered to subsidiary company or vice versa under Indian by GAAR. regulations should not be impacted. Case 6Case 3 • A taxable Indian company has a subsidiary that is• An individual provides services to a corporation with sustaining losses and needs capital to carry on its which he or she does not deal at arm’s length. The business. The subsidiary would not be able to obtain company does not pay salary to the individual because any tax savings in the year. The holding company payment of salary would increase the amount of loss borrows the money from a bank and subscribes to that the company will incur in the year. the shares of the subsidiary and claims a deduction• There may be a provision in the Act requiring salary to for the interest. be paid in these or any circumstances; the failure to pay • Generally, based on judicial precedents, the interest salary is, therefore, not contrary to the scheme of the would be deductible for the holding company. Act read as a whole. However, the implication of provisions of Section• In the circumstances, in the Indian context, the taxpayer 14A could be considered to bring the same under a may choose to determine the terms of transactions ‘tax benefit’ and hence under GAAR provisions. which are not expressly prohibited under the terms of the Act. General Anti-Avoidance Rules India and International perspective 21
  • 22. Case 7 Case 9 • A non-resident company has an Indian subsidiary. • A non-resident company has an Indian subsidiary. The subsidiary has substantial reserves and the The subsidiary has substantial reserves and the Indian non-resident company desires to cash out by selling subsidiary desires to repatriate surplus cash through to an unrelated party. The gains on sale would be buy back of its shares and no tax is paid in India on substantial and subject to higher rate of tax. The the profits repatriated for the reason that the capital subsidiary distributes the reserves as dividend, gain on buy back of shares is exempt in India under which reduces the valuation of the company. The the applicable treaty of the non-resident. non-resident then sells the subsidiary. • The shares may be bought back by the Indian • The payment of the dividend and the consequent subsidiary for a number of reasons, namely, to DDT on such dividend should not be construed as increase holding of resident shareholders, increase covered under GAAR. the earnings per share or to pay surplus cash not required by business, etc. Further, the provisions Case 8 of the proposed Code also specifically provide that • A non-resident company has an Indian subsidiary. distribution of profits through a scheme of buy back The subsidiary has been capitalized by nominal of shares under the applicable provisions of the capital only and it has taken substantial borrowings Companies Act shall not be deemed as dividend. from group companies and/or third parties Accordingly, the buyback of shares should not be (non-residents/residents) such that the debt is several subject to GAAR provisions merely because no Indian times the equity for the Indian subsidiary. A question tax has been paid in the transaction. may arise on the deductibility of interest paid by the Indian subsidiary for the reason that it is thinly capitalized. • Under the current income tax law, there are no specific provisions for disallowance of interest on the basis that the taxpayer is thinly capitalized, However, under the proposed GAAR provisions (where tax benefit is the purpose) coupled with the transfer pricing provisions (arm’s length principle), the tax authorities may consider disallowance of interest provided the conditions are satisfied. However, it is relevant to note that countries have adopted thin capitalization rules based on the principle of either the fixed ratio approach or the arm’s length approach or the safe harbor approach.22
  • 23. Way forwardThe GAAR provisions are like a double-edged sword • Detailed guidelines to be provided on the lines of theand would need to be judicially invoked by the revenue Canadian law with relevant examples illustrating theauthorities. reasons and analogy in applying GAAR provisions. • GAAR should not be judged on the basis of a singleAs discussed earlier, the Courts in India have examined transaction, but on a series of transactions. Further,the issue of tax avoidance and laid down the principles where no ‘tax benefit’ arises under the whole seriesas to what constitutes tax avoidance. In light of the of transactions, the same should not be subject tovarious judicial precedents, the tax authorities in India GAAR evaluation, even though a part of the seriestend to raise the issue of tax avoidance and deny relief may result in ‘tax benefit’.to the taxpayer. Given the uncertainties involved in such • Corresponding adjustments to be provided in theapplication, it is imperative for the proposed GAAR to hands of the parties to the transaction.be successful; it should not impact genuine businesstransactions or promote uncertainty. One of the key Proceduralobjectives for introducing the Direct Tax Code is to • If CIT finds a transaction, which comes under thesimplify the language to enable better comprehension purview of GAAR, the same may be referred to anand remove ambiguity to foster voluntary compliance, independent quasi-judicial body.thus reducing litigation. However, the scope of GAAR The CIT and taxpayer can make submissions and theprovisions in the present draft could cause massive ruling by the quasi-judicial body can be final.uncertainty and lead to extensive litigation as potential • Threshold limit should be around Rs 150 million onlegitimate tax planning could also become the target of the lines of transfer pricing assessment.GAAR. • Provision of Advance Ruling facility - existing definition under the Code to be widened to includeIn this connection, it would be imperative that the GAAR.guidance note to be formulated should be sensitive tothe issue of addressing avoidance from the prospect Treaty and other provisionsof upholding the rule of law, the object and purpose • Treaty override could be implemented throughof the legislation, rather than be construed as law in protocol with the respective countries providingitself and giving a free rein to administrative or judicial for limitation of benefits and beneficial ownershipdiscretion. Some suggestions on reframing/modeling the principles therein.provisions on the basis of international experience may • It may be more appropriate to provide for thinbe adopted: capitalization rules which could also be covered under transfer pricing provisions than allowing theLegislation same to be covered under GAAR.• Our model could be based on the Canada model - the principles laid down by Canada Supreme Court In this context, we may refer to what Chris Evans, has to be adhered. written in his Article “Containing Tax Avoidance: Anti-• The tax benefit on the transaction should not be Avoidance Strategies (2008)” – the only criterion. If the transaction is done where tax benefit and commercial benefit are present, the It may be too cynical to assume “the existence of tax 20 .H. Gustafson, “The C Politics and Practicalities of transaction should not be covered by GAAR. avoidance as a constant and perpetual motivation Checking Tax Avoidance• The provisions could be made applicable in respect for every taxpayer”20, but there is no doubt that tax in the United States” in G. of transaction where entering into the transaction avoidance is widespread and that it presents a major S. Cooper, Tax Avoidance and the Rule of Law, and the cause and effect of the transaction occur problem for those concerned with public finance (Amsterdam: IBFD, 1997), after the date of implementation. issues. There is some evidence that the aggressive retail at p 376. General Anti-Avoidance Rules India and International perspective 23
  • 24. marketing of tax avoidance products and schemes may personal social responsibility – and the reputational 21 . Richardson, “Reducing I Tax Avoidance by Changinghave been constrained in recent years, but avoidance damage that excessive and egregious avoidance Structures, Process andactivity is by its nature opportunistic and ad hoc. Simply activity can attract – remains the ultimate deterrent, Drafting” in G. S. Cooper,raising the price of avoidance (through successful notwithstanding the impressive arsenal that can be Tax Avoidance and the Rule of Law, (Amsterdam: IBFD,containment, increased regulation and constrained available to those who seek to counter avoidance. 1997), at p 327.supply) will not choke off demand. Beyond that we should also perhaps be mindfulIndeed, no single response or approach – whether that two of the traditional goals of public finance –administrative, legislative or judicial – can adequately simplicity and equity – have critical roles to play inor effectively contain avoidance activity. Such determining social responses to avoidance activity.containment only begins to occur where strategies In recent years, these two goals may have been lessdrawn from all three spheres complement each other prominent in tax reform than the efficiency goal thatby operating in combination. As Sir Ivor Richardson lends itself to easier economic measurement andastutely pointed out some years ago, current evaluation.requirements for a comprehensive and integratedapproach go beyond a more traditional analysis where It is paradoxical that the more complex that the“the legislature … exerts control of tax avoidance tax regime becomes (often in attempts to containthrough special and general anti-avoidance provisions; avoidance activity), the more likely it will be thatthe revenue administration contributes in administering opportunities for avoidance will arise. Avoidancethose provisions and exercising discretions; and the activity thrives in complexity and uncertainty. Andjudiciary is expected to strike the right balance between where that complexity exacerbates the naturalacceptable and unacceptable tax planning through its interaction (sometimes mediated by intermediaries)interpretation and application of tax legislation21.” between the taxpayer and the revenue authority such that it becomes frictional rather than cooperative,Ultimately, however, corporate and personal taxpayers there will almost inevitably be a higher probability ofthemselves have to take responsibility for the level avoidance activity.of avoidance and the degree of acceptance of suchbehaviour that exists at any time in any society. The It may be relevant for taxpayers to examine therevenue authority, the legislature and the judiciary transactions/arrangements entered into, so thatcan play a role in shaping the demand for, and supply the same do not fall within the boundary of beingof, tax avoidance activity, but such issues belong, in considered as impermissible avoidable transactionsthe final analysis, in the realms of moral and ethical entered into with the object of obtaining a tax benefit.behaviour of the taxpayers themselves. Corporate and24
  • 25. Notes General Anti-Avoidance Rules India and International perspective 25
  • 26. ContactsMumbai Ahmedabad Vadodara264-265, Vaswani Chambers, “Heritage” 3rd Floor, Chandralok,Dr. Annie Besant Road, Near Gujarat Vidyapith, 31, Nutan Bharat Society,Worli, Mumbai 400 030. Off Ashram Road, Alkapuri, Vadodara – 390 007Tel: + 91 (022) 6619 8600 Ahmedabad – 380 014 Tel: + 91 (0265) 233 3776Fax: + 91 (022) 6619 8401 Tel: + 91 (079) 2758 2542 Fax: +91 (0265) 233 9729 Fax: + 91 (079) 2758 2551Delhi/Gurgaon Chennai HyderabadBuilding 10, Tower B, No.52, Venkatanarayana Road, 1-8-384 385, 3rd Floor,7th Floor, DLF Cyber City, 7th Floor, ASV N Ramana Tower, Gowra Grand S.P.Road, Begumpet,Gurgaon 122 002 T-Nagar, Chennai 600 017. Secunderabad – 500 003.Tel : +91 (0124) 679 2000 Tel: +91 (044) 6688 5000 Tel: +91 (040) 4031 2600Fax : + 91 (0124) 679 2012 Fax: +91 (044) 6688 5019 Fax:+91 (040) 4031 2714Bangalore KolkataDeloitte Centre, Anchorage II, Bengal Intelligent Park Building,100/2, Richmond Road, Alpha, 1st floor, Plot No –A2,Bangalore 560 025. M2 N2, Block – EP GPTel: +91 (080) 6627 6000 Sector – V, Salt Lake ElectronicsFax: +91 (080) 6627 6409 Complex, Kolkata - 700 091. Tel : + 91 (033) 6612 1000 Fax : + 91 (033) 6612 100126
  • 27. General Anti-Avoidance Rules India and International perspective 27
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