2 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.orgTABLE OF CONTENTSIntroduction ............................................................................................................................................................ 3GAAR : Concept ..................................................................................................................................................... 3GAAR in other countries.........................................................................................................................................4Experiments with GAAR in India............................................................................................................................5Impact.....................................................................................................................................................................5Report of the Expert Committee on GAAR ............................................................................................................6Implementation Issues............................................................................................................................................14Illustrations.............................................................................................................................................................15The Future of GAAR : Closing Remarks ............................................................................................................... 22
3 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.comIntroductionThe rise of the Indian economy in past two decades has been one of the most impacting events to occurin the country post its independence from its colonial rulers. One of the most significant markers of thisgrowth has been the resilience of the economy to external pressures and troughs. The Indian economyhas been relatively unscathed in the aftermath of the global financial meltdown of 2008. The country hasseen a massive rise in gross domestic production (“GDP”) and consequently per capita incomes have alsorisen across the board.The Indian economy no longer functions as a singular isolated entity, in the globalized era that existstoday cross border trade and transactions are the norm rather than the exception. In such a circumstanceorganizations are more than likely to move operations to countries where suitable conditions exist forsuch businesses to flourish. Such movement of business and consequently profits outside India is notlooked in a good vein by the government. It is therefore, in the interest of safeguarding the interests ofrevenue that the General Anti Avoidance Rules (“GAAR”) were proposed by the honourable erstwhilefinance minister Mr Pranab Mukherjee along with the finance act 2012.This paper is our humble attempt at demystifying GAAR and to chart out the past, present and perhapsthe future of this critical regulation.GAAR : ConceptThe most obvious issues in taxation today arise over the geographical boundaries which, under ourcurrent tax law, determine the allocation of revenue between different jurisdictions. But there is anotherset of boundaries that is of major significance in any discussion of taxation: this consists of the boundarybetween illegal evasion and ‘legal’ avoidance and the boundary between what is sometimes termed‘acceptable’ and ‘unacceptable’ avoidance.1There is a broad consensus among legislators around the world towards the need for cohesive antiavoidance strictures which differentiate between legitimate tax mitigation and tax avoidance. Theintroduction of GAAR, ideally, seeks to place curbs on tax avoidance without impinging on the right ofthe business to effectively mitigate the tax impact on its business within acceptable legal boundaries.This point to a need for better legislation, giving clearer signals to taxpayers, better tools to the judiciaryand an improved basis for enhanced cooperation between taxpayers, their advisers, and the taxauthorities. Further work is clearly needed on forms of drafting, both at the specific and at the Metalevels. Such work should try to move beyond boundaries and towards tackling the underlying issues.21Beyond Boundaries : Developing Approached to Tax Avoidance and Tax Risk Management, OxfordUniversity CBT2Beyond Boundaries : Developing Approached to Tax Avoidance and Tax Risk Management, OxfordUniversity CBT
4 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.orgThe implementation of GAAR around the world has not been without its fair share of challenges;countries such as Canada, Australia, and South Africa have had previous experience dealing with a set ofanti avoidance rules. Their experience suggests that GAAR does not provide an easy solution. However,most importantly, none of the jurisdictions have backed down despite setbacks but have rather comeback with newer and stronger versions of the guidelines wherever the originals plans have been defeated3The only true solution to avoidance is to have a much more principle-based tax system which allows taxpayers to operate with a level of certainty that is required for businesses to function and grow.GAAR In Other CountriesAs discussed earlier, the global experience with GAAR has been mixed, at best. Australia explored theconcept of GAAR as early as 1981, John Howard, who would go on to become the prime minister of thecountry, introduced the concept in his capacity as the federal treasurer. The measures proposed sought tocurb down on arrangements which were termed “blatant” and “artificial”, seeking to counter schemeswhere it could be concluded, with due respect to its surrounding circumstances, that the scheme wasentered into for the sale and dominant purpose of obtaining a tax benefit.Canada was one of the first countries to explore the concept by means of explanatory notes issued in1988 which laid down the rules governing abusive tax avoidance transactions. The guidelines stated thattheir intention was not to interfere with legitimate commercial and family transactions but rather to curbavoidance transactions which were defined as transactions which would result in a direct or indirect taxbenefit or form part of a series of transactions which would result in tax benefits. However, transactionswhich serve legitimate business purposes are not considered avoidance transactionsSimilarly, South Africa, and China have enacted counter tax avoidance proposals which seek to curb uponthe aggressive use of tax havens for the explicit avoidance of taxes, and transactions whose sole purposeis to avoid taxes. Among other transactions, Round tripping, accommodating parties and differencebetween legal substance of arrangement and legal substance is individual steps have been identified asevents indicative of tax avoidance.The United Kingdom has also looked into the setting up of a similar stricture and a draft legislation hasbeen published which is slated to come into effect from April 2013. The proposed UK GAAR is muchnarrower in its scope and implication than the other jurisdictions as discussed earlier, the aim being "todeter and counter abusive tax avoidance, while providing certainty, retaining a tax regime that is attractiveto businesses, and minimising costs for taxpayers and HMRC"It is certainty, that is of the utmost import when it comes to structuring the businesses of this globalizedera and therefore it is critical that the tax regimes in jurisdictions that a business operates in provide thatcertainty in the form of a stable rules based regime to its current and potential taxpayers.3Beyond Boundaries : Developing Approached to Tax Avoidance and Tax Risk Management, OxfordUniversity CBT
5 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.comExperiments With GAAR In IndiaThe grounds for debate were established by two landmark cases namely, Azadi Bachao Andolan VsUnion of India which further relied upon the case of Duke of Westminster (19 TC 420) settled in thecourts of the United Kingdom. The later laid down the position with respect to avoidance and evasion oftaxes which was then upheld by the Indian judiciary during the course of the former. The courts created aclear demarcation between Tax Evasion which was illegal and Tax Avoidance which, though wasundesirable, but was strictly within the confines of the law and therefore could not be clamped downupon.The case of Vodafone International Holding BV v Union of India was perhaps the tipping point for theenactment of the GAAR provisions which had been first proposed as part of the New Direct Tax Code(“DTC”) in 2009.The Indian GAAR as initially proposed and then enacted in 2012, albeit with minor modifications, theproposed provisions were much broader in their scope as compared to other jurisdictions around theworld and even cover transactions which have a non tax avoidance motive, as long as one of the mainpurposes or outcomes of the transactions is to obtain a tax benefit. A tax benefit is described as areduction or avoidance or deferral of tax as a result of the tax treaty. Therefore a transaction whichprovides a tax benefit and which satisfies certain specified conditions would be qualified as animpermissible avoidance agreement and would be subject to the implication of GAAR.ImpactThe draft guidelines as proposed by the government, earlier proposed to come into effect from 1st April2013 were liberally interspersed with ambiguous terms and conferred a wide range of discretionarypowers on the tax authorities without any safeguards being built in to protect the interests of thetaxpayers.In addition, concerns have been voiced over the ambiguity in the draft guidelines. The draft containedseveral terms which are ambiguous in their meaning and did not provide definitions, scope, or analysis oftheir meaning with respect to these provisions. Terms such as “Bonafide purpose” “Direct and indirect”and “Misuse and Abuse” have not been described making it difficult for the taxpayers to make concretedecisions with respect to their Indian operations. Further, the situation was compounded by theillustrations which lacked clarity with respect to interpretation and implications of the proposedguidelines. It became apparent that the draft was going to make life difficult for foreign funds, even thosewith perfectly legitimate structures. FIIs and their sub accounts would have run the risk of denial of treatybenefits in India unless tests of economic substance could be satisfied by the offshore entities.It was perceived that the guidelines were drafted without adequate consultation with the stakeholders andthat the rules, as they were framed, were too strict. It was under such circumstances that foreign fundsvoted with their feet and withdrew a large chunk of capital from India; dissent was also voiced by residenttaxpayers and tax experts alike. Facing a certain backlash the government constituted an ExpertCommittee on General Anti Avoidance Rules (GAAR) to undertake stakeholder consultations andfinalise the guidelines for GAAR after widespread consultations to ensure greater clarity on GAAR issues.
6 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.orgREPORT OF THE EXPERT COMMITTEE ON GAARThe draft report of the expert committee was released on the 1st of September 2012, after examining theresponses to the draft a final report was submitted by the committee on the 30th of September. On the14th of January 2013, the honourable Finance minister issued a press statement accepting most of themajor recommendations of the committee, albeit with some modifications. The recommendations andtheir status is discussed below in greater detailS.No As Per FinanceAct,2012Expert CommitteeRecommendationStatus as on 15thJanuary 2013Impact1. GAAR will beapplicable from 1stapril,2014 (AY 2014-2015)The implementation of GAARmay be deferred by three yearson administrative grounds.Implementation ofGAAR deferred by2 years.2. The Government shouldabolish the tax on gains arisingfrom transfer of securitieswhich are subject to securitiestransaction tax (STT), whetherin the nature of capital gains orbusiness income, for bothresidents as well as non-residents3. Any arrangement,the main purpose orone of the mainpurpose of which isto obtain taxbenefit.The Act should be amended toprovide that only arrangementswhich have the main purpose(and not one of the mainpurposes) of obtaining taxbenefit should be coveredunder GAARAccepted A tighter definition.If tax benefit is onlyone of the reasons,the transactionshould not be heldto beimpermissible4. Section 97 of the Act should beamended to include a definitionof “commercial substance”5. The definition of “connectedperson” may be restricted to“Associated person” undersection 102 and “associatedenterprise” under section92A.-The two separatedefinitions in thecurrent provisions,namely, „associatedperson‟ and„connectedperson‟ will becombined and therewill be only one
7 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.com provisiondefining a‘connected person6. Following factorsshould not be takeninto account fordeterminingsubstances:i. Period forwhich thearrangementexisted.ii. Actualpayment oftaxesiii. Exit routeprovided byarrangmentThe section 97(2) may beamended to provide that thefollowing factors:i. the period or time forwhich the arrangementexists;ii. the fact of payment oftaxes, directly orindirectly, under thearrangement;iii. The fact that an exit route(including transfer of anyactivity or business oroperations) is provided bythe arrangement,Are relevant but may not besufficient to prove commercialsubstanceAccepted The assessingofficer cant factorin these whileinvoking GAAR,but the approvingpanel can considerthem.7. A minimum of threemembers:Two commissionersof income tax andone official of thelevel of jointsecretary or abovefrom the IndianLegal Service.Constitution of the ApprovingPanel (AP), the Committeerecommends that –a. The Approving Panelshould consist of fivemembers includingChairman;b. The Chairman should be aretired judge of the HighCourt;c. Two members should befrom outside Govt. fromthe fields of accountancy,economics or business,with knowledge of mattersof income tax; andd. Two members should beChief Commissioners ofincome tax; or one ChiefCommissioner and oneCommissionere. Appropriate mechanismmay be provided to ensureconfidentiality ofinformation of thetaxpayer becomingavailable to the membersoutside the Government.The ApprovingPanel shall consistof :a. A chairpersonwho is or hasbeen a judge ofHigh Court.b. One member ofthe IndianRevenueService notbelow the rankof ChiefCommissionerof Income Tax;andc. One memberwho shall be anacademic orscholar havingspecialknowledge ofmatters such asdirect taxes,businessaccounts andinternationaltrade practices.Should provideindependence onaccount ofinclusion of a judgeand provide balanceon account ofpresence of expert.
8 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.org Where anti-avoidance rules areprovided in a tax treaty in theform of limitation of benefit(as in the Singapore treaty) etc.,the GAAR provisions shouldnot apply overriding the treaty.RECOMMENDATION TO BE PRESCRIBED AS PART OF INCOME TAX RULES1. The GAAR provisions should besubject to an overarchingprinciple that –(1) Tax mitigation should bedistinguished from tax avoidancebefore invoking GAAR.(2) An illustrative list of taxmitigation or a negative list forthe purposes of invoking GAAR,as mentioned below, should bespecified-(i) Selection of one of the optionsoffered in law. For instance –(a) payment of dividend or buyback of shares by a company(b) setting up of a branch orsubsidiary(c) setting up of a unit in SEZ orany other place(d) funding through debt orequity(e) purchase or lease of a capitalasset(ii) Timing of a transaction, forinstance, sale of property in losswhile having profit in othertransactions(iii) Amalgamations andThese principleswould have ensuredthat GAAR wasprimarily rulesdriven and wouldhave been able togive investors moreconfidence.
9 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.com (as defined in the Act)as approved by the High Court.(3) GAAR should not be invokedin intra-group transactions (i.e.transactions between associatedpersons or enterprises) which mayresult in tax benefit to one personbut overall tax revenue is notaffected either by actual loss ofrevenue or deferral of revenue.(4) GAAR is to be applicable onlyin cases of abusive, contrived andartificial arrangements.2 No specificprovision.A monetary threshold of Rs 3crore of tax benefit (including taxonly, and not interest etc) to ataxpayer in a year should be usedfor the applicability of GAARprovisions. In case of tax deferral,the tax benefit shall bedetermined based on the presentvalue of moneyPartiallyAccepted:No Mention oftax deferralclause.3. No specificgrandfathering.Investmentsmade beforeannouncementof GAAR notprotected.All investments (though notarrangements) made by a residentor non-resident and existing as onthe date of commencement of theGAAR provisions should begrandfathered so that on exit (saleof such investments) on or afterthis date, GAAR provisions arenot invoked for examination ordenial of tax benefit.Only investmentmade before 30,August 2010 willbegrandfathered.If investments aremade after thegrandfathering date,they will be subjectto imposition ofGAAR if the exitsare made after thedate on whichGAAR comes intoeffect.4. No specificExclusion fromGAAR whereSAAR alsoexist.Where SAAR is applicable to aparticular aspect/element, thenGAAR shall not be invoked tolook into that aspect/elementWhere GAARand SAAR areboth in force,only one of themwill apply to agiven case, andguidelines will bemade regardingthe applicabilityof one or theother.5. No specificprovision for FII.Provisions in theThe Foreign Institutional Investor(FII) is the taxable unit fortaxation in India. Accordingly, theAccepted withmodificationClause (a) fullyFIIs do no enjoyany advantageunder domestic lawwith respect to
10 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.org will not beapplicable if GAARinvoked.And no specificprovision in relationto non –residentinvestor in FIIs.Committee makes the followingrecommendations-(a) Where an FII chooses not totake any benefit under anagreement entered into by Indiaunder section 90 or 90A of theAct and subjects itself to tax inaccordance with domestic lawprovisions, then, the provisionsof Chapter X-A shall not apply tosuch FII;(b) All investors above the FIIstage should be excluded fromthe purview of GAAR asotherwise it may result in multipletaxation of the same income.Whether an FII chooses or doesnot choose to take a treatybenefit, GAAR provisions wouldnot be invoked in the case of anon-resident who has invested,directly or indirectly, in the FIIi.e. where the investment of thenon-resident has underlying assetsas investments made by the FII inIndia. Such non-residents includepersons holding offshorederivative instruments (commonlyknown as Participatory Notes)issued by the FII.acceptedClause(b):GAAR will notapply to nonresidentinvestors in FIIcapital gains ordomestic income.Therefore thisclause does notseem to grant themany additionalrelaxations.6. No limit on the taxconsequence.Would haveextended to theentire arrangementeven if only a partwas impermissible.Where only a part of thearrangement is impermissible,the tax consequences of an―impermissible avoidancearrangement will be limited tothat portion of thearrangementAccepted This is a welcomemove and willprevent unduescrutiny oflegitimateoperations byimposition ofGAAR onimpermissible deals.7. While determining the taxconsequences of animpermissible avoidancearrangement, correspondingadjustment should be allowed inthe case of the same taxpayer inthe same year as well as indifferent years, if any. However,
11 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.com relief by way ofcorresponding adjustmentshould be allowed in the case ofany other taxpayer.8. Assessing officerhas to inform to thecommissionerbefore invokingGAAR.Commissioner toissue notice toassessee to makesubmission.A requirement of detailedreasoning by the AssessingOfficer in the show cause to thetaxpayer may be prescribed in therulesAssessing officerwill be requiredto issue a showcause notice,containingreasons beforeinvoking theprovisions ofGAAREnsures thatfrivolous noticescannot be issuedunder GAAR.9. No specificprovision forreporting ofimpermissibletransactions byauditors.The tax audit report may beamended to include reporting oftax avoidance schemes above aspecific threshold of tax benefitof Rs. 3 crores or aboveThe Tax Auditorwill be requiredto report any taxavoidancearrangement.Likely to leadhigher compliancecosts anddifferences ofopinion betweenauditors andtaxpayers.10. The following statutory formsneed to be prescribed:-a. For the Assessing Officer tomake a reference to theCommissioner u/s 144BA(1)(Annexe-8)b. For the Commissioner to makea reference to the ApprovingPanel u/s 144BA(4) (Annexe-9)c. For the Commissioner toreturn the reference to theAssessing Officer u/s 144BA(5)(Annexe-10)Accepted withmodification:Forms yet to beprescribed11. No specific timelimit, except fordirections byapproving panel.The following time limits shouldbe prescribed that -i) in terms of section 144BA(4),the Commissioner (CIT) shouldmake a reference to theApproving Panel within 60 daysof the receipt of the objectionfrom the assessee with a copy tothe assessee;ii) in the case of the CITaccepting the assesses objectionand being satisfied that provisionof Chapter X-A are notAccepted withmodification:Time limit yet tobe provided foractions ofvariousauthorities.
12 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.org, the CIT shallcommunicate his decision to theAO within 60 days of the receiptof the assesses objection asprescribed under section144BA(4) read with section144BA(5) with a copy to theassessee.iii) No action u/s 144BA(4) or144BA(5) shall be taken by theCIT after a period of six monthsfrom the end of the month inwhich the reference under sub-section 144BA(1) was received bythe CIT and consequently GAARcannot be invoked against theassessee.RECOMMENDATIONS TO BE IMPLEMENTED VIA CIRCULAR1. GAAR shall apply only to theincome received, accruing orarising, or deemed to accrue orarise, to the taxpayers on or afterthe date GAAR provisions comeinto force. In other words,GAAR will apply to income ofthe previous year, relevant to theassessment year in which GAARbecomes effective and subsequentyears.2. Where Circular No. 789 of 2000with respect to Mauritius isapplicable, GAAR provisionsshall not apply to examine thegenuineness of the residency ofan entity set up in Mauritius3. When the AO informs theassessee in his initial intimationinvoking GAAR, he shouldinclude how the factors listed insection 97(2) have beenconsidered (after amendment asrecommended).
13 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.comOTHER RECOMMENDATIONS1. The administration of Authorityfor Advance Ruling (AAR) shouldbe strengthened so that anadvance ruling may be obtainedwithin the statutory time frame ofsix monthsAccepted withmodification:No Time frame ismentioned. It states;sec 245N(a)(iv) thatprovides for anadvance ruling bythe Authority foradvance rulingwhether anarrangement is animpermissibleavoidancearrangement will beretained and theadministration ofthe AAR will bestrengthened.2. Until the abolition of the tax ontransfer of listed securities,Circular 789 of 2000 acceptingTax Residence Certificate (TRC)issued by the Mauritius authoritiesmay be retained.3. While processing an applicationunder section 195(2) or 197 of theAct, pertaining to the withholdingof taxes,(a) the taxpayer should submit asatisfactory undertaking to pay taxalong with interest in case it isfound that GAAR provisions areapplicable in relation to theremittance during the course ofassessment proceedings; or(b) in case the taxpayer isunwilling to submit a satisfactoryundertaking as mentioned in (a)above, the Assessing Officershould have the authority withthe prior approval ofCommissioner, to inform thetaxpayer of his likely liability incase GAAR is to be invoked
14 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.org assessment procedure.4. To minimize the deficiency oftrust between the taxadministration and taxpayers,concerted training programmesshould be initiated for all AO‘splaced, or to be placed, in the areaof international taxation, tomaintain officials in this field forelongated periods as in othercountries, to place on the intranetdetails of all GAAR cases in anencrypted manner to comprise anadditive log of guidelines forfuture application.Change In GAAR without recommendations1. Directions of APbinding only onassessing officer.Assessee could havefiled appeal to ITAT(the income taxappeals body)No recommendation Binding on bothassesses andassessing officersIn the recentpast, challengesto even bindingAAR ruling havebeen admittedbefore thecourts.Therefore a writpetition againstthe order of thedirections of theAP should beadmittable.Implementation IssuesThe expert committee has cited several issues and concerns that have been expressed with respect toimplementation of GAAR. Some of the reasons cited include : Deficiency of trust between tax administration and taxpayers; Anticipated attempts to invoke GAAR in a general manner, if not in every possible case; Lack of accountability in the manner in which tax officers conduct business, and for its outcome; Fear of audit by C&AG ; Compulsion for tax officers to meet budget targets; Past experience in implementing regulations pertaining to transfer pricing which gave little confidence,according to them, in fair and appropriate implementation; Advance ruling not being obtained in the specified period of six months.44Final Report of Expert Committee on GAAR pg 58-59
15 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.comIllustrationsFACTSIndian co. is a company incorporated in India. Itsets up a unit in a Special Economic Zone(SEZ) in F.Y. 2013-14 for manufacturing andselling its products. It claims 100% deduction ofprofits earned from that unit in F.Y. 2013-14and subsequent years as per section 10AA ofthe ActOPINIONThe tax benefit that will accrue on account ofsetting up unit in SEZ is a case of tax mitigationwhere the tax payer is taking advantage of afiscal incentive offered to him by submitting tothe conditions and economic consequences ofthe provisions in the legislation e.g., setting upthe business unit in SEZ area. Hence, theRevenue should not invoke GAAR with respectto this arrangement.FACTSIndian co. is a company incorporated in India. Itsets up a unit in a Special Economic Zone(SEZ) and but transfers the product of non-SEZ unit at a price lower than the fair marketvalue, reflecting only negligible activity in SEZunit therefore transferring its profits to the SEZunit.OPINIONSuch tax avoidance would be countered withSAAR in the form of TP regulations and since itdoes not involve fraud and misrepresentation itwould not amount to tax evasion. Hence, theRevenue should not invoke GAAR in such acase.Figure 1Figure 2
16 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.orgFACTSAn Indian co. has set up a holding company in aNon Tax jurisdiction (NTJ) which has set upsubsidiaries in NTJ (Sub 1 and 2) which paydividends to the holding co. The holding co.pays no dividends to Indian Co.OPINIONNo GAAR would be applicable as declarationor non declaration of dividend is the prerogativeof a company. India does not possess anti-deferral provisions in the form of ControlledForeign Company (CFC) rules in the I.T. Actand therefore GAAR cannot be imposed.FACTSIf the holding co. in the illustration merges intothe Indian co. along with the accumulateddividend from Sub1 and Sub 2, would GAARbe invoked?OPINIONSection 47 of the Income Tax Act specificallyexempts capital gains on the cross bordermerger of the foreign company with an Indiancompany. Therefore GAAR cannot be imposedin such a circumstance.Figure 3Figure 4
17 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.comFACTSAn Indian company claims deduction for leaserentals in case of acquisition of assets throughlease, in contrast to depreciation that would beclaimed as in the case of outright purchase of anasset. Would the lease rent payment, beinghigher than the depreciation, be disallowed asexpense under GAAR?OPINIONSince the Assessee is merely exercising itschoice within acceptable legal boundaries. Noprovisions of GAAR should be applicable inthis circumstanceFigure 5
18 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.orgFACTSAn Indian co. has raised funds via the debtroute instead of raising equity from a Foreignco. incorporated in a Non Tax Jurisdiction.What would be the repercussion in case : Zero or constant interest rates areapplicable Interest is directly proportional torevenueOPINION This should not cause constituteavoidance, since there are no specificprovisions dealing with thinlycapitalized companies in the act. Anevaluation of whether a business shouldhave raised funds through equityinstead of debt is generally be left tocommercial judgment of a taxpayer.Therefore in the first circumstanceGAAR should not be attracted The calculation of interest in themanner of dividend reflects anarrangement whose main purpose is toobtain a tax benefit by claiming actualdividend payment as interest payment.Therefore the provisions of GAAR willbe attracted.Figure 6
19 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.comFACTSIndian Co. incorporates a Subsidiary Co. in anon tax jurisdiction with equity of USD 1million. The subsidiary company has nobusiness activities and therefore no reserves, itfurnishes a loan, for business purposes, of USD1 million to the Indian Co. on which interest ispayable at the rate of 10% per annum. TheIndian Co claims deduction of interest payableto Subsidiary co from business profits.OPINIONIn the eyes of the tax authorities, the primarypurpose of this arrangement shall be construedto be to obtain interest deduction in the handsof Indian co. and thereby tax benefit. Thereseems to be no commercial substance inestablishing Subsidiary co. since there is noeffect on the business risk or cash flow, apartfrom the tax benefits, of the Indian co.Therefore GAAR will be applicable.FACTSA large corporate group , based in a non taxjurisdiction, has created a services company inIndia to manage its non core functions. Theservices company then charges the holdingcompany for the services rendered at a cost plusbasis.OPINIONThe transactions in this case will be governed byspecific anti avoidance provisions (SAAR) in theform of Transfer pricing regulations. Thereforein our opinion, GAAR should not be applicable.Figure 7Figure 8
20 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.orgFACTSHolding co. is a company incorporated in theUK and is a non resident as per the act. Holdingcompany invests in investing company which isa resident of a non tax jurisdiction. There is nobusiness activity being carried out by Investingco. All rights of voting, management, right tosell etc. are vested by investing company withHolding co.Investing company further invests in 49%equity of a Indian JV company, namely IndianCo. With the remaining 51% being invested byPartner Company, which is also a companyincorporated in India.Later the shares of the Indian co. are sold toBuyer Co. a Indian company which is a groupcompany of Partner Co.OPINIONSince there is no business purpose inincorporating Investing co. in a non taxjurisdiction, it can be suggested that the mainpurpose of the arrangement is to obtain a taxbenefit. The alternate course available in thiscase is direct investment by Holding Co. in thejoint venture. The tax benefit would be thedifference in tax liabilities between the twoavailable courses.Further since all rights of investing co. arevested with the holding co. it is evident thatthere is no commercial substance inincorporating A Ltd therefore GAAR may beinvoked by the tax authorities.Figure 9
21 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | email@example.comFigure 10FACTSThe shares of Asset Co. an asset owning Indiancompany, are held by another Indian companyIndian Co. Indian Co., in turn, is held by twocompanies Holding Co. Partner Co.,incorporated in a Non tax Jurisdiction. The taxtreaty provides for non-taxation of capital gainsin the source country and NTJ charges nocapital gains tax in its jurisdiction. Indian Co. isliquidated by consent of shareholders resultingin transfer of the asset/shares from Indian Co.to Holding Co and Partner Co.Subsequently such shares in Asset Co are soldby Holding and Partner Cos to Purchasing Co.also incorporated in the NTJ.Holding co and Partner co. claim treaty benefitsand the resultant gains from the transaction areclaimed to be not taxableOPINIONThis transaction can be effected in one ofseveral ways, being :1. As effected2. Sale of shares in Indian Co. by Holdingand Partner Co. to Purchasing Co.3. Sale of Shares in Asset co. by Indian Coto Purchasing Co.In Option 1 and option 2, there should not beany tax liability in India except taxation ofDeemed dividend to the extent of available freereserves in Indian Co. at the time of liquidation(Option 1).There shall be a tax liability in the hands of theIndian Co. in Option 3, upon the sale of Assetco. to Purchasing co.Based on the recommendations of the expertcommittee report, there should not be anyimposition of GAAR as the tax payer is onlyexercising his options in the most tax efficientmanner.
22 Arkay & Arkay | Chartered Accountants | Delhi | +91 11 2735-7350 | firstname.lastname@example.orgTHE FUTURE OF GAAR : CLOSING REMARKSAs it is around the world, it is evident that GAAR is here to stay in India. However in light of thetumultuous relationship between the tax authorities and the taxpayers it needs to be ensured that insteadof a broad scoped instrument for harassment, GAAR becomes a narrow focussed tool for the specificchecking of aggressive tax avoidance schemes.While the Finance Minsters acceptance of some of the recommendations is a welcome step, more needsto be done to assuage and safeguard the interest of the legitimate investors in India. The relaxation incapital gains tax for example, will perhaps be notified as part of the upcoming budget to be presented inthe near future. Similarly, the statement of the finance minister has not addressed the recommendation ofthe expert committee with respect to circular 789 and allowability of treaty benefits with respect tojurisdictions where the DTAA have inbuilt anti abuse provisions in the form of limitation of benefits(“LOB”) clauses.A lot will depend on the implementation of GAAR, the government will need to undertake confidencebuilding exercises to calm the fears with respect to GAAR. Interestingly, the chairman of the expertcommittee which prepared this report is now also the Advisor to the honourable Finance Minster. Theupcoming budget will be interesting to say the least.
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