1. http://www.thinkplaninvest.com/2012/05/what-is-gaar/What is Gaar ?General Anti-Avoidance (GAAR) was proposed by finance minister in mid-March as part ofthe budget for fiscal 2013 to avoid the tax evasion of the foreign investors. At present situation,there is no Know Your Customer (KYC) formalities for the foreign investors. The money whichis invested in the stock market is coming from a foreign entity, but our government has no rightsto ask or verify the person name or identity to check the source of the money.This leads to the huge amount of black money in India routes via hawala and coming back to theIndian market. General Anti-Avoidance (GAAR) is proposed to tap the tax evasion and putsthe strict rules on foreign investors.http://profit.ndtv.com/News/Article/what-is-gaar--303611Reuters, 29 Jun 2012 | 07:40 AMBasic Points in GAARGAAR aims to target tax evaders, partly by stopping Indian companies and investors fromrouting investments through Mauritius or other tax havens for the sole purpose of avoiding taxes.However, the ambiguous language, the lack of details, and the sudden onset of the provisionshave been among the factors that have upset foreign investors.The finance minister proposed to remove the onus of proof entirely from the taxpayer and shift itto the revenue departments.A local or foreign taxpayer will also be able to approach authorities in advance for a ruling ontheir potential tax liabilitiesAn independent member would be in the GAAR approving panel, while one member would bean officer of the level of Joint Secretary, or above, from the Ministry of Law.A committee would be constituted under the Chairmanship of the Director General of IncomeTax, with the task of providing recommendations by May 31 for formulating the rules andguidelines to implement GAAR provisions.On the proposed retrospective amendment in tax rules, Mukherjee said the changes will notoverride the provisions of double-tax avoidance treaties India has with 82 countries.The retroactive changes will only impact those cases where a deal has been routed through low-tax and no-tax countries with whom India does not have tax treaties.
2. The proposed retrospective changes in tax rules will not be used to reopen cases whereassessment orders have already been finalized.According to the draft, GAAR will come into effect from April 1 2013. According to theguidelines, FII not opting for treaty benefits and ready to pay taxes will not come under GAAR,but those who do opt for dual taxation avoidance agreements will come under its purview.http://www.pwc.com/in/en/assets/pdfs/publications-2012/pwc-white-paper-on-gaar.pdfThe Evolution.General Anti-avoidance Rule (GAAR) is a concept which generally empowers the RevenueAuthorities in a country to deny the tax benefits of transactions or arrangements which do nothave any commercial substance or consideration other than achieving the tax benefit. Denial oftax benefits by the Revenue Authorities in different countries, often by disregarding the form ofthe transaction,has been a matter of conflict between the Revenue Authorities and the taxpayers.Traditionally, the principles regarding what constitutes an impermissible tax avoidingmechanism have been laid down by the Courts in different countries, with a series of decisions ofthe English Courts starting from the Duke of Westminster’s case.In India also, the ruling of the Supreme Court in McDowell’s case was a watershed. This rulingitself has been interpreted by different courts including the Supreme Court in various subsequentdecisions. In its recent ruling in the famous Vodafone case, the Supreme Court has stated thatGAAR is not a new concept in India as the country already has a judicial anti-avoidance history."International Taxation (DTAA Comprehensive agreements – With respect to taxes on income)". Income Taxdepartment, Government of India. Retrieved 11 July 2012India has comprehensive Double Taxation Avoidance Agreement (DTAA) with 83countries.This means that there are agreed rates of tax and jurisdiction on specified types ofincome arising in a country to a tax resident of another country. Under the Income Tax Act 1961of India, there are two provisions, Section 90 and Section 91, which provide specific relief totaxpayers to save them from double taxation. Section 90 is for taxpayers who have paid the tax toa country with which India has signed DTAA, while Section 91 provides relief to tax payers whohave paid tax to a country with which India has not signed a DTAA. Thus, India gives relief toboth kind of taxpayers.http://www.pwc.com/in/en/assets/pdfs/publications-2012/pwc-white-paper-on-gaar.pdfIt is common for taxpayers to arrange their affairs in a way that will give them tax benefits,which are through genuine and legitimate actions. Over the past few years it has been noticedthat the Revenue Authorities have attempted to deny tax benefits, whether under the tax treaty ordomestic law, by disregarding the form and looking through the transactions. However, genuine
3. transactions consummated in a tax efficient manner need to be distinguished from shamtransactions or colourable devices used for evading tax.The approach of Revenue Authorities has resulted in protracted litigation and uncertainty. TheRevenue Authorities‟ attempts in this regard have not succeeded in most cases, especially in theSupreme Court, the most recent being in the Vodafone case.In India, there are specific anti-avoidance provisions in the domestic tax laws as well as„limitation of benefits‟ clauses in some tax treaties. Additionally, the Government proposes tointroduce GAAR provisions through the Direct Taxes Code. The proposed GAAR provisionswould override the provisions of the tax treaties signed by India.http://www.pwc.com/in/en/assets/pdfs/publications-2012/pwc-white-paper-on-gaar.pdfThe Need 1. Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient,equitable and effective manner. Sectors that provide a greater opportunity for tax avoidance tend to cause distortions in the allocationof resources. Since the better-off sections are more endowed to resort tosuch practices, tax avoidance also leads to cross-subsidization of the rich.Therefore, there is a strong general presumption in the literature on taxpolicy that all tax avoidance, like tax evasion, is economicallyundesirable and inequitable. On considerations of economic efficiencyand fiscal justice, a taxpayer should not be allowed to use legalconstructions or transactions to violate horizontal equity. 2. In the past, the response to tax avoidance has been the introduction oflegislative amendments to deal with specific instances of tax avoidance.Since the liberalization of the Indian economy, increasingly sophisticatedforms of tax avoidance are being adopted by the taxpayers and theiradvisers. The problem has been further compounded by tax avoidancearrangements spanning across several tax jurisdictions. This has led tosevere erosion of the tax base. Further, appellate authorities and courtshave been placing a heavy onus on the Revenue when dealing withmatters of tax avoidance even though the relevant facts are in theexclusive knowledge of the taxpayer and he chooses not to reveal them. 3. In view of the above, it is necessary and desirable to introduce a generalanti-avoidance rule which will serve as a deterrent against such practices.This is also consistent with the international trend.
4. 4. Double Taxation Avoidance Agreements are being misuse by investors to avoid paying taxesby routing investments through various countries which has tax treaty with India, in particularMauritius and Singapore which account for 48% of FDI inflow to India.Broad PrespectiveThe GAAR is a broad set of provision which grants powers to authorities to „invalidate anyarrangement‟, for tax purposes, if it is entered into by the assessee with the main purpose ofobtaining a „tax benefit‟. A tax benefit would include a benefit relating to Income-tax, WealthTax,Dividend Distribution Tax and Branch Profit Tax (which is sought to be introduced underthe Code).Apart from the „tax benefit‟ test, the arrangement also has to satisfy at least oneout of four additional tests discussed in the ensuing paragraphs.The principal condition for invalidating an arrangement under the GAAR provisions is that thearrangement (or any step thereof) must have been entered into with the main purpose ofobtaining „tax benefit‟. This condition in most cases, is likely to get satisfied automatically at theassessment stage itself. Given that, under the proposedlaw, specific presumption is to that effect,GAAR provisions will be attracted automatically unless the taxpayer is able to prove otherwise.This would cast an onerous burden on the taxpayer in such cases which will have to bedischarged with appropriate positive evidence.Once the test of the main purpose of taxbenefit is satisfied, the taxpayer is requiredto undergo further scrutiny to pass variousother critical tests to avoid the applicationof the GAAR provisions and prevent thepossible action of invalidating thearrangement. These critical tests, includewhether (a) the arrangement is not carriedout in a manner normally not employed forbonafide purposes or (b) it is not at arm‟slength or (c) it results in direct or indirectmisuse/abuse of the provisions of the Codeor (d) it lacks commercial substance.Further, in accordance with the enlargeddefinition of the test of „lack of commercialsubstance‟, it would also be necessary forthe taxpayer to pass certain further testssuch as: whether there is a significant effectupon the business risks or net cash flow ofthe concerned parties, the test of substanceover form, whether the arrangementinvolves „round trip financing‟ or anyaccommodating or tax indifferent party orany element having effect of offsetting each
5. other and so on. Most of these tests (fordetails refer to Chapter 4) are highlysubjective. If any one of these tests issatisfied, then the CIT would assume thejurisdiction to apply the GAAR provisions.Such an arrangement would beregarded as „Impermissible AvoidanceArrangement‟, and the CIT would havethe power to invalidate the arrangementand determine the consequences thereofunder the Code with exceptionallywide powers.Tax evasion v. Tax avoidanceIt is important to highlight the distinctionbetween Tax Evasion and Tax Avoidance.The Organisation for Economic Cooperationand Development (OECD) hasdefined tax evasion as “A term that isdifficult to define but which is generally usedto mean illegal arrangements where liabilityto tax is hidden or ignored i.e. the tax payerpays less tax than he is legally obligated topay by hiding income or information fromtax authorities”6. In case of tax evasiondeliberate steps are taken by the tax payerin order to reduce the tax liability by illegalor fraudulent means.7 Tax avoidance, onthe other hand is defined by the OECD8 as“term used to describe an arrangement of atax payer‟s affairs that is intended to reducehis liability and that although thearrangement could be strictly legal it isusually in contradiction with the intent ofthe law it purports to follow”. The keydistinction being that in tax avoidance thekey facts or details are not hidden by thetax payer but are on record. In Australia,the Ralph Review of Business Taxation hascharacterized tax avoidance as misuse orabuse of the law that is often driven bystructural loopholes in the law to achievetax outcomes that were not intended byParliament but also includes themanipulation of law and focus on form and
6. legal effect rather than the substance9.Another term which is sometimes usedwhile analysing tax evasion and taxavoidance is tax planning. The OECDdefines tax planning10 as “arrangement of aperson‟s business and /or private affairs inorder to minimise tax liability”. It may benoted that, in practice in some cases, thedividing line between tax planning and taxavoidance, or between permissible taxavoidance and impermissible taxavoidance, may not be clear.It may be noted that the GAAR is not anantidote for „tax evasion‟, but for „taxavoidance‟. The GAAR cannot deal with taxevasion since it cannot deal with what isnot reported. The Government hasrecognised that the GAAR is meant fortackling tax avoidance..5 Bahamas, Bermuda, Isle of Man, British Virgin Islands, Cayman Islands, Jersey, Gibraltar, Monaco etc.6 OECD, Glossary of tax terms7 Draft Comprehensive Guide to the General Anti- Avoidance Rule By South African Revenue Service8 OECD, Glossary of tax terms9 Ralph Review of Business Taxation – A Tax System Redefined, July 1999,10 OECD, Glossary of tax termsApplicabilityIt may be noted that the GAAR provisionswould be applicable to all taxpayersirrespective of their residential or legalstatus (i.e. resident or non-resident,corporate entity or non-corporate entity).The provisions also apply to all transactionsand arrangements irrespective of theirnature (i.e. business or non-business) if, thetax benefit accrues to the taxpayer and hefails to establish that the main purpose ofentering into that transaction/arrangement was not to obtain tax benefit.For GAAR provisions, it is also not relevantwhether transactions/ arrangements areentered into with group concerns or thirdparties and whether they are domestic orcross-border transactions. Threshold limitsand guidelines for circumstances where the
7. GAAR provisions can be invoked areexpected to be provided under the Rules.However, the canvas of the GAARprovisions, if enacted in the present form, isexceptionally wide and the consequencesare severe. The discretionary powers of theCIT are very subjective and also very wide.Of course, one may expect that while finallyenacting the law, these apprehensions willbe properly addressed and the provisionswill provide effective safeguards againstthe possibility of unintended unduehardships to taxpayers and the possibilityof abuse of the discretionary powers at theimplementation levelhttp://business.mapsofindia.com/articles/budget-2012-gaar.htmlPractical effectImpact on FIIEvery year the FIIs invest almost INR 1.8 lakh crores through the Participatory Notes. If theGAAR provisions are implemented exactly as they have been proposed in the Union Budget2012-13 then several FIIs will have to rethink their plans. Financial experts, however, feel thatthe impact will not be limited to the investors only – there can be some significant effect on theshare markets in India as well.To start with, there will be a reduction in the substantial overseas funds flowing into India as theFIIs from Mauritius might be forced to change their strategy. They have stated that thegovernment decision to tax P-Notes could be a major mistake as it will deter internationalinvestors from looking at India as a viable destination.The exchange value of the Rupee is weak and if the government pursued this step, the worth ofIndia‟s national currency could depreciate further. The current account deficit is already inexcess of 3 percent of the GDP and if this decision is implemented then the situation will becomegraver.http://articles.economictimes.indiatimes.com/2012-04-29/news/31477500_1_gaar-tax-avoidance-tax-officers Tina Edwin, ET Bureau Apr 29, 2012, 02.04PM ISTDomestic Companies
8. GAAR can prove tricky for domestic companies too, and many of their transactions, done in thenormal course of business, can be questioned and tax benefit disallowed. Take for instance themerger of a loss-making company into a profit-making one. On merger, losses would offsetprofits and the lower net profit, if any, would mean substantially lower tax liability for thecompany.The merger may have been driven by pure commercial considerations, better integration ofoperations or to ensure the loss-making company does not shut down, but tax department canclaim it was a tactic to avoid taxes.In another situation, a company can choose between leasing an asset and purchasing the same.On a leased asset, it can claim deduction on lease rental while on an asset that was bought, it canclaim depreciation. Disputes can arise on leasing versus buying.Likewise, a company can be asked why it raised funds through borrowing when it could haveissued equity. On borrowings, a company can claim deduction on interest paid. Both decisionsdepend on what is more beneficial for the companyIndian MNCsIndian companies expanding overseas too have reasons to be worried. Most set up a holdingcompany outside India and will have many offshoots. A holding company overseas may alsoenable easier access to cheap overseas borrowings. Subsidiary operating companies may paydividends to the holding company, which it may not transfer to the Indian parent, as that moneycould be ploughed into other overseas activities. Under GAAR, tax authorities could rule that theIndian parent did not bring the dividend to India to avoid paying taxes.Reason for delayFinance Minister Pranab Mukherjee told in parliament, "To provide more time to both thetaxpayer and tax administration, to address all related issues, I propose to defer the applicabilityof GAAR provisions," He said a committee would submit its recommendations on GAAR byMay 31. The rule will apply to income starting from the financial year that begins in April 2013.The vagueness of the original plan, which was unveiled as part of Indias budget for the fiscalyear beginning in April, caused uncertainty among foreign investors, putting an already weakgovernment on the defensive.This uncertainity among investors resisted them to invest in India and its impact is beingreflected on the capital market since the announcement of implementing GAAR from year 2012was made. So, to avoid further slowdown of already struggling economy, finance ministerdelayed its implementation till next financial year.
9. Our Analysis:The most attractive word in the world of Taxation at present is GAAR (General AntiAvoidance Rule). In several countries; anti tax avoidance rules have been framed. Businessorganisations tend to either pay no tax or too less the tax which is actually applicable tothem. They enter into certain ARRANGEMENTS ( this word is much wider thanAGREEMENTS ) which result into low tax and/or deferrement of tax. While applying GAARby the Tax Authorities; they try to find out whether there is business substance in the agreementor just to avoid the tax such arrangement has been made. If found that such arrangement ismade to avoid tax rather than the NEED of the BUSINESS; the tax authorities may disregard thewhole or part of such transactions and include the earnings in the assessees income. Penaltieswould also be imposed on the assessee. The acute difficulty which is likely to be faced by theassessees in India is that the burden of not avoiding tax is on assessees whereas in many foreigncountries it is on Tax Authorities to prove that arrangements have been entered into to avoid tax.The Vodafone Ruling-Laying down the anti-avoidance perspectiveFacts• The Hutchison Group (Hong Kong) hadacquired interests in mobiletelecommunications industry in India from1992 onwards and over a long period oftime, a large and complicated ownershipstructure evolved. The Hutchison Grouphad an interest in the Indian operatingcompany Hutchison Essar Ltd (HEL)through a number of overseas holdingcompanies. HEL had further step downoperating subsidiaries in India.• The majority of the share capital of HEL,which was under the direct or indirectcontrol of Hutchison Group, was held by
10. various Mauritius/Indian companies,which in turn were held by Mauritian/Cayman Islands companies.• Hutchison held certain call and put options(representing 15% of the shareholding ofHEL) over companies controlled by otherpersons. These options were in favour of3Global Services Pvt. Ltd. (3GSPL), anIndian company, against consideration ofcredit support.• In late 2006, HutchisonTelecommunications International Ltd.,Cayman Islands (HTIL) received variousoffers from potential buyers to acquire itsequity interest in HEL including one fromVodafone Group Plc, who made a nonbindingoffer for 67% of HEL for a sum ofUSD 11.076 billion, based on an enterprisevalue of USD 18.8 billion of HEL.A sale purchase agreement (SPA) wasentered into on 11 February, 2007 betweenVIH and HTIL, under which VIH was toacquire the sole share of CGP Investment(Holdings) Ltd., a Cayman Islandscompany (CGP).• Subsequently, on 20 February, 2007 VIHfiled an application under Press Note 1 of2005 for an approval from ForeignInvestment Promotion Board (FIPB) andfor FIPB to make a noting of thetransaction. On 7 May, 2007, FIPB grantedapproval to VIH and on 8 May, 2007, VIHpaid over the consideration.IssueThe controversy in this case centred on thetaxability in India of the offshore transfer ofshares in CGP, a Cayman Islands Company bythe Hutchison Group to the Vodafone Group.The Indian Revenue Authorities contendedthat in view of the substantial underlyingassets in India, in the form of HEL and itsbusiness, the transfer was not of the share ofCGP but in substance that of the underlyingIndian assets. Accordingly, the capital gainarising from the transfer was taxable in Indiaand VIH was liable to withhold tax from theconsideration payable to HTIL.The issues before the Supreme Court were asfollows:• Were the gains arising on the sale of CGPtaxable in India?-- Where was the situs of the shares ofCGP?-- Did the transaction result in transfer ofany asset in India?• Was VTIL liable to withhold Indian tax
11. from the consideration?The RulingThe Supreme Court held as follows:• Gains arising on sale of the share of CGPwere not taxable in India-- The share of CGP was situated outsideIndia (i.e., in the Cayman Islands)-- The transaction did not result in thetransfer of any asset in India• VTIL was not liable to withhold tax frompayment of the sale consideration foracquisition of CGP. 4. Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient,equitable and effective manner. Sectors that provide a greater opportunity for tax avoidance tend to cause distortions in the allocationof resources. Since the better-off sections are more endowed to resort tosuch practices, tax avoidance also leads to cross-subsidization of the rich.Therefore, there is a strong general presumption in the literature on taxpolicy that all tax avoidance, like tax evasion, is economicallyundesirable and inequitable. On considerations of economic efficiencyand fiscal justice, a taxpayer should not be allowed to use legalconstructions or transactions to violate horizontal equity. 5. In the past, the response to tax avoidance has been the introduction oflegislative amendments to deal with specific instances of tax avoidance.Since the liberalization of the Indian economy, increasingly sophisticatedforms of tax avoidance are being adopted by the taxpayers and theiradvisers. The problem has been further compounded by tax avoidancearrangements spanning across several tax jurisdictions. This has led tosevere erosion of the tax base. Further, appellate authorities and courtshave been placing a heavy onus on the Revenue when dealing withmatters of tax avoidance even though the relevant facts are in theexclusive knowledge of the taxpayer and he chooses not to reveal them. 6. In view of the above, it is necessary and desirable to introduce a generalanti-avoidance rule which will serve as a deterrent against such practices.This is also consistent with the international trend.