Demystifying GAAR and its associated concepts on Higher Education

The long, arduous journey started way back in 1997, when the then Finance Minister P Chidambaram proposed GAAR, but the government failed to introduce it. After the 2008 global financial crisis, when there was an international movement against tax avoidance, GAAR resurfaced in the then proposed direct tax code.

The objective is to deter taxpayers from entering into abusive and contrived schemes. While such intentions to avoid the misuse of tax laws are welcome, people are very apprehensive, largely because tax authorities will have wider powers under GAAR to challenge any given arrangement.

What is GAAR

• Tax avoidance is an area of concern across the world.

• The rules are framed in different countries to minimize such avoidance of tax.

• Such rules in simple terms are known as” General Anti Avoidance Rules” or GAAR

• Thus GAAR is a set of general rules enacted so as to check the tax avoidance.

Origin of GAAR

• Between the two extremes of tax planning and tax evasion lies tax avoidance, a form of abusive tax planning complying with the letter, but not the spirit of the law; for instance, a transaction structured in a manner with the sole intention of tax benefit, but not for any substantial business consideration.

• Further, using convoluted structures, companies were set up in tax jurisdiction only to avail the benefits of the double taxation avoidance agreements (DTAAs), that is, treaty shopping was practiced. The objective of GAAR is to curb such practices.

• The anti-tax avoidance drive came into the limelight when developed countries faced the pinch of tax avoidance as much as the developing countries.

• Soon, it was observed that tax avoidance results in dismal public finances and undue enrichment of the rich at the cost of the poor.

• This resulted in the Base Erosion and Profit Shifting (BEPS) project under the aegis of the Organisation for Economic Co-operation and Development (OECD) members, where over 100 countries collaborate to implement the BEPS measures to curb tax avoidance.

• GAAR is different from specific anti-avoidance rules (SAAR).

• SAAR captures specific instances of tax avoidance and lays down the consequent repercussions. For example, provisions like transfer pricing, dividend stripping, and cap on payment of interest on loans to overseas parent companies in the Income Tax Act, 1961 are instances of SAAR. However, in this game of cat and mouse, revenue has always been at the receiving end and the errant tax payer is miles ahead of the revenue department.

• David Hartnett of Her Majesty’s Revenue and Custom or HMRC (of the United Kingdom government) has aptly explained this situation as one of squeezing the balloon in one area only to see a new bulge appearing in another. Besides, it is next to impossible to contemplate all possible situations and frame SAAR to curb them.

• To tide over these limitations, several economies in the world came up with the concept of GAAR, which has a much wider reach and can be applied to any situation that smells of tax avoidance.

Need for GAAR

• GAAR can be defined as statutory codification of the “substance” versus “form” rule to look through a given transaction piercing the form.

• GAAR can also be defined as a rule that empowers a taxman to negate a transaction structured by an unscrupulous taxpayer, which, in the absence of GAAR, would have been permitted under the law.

• The provisions of GAAR are to be applied to an impermissible avoidance arrangement (IAA), in simpler terms, an arrangement designed with the objective to avoid tax.

• Besides, GAAR has a non-obstante provision, which can override all other provisions of the Income Tax Act, 1961, including SAAR. Concerns have been raised that where specific rules operate, general rules should not be allowed to override.

• The government has adopted a different approach and, recently, the Central Board of Direct Taxes (CBDT) issued a clarification (on 27 January 2017).

• The clarification stated that SAAR is not sufficient to address all situations of abuse, and therefore, GAAR and SAAR can co-exist.

• This adds more to the list of worries of the taxpayers and their consultants.

• It means that under the GAAR regime a company is restrained from tax planning and has to necessarily adopt the most disadvantageous option? The answer is “no.” However, the onus will be on the assessee to establish that the arrangement has commercial substance and tax advantage is not the sole guiding factor.

• It is strange that most of the multinational companies operating in India, which are already subject to GAAR in overseas jurisdictions, are more worried than the domestic companies.

• There has been a lot of hue and cry in the past over the possible misuse of GAAR provisions. Therefore, procedural safeguards have been provided in the form of a three-tier mechanism to remove arbitrariness.

• The system starts with the assessing officer, the principal commissioner of income tax and, finally, the approving panel (which includes a retired high court judge). A period of six months is allowed to decide the applicability of GAAR.

• The multi-tier decision-making process is also beneficial from the revenue perspective. It is a fact that there is a strong lobby that shrieks and alleges tax terrorism at the drop of a hat.

• Such a procedural safeguard is expected to instill confidence among the assessing officers for scrutinizing the arrangements.

• Now, whether GAAR can compel cleaner business practices is yet to be seen, but it will certainly influence the internal functioning of companies.

• For instance, in-house legal and taxation departments would have to work in tandem to avoid communication gaps while creating any arrangement.

• They would also have to exercise due caution in internal corporate communication via e-mails, telephone calls, etc, because these records can be used as adverse evidence against the company.

• Since the burden would lie on the assessee to establish commercial substance in the transaction, a proper chain of documents would have to be maintained to rebut the presumption of an IAA invoked by the revenue department.

GAAR VIS-À-VIS SPECIFIC ANTI AVOIDANCE RULES (‘SAAR’)

• It is widely perceived that GAAR has been incorporated to curb the international arrangements wherein, the treaty benefits are claimed by the assessee's, pertaining to transactions flowing from tax havens of the world, in the absence of any commercial substance with regard to the same.

• However, the provisions of the GAAR, apart from other specific anti avoidance rules, such as Transfer Pricing, dividend stripping, bonus stripping, etc., also act as a deterrence to the domestic arrangements which are entered for the main purposes of tax benefit and fulfills the secondary tests.

• To protect its tax base, India has renegotiated its treaty with Mauritius, Singapore and Cyprus, through which, India has recorded maximum inflow of the foreign investment, because of the favourable tax provisions under the erstwhile treaties between India and such countries.

• Investments were routed through such countries, without having any substantial presence in such countries, to take the benefit of the tax treaty and the domestic tax provisions of such tax havens.

• The amended treaty also provides for a detailed out Limitation of Benefit ('LOB') clause, which suggests that the treaty benefits shall not be available, in a scenario wherein, the conditions provided under the LOB clause are not fulfilled.

• Albeit, it is widely debated that in the presence and fulfillment of a LOB clause or any Specific Anti Avoidance Rule ('SAAR') the provisions of GAAR should not be applicable, since the specific provision would override the general provision.

• However, Hon'ble CBDT vide Circular dated January 27, 2017 has inter alia clarified that Specific Anti Avoidance Provisions may not address all situations of abuse.

• It has been further clarified that the provisions of GAAR and SAAR/LOB can coexist and are applicable, as may be necessary, in the facts and circumstances of the case.

Shome Panel Report on GAAR

• Earlier,the Government had constituted an Expert Committee on General Anti Avoidance Rules (GAAR) to undertake stakeholder consultations and finalise the GAAR guidelines as well as a roadmap for implementation.

• The Committee, chaired by Dr. Parthasarathi Shome, has submitted its draft report after analysis of the GAAR provisions and noting the concerns expressed by various shareholders.

• The draft report has recommended certain amendments in the Income-tax Act, 1961; guidelines to be prescribed under the Income-tax Rules, 1962; circular to clarify GAAR provisions along with illustrations; and other measures to improve tax administration specifically oriented towards GAAR matters.

The terms of reference of the Committee are

a) Receive comments from stakeholders and the general public on the draft GAAR guidelines which have been published by the Government on its website.

b) Vet and rework the guidelines based on this feedback and publish the second draft of the GAAR guidelines for comments and consultations.

c) Undertake widespread consultations on the second draft GAAR guidelines.

d) Finalize the GAAR guidelines and a roadmap for implementation and submit these to the government.

Highlights of the Recommendations

Recommendations for amendments in the Income-tax Act, 1961

• The implementation of GAAR may be deferred by three years on administrative grounds. GAAR is an extremely advanced instrument of tax administration – one of deterrence, rather than for revenue generation – for which intensive training of tax officers, who would specialize in the finer aspects of international taxation, is needed. Hence GAAR should be deferred for 3 years. But the year, 2016-17, should be announced now. In effect, therefore, GAAR would apply from 2017-18.

• Abolish the tax on gains arising from transfer of listed securities, whether in the nature of capital gains or business income, to both residents as well as non-residents.

• The Act should be amended to provide that only arrangements which have the main purpose (and not one of the main purposes) of obtaining tax benefit should be covered under GAAR. An arrangement shall be deemed to be lacking commercial substance, if it does not have a significant effect upon the business risks, or net cash flows, of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained.

• As regards constitution of the Approving Panel(AP), the Committee recommends that –The Approving Panel should
consist of five members including

I. Chairman;

II. The Chairman should be a retired judge of the High Court;

III.Two members should be from outside Govt. and persons of eminence drawn from the fields of accountancy, economics or business, with knowledge of matters of income-tax; and

IV.Two members should be Chief Commissioners of income tax; or one Chief Commissioner and one Commissioner.

The Approving Panel should be a permanent body with a secretariat. It should have a two year term. A decision of the AP should occur by a majority of members.

Recommendations under Income tax Rules

• The GAAR provisions should be subject to an overarching principle that – (1) Tax mitigation should be distinguished from tax avoidance before invoking GAAR.

• A monetary threshold of Rs 3 crore of tax benefit (including tax only, and not interest etc) to a taxpayer in a year should be used for the applicability of GAAR provisions. In case of tax deferral, the tax benefit shall be determined based on the present value of money.

Other recommendations

The Committee has made following recommendations in respect of tax administration:-

• The administration of Authority for Advance Ruling (AAR) should be strengthened so that an advance ruling may be obtained within the statutory time frame of six months.

• Shall not invoke GAAR where the taxpayer submits a satisfactory undertaking to pay tax along with interest in case it is found that GAAR provisions are applicable in relation to the remittance during the course of assessment proceedings;

• To minimize the deficiency of trust between the tax administration and taxpayers, concerted training programmes should be initiated for all AO‘s placed, or to be placed, in the area of international taxation.

Application of GAAR

The provisions of GAAR are to be applied to an impermissible avoidance arrangement (IAA), in simpler terms, an arrangement designed with the objective to avoid tax.

• To determine an IAA, the following factors are to be considered: (i) purpose of the arrangement is to obtain tax benefit; (ii) it is not at an arm’s length price; (iii) it lacks commercial substance; (iv) it results in abuse of the tax law; and (v) it is not carried out in an ordinary manner.

• Procedural safeguards have been provided in the form of a three-tier mechanism to remove arbitrariness. The system starts with the assessing officer, the principal commissioner of income tax and, finally, the approving panel (which includes a retired high court judge). A period of six months is allowed to decide the applicability of GAAR.

Concerns

The present scheme of GAAR addresses most of the concerns raised by the industry, yet the anxiety in its implementation is apparent.

• The Indian text of the GAAR provisions is broadly worded and has a much wider scope of applicability as compared to other jurisdictions. Further, there are concerns such as the interplay between GAAR and DTAAs, the thin line of difference between tax planning and tax avoidance, the co-existence of GAAR and Specific Anti-Avoidance Rules (SAAR), the scope of conflicting interpretation over IAAs, the functioning of the approving panel, etc.

• The discretionary powers to invoke GAAR and undo a transaction that complies with the provisions of the existing tax regime may extensively hinder the business environment.

Way ahead

The tax authorities must understand and appreciate that the assesses are not hesitant to pay tax but are apprehensive about the uncertainties in the tax regime.

Conclusion

Uncertainties in the tax regime reduce the ease of doing business. The ministry and the concerned departments should strive to mitigate these uncertainties to boost investor confidence in the Indian economy.

The arbitrary use of GAAR will drive away investments necessary for economic growth. There is a need to factor in this ground situation to ensure GAAR does not end up choking efficient tax planning. GAAR will require walking a tight rope to strike a balance between conflicting interests, like revenue collection and taxation planning. This certainty will boost investor confidence and create a win-win situation for both the government and taxpayers.

By Gudipati Rajendera Kumar