Revisiting General Anti-Avoidance Rules in Income Tax Law

  1. Introduction

Tax minimisation pursuits are as old as tax itself. While there is no fundamental right to be immune from taxation,[1] there is nonetheless judicial recognition that “every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be”.[2] The Indian judiciary has witnessed tumultuous swings on the scope of taxpayers’ abilities to adjust their affairs. On the one hand are the sui generis observations of Justice Chinnappa Reddy in McDowell[3] inter alia highlighting that “no one can now get away with a tax avoidance project with a mere statement that there is nothing illegal about it” versus the other decisions of the Supreme Court, such as Azadi Bachao Andolan,[4] Walfort Share,[5] Vodafone International,[6] etc., which continue to vindicate tax planning.

In the year 2012 and in the context of income tax law, the Parliament intervened by inserting statutory provisions to address tax avoidance disputes and thereby adding legislative certainty as regards their respective rights of the taxpayers vis-à-vis the tax officer’s ability to revisit transactions. It is not for the first time that anti-avoidance rules have been inserted in the tax law. In fact tax laws are replete with provisions which repel specific class of prohibited transactions.[7] The difference between these provisions vis-à-vis the 2012 change, which introduced General Anti-Avoidance Rules (or GAAR), is that GAAR are potentially limitless in their scope and extend to all transactions.

  1. Legislative history

The introduction of GAAR in the law was originally proposed in the Direct Taxes Code Bill, 2009, which was followed by Direct Taxes Code Bill, 2010, but did not fructify. Thereafter the GAAR provisions were enacted in the Income Tax Act, 1961 (Act) in terms of the amendments carried out by Finance Act, 2012. Seeking to accommodate the representations from various quarters, the Government of India appointed an Expert Committee under the chairmanship of Dr Parthasarathi Shome which made extensive recommendations on GAAR.[8] Taking note of these recommendations, the relevant provisions of the Act were amended and also supplemented by detailed rules and administrative clarifications. The application of the GAAR law was also revised and amended law came into force from 1-4-2017.[9]

  1. Scope of GAAR – Impermissible avoidance arrangement

For the GAAR law to apply, it is necessary that an “impermissible avoidance arrangement” (IAA) exists.[10] The expression IAA has been defined in the Act[11] and the relevant provision states as under:

  1. Impermissible avoidance arrangement.— (1) An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain a tax benefit, and it—

 (a) creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length;

 (b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;

 (c) lacks commercial substance or is deemed to lack commercial substance under Section 97, in whole or in part; or

 (d) is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

As can be seen from the above, IAA is defined very widely to cover not just the transactions which are not at arm’s length but even those which are considered as resulting in misuse of the Act (either directly or indirectly), lacking commercial substance or lacking bona fide purpose. The same provision further provides that even where the “main purpose of a step in, or a part of, the arrangement is to obtain a tax benefit”, it shall be presumed that the entire arrangement has the main purpose of obtaining a tax benefit; the burden is upon the taxpayer concerned to rebut such presumption.[12]

As if such detailed scope of IAA was not enough, there are other provisions in the Act which supplement (rather enlarge) the scope of IAA. The Act defines the scope of arrangements which are deemed to lack commercial substance,[13] meaning and scope of “round tripping” (which is one of the situations which is deemed to lack commercial substance),[14] besides delineating when does a person become an “accommodating party” for the purpose of IAA,[15] factors considered irrelevant to determine commercial substance in a transaction,[16] etc. In addition, another provision contains a near-exhaustive set of definitions specific to the GAAR chapter under the Act.[17]

  1. Consequences of application of GAAR

Once a transaction is covered within the scope of IAA, then wide-ranging consequences can follow.[18] It is stipulated that where an IAA exists, “then the consequences, in relation to tax, of the arrangement, including denial of tax benefit or a benefit under a tax treaty, shall be determined, in such manner as is deemed appropriate, in the circumstances of the case”. The Act itself stipulates the likely consequences in such scenarios, which include disregarding, combining or recharacterizing any step or the whole IAA; disregarding any accommodating party or treating any accommodating party and any other party as one and the same person; reallocating amongst the parties to the arrangement accruals, receipts, expenditures, etc., repositioning the place of residence of any party to the arrangement or the situs of an asset or transaction; lifting of corporate veil, etc. The Act further provides that, to this end, “(i) any equity may be treated as debt or vice versa; (ii) any accrual, or receipt, of a capital nature may be treated as of revenue nature or vice versa; or (iii) any expenditure, deduction, relief or rebate may be recharacterized.”[19] The Act, in addition, provides consequences in respect of the connected persons and accommodating parties.[20] In short, once a transaction is declared as an IAA, the underlying tax benefit would be brought to tax irrespective of the legal form of the transaction or the position of the parties.

  1. Procedural dynamics

The aforesaid survey of statutory provisions relating to GAAR unfailingly manifests its wide scope and consequences. In order to ensure against its indiscriminate application and arrest potential of abuse, the Act provides for framing of “guidelines” and stipulation of “conditions” which may be prescribed and the GAAR provisions “shall be applied in accordance” with such guidelines and conditions.[21] These guidelines are prescribed in Part DA of the Income Tax Rules, 1962 (Rules).

The very first provision in the Rules stipulates carve-outs i.e. situations where GAAR provisions shall not apply.[22] There are four different situations identified in this provision. First is a monetary threshold in terms of which GAAR would not apply to an IAA where the tax benefit does not exceed INR 3 crores. This is presumably to give relief to small transactions. Second is a class exclusion whereby GAAR does not apply to foreign institutional investors (i.e. FIIs) who do not claim tax treaty benefits and satisfy other stipulated conditions. Third is also a class exclusion whereby non-resident investors of a FII are excluded. The rationale for these exclusions was discussed in detail in the Expert Committee Report, which is evidently to protect foreign investors and grant legal certainty to them. Fourth is a provision colloquially referred as grandfathering provision whereby income arising out of investment transfer made prior to 1-4-2017 (i.e. before application of GAAR) is excluded from the scope of GAAR. This is to ensure against the retrospective application of GAAR law. The other provisions in the Rules provide for the show-cause notice mechanism to be issued by the assessing officer (AO) to the taxpayer concerned before application of GAAR,[23] time-limits for various actions to be undertaken under the GAAR provisions, etc. In addition, certain administrative clarifications[24] have been issued by the Income Tax Department which explain its perspective on the interpretation and application of GAAR provisions.

This takes us back to the Act which prescribes a detailed procedure for applying GAAR.[25] It is stipulated that in a situation where the AO considers that the transaction may be an IAA, he is required to a make a reference to the Principal Commissioner of Income Tax, who, if he agrees, shall issue a notice to the taxpayer concerned and issue necessary directions after hearing the response. In the event the explanation of the taxpayer is not found satisfactory, then a reference has to be made to an approval panel which would, after hearing both the taxpayer and the tax officer, pass directions determining whether a case for IAA is made out. The approval panel would comprise of three members; the chairperson being a serving or former High Court Judge, one senior Indian Revenue Service member and one member who “shall be an academic or scholar having special knowledge of matters, such as direct taxes, business accounts and international trade practices”. The completion of proceedings relating to IAA shall be in terms of the directions of the approval panel, which must be issued within six months of reference being made to it.

  1. Conclusion

A review of the procedural dynamics reveals that multiple stages of hearing and application of mind by different classes of authorities, including those representing the judiciary and external experts, are envisaged in the GAAR application process. This is possibly directed towards driving away subjectivity before the GAAR consequences are applied, in line with the recommendations of the Expert Committee and also emulating international best practices. On a larger level, however, the introduction of GAAR in the tax law reveals the legislative non-tolerance towards tax avoidance manoeuvers. Looked from another perspective, the constant tussle between the taxpayer and the tax officer is sought to be injuncted by the legislature with GAAR, by prescribing the substantive parameters on which the conduct of the taxpayer shall be assessed and the procedure which shall preserve the sanctity of adjudication and instil fairness in this exercise. It is noteworthy that despite the extensive litigation generally observed in tax laws, not a single case has been reported where GAAR law has been applied even though the law already being in force for a few years now. This indicates that the introduction of GAAR in the income tax law has brought about both a perceptual and implementation change insofar tax avoidance is concerned.

†Tarun Jain, Advocate, Supreme Court of India; LLM (Taxation), London School of Economics.

[1]State of W.B. v. Subodh Gopal Bose, AIR 1954 SC 92, para 20, vide Patanjali Sastri C.J.

[2]IRC v. Duke of Westminster, 1936 AC 1.

[3]McDowell and Co. Ltd. v. CTO, (1985) 3 SCC 230 : (1985) 154 ITR 148.

[4]Union of India v. Azadi Bachao Andolan, (2004) 10 SCC 1 : (2003) 263 ITR 706.

[5]CIT v. Walfort Share and Stock Brokers (P) Ltd., (2010) 8 SCC 137 : (2010) 326 ITR 1.

[6]Vodafone International Holdings BV v. Union of India, (2012) 6 SCC 613 : (2012) 341 ITR 1.

[7]For illustration, see Ch. X, Income Tax Act, 1961.

[8] Expert Committee Report available HERE .

[9]S. 95(2) of the Income Tax Act, 1961 states “[t]his Chapter shall apply in respect of any assessment year beginning on or after the 1st day of April, 2018”.

[10]S. 95(1), Income Tax Act, 1961.

[11] S. 96(1), Income Tax Act, 1961.

[12] S. 96(2), Income Tax Act, 1961.

[13] S. 97(1), Income Tax Act, 1961.

[14] S. 97(2), Income Tax Act, 1961.

[15] S. 97(3), Income Tax Act, 1961.

[16] S. 97(4), Income Tax Act, 1961. It is noteworthy that “the fact of payment of taxes, directly or indirectly, under the arrangement”, “period or time for which the arrangement exists”, etc. are specifically provided as immaterial for the purpose of the commercial substance analysis.

[17] S. 102, Income Tax Act, 1961. For illustration, this provision defines expressions such as arrangement, asset, benefit, connected person, fund, party, relative, tax benefit, etc.

[18] S. 98, Income Tax Act, 1961, titled “consequences of impermissible avoidance arrangement”.

[19] S. 98(2), Income Tax Act, 1961.

[20] S. 99, Income Tax Act, 1961.

[21] S. 101, Income Tax Act, 1961.

[22] R. 10-U, Income Tax Rules, 1962.

[23] R. 10-UB, Income Tax Rules, 1962.

[24]For illustration, see Circular No. 7 of 2017 dated 27-1-2017, available HERE .

[25] S. 144-BA, Income Tax Act, 1961.

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