GAAR India and International perspective

General Anti-Avoidance RulesIndia and International perspective

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3General Anti-Avoidance Rules India and International perspective

Contents

Executive summary 4

Pre GAAR concept 6

Pre GAAR concept – India experience 8

GAAR concept 10

International experience 11

India Regime 17

Way forward 23

Internationally, tax avoidance has been recognized as an area of concern and several countries have expressed concern over tax evasion and avoidance. This is also evident from the fact that either nations are legislating the doctrine of General Anti-Avoidance Regulations in their tax code or strengthening their existing code. In India, the proposed Direct Tax Code 2010 (DTC 2010 or Code) seeks to address the issues relating to tax avoidance and evasion by bringing in General Anti-Avoidance Rules (GAAR) in addition to various transaction-specific Special Anti-Avoidance provisions.

The Discussion paper issued along with the proposed new tax code states that tax avoidance arrangements adopted by taxpayers span across several tax jurisdictions, and it is desirable to introduce GAAR that would serve as a deterrent to the use of increasingly sophisticated forms of tax avoidance by taxpayers. The paper also states that the appellate authorities and Courts have cast a heavy onus on the revenue authorities for dealing with matters of tax avoidance, especially when the relevant facts are in the exclusive knowledge of the taxpayer who chooses not to reveal them.

The introduction of GAAR regulation recognizes that it may not always be feasible for the judiciary to address the unforeseen implications of transactions carried out for tax purposes and also the need to provide some semblance on the matter of tax avoidance. However, where tax benefit is to be considered as the sole criterion (as is currently recognized under the proposed new Code) for determining tax avoidance, such a

provision may undermine the common denominator in determination of a tax avoidance scheme, i.e., the principle that though the taxpayer is free to choose the most tax efficient method, the commercial justification for the choice taken and tax consideration (benefit) is not the only reason.

Considering the goals of tax avoidance legislation, namely, deferral, re-characterization, elimination and shifting, India would need to address the issue in the proper perspective so that the provisions and their implementation do not become a law onto themselves. In the circumstances, one should be aware of some issues relating to the promulgation of a General Anti-Avoidance Rule, in terms of it being receptive to:

• Providingarobustframeworkbasedonsoundlegaljurisprudence and principles to address the issue of abusive transactions, which tend to ride on the shortcomings of the tax system. As indicated by many international tax theorists and practitioners, the design of GAAR should be by reference to ‘busi-ness-purpose test’ with emphasis on the different concepts of the economic substance associated with the categories of tax avoidance behavior, such as tax evasion, acceptable tax avoidance and abusive tax avoidance rather than narrow the scope to the aspect of a tax benefit test.

• Incorporateasubstanceoverformrulewhereatransaction or a series of transactions are entered into to judge the authenticity and purpose of the transaction rather than teleologically apply the tax benefit provision, surpassing all other aspects of the transaction.

Executive summary

4

“Tax avoidance like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner1.”

1 Discussion paper on Direct Taxes Code 2009

5General Anti-Avoidance Rules India and International perspective 55

• Theissueofbilateraltaxtreatyoverridebywayofbringing the same under the relevant treaties in terms of limitation of benefits clause. In the absence of the same, it may result in violation of international principles of treaty interpretation.

• Strikingabalancebetweenwidecoverageanduncertainty – it is imperative that the Government issues detailed guidelines on inherent principles and on the type of transactions/arrangements they may consider as ‘avoidable transaction’. A mechanism similar to an advance ruling may be considered to avoid uncertainty, protracted litigation and disputes.

This paper outlines some of the nuances relating to General Anti-Avoidance Rule by examining the historical perspective for tax avoidance generally and in India. The concept of GAAR, international experience on GAAR legislation in some jurisdictions, the proposed provisions under the Direct Tax Code followed by a comparison with other countries, few instances on the applicability of the GAAR provisions, and the way forward for both the authorities and the taxpayers have been covered in the paper.

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Pre GAAR concept

Internationally and in India, a constant debate has been raging over the issue of tax avoidance. Over the years, the term ‘tax avoidance’ has come to be understood as arranging affairs with the main object or purpose of obtaining tax advantage while prima facie fully intending to comply with the law in such respect. Some principles underlying the meaning of ‘tax avoidance’ are:

• Theexpression‘taxavoidance’isusedtodescribeevery attempt by legal means to prevent or reduce tax liability, which would be otherwise incurred, by taking advantage of some provision or lack of provision in the law. It pre supposes the existence of alternatives, one of which would result in less tax than the other. Moreover, motive would be an essential element of tax avoidance. A person who adopts one of the several possible courses to save tax must be distinguished from a taxpayer who adopts the same course for business or personal reasons2.

• AcourseofactiondesignedtoconflictwithordefeattheevidentintentionofParliament3.

• Whereitreducestheincidenceoftaxbornebyanindividual taxpayer contrary to the intentions of Parliament4.

• Taxplanningmaybelegitimate,provideditiswithinthe framework of law. Colorable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay their taxes honestly without resorting to subterfuges5.

• Further,CourtsinIndiahavebroadlyindicatedthat if some device has been used by a taxpayer to conceal the true nature of the transaction, it is the duty of the taxing authority to unravel the device and determine its true character. However, the legal effect of the transaction cannot be displaced by probing into the ‘substance of the transaction’.

Considering these continuing difficulties of classifying transactions as being acceptable within the framework of law or not, a need is being felt to move towards a structured approach to address the issue of avoidance both from a legal and economic point.

Thus, ‘tax avoidance’ could be said to transact between substance over form of a transaction, the issue being of whether it is legal or economic substance.

‘Legal substance’ would refer to characterization which emerges from a close study of the rights and obligations in a legal relation whereas ‘Economic substance’ has different interpretations as propounded by various jurisdictions:• ‘Realeconomicsubstance’–ThisistheAmerican

notion under which the Economic substance is determined by looking at both objective and subjective factors to see if there is any potential for profit other than tax savings, or if there is any meaningful change in the economic position of the taxpayer. Under this doctrine, a transaction lacking economic substance will be ignored. In Gregory vs Helverig (1934) - US, the Court outlined that “it does not follow that Congress meant to cover such a transaction. The meaning of a sentence may be more than that of the separate words, as a melody is more than the notes, and no degree of particularity can ever obviate recourse to the setting in which all appear, and which all collectively create. If what was done here was what was intended by [the statute], it is of no consequence that it was all an elaborate scheme to get rid of income tax, as it certainly was… [But] the purpose of the section is plain enough; men engaged in enterprises… might wish to consolidate, or divide, to add to, or subtract from, their holdings. Such transactions were not to be considered as realizing any profit, because the collective interests still remained in solution.

In other words, the benefit of the objective tax result

would be denied, where the transaction did not change the economic position, apart from the tax benefit, nor did it reflect any facet of the business, which could be considered as lacking economic substance, and was not “the thing which the statute intended”.”

• StepTransactionplusbusinesspurpose–ThisUKversion combines step transactions doctrine and business purpose doctrine and enables the courts to overlook the step transactions that serve no business purpose. This could be evolved from the various juridicalpronouncementsmadebytheUKcourtswithregard to transaction considered as entered into with the objective of tax avoidance.

InDukeofWestminstervsIRC,theirLordshipsheldthatthe Act is to receive a strict or literal interpretation and

2 Carter Commission in Canada

3 Lord Nolan in IRC v. Willoughby

4 Lord Templeman

5 Simon in Latilla v. I.R.C. (11 ITR Suppl. 78, 79) (HL)


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 interpretation approach is adopted. The principle outlined herein came to be considered as a general rule of statutory construction, not a separate judicial doctrine.

The common denominator which can be found in most countries is that if a taxpayer has multiple avenues available to structure his transaction, he is free to choose the most tax-efficient avenue, provided a level of commercial justification for the same exists, and tax is not the only reason.

In respect of international recognition to the concept, the Vienna Convention provides that international agreements are to be interpreted in ‘good faith’. In case any international agreement/treaty leads to unintended consequencesliketaxevasionorflowofbenefitstounintended person, it is open to the signatory to take corrective steps to prevent abuse of the treaty. Such corrective steps are consistent with the obligations under the Vienna Convention.

Further,theOECDleavesittotheindividualcountriesto introduce anti-abuse legislation, which they consider could be applied without interference by the Model Convention or the bi-lateral tax treaty between the countries inter-se. However, the OECD Commentary on Article 1 of the Model Tax Convention also clarifies that a general anti-abuse provision in the domestic law in the nature of ‘substance over form rule’ or ‘economic substancerule’wouldnotbeinconflictwiththetreaty.In other words, the general anti-abuse rule would override the provisions of the tax treaty.

Hence, the underlying principle emanating from international experience in respect of tax avoidance and where GAAR legislation has not been enacted is the recognition that the contentious issue of determining/establishing the doctrine of substance over form would have to be established through an examination of the legal substance, the legal form, or the real economic substance of the transaction. This has also been duly adapted under Indian jurisprudence as outlined in the section below.

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8

Pre GAAR concept India experience

Indian tax laws, though providing for specific anti-avoidance measures, do not have any general anti-avoidance rules or regulations. The Courts have over the years drawn out the general parameters and principles in outlining whether a transaction or scheme would be considered as tax avoidance/tax evasion or tax planning under the tax laws, as outlined below, though the uncertainty continues.

The Hon’ble Supreme Court (SC) in A Raman’s case6 observed that:“...the law does not oblige a trader to make the maximum profit that he can get out of his trading transactions. Income which accrues to a trader is taxable in his hands. Income which he could have, but has not earned, is not made taxable as income accrued to him. Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. A taxpayer may resort to a device to divert the income before it accrues or arises to him. Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income-tax Act. Legislative injunction in tax statutes may not, except on peril of penalty, be violated, but may lawfully be circumvented....”

Further,inBankofChettinad’scase7,theHon’blePrivyCouncil(PC)statedthat:“...the tax authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the tax authorities to unravel the device and to determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the substance of the transaction...”

Another important Indian case8 addressing the substance over form question reiterated the principles laid down by the House of Lords in the decision of Duke of

Westminster,andtooktheviewthattaxplanningwaslegitimate so long as it was strictly within the four corners of the law and any ‘colorable’ device or dubious methods to minimize tax incidence were not legally permissible.

It appears that there is no single approach towards the issue of substance over form. A clear tendency exists for Revenue authorities to try and counter any kind of undesired outcome (in their eyes) of a certain piece of legislation by applying the substance over form doctrine. However, while examining a legally valid transaction, the Revenue authorities should proceed objectively and not hypothetically attribute ‘motives’ behind the taxpayer’s action.

Wehavewitnessedacontentiousjourneyfordetermining whether the affairs planned by the taxpayer were legitimate to be strictly within the four corners of the law or was a colorable device or dubious method entered into with a purpose to minimize tax incidence leading up to the decision9 wherein the SC reiterated and continued to enshrine the principles as laid out in DukeofWestminsterasunder:

“...With respect, therefore, we are unable to agree with the view that Duke of Westminster’s case (1936) AC 1 (HL); 19 TC 490 is dead, or that its ghost has been exorcised in England. The House of Lords does not seem to think so, and we agree, with respect. In our view, the principle in Duke of Westminster’s case (1936) AC 1 (HL); 19 TC 490 is very much alive and kicking in the country of its birth. And as far as this country is concerned, the observations of Shah J. in CIT v. Raman, (1968) 67 ITR 11 (SC) are very much relevant even today...” and

“...It thus appears to us that not only is the principle in Duke of Westminster’s case (1936) AC 1 (HL); 19 TC 490 alive and kicking in England, but it also seems to

6 CIT v. A. Raman and Co, [1968] 67 ITR 11 (SC)

7 BankofChettinadLtd.v.CIT[1940]8ITR522(PC)

8 McDowell and Co. Ltd. v. Commercial Tax Officer, [1985]154 ITR 148 (SC)

9 Union of India v. Azadi BachaoAndolan,[2003]263 ITR 706 (SC)

While examining a legally valid transaction, the Revenue authorities should proceed objectively and not hypothetically attribute ‘motives’ behind the taxpayer’s action.


have acquired judicial benediction of the Constitutional Bench in India, notwithstanding the temporary turbulence created in the wake of McDowell’s case (1985) 154 ITR 148 (SC).”

Further,theSCinAzadiBachaoAndolan’scaseobservedthat:• ThecontentionthattheDoubleTaxationAvoidance

Convention (DTAC) between India and Mauritius is ultra vires is not acceptable — even if the DTAC is susceptible to ‘treaty shopping’ on behalf of the residents of third countries.

• Ataxtreatyorconventionmustbegivenaliberalinterpretation. A holistic view has to be taken in this regard.

• Anact,whichisotherwisevalidinlaw,cannotbetreated as non-est merely on the basis of some underlying motive (supposedly resulting in some economic detriment or prejudice to the national interest, as perceived by the respondents).

However, the Revenue authorities have over the years challenged various forms of transactions entered into by taxpayers, specifically with regard to cross-border transactions. The recent example being in the case of the purchase of shares by Vodafone International of a foreign company, which held directly/indirectly

shares in an Indian company. In the matter before theBombayHighCourt,itwasobservedthatthedomestic tax law recognizes the right of a taxpayer to plan his transactions to reduce the incidence of tax. In the absence of statutory provisions to the contrary, instruments and legal structures which are utilized for a bonafide business purpose do not permit an enquiry by the authorities into the underlying economic interest. However, the parties cannot conceal the nature of their legal relationship by adopting a structure which is different from the legal character assumed by them.

Considering the background to the ongoing tussle, the intention of the Government in proposing to legislate GAAR provisions could be drawn from the principle for recognizing the continuum of Courts addressing unforeseen implication of transactions under the tax provisions and in the circumstances, to provide a vision to an assumed obscure state of affairs.

However, it needs to be seen how the principles enshrined through judicial pronouncements (being principle based or purposive) would continue to be followed under the proposed GAAR regime as is proposed under DTC 2010, wherein the distinction between tax avoidance and tax evasion is being sought to be obliterated.

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GAAR concept

Legislatures in various countries are moving towards promulgating General Anti-Avoidance Rules to address the ongoing debate between illegal evasion and ‘legal’ avoidance, or what is termed as ‘acceptable’ and ‘unacceptable’ avoidance of tax.

According to legal experts, the implementation of GAAR has led to difficulties in various jurisdictions. In spite of that, none of the jurisdictions have shown signs of dispensing with the provisions; in fact, they have revised the concept when judicial pronouncements have refused to recognize the same.

However, GAARs should not be relied upon to address foreseeable methods of tax avoidance occasioned by statutory difference in the tax treatment of similar transactions or relationships10. In these circumstances, to the extent that the avoidance is considered unacceptable, the preferred response for legislature is to either amend the specific provisions at issue or introduce a specific anti-avoidance to preclude their use for unacceptable tax avoidance11.

In dealing with the issue of tax avoidance through a legislative code or judicial principles, it is imperative to provide clarity in dealing with the situation. This may be through a purposive interpretation of legislation so as not to offend the rule of law where such a general rule could be considered to be on the boundary of having no limits.

AsstatedbyJudithFreedman12 in summarizing the findings in the stated publication, there is a need for

better legislation, giving clearer signal to taxpayers, better tools to the judiciary and an improved basis for enhanced cooperation between taxpayers and revenue authorities.Further,theonlytruesolutiontoavoidanceis to have a more principle based tax system, but this requires more than mere changes to wording and that further work is clearly needed on forms of drafting (rather than just pick and implement), both at the specific and meta levels.

Further,intherecentlyreleased“AstudytoconsiderwhetheraGAARruleshouldbeintroducedintotheUKTax System”, it has been stated: “....that introducing a broad spectrum GAAR would not be beneficial for the UK tax system. This would carry a real risk of undermining the ability of business and individuals to carry out sensible and responsible tax planning and that on the other hand introducing a moderate rule which does not apply to responsible tax planning, and is targeted at abusive arrangements would be beneficial for the UK Tax system....”

10 T Edgar: ‘Designing and Implementing a Target Effective General Anti-Avoidance Competence’

11 David Duff-Relationships, BoundariesandCorporateTaxation: Compliance and Avoidance in Era of Globalization

12 EditorialComment:BeyondBoundaries:DevelopingApproaches to Tax Avoidance and Tax Risk Management

“A broad spectrum GAAR carries a real risk of undermining the ability of business and individuals to carry out sensible and responsible tax planning and that on the other hand introducing a moderate rule which does not apply to responsible tax planning, and is targeted at abusive arrangements would be beneficial.”


International experience

Canada

GeneralA taxpayer is entitled to structure affairs so as to minimize tax within the confines of the law. However, tax planning (or tax minimization) must be contrasted with tax evasion, which may render the taxpayer liable to fines or imprisonment. Some forms of tax planning are restricted through the use of specific anti-avoidance provisions, more generally abusive planning, is checked through a statutory GAAR.

Background of legislation Canadian tax laws contain GAAR provisions since 1988. ExplanatorynotesissuedbytheFederalDepartmentofFinancein1988statedthattherule:

“....is intended to prevent abusive tax avoidance transactions or arrangements but at the same time is not intended to interfere with legitimate commercial and family transactions. Consequently, the new rule seeks to distinguish between legitimate tax planning and abusive tax avoidance and to establish a reasonable balance between the protection of the tax base and the need for certainty for taxpayers in planning their affairs....“

Trigger event If a transaction is an ‘avoidance transaction’, the Canada Revenue Agency (CRA) may deny the tax benefit that would otherwise result. An avoidance transaction is any transaction that would otherwise result in a direct or indirect tax benefit, or that is part of a series of transactions that would otherwise result in a tax benefit.ForGAARpurposes,atransactionincludesanarrangement or event. However, a transaction will not be considered to be an avoidance transaction if it can reasonably be considered to have been undertaken or arranged primarily for bonafide purposes other than to obtain the tax benefit.

Even if a transaction is an avoidance transaction, GAAR will apply only if the transaction results in a misuse or an abuse of the provisions of tax laws. In other words, GAAR applies only to transactions that lack a bonafide non-tax purpose and that result in a misuse or abuse of the tax laws.

The Canadian Supreme Court in the case of Canada Trustco Mortgage Co. [2005] SCC 54 established the

following principles to guide the interpretation of the GAAR:• Whiletheeconomicsubstanceofatransaction

might be relevant at various stages of GAAR analysis, ‘economic substance’ has little meaning in isolation from the proper interpretation of specific provisions of the Act. Accordingly, any argument that is based on notions of ‘economic substance’ must be considered in light of the specific provisions being examined.

• Afindingofmisuseorabuseispossibleinthefollowing situations:

– the taxpayer uses specific provisions of the tax laws in order to achieve an outcome that those specific provisions seek to prevent;

– a transaction defeats the underlying rationale of the provisions that are relied upon; or

– an arrangement circumvents the application of certain provisions, such as specific anti-avoidance rules, in a manner that frustrates or defeats the ‘object, spirit or purpose’ of those provisions.

• Abuseisnotestablishedifitisreasonabletoconclude that an avoidance transaction was within the ‘object, spirit or purpose’ of the provisions that confer the tax benefit.

Recently, the Canadian Supreme Court had, in the case of Copthorne Holdings Ltd. v. Canada, 2011 SCC 63, observed that the general anti-avoidance rule scheme is set out in the Act and requires that three questions be decided: (1) was there a tax benefit; (2) was the transaction giving rise to the tax benefit an avoidance transaction; and (3) was the avoidance transaction giving rise to the tax benefit abusive.

The Court further observed that “in order to determine whether a transaction is an abuse or misuse of the Act, a court must first determine the object, spirit or purpose of the provisions that are relied on for the tax benefit, having regard to the scheme of the Act, the relevant provisions and permissible extrinsic aids.

While an avoidance transaction may operate alone to produce a tax benefit, it may also operate as part of a series of transactions that results in the tax benefit. While the focus must be on the transaction, where it is part of a series, it must be viewed in the context of the series to enable the court to determine whether abusive tax avoidance has occurred. In such a case, whether a

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transaction is abusive will only become apparent when it is considered in the context of the series of which it is a part and the overall result that is achieved.

The analysis will lead to a finding of abusive tax avoidance: (1) where the transaction achieves an outcome the statutory provision was intended to prevent; (2) where the transaction defeats the underlying rationale of the provision; or (3) where the transaction circumvents the provision in a manner that frustrates or defeats its object, spirit or purpose. These considerations are not independent of one another and may overlap”.

Providingfurtherguidelines,theCourtemphasizedthatthe transaction may have a tax purpose, but that does not necessarily mean that the tax purpose will always be the primary reason for the transaction.

However, where a transaction takes place primarily for a non-tax purpose, there will be no avoidance transaction. In the absence of an avoidance transaction, the fact that a transaction may have a secondary tax benefit purpose willnottriggertheGAAR.Whetherthetransactionsarebetween parties at arm’s length or not at arm’s length should be immaterial (Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536).

Further,wherecorporatereorganizationtakesplace,the GAAR does not apply unless there is an avoidance transaction that is found to constitute an abuse. Even where corporate reorganization takes place for a tax reason, the GAAR may still not apply. It is only when a reorganization is primarily for a tax purpose and is done in a manner found to circumvent a provision of the Income Tax Act that it may be found to abuse that provision. And it is only where there is a finding of abuse that the corporate reorganization may be caught by the GAAR.

Procedural requirementsIn Canada Trustco, the Canadian Supreme Court laid down the following procedural principles:• Theonusisonthetaxpayertorefutethefollowing

(on a balance-of-probabilities basis): – the assertion that a tax benefit results from the

transaction. It is not permissible, however, for the CRA to take the position that more tax would have been paid if the taxpayer had engaged in some other transaction or that the amount of tax paid is less than some notional amount that the CRA believes should have been paid; and

– the assertion that the transaction was an avoidance transaction. The taxpayer might be able to refute this assertion by showing a bonafide and primary non-tax purpose for the transaction.

• Ifthereisataxbenefitandanavoidancetransaction,the burden then falls on the CRA to establish that there is abusive tax avoidance.

Australia

GeneralTax 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 legislationAustralia’s GAAR was introduced in 1981 and is containedinPartIVAoftheIncomeTaxAssessmentAct1936 (ITAA 1936).


John Howard, the then Treasurer, described the objective of GAAR in these terms:

“The proposed provisions embodied in a new Part IVA seek to give effect to a policy that such measures ought to strike down blatant, artificial or contrived arrangements but not cast unnecessary inhibitions on normal commercial transactions by which taxpayers legitimately take advantage of opportunities available for the arrangement of their affairs.”

In his speech, the then Treasurer reaffirmed the limited scope of the new legislative solution “In order to confine the scope of the proposed provisions to schemes of the “blatant” or “artificial” variety, the measures in this Bill are expressed so as to render ineffective a scheme whereby a tax benefit is obtained and an objective examination, having regard to the scheme itself and to its surrounding circumstances and practical results, leads to the conclusion that the scheme was entered into for the sole or dominant purpose of obtaining a tax benefit.”

The Australian GAAR is a provision of last resort, i.e. it should not apply unless the taxpayer’s claim is otherwise allowable. It, therefore, counters schemes that strictly satisfy the technical requirements of the tax law, includingtheordinaryprovisionsandSAAPs,butwhenobjectively viewed, are considered to be conducted or carried out with the sole or dominant purpose of obtaining a tax benefit.

If certain conditions are met, the provisions allow the Commissioner to cancel all or part of any tax benefits which a taxpayer derives from the scheme.

ThethreekeyconditionswhichmustbesatisfiedforPartIVA to apply are: (i) there must be a ‘scheme’, (ii) there must be a ‘tax benefit’ obtained in connection with the scheme, and (iii) it must be reasonable to conclude that at least one person entering into the scheme did so for the ‘sole or dominant purpose’ of obtaining a tax benefit.

On 18 November 2010, the Australian Government releasedforpubliccommentaDiscussionPaperthatdeals with the review of the existing anti-avoidance rules. The paper deals with possible improvements to both the general and specific anti-avoidance provisions with a view to simplify as well as improve the operation of these provisions.

Is there a scheme?A ‘scheme’ for these purposes is defined broadly as:a) any agreement, arrangement, understanding,

promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

b) any scheme, plan, proposal, action, course of action or course of conduct.

It may comprise many steps or parts and is not necessarily limited to the step that produced the tax benefit.Furthermore,foranygivenscenario,itispossible that a number of schemes may be identified within the total steps undertaken.

Is there a benefit?A tax benefit is obtained in any of the following cases where the event would not have occurred but for the scheme:• anamountisnotincludedinassessableincome,

including amounts which are converted from assessable income to capital gains eligible for discount treatment;

• adeductionisallowed;• withholdingtaxisnotpayable;• propertyisdisposedoffunderadividendstripping

scheme;• aforeigntaxoffsetisallowed;or• acapitallossisincurred.

What is the purpose?The GAAR will only apply where at least one person who entered into or carried out the scheme did so for the sole or dominant purpose of enabling a taxpayer to obtain a tax benefit. In order to ascertain the purpose of the scheme the following eight matters should be considered:1) the manner in which the scheme was entered into or

carried out;2) the form and substance of the scheme;3) the time at which the scheme was entered into and

the length of the period during which the scheme was carried out;

4) theincometaxresultthat,butforPartIVA,wouldbeachieved by the scheme;

5) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

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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 having been entered into or carried out; and

8) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in (6).

Procedure for applying GAARTheCommissionerofTaxationhasreleasedPracticeStatement13 which provides detailed guidelines for tax officersonthepracticalapplicationofPartIVA.

Interaction between the GAAR and other provisions of the Taxes ActsTheoperationofPartIVAofITAA1936isnotlimitedby any other provisions of ITAA 1936, ITAA 1997, or the International Tax Agreements Act 1953 (ITAA 53), wherein all tax treaties are enacted as schedules.

Specific Anti-Avoidance RulesThere are a number of specific rules in the ITAA 1936 and ITAA 1997 targeted at certain schemes that are regarded as impermissible by the Australian Government. Examples of these (on a non-exhaustive basis) are outlined below:

Alienation of incomeA right to income arising out of the ownership of propertycanbetransferred.Wheretherighttoincomeis transferred but the property giving rise to the income is retained by the transferor, the consideration received for the transfer of the right to income is assessable as income14.

This provision does not apply where the right to income is transferred for a period of less than 7 years; the parties to the transfer are associated and the consideration for the transfer is less than an arm’s length consideration; the transfer is then disregarded for tax purposes and so the transferor remains assessable on the income15.

Foreign tax credit schemesSchemes entered into after 13 August 1998 to acquire or generate foreign tax credits that can be used to shelter low-taxed foreign-sourced income from Australian tax. A specific power is provided to the Commissioner to amend a foreign tax credit determination.

Dividend strippingDividend stripping is not defined in the legislation. The essence of dividend stripping is that value is taken out of a company in the form of a dividend, normally an abnormally large dividend which clears all the current and accumulated profits out of the company, in order to achieve a tax benefit.

In case of dividend stripping arrangement, the Commissioner is allowed to cancel the tax benefits derived by shareholders who sell their shares before a dividend is declared. The share-dealing company in such a situation is also denied a rebate in respect of the dividend. A rebate is also denied where the purchaser of the shares is not a share-dealing company but seeks to claim the loss on the shares as a capital loss16.

13 PSLA2005/24‘Applicationof General Anti-avoidance Rule’

14 Section 102CA ITAA 36

15 Section102BITAA36

16 Section46AandBITAA36


Dividend streamingThescopeofPartIVAincludesfrankingcredittradingand dividend streaming schemes where one of the purposes of the scheme is to obtain a franking credit benefit17.Frankingcreditschemesinvolvethedispositionof shares or an interest in shares where the elements described in the provision exist.

Wherethecompanyandthepersonreceivingthedividend or distribution are parties to the scheme, the Commissioner has a choice as to whether: • topostadebittothecompany’sfrankingaccount;

or• todenythefrankingcreditbenefittotherecipientof

the dividend or distribution.

The amount of debit to franking account is the amount that the Commissioner considers reasonable in the circumstances, i.e. not being an amount larger than the debit to the franking account occasioned by the payment of dividend.

China

Time since in statuteThe new EITL18, which came into effect on 1 January 2008, includes a general anti-avoidance provision (Article 47 of the EITL).

What are the trigger eventsArticle47oftheEITLprovides:“Ifanenterpriseengagesin a business arrangement without bonafide commercial purposes that results in reducing its taxable revenue or taxable income, the tax bureau has the right to make adjustments based on reasonable methods.”

The tax authorities may initiate a GAAR audit of enterprises that enter into the following arrangements:• abuseoftaxincentives;• abuseoftreaties;• abuseofthecorporatestructure;• useoftaxhavensfortheavoidanceoftaxes;and• otherbusinessarrangementswithoutbonafide

commercial purposes.

Procedure for applying GAARTax authorities identify potential cases for investigation based on the information submitted by taxpayers or gathered through their own channels.

GAAR audits and adjustments must be reported level by level up to the State Administration of Taxation for approval.

Specific Anti-Avoidance RulesApart from GAAR, China has specific rules concerning:• Transferpricing• Thincapitalization• Controlledforeigncompanies• Recognitionofabeneficialownerfortreatypurposes

Impact on treaty usageUnder Article 58 of the EITL, treaty provisions prevail in casethereisaconflictwiththeprovisionsoftheEITL.Accordingly, absent any provision in a particular treaty to the contrary and depending on the specific application of the GAAR provision to the particular transaction, this could be read to mean the provisions of that treaty will prevail over the GAAR provisions of the EITL. However, this issue has not yet been tested to date, and accordingly, whether such a reading of the law will be accepted remains unclear.

However, it may be noted that in many, if not most cases, it is likely that GAAR would be applied to alter the facts to which Chinese law would be applied, and as suchaconflictinsofarasthetreatyisconcernedwouldnot arise.

It should be noted that the more recent treaties concluded by China include provisions specifically stating that domestic GAAR would operate to counter transactions without justified commercial purpose but to take advantage of the treaty benefits.

South Africa

GeneralGAAR operates as one of the measures to counter tax avoidance, and is generally considered as a residual measure, which may apply in addition to or as an alternative to any other or specific anti-avoidance provision.

Background of legislationDuring 2006, the Income Tax Act 50 of 1962 was amended to enable the South African Revenue Service (SARS) to more effectively combat tax avoidance in South Africa. Section 103(1), the general anti-avoidance

17 Section 177EA ITAA 36

18 Enterprise Income Tax Law

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provision, was repealed and the GAAR was introduced. TheGAARiscontainedinPartIIAofChapterIIIoftheIncome Tax Act and specifically applies to impermissible avoidance arrangements as defined.

A provision against tax avoidance applies where:• animpermissibleavoidanceagreementhasbeen

entered into with its sole or main purpose being to obtain a tax benefit; and

• inthecontextofbusiness: – it was entered into or carried out in a manner

that would not normally be employed for bonafide business purposes other than for obtaining a tax benefit; or

– it lacks commercial substance;• inthecontextotherthanbusiness,itwasentered

into or carried out by means or in a manner not normally employed for a bonafide purpose, other than obtaining a tax benefit; or

• ithascreatedrightsorobligationswhichwouldnotnormally be created between persons dealing at arm’s length, or it would result directly or indirectly in the misuse or abuse of the provisions of the Income Tax Act.

Tax consequencesIf the above requirements are met, South African revenue authorities may:• disregard,combineorre-characterizethe

arrangement or any step thereof;• disregardanyaccommodatingortax-indifferent

party or treat this party and any other party as one and the same person;

• deemthepartieswhoareconnectedpersonsinrespect of each other as one and the same person;

• re-allocateanyincome,receiptoraccrualofacapitalnature or expenditure;

• re-characterizeanyincomeofacapitalnatureasincome of a revenue nature;

• treatthetransactionasifithasnotbeencarriedout,or in any other manner that in ‘revenue authorities’ view is adequate for the prevention or diminution of the tax benefit.

Trigger event The presence of certain criteria is considered as indicative of tax avoidance. These include:• thelegalsubstanceofthearrangementasawhole

is inconsistent with, or differs significantly from, the legal form of its individual steps;

• thepresenceofroundtripfinancing;• thepresenceofanaccommodatingortax-indifferent

party (described as a party for whom the amounts received from the arrangement are not subject to normal tax, or the tax liability is significantly offset by an expenditure incurred by that party in terms of the arrangement);

• thepresenceofelementswhichhavetheeffectofoffsetting or cancelling each other.

Further developmentsThe SARS have recently released a ‘Draft Comprehensive Guide to the General Anti–Avoidance Rule’ which provides for guidance to revenue authorities on interpretation and application of GAAR.

Broadly,ininterpretingtheprovisionsrelatingtoGAAR,the guideline provides that a tax benefit may be denied under the GAAR if such tax benefit would misuse or abuse the object, spirit or purpose of the provisions of the Income Tax Act that are relied upon for the tax benefit. It would require a purposive approach to interpret the provisions of the Income Tax Act, which is already the accepted approach to legislative interpretation in South Africa. The introduction of the misuse or abuse test is specifically directed at ensuring that the remedy provided by the section is advanced and that the mischief against which the section is directed is suppressed. As a result, a mere literal interpretation of the provisions will no longer safeguard a taxpayer who applies the provisions in the Income Tax Act in a context or manner which is not intended by the Income Tax Act.

Although it is accepted that where the substantive tax provision is clearly articulated and free from ambiguity, a departure from the ordinary meaning of the language used is not required. The misuse or abuse requirement in the GAAR nevertheless requires that the intention of the legislator is considered in determining whether the provisions of the Income Tax Act are applied in a manner which is intended.

Further,thepurposetestundertheGAARisamoreobjective test, wherein the sole or main purpose of the arrangement itself is the relevant purpose and no longer the subjective purpose of the taxpayer.


India Regime

Proposed GAAR – DTC 2010Under the Code, GAAR will be invoked if the following conditions are satisfied:a) The taxpayer should have entered into an

arrangement.b) The main purpose of the arrangement should be to

obtain a tax benefit and the arrangement: i) has been entered into, or carried out, in a manner

not normally employed for bonafide business purposes;

ii) has created rights and obligations which would not normally be created between persons dealing at arm’s length;

iii) results, directly or indirectly, in the misuse or abuse of the provisions of this Code; or

iv) lacks commercial substance, in whole or in part.

Meaning of arrangementAn ‘arrangement’ will mean any transaction, conduit, event, trust, grant, operation, scheme, covenant, disposition, agreement or understanding, including all steps therein or parts thereof, whether enforceable or not. Therefore, if the motive behind individual steps is to obtain a tax benefit, but the overall scheme is not so, the individual steps will nevertheless be treated as an arrangement and the GAAR may be invoked.

An arrangement will also include any interposition of an entity or transaction where the substance of such entity or transaction differs from the form given to it.

Lack of commercial substanceThe lack of commercial substance, in the context of an arrangement, shall be determined, but not limited to, by the following indicators:i) The arrangement results in a significant tax benefit

for a party but does not have a significant effect uponeitherthebusinessrisksorthenetcashflowsof that party other than the effect attributable to the tax benefit.

ii) The substance or effect of the arrangement as a whole differs from the legal form of its individual steps.

iii) The arrangement includes or involves: a) round trip financing; b) an ‘accommodating party’, as defined; c) elements that have the effect of offsetting or

cancelling each other;

d) a transaction which is conducted through one or more persons and disguises the nature, location, source, ownership or control of funds; or

e) an expectation of pre-tax profit which is insignificant in comparison to the amount of the expected tax benefit.

The concepts of ‘round trip financing’ and ‘accommodating party’ will be defined in the Code.

Tax consequences of impermissible avoidance arrangementsIf the conditions specified above are satisfied, the Commissioner will be empowered to declare the arrangement as an impermissible avoidance arrangement and determine the tax consequences of the taxpayer as if the arrangement had not been enteredinto.Forthispurpose,hemay:i) disregard, combine, or re-characterize any steps

in, or parts of, the impermissible avoidance arrangement;

ii) disregard any accommodating party or treat any accommodating party and any other party as one and the same person;

iii) deem persons who are connected persons in relation to each other to be one and the same person for purposes of determining the tax treatment of any amount;

iv) re-allocate any gross income, receipt or accrual of a capital nature, expenditure or rebate amongst the parties;

v) re-characterize any gross income, receipt or accrual of a capital nature or expenditure;

vi) re-characterize any multi-party financing transaction, whether in the nature of debt or equity, as a transaction directly among two or more such parties;

vii) re-characterize any debt financing transaction as an equity financing transaction or any equity financing transaction as a debt financing transaction;

viii) treat the impermissible avoidance arrangement as if it had not been entered into or carried out or in such other manner as the Commissioner in the circumstances may deem appropriate for the prevention or diminution of the relevant tax benefit; or

ix) disregard the provisions of any agreement entered into by India with any other country under section 265.

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An arrangement declared as an impermissible avoidance arrangement shall be presumed to have been entered into or carried out for the main purpose of obtaining a tax benefit unless the party obtaining the tax benefit proves that obtaining a tax benefit was not the main purpose of the avoidance arrangement.

Procedure for applying GAARThe power to invoke GAAR is bestowed only upon the CommissionerofIncomeTax(CIT).Forthispurpose,theCode empowers him to call for such information as may be necessary. He is also required to follow the principles of natural justice before declaring an arrangement as an impermissible avoidance arrangement. He will determine the tax consequences of such impermissible avoidance arrangement and issue necessary directions to the Assessing Officer for making appropriate adjustments. The directions issued by him will be binding on the Assessing Officer.

Key issues The key issues / implications under the proposed GAAR are: • Taxavoidancehasbeenwidelydefinedwiththe

objective to encompass a number of circumstances and instances of tax avoidance, leading to uncertainty and extensive litigation.

• GAARcanbeinvokedwhereobtainingataxbenefitis the ‘main purpose’, and it is not clear as to what is meant by ‘main purpose’; the courts would be left to decide whether in the given facts the main purpose of the transaction/arrangement was to obtain tax benefit.

• Whereanadjustmentismade(invokingGAAR),itisnot clear whether the full effect of the same would be given to ensure that there is no double taxation.

• Theonusofprovingthatanarrangementhasnotbeencarried out for the main purpose of obtaining a tax benefit is with the taxpayer, while the tax authorities may not have any evidence of tax avoidance.

• Thereisnocut-offdateforapplicabilityofGAARprovisions to any arrangement and, therefore, where the impact of past arrangements continues in Direct Tax Code regime; the same may still be covered by GAAR irrespective of the fact that the arrangement has been approved by the tax officer or subjected to judicial review.

GAAR – Tax TreatyIt has been provided that the GAAR provisions would apply to a taxpayer notwithstanding that the treaty provisions are more beneficial. Considering the approaches as outlined before (under the Vienna Convention and the OECD wherein the underlying principle would be that GAAR could override the provi-sions of a treaty), it is important to note that OECD Commentary on Article 1 of the Model Tax Convention also clarifies that a general anti-abuse provision in the domestic law in the nature of ‘substance over form rule’ or‘economicsubstancerule’wouldnotbeinconflictwith the treaty.

However, as enshrined in the Vienna Convention19, “everytreatyinforceisbindinguponthepartiestoitandmustbeperformedbythemingoodfaith”,‘Pactasunt servanda’ is based on good faith. This entitles states to respect obligations. This good faith basis of treaties implies that a party cannot invoke provisions of its domestic law as a justification for a failure to perform.

Thus, if a legislature unilaterally enacts new domestic tax laws which are contrary to an existing treaty, without the treaty having been amended or terminated, such action is violation of international law and also violates the principles of ‘pacta sunt servanda’. This type of treaty violation is known as ‘treaty override’.

Further,accordingtorulesoflegislativeinterpreta-tion, specific legislation overrides general legislation. Therefore, changes of a domestic law generally, which could be the case with GAAR, may not affect the treaty. Considering the same, in the absence of an anti-avoid-ance provision under the treaty, it remains to be seen whether the provisions would be able to override the treaty.

Specific anti-abuse rules In addition to the GAAR provisions, the Code provides for specific anti-avoidance rules to deal with some of the following circumstances. These are similar to the provisions under the Income-tax Act, 1961:i) Certain payments deemed to be dividend [Clause

314(4) r.w 314(81)];ii) Clubbing of income arising to other person by virtue

of a transfer without transfer of the asset [Clause 8(1)];

iii) Denying tax benefits to a business formed by 19 Article 27


splitting up, or the reconstruction or a business already in existence [Schedule 11, 12 & 13];

iv) Denying tax benefits to a business formed by transfer to a new business of machinery or plant previously used for any purpose [Schedule 11, 12, 13];

v) Expenditure incurred in relation to income not includible in total income [Clause 18];

vi) Paymenttoassociatedpersonsinrespectofexpend-iture [Clause 115];

vii) Transfer of shares to a firm or closely held company without or for inadequate consideration [Clause 58(2)(j)];

viii) Carry forward and set off of losses in the case of certain companies [Clause 66];

ix) International transactions not at arm’s length [Clause 116];

x) Transactions resulting in transfer of income to non-residents [Clause 119];

xi) Avoidance of tax in certain transactions in securities [Clause 120].

Comparison of the proposals with legislation in other jurisdictions A comparison of the proposed Indian GAAR provisions

vis-à-vis other countries (discussed in the preceding sections) indicates that the provisions are broadly on the lines incorporated by South Africa. However, the South African draft guidance indicates that “in essence, a tax benefit may be denied under the GAAR if such tax benefit would misuse or abuse the object, spirit or purpose of the provisions of the Income Tax Act that are relied upon for the tax benefit. This clearly requires a purposive approach to interpreting the provisions of the Income Tax Act, which is already the accepted approach to legislative interpretation in South Africa”.

Further,asindicatedunderSouthAfricaGAAR,thepurpose test is a more objective test, wherein the sole or main purpose of the arrangement itself is the relevant purpose and no longer the subjective purpose of the taxpayer.

Thus, in implementation, one would need to adapt the principlethatthe“taxbenefit”wouldmisuseorabusetheobject, spirit or purpose of the provisions of the Income Tax Act. However, under the proposed law in India, even where the main purpose of a step in the transaction, or the part of a transaction is to obtain a ‘tax benefit’, the arrangement would be presumed to be carried out with

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the main purpose of obtaining a tax benefit. Though the provisions indicate the establishment of main purpose, it is unclear as to the methodology of determining the main purpose.Further,theabsenceofsimultaneousbusinesspurpose or a bonafide purpose test and the mere presence of a tax benefit give rise to the presumption that the avoidance arrangement was designed and entered into solely or mainly to obtain a tax benefit. This may also lead to greater onus on the taxpayer to establish that the main purpose was not the ‘tax benefit’. Hence, it is imperative that the criterion of ‘tax benefit’ should not be made the sole purpose and object of invoking GAAR provisions.

As such, it may be appropriate to adopt the approach adapted under the Canadian provisions wherein it is stated that an avoidance transaction means any transactiona) that, but for this section, would result, directly or

indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bonafide purposes other than to obtain the tax benefit; or

b) that is part of a series of transactions, which series, but for this section, would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bonafide purposes other than to obtain the tax benefit.

It is further provided that the provisions would be applicable to a transaction only if it may reasonably be considered that the transaction would result directly or indirectly in a misuse of the provisions of any one or more of the Act, treaty etc., or would result directly or indirectly in an abuse having regard to those provisions.

Thus, under Canadian law and as even interpreted by their Courts, the misuse or abuse test would involve a

two-part inquiry. • Thefirstistointerprettheprovisionsgivingriseto

the tax benefit to determine their object, spirit and purpose which would be the question of law.

• Thesecondistoexaminethefactualcontextofacase in order to determine whether the avoidance arrangement defeated the object, spirit or purpose of the provisions under consideration. This would generally be a question both of law and fact, in which the onus will be upon the Commissioner to assess the factual element of the case.

Further,itmayalsoberelevanttoconsidertherecentreportonintroductionofGAARintheUKforsomeofthemethodologies and rules being suggested in this respect.

Hence, considering the intent of introducing GAAR, there is a likelihood in implementing the provision by underplaying the object, spirit and purpose of the provisions and the arrangement based on the facts of the case. In the circumstances, it may be advisable to appreciate and adapt the two part inquiry in terms of the provisions and the arrangement rather than restrict it to determining whether the main purpose of thearrangementwasa‘taxbenefit’.Further,asingleobjective test may undermine the importance of looking into the objective and purpose of the legislation, which may not be the intention of the legislation itself.

Case study in respect of applicability of the proposed provisions (Cases considered from the Canadian authorities circular)

Case 1• Acorporationtransferspropertyusedinitsbusiness

to a related corporation to permit the deduction of non-capital losses of the related corporation. All of the shares of the two corporations have been owned

It may be advisable to appreciate and adapt the two part inquiry in terms of the provisions and the arrangement rather than restrict it to determining the whether main purpose of the arrangement was a ‘tax benefit’.


by the same taxpayer during the period in which the losses were incurred.

• Wherethetransactioncouldbeconsideredasconsistentwith the scheme of the Act, it may be argued that the GAAR provisions would not be infringed. However, if a transfer of a property or other transaction is undertaken to avoid a specific rule, such as a rule designed to preclude the deduction of losses after the acquisition of control of a corporation by an arm’s length person, such a transfer would be a misuse of the provisions of the Act and be subject to provisions of the Act.

• Thus,genuinecorporatereorganizationshouldnotbe affected.

Case 2• Acompanyhaspropertywithanunrealizedcapital

gain that it wishes to sell to a third party. A related corporation, a wholly owned subsidiary has a net capital loss. Instead of selling the property directly to the third party and realizing a capital gain, the person transfers the property to the related corporation. The related corporation sells the property to the third party and reduces the resulting taxable capital gain by the amount of its net capital loss.

• WheretheprovisionsoftheActprovidethatthesaleto a related corporation should be at arm’s length, it could be argued that the transaction may not infringe the provisions as in determining the cost in the hands of the related corporation, the cost to the company would be considered.

• Thus,thetransferofpropertybyholdingcompanyto subsidiary company or vice versa under Indian regulations should not be impacted.

Case 3• Anindividualprovidesservicestoacorporationwith

which he or she does not deal at arm’s length. The company does not pay salary to the individual because payment of salary would increase the amount of loss that the company will incur in the year.

• TheremaybeaprovisionintheActrequiringsalarytobe paid in these or any circumstances; the failure to pay salary is, therefore, not contrary to the scheme of the Act read as a whole.

• Inthecircumstances,intheIndiancontext,thetaxpayermay choose to determine the terms of transactions which are not expressly prohibited under the terms of the Act.

Case 4• Ataxablecompanyhasagreedtopurchaseallof

the shares of an operating company, which is also a taxable Indian company The purchaser incorporates a holding company which borrows the purchase price and pays the vendor for the shares. The holding company and the operating corporation amalgamate so that the interest payable on the monies borrowed to acquire the shares can be deducted in computing the income from the business of the amalgamated corporation.

• Generally,leverageofdebtbyIndiancompaniesandsubsequent amalgamation should not be considered as abusive under GAAR. However, the implication of provisions of Section 14A could be considered to bring the same under a ‘tax benefit’ and hence under GAAR provisions.

Case 5• AtaxableIndiancompanymergeswithanother

taxable Indian company that is a shell company. Upon merger, the shareholders who controlled the predecessor receive common shares of the merged company and the minority shareholders of the predecessor receive redeemable preferred shares that are immediately redeemed. The sole reason that the minority shareholders receive shares instead of cash is to cause the merger to comply with the requirements of the Act.

• Structuringofcompanyreorganizationthroughredeemable preference shares should not be covered by GAAR.

Case 6• AtaxableIndiancompanyhasasubsidiarythatis

sustaining losses and needs capital to carry on its business. The subsidiary would not be able to obtain any tax savings in the year. The holding company borrows the money from a bank and subscribes to the shares of the subsidiary and claims a deduction for the interest.

• Generally,basedonjudicialprecedents,theinterestwould be deductible for the holding company. However, the implication of provisions of Section 14A could be considered to bring the same under a ‘tax benefit’ and hence under GAAR provisions.

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Case 7• Anon-residentcompanyhasanIndiansubsidiary.

The subsidiary has substantial reserves and the non-resident company desires to cash out by selling to an unrelated party. The gains on sale would be substantial and subject to higher rate of tax. The subsidiary distributes the reserves as dividend, which reduces the valuation of the company. The non-resident then sells the subsidiary.

• ThepaymentofthedividendandtheconsequentDDT on such dividend should not be construed as covered under GAAR.

Case 8 • Anon-residentcompanyhasanIndiansubsidiary.

The subsidiary has been capitalized by nominal capital only and it has taken substantial borrowings from group companies and/or third parties (non-residents/residents) such that the debt is several times the equity for the Indian subsidiary. A question may arise on the deductibility of interest paid by the Indian subsidiary for the reason that it is thinly capitalized.

• Underthecurrentincometaxlaw,therearenospecific 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.

Case 9• Anon-residentcompanyhasanIndiansubsidiary.

The subsidiary has substantial reserves and the Indian subsidiary desires to repatriate surplus cash through buy back of its shares and no tax is paid in India on the profits repatriated for the reason that the capital gain on buy back of shares is exempt in India under the applicable treaty of the non-resident.

• ThesharesmaybeboughtbackbytheIndiansubsidiary for a number of reasons, namely, to increase holding of resident shareholders, increase the earnings per share or to pay surplus cash not requiredbybusiness,etc.Further,theprovisionsof the proposed Code also specifically provide that distribution of profits through a scheme of buy back of shares under the applicable provisions of the Companies Act shall not be deemed as dividend. Accordingly, the buyback of shares should not be subject to GAAR provisions merely because no Indian tax has been paid in the transaction.


The GAAR provisions are like a double-edged sword and would need to be judicially invoked by the revenue authorities.

As discussed earlier, the Courts in India have examined the issue of tax avoidance and laid down the principles as to what constitutes tax avoidance. In light of the various judicial precedents, the tax authorities in India tend to raise the issue of tax avoidance and deny relief to the taxpayer. Given the uncertainties involved in such application, it is imperative for the proposed GAAR to be successful; it should not impact genuine business transactions or promote uncertainty. One of the key objectives for introducing the Direct Tax Code is to simplify the language to enable better comprehension and remove ambiguity to foster voluntary compliance, thus reducing litigation. However, the scope of GAAR provisions in the present draft could cause massive uncertainty and lead to extensive litigation as potential legitimate tax planning could also become the target of GAAR.

In this connection, it would be imperative that the guidance note to be formulated should be sensitive to the issue of addressing avoidance from the prospect of upholding the rule of law, the object and purpose of the legislation, rather than be construed as law in itself and giving a free rein to administrative or judicial discretion. Some suggestions on reframing/modeling the provisions on the basis of international experience may be adopted:

Legislation• OurmodelcouldbebasedontheCanadamodel-

the principles laid down by Canada Supreme Court to be adhered.

• Thetaxbenefitonthetransactionshouldnotbethe only criterion. If the transaction is done where tax benefit and commercial benefit are present, the transaction should not be covered by GAAR.

• Theprovisionscouldbemadeapplicableinrespectof transaction where entering into the transaction and the cause and effect of the transaction occur after the date of implementation.

• DetailedguidelinestobeprovidedonthelinesoftheCanadian law with relevant examples illustrating the reasons and analogy in applying GAAR provisions.

• GAARshouldnotbejudgedonthebasisofasingletransaction,butonaseriesoftransactions.Further,where no ‘tax benefit’ arises under the whole series of transactions, the same should not be subject to GAAR evaluation, even though a part of the series may result in ‘tax benefit’.

• Correspondingadjustmentstobeprovidedinthehands of the parties to the transaction.

Procedural• IfCITfindsatransaction,whichcomesunderthe

purview of GAAR, the same may be referred to an independent quasi-judicial body.

The CIT and taxpayer can make submissions and the ruling by the quasi-judicial body can be final.

• ThresholdlimitshouldbearoundRs150milliononthe lines of transfer pricing assessment.

• ProvisionofAdvanceRulingfacility-existingdefinition under the Code to be widened to include GAAR.

Treaty and other provisions• Treatyoverridecouldbeimplementedthrough

protocol with the respective countries providing for limitation of benefits and beneficial ownership principles therein.

• Itmaybemoreappropriatetoprovideforthincapitalization rules which could also be covered under transfer pricing provisions than allowing the same to be covered under GAAR.

In this context, we may refer to what Chris Evans, has writteninhisArticle“ContainingTaxAvoidance:Anti-Avoidance Strategies (2008)” –

It may be too cynical to assume “the existence of tax avoidance as a constant and perpetual motivation for every taxpayer”20, but there is no doubt that tax avoidance is widespread and that it presents a major problem for those concerned with public finance issues. There is some evidence that the aggressive retail

Way forward

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20 C.H.Gustafson,“ThePoliticsandPracticalitiesofChecking Tax Avoidance in the United States” in G. S. Cooper, Tax Avoidance and the Rule of Law, (Amsterdam:IBFD,1997),at p 376.

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marketing of tax avoidance products and schemes may have been constrained in recent years, but avoidance activity is by its nature opportunistic and ad hoc. Simply raising the price of avoidance (through successful containment, increased regulation and constrained supply) will not choke off demand.

Indeed, no single response or approach – whether administrative, legislative or judicial – can adequately or effectively contain avoidance activity. Such containment only begins to occur where strategies drawn from all three spheres complement each other by operating in combination. As Sir Ivor Richardson astutely pointed out some years ago, current requirements for a comprehensive and integrated approach go beyond a more traditional analysis where “the legislature … exerts control of tax avoidance through special and general anti-avoidance provisions; the revenue administration contributes in administering those provisions and exercising discretions; and the judiciary is expected to strike the right balance between acceptable and unacceptable tax planning through its interpretation and application of tax legislation21.”

Ultimately, however, corporate and personal taxpayers themselves have to take responsibility for the level of avoidance and the degree of acceptance of such behaviour that exists at any time in any society. The revenue authority, the legislature and the judiciary can play a role in shaping the demand for, and supply of, tax avoidance activity, but such issues belong, in the final analysis, in the realms of moral and ethical behaviour of the taxpayers themselves. Corporate and

personal social responsibility – and the reputational damage that excessive and egregious avoidance activity can attract – remains the ultimate deterrent, notwithstanding the impressive arsenal that can be available to those who seek to counter avoidance.

Beyond that we should also perhaps be mindful that two of the traditional goals of public finance – simplicity and equity – have critical roles to play in determining social responses to avoidance activity. In recent years, these two goals may have been less prominent in tax reform than the efficiency goal that lends itself to easier economic measurement and evaluation.

It is paradoxical that the more complex that the tax regime becomes (often in attempts to contain avoidance activity), the more likely it will be that opportunities for avoidance will arise. Avoidance activity thrives in complexity and uncertainty. And where that complexity exacerbates the natural interaction (sometimes mediated by intermediaries) between the taxpayer and the revenue authority such that it becomes frictional rather than cooperative, there will almost inevitably be a higher probability of avoidance activity.

It may be relevant for taxpayers to examine the transactions/arrangements entered into, so that the same do not fall within the boundary of being considered as impermissible avoidable transactions entered into with the object of obtaining a tax benefit.

21 I.Richardson,“ReducingTax Avoidance by Changing Structures,ProcessandDrafting” in G. S. Cooper, Tax Avoidance and the Rule ofLaw,(Amsterdam:IBFD,1997), at p 327.


Notes

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GAAR India and International perspective

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