Google Gaar

7/31/2019 Google Gaar

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General Anti Avoidance Rule


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RUTUL

2 TO 6 SLIDES


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Under the Code, GAAR will be invoked if the followingconditions are satisfied:

a) The taxpayer should have entered into anarrangement.

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 notnormally be created between persons dealing at armslength;

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

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

Proposed GAAR DTC 2010


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Meaning of arrangement

An arrangement will mean any transaction,conduit, event, trust, grant, operation, scheme,covenant, disposition, agreement orunderstanding, including all steps therein or partsthereof, whether enforceable or not.

Therefore, if the motive behind individual steps isto obtain a tax benefit, but the overall scheme isnot so, the individual steps will never the less betreated as an arrangement and the GAAR maybe invoked.

An arrangement will also include anyinterposition of an entity or transaction where thesubstance of such entity or transaction differsfrom the form given to it.


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Lack of commercialsubstance The lack of commercial substance, in the

context of an arrangement, shall bedetermined, but not limited to, by thefollowing indicators:

i) The arrangement results in a significant taxbenefit for a party but does not have asignificant effect upon either the businessrisks or the net cash flows of 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 itsindividual steps.

iii) The arrangement includes or involves:


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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 oneor more persons and disguises the nature,location, source, ownership or control of funds; or

e) an expectation of pre-tax profit which isinsignificant in comparison to the amount of the

expected tax benefit. The concepts of round trip financing and

accommodating party will be defined in theCode


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PARTH

7 TO 10


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Impermissible AvoidanceArrangement

Impermissible tax avoidance arrangements.

An avoidancearrangement is an impermissible avoidance arrangement if its sole

or main purpose was to obtain a tax benefit and

(a) in the context of business

(i) it was entered into or carried out by means or in a manner

which would not normally be employed for bona fide business

purposes, other than obtaining a tax benefit; or

(ii)it lacks commercial substance, in whole or in part, taking into

account the provisions of section 80C

(b) in a context other than business, it was entered into or carried

out by means or in a manner which would not normally be

employed for a bona fide purpose, other than obtaining a tax benefit

or


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(c) in any context

(i) it has created rights orobligations that would not normally be

created between persons dealing atarms length; or

(ii) it would result directly or indirectly

in the misuse or abuse of theprovisions of this Act (including theprovisions of this Part).


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Whom does GAAR affect?

Almost anybody andeverybody. Corporations may be forcedto restructure salaries of employees iftaxmen conclude that these were

structured only to avoid taxes. Foreign institutional investors (FIIs), who

invest through countries such asMauritius to exploit bilateral tax treaties

will be affected after GAAR comes intoforce. It's feared that once GAAR isinvoked, FIIs will have to pay capitalgains tax for their investment in Indianequities.


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Tax consequences ofimpermissible avoidance

arrangements If the conditions specified in the arrangement aresatisfied, the Commissioner will be empowered todeclare the arrangement as an impermissibleavoidance arrangement and determine the taxconsequences

of the taxpayer as if the arrangement had notbeen entered into. For this purpose, he may:

i) disregard, combine, or re-characterize any stepsin, or parts of, the impermissible avoidancearrangement;

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

iii) deem persons who are connected persons I

relation to each other to be one and the sameperson for


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iv) re-allocate any gross income, receipt or accrualof a capital nature, expenditure or rebate amongstthe parties;

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

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

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

viii) treat the impermissible avoidance arrangementas if it had not been entered into or carried out or insuch other manner as the Commissioner in thecircumstances may deem appropriate for theprevention or diminution of the relevant tax benefit;or


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VISHAL

11 TO 14


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Procedure for applying GAAR

The power to invoke GAAR is bestowed only upon theCommissioner of Income Tax (CIT). For this purpose, the

Code 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 determinethe 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 theAssessing Officer.


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Key issues

The key issues / implications under theproposed GAAR are:

Tax avoidance has been widely defined withthe objective to encompass a number ofcircumstances and instances of taxavoidance, leading to uncertainty andextensive litigation.

GAAR can be invoked where obtaining a taxbenefit is the main purpose, and it is not

clear as to what is meant by main purpose;the courts would be left to decide whether inthe given facts the main purpose of thetransaction/arrangement was to obtain taxbenefit.


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c

Where an adjustment is made (invoking GAAR), it is notclear whether the full effect of the same would be givento ensure that there is no double taxation.

The onus of proving that an arrangement has not beencarried out for the main purpose of obtaining a taxbenefit is with the taxpayer, while the tax authoritiesmay not have any evidence of tax avoidance.

There is no cut-off date for applicability of GAARprovisions to any arrangement and, therefore, wherethe impact of past arrangements continues in Direct TaxCode regime; the same may still be covered by GAAR

irrespective of the fact that the arrangement has beenapproved by the tax officer or subjected tojudicialreview.


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YUSUF

15 TO 19


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GAAR Tax Treaty

It has been provided that the GAAR provisions would apply toa taxpayer notwithstanding that the treaty provisions are morebeneficial. Considering the approaches as outlined before(under the Vienna Convention and the OECD wherein theunderlying principle would be that GAAR could override theprovisions of a treaty), it is important to note that OECDCommentary on Article 1 of the Model Tax Convention alsoclarifies that a general anti-abuse provision in the domesticlaw in the nature of substance over form rule or economicsubstance rule would not be in conflict with the treaty.

However, as enshrined in the Vienna Convention19, everytreaty in force is binding upon the parties to it and must beperformed by them in good faith, Pacta sunt servanda is

based on good faith. This entitles states to respectobligations. This good faith basis of treaties implies that aparty cannot invoke provisions of its domestic law as a

justification for a failure to perform.


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Thus, if a legislature unilaterally enacts newdomestic tax laws which are contrary to anexisting treaty, without the treaty having beenamended or terminated, such action is violationof international law and also violates the

principles of pacta sunt servanda. This type oftreaty violation is known as treaty override. Further, according to rules of legislative

interpretation, specific legislation overridesgeneral legislation. Therefore, changes of a

domestic law generally, which could be the casewith GAAR, may not affect the treaty.Considering the same, in the absence of an anti-avoidance provision under the treaty, it remainsto be seen whether the provisions would be ableto override the treaty.


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Specific anti-abuse rules

In addition to the GAAR provisions, the Code provides forspecific anti-avoidance rules to deal with some of thefollowing circumstances. These are similar to the provisionsunder 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 virtueof a transfer without transfer of the asset [Clause 8(1)];

iii) Denying tax benefits to a business formed by 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 anew business of machinery or plant previously used for anypurpose [Schedule 11, 12,13];

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


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c

vi) Payment to associated persons in respectof expenditure [Clause 115];

vii) Transfer of shares to a firm or closely heldcompany without or for inadequateconsideration [Clause 58(2)(j)];

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

ix) International transactions not at armslength[Clause 116];

x) Transactions resulting in transfer of incometo nonresidents[Clause 119];

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


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