General Anti-Avoidance Rules (GAAR)
GAAR refers to General Anti-Avoidance Rules. These rules target any transaction or business arrangement that is entered into with the objective of avoiding tax. The objective is to check aggressive tax planning.
What is meaning of Tax Avoidance?
Avoidance means an attempt to reduce tax liability through legal means, i.e. to regulate your affairs in such a way that you pay the minimum tax imposed by the Act as opposed to the maximum. For example, Suresh makes a company XYZ to sell some product. The company XYZ pays 25% tax, but if Suresh himself sold the products he would pay 30%. Suresh has formed the company only to save 5% tax.
Difference between Tax Avoidance and Tax Evasion?
Tax Evasion and Tax avoidance are two different things. While Avoidance is legal management to avoid tax, evasion is illegal means to reduce tax liabilities, i.e. falsification of books, suppression of income, overstatement of deductions, etc.
Tax planning, as opposed to tax evasion which is illegal, is an accepted practice whereby the tax-payer uses provisions of the law or loopholes to minimise his tax liability.
Some countries, in addition to GAAR, have Specific Anti-Avoidance Rules (SAAR) to plug particular loopholes in the law or prevent some types of transactions that result in loss to Revenue. GAAR has been a part of the tax code of Canada since 1988, Australia since 1981, South Africa from 2006 and China from 2008. Australia and China also have SAAR in place to check abuse of tax treaties and transfer pricing.
Implication of GAAR implementation
- The implication of GAAR is that the Income-tax department will have powers to deny tax benefit if a transaction was carried out exclusively for the purpose of avoiding tax.
- For example, if an entity is set up in Mauritius with the sole intention of claiming exemption from capital gains tax, the tax authorities have the right to deny the claim for exemption provided under the India-Mauritius tax treaty.
How would it work?
The Income Tax Commissioner will be empowered to declare an arrangement as an Impermissible Avoidance Arrangement (IAA) if:
- The whole, a step or a part of the arrangement has been entered with the objective of obtaining tax benefit, and
- The arrangement creates rights and an obligation not normally created in arm’s length transactions or results in direct or indirect misuse or abuse of the provisions of the code or lack commercial substance in whole or part, or is not bonafide.
This is so far reaching in nature that almost each and every transaction, which results in saving tax could be regarded as an IAA.
This means that GAAR enables tax authorities to declare any arrangement entered into by a taxpayer as an IAA. If it is so declared, then the tax authorities can disregard, combine or re-characterize any step of such arrangement or the entire arrangement, disregard any accommodating party involved in such arrangement, treat the transaction as if it had not been entered into or carried out, reallocate any income or expenditure, look through any arrangement by disregarding any corporate structure, re-characterize debt as equity or vice-versa and so on.
In effect, for tax purposes, any transaction can be treated in a manner different from the manner in which it is carried out if it is regarded as an IAA.
Parthasarathy Shome Panel
The Parthasarathy Shome panel was formed by PM of India in 2012, for drawing up the final guidelines on GAAR and mainly to bring about tax clarity and address the concerns of foreign investors. Instead of only FIIs, the panel was asked also to look into issues pertaining to all non-resident tax payers.
With various recommendations to revive the inflow of foreign capital, the panel has advocated postponement of the controversial tax provision by three years till 2016-17 along with abolition of capital gains tax on transfer of securities.
Further, it has suggested that the GAAR provisions should not be invoked to examine the genuineness of the foreign investor entities’ residency in the island nation of Mauritius. Other major recommendations are –
Defer implementation of GAAR:
- The implementation of GAAR shall be deferred by three years on administrative grounds for which intensive training of tax officers, who would specialise in the finer aspects of international taxation, is needed. The deferral of GAAR by three years on the basis of economic conditions and administrative realities would help mature the thinking in respect of GAAR and accelerate the decision on investment in foreign direct investment (FDI). It identifies the need for training of tax officers and a time-bound disposal of the proceedings to ensure effective implementation.
Threshold of tax benefit:
GAAR should be made applicable only if the monetary threshold of tax benefit is Rs.3 crore and more with changes in Income Tax Rules 1962. The committee recommendation of a monetary threshold of tax benefit would filter the smaller tax conflicts out and on the other hand would suggest the need of continued responsive legislation on specific tax-avoidance practices to ensure that the legitimate revenue is raised through voluntary compliance. It clearly highlights that the GAAR is not recommended to be used as revenue raising measure
GAAR should not be invoked to examine the genuineness of the residency FII from Mauritius and the government should retain the provisions of the CBDT circular issued in the Year 2000 on acceptance of Tax Residence Certificate (TRC) issued by Mauritius. Over 44 per cent of foreign investment in India comes through Mauritius and Singapore. For investments from Singapore and elsewhere, the benefits offered by India through bilateral treaties should supersede domestic tax laws and it is a constructive step in this regard.
GAAR should apply “only in cases of abusive, contrived and artificial arrangements”, the Shome panel suggested that the I-T Act may be amended to provide that only arrangements which have the main purpose (and not one of the main purposes) of obtaining tax benefit should be covered under GAAR. The report has recognized the business needs in difficult times of undertaking the corporate restructuring and clearly recommends that in a court-approved corporate restructuring, GAAR would not be invoked. Even the intra-group transactions with no effect on overall tax revenue have been recommended to be insulated from the GAAR. This clearly shows the pragmatic approach to the recommendations
Increase Securities Transaction Tax (STT):
The Shome Committee has proposed to do away with short-term capital gains tax by increasing the transaction tax. It asked the government should abolish the tax on gains arising from transfer of listed securities, whether in the nature of capital gains or business income, to both residents as well as non-residents. In order to make the proposal tax neutral, the government may consider increasing the rate of Securities Transaction Tax (STT) appropriately. The proposition seems to be that what the tax which India collects on account of short-term capital gains is, domestically as well as cross border. That number does not seem to be particularly a large number. The thought of the committee seems to say, why not abolish the short-term capital gains tax and if at all there is a deficit, why not tweak the securities transactions tax a bit.
Panel of GAAR:
The Approving Panel (AP) for purposes of invoking GAAR provisions should consist of five members, including Chairman, who should be a retired judge of the High Court. Besides, two members should be from outside government and persons of eminence drawn from the fields of accountancy, economics or business, with knowledge of matters of income- tax, and two members should be chief commissioners of income-tax or one Chief Commissioner and one Commissioner. It also suggested that GAAR can be invoked only with the approval of the Commissioner.
Current Status (January 2013)
When will GAAR be invoked:
- The rules will be invoked when the purpose of an arrangement is to obtain a tax benefit. Earlier it was as “One of the main purposes”.
- It will apply only to investments made after August 30, 2010. (This means retrospective from August 2010 onwards)
Position of Residents
- GAAR will not apply to non-resident investors in FIIs. This clarifies that the tax authorities will not go behind the FIIs and applies GAAR to those who invest in India through them.
Position of Foreign Institutional Investors
- GAAR will not apply to FIIs that do not claim any double taxation avoidance treaty benefit. Similarly, FIIs that pay appropriate tax will not be subject to GAAR.
Position of India’s tax treaties?
- GAAR Will be Invoked If any arrangement is found to be impermissible under GAAR, it will be denied treaty benefits. This essentially means treaty benefits will be available to residents of the country and not those who use to route to save tax. GAAR can over-ride bilateral tax treaties, but genuine residents can claim treaty benefits. Government’s decision on GAAR is silent on if a Mauritius investors with a tax residency certificate will be treated as a Mauritius resident. So investors routing their investments through Mauritius to avail tax benefit will face uncertainity in new GAAR regime.
How taxpayers will be saved from harassment?
- Assessing officer will be required to issue a show cause notice stating reasons for invoking GAAR
- Taxpayer will have an opportunity to put its case before the officer
- The three member panel that will finally approve GAAR will have only one income tax official
- There will be a mechanism of obtaining advance ruling whether an arrangement is permissible or not
- Time limits will be prescribed for various authorities under GAAR
- GAAR will apply only when tax benefit exceeds Rs 3 crore
- Same income will not be taxed twice by invoking GAAR
Where SAAR and GAAR both apply, only one will be invoked Where only a part of an arrangement impermissible GAAR will apply to only that part
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