Draft guidelines regarding implementation of General Anti Avoidance
Rules (GAAR) in terms of section 101 of the Income Tax Act, 1961.
Background
The Chairman, CBDT, Vide OM F.NO. 500/111/2009-FTD-1 Dated 27 February, 2012
constituted a Committee under the Chairmanship of the Director General of the Income
Tax (International Taxation) to give recommendations for formulating the guidelines for
proper implementation of GAAR Provisions under the Direct Tax Code Bill, 2010 and to
suggest safeguards to these provisions to curb the abuse thereof. The Committee
comprised of the following officers :-
1. Director General of Income Tax (International Taxation)- Chairperson
2. Joint Secretary (FT& TR-I)
3. Joint Secretary (FT& TR-II)
4. Joint Secretary (TPL-I)
5. Director of International Taxation, Ahmedabad
6. Director, FT & TR-III
7. Addl. Director on Income Tax, Range-I (IT), New Delhi, Member Secretary.
The terms of reference of the Committee was as under :-
a) Recommendations for formulating guidelines to implement the provisions of
General Anti-Avoidance Rules(GAAR) as per section 123 of the Direct Tax Code
Bill, 2010; and
b) Draft a circular as a safeguard so that the GAAR provisions are not applied
indiscriminately in every case.
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The Committee met for the first time on 6th March, 2012 and felt that the existing
provisions of the Direct Tax Code Bill 2010(DTC) needed certain modifications and
therefore various specific suggestions were made in this regard. These included
suggestions on defining various terms as appearing in the DTC, changing the procedure
of invoking the provisions of GAAR, prescribing time limits etc.
Subsequent to the first meeting, the Finance Bill 2012 was presented before the
Parliament and it was gathered that most of the suggestions given in the first meeting
were addressed in the Finance Bill 2012. The Committee thereafter examined the
provisions related to GAAR in the Finance Bill 2012 as modified through Government
amendments during the passage of the Bill in Parliament. The recommendations
regarding guidelines/circulars have been made in light of the final provisions relating to
GAAR in the Finance Act, 2012.
The Committee held several meetings between 06.03.2012 to 28.05.2012.
After exhaustive deliberations and broad based discussions with the officers,
representatives of FIIs, members of the advisory committee and others stake holders,
the Committee makes the following recommendations which would need to be split
between Circulars and the Rules.
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Proposals for inclusion in the guidelines
A) Guidelines u/s 101
Section 101 of the Finance Act, 2012, provides that "the provisions of this
Chapter shall be applied in accordance with such guidelines and subject to such
conditions and the manner as may be prescribed". The Committee makes the
following recommendations to be incorporated in the guidelines.
a) Monetary threshold
The committee feels that in order to avoid the indiscriminate application of the
GAAR provisions and to provide relief to small taxpayers, there should be
monetary threshold for invoking the GAAR provisions. In this regard, the
following recommendation is made by the committee.
Only an arrangement or arrangements where the tax benefit through the
arrangement(s) in a year to an assessee is above Rs. ___ lacs will be
covered by GAAR provisions.
b) Prescription of statutory forms
The committee feels that consistency of approach is essential in the procedures
for invoking the GAAR provisions. It also feels that adequate safeguards should
be provided to ensure that principles of natural justice were not violated and
there is transparency in the procedures. Therefore, the committee is of the
opinion that there should be prescribed statutory forms for the following:-
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i) For the Assessing Officer to make a reference to the Commissioner u/s
144BA(1) (Annexure-A)
ii) For the Commissioner to make a reference to the Approving Panel u/s
144BA(4) (Annexure-B)
iii) For the Commissioner to return the reference to the Assessing Officer
u/s 144BA(5) (Annexure-C)
(The drafts thereof have been prepared and enclosed as above)
c) Prescribing the time limits
The committee feels that there should be absolute certainty about the time limits
during which the various actions under the GAAR provisions are to be
completed. Some of these time lines have been prescribed under the act under
sections 144BA(1) and 144BA(13). For the remaining actions the following time
lines are suggested by the committee :-
It may be prescribed that in terms of section 144BA(4), the CIT should make
a reference to the Approving Panel within 60 days of the receipt of the
objection from the assessee and in case of the CIT accepting the
assessees objection and being satisfied that provision of chapter X -A are
not applicable, the CIT shall communicate his decision to the AO within 60
days of the receipt of the assessees objection as prescribed under section
144BA(4) r.w.s. 144BA(5). No action u/s 144BA(4) or (5) shall be taken by
the Commissioner after the period of six months from the end of the month
in which the reference under sub-section 144BA(1) was received by the
Commissioner.
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B) Recommendations regarding setting up of the Approving Panel u/s 144(BA)
Section 144BA(14) has empowered the CBDT to constitute Approving Panel
consisting of not less than 3 members, out of which one member of the panel
would be an officer of the level of Joint Secretary or above from the Ministry of
Law and the others being the Income Tax Authorities of the rank of
Commissioner and above. The committee deliberated on the constitution of this
committee for efficient output and has made the following recommendations :-
(a) To begin with, there should be one Approving Panel, which shall be
situated at Delhi. Subsequently, the CBDT should review the number of
Approving Panels required on the basis of the workload in the
FY 2014-15.
(b) The Approving Panel should comprise of three members, out of which,
two members should be of the level of Chief Commissioners of Income
Tax and the third member should be an officer of the level of Joint
Secretary or above from the Ministry of Law. All the members should be
full time members.
(c) The Approving Panel should be provided the secretariat staff along with
appropriate budgetary and infrastructure support by the CBDT. The
secretariat should be headed by an officer of the level of
Joint/Additional Commissioner of Income Tax.
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C) Recommendations for the Circular on GAAR
a) Explaining the provisions of GAAR
For the purpose of explaining the provisions of GAAR and better understanding
thereof, the Committee suggests a detailed note to be included in the circular,
which is enclosed as Annexure- D.
b) Special provisions for Foreign Institutional Investors (FII's)
Foreign Institutional Investors have expressed certain concerns regarding GAAR
provisions. The committee met the representatives of Asia Securities Industry &
Finance Markets Association and Capital Markets Tax Committee of Asia. After
discussions, the representatives of these bodies gave following suggestions to
resolve their apprehensions.
1. To exempt Capital Market transactions entirely from the GAAR provisions
2. A flat tax on FIIs gains without any distinction between various transactions
could be considered.
3. The tax authorities could attempt to clarify the details of each provision in the
GAAR. For this, they gave comments on how the relevant provision may be
clarified.
The committee considered the suggestions of the representatives. Option No.
(1) & (2) above are not viable options as it is not permitted under the
provisions of the Income Tax Act. However option (3) could be considered.
For this purpose, safe harbour could be provided to the FIIs subject to the
payment of taxes as per domestic law. Accordingly, the committee
recommends the following.
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GAAR Committee Report
Where a Foreign Institutional Investor (FII) chooses not to take any
benefit under an agreement entered into by India under section 90 or
90A of the Act and subjects itself to tax in accordance with the domestic
law provisions, then, the provisions of Chapter X-A shall not apply to
such FII or to the non-resident investors of the FII.
Where an FII chooses to take a treaty benefit, GAAR provisions may be
invoked in the case of the FII, but would not in any case be invoked in
the case of the non-resident investors of the FII.
c) Clarity regarding retrospective/prospective operations of the GAAR provisions
Certain apprehensions have been raised regarding the
retrospective/prospective operation of the GAAR provisions. It may therefore
be clarified that :-
The provisions of GAAR will apply to the income accruing or arising to
the taxpayers on or after 01.04.2013.
d) Interplay between Specific Anti-Avoidance Rules (SAAR) and General Anti-
Avoidance Rules (GAAR).
Concerns have been raised that there could be interplay between the SAAR
and GAAR. The committee examined this issue and the recommendation of
the committee is as below:-
While SAARs are promulgated to counter a specific abusive behavior,
GAARs are used to support SAARs and to cover transactions that are
not covered by SAARs. Under normal circumstances, where specific
SAAR is applicable, GAAR will not be invoked. However, in an
exceptional case of abusive behavior on the part of a taxpayer that
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might defeat a SAAR, as illustrated in Example No. 16 in Annexure E (or
similar cases), GAAR could also be invoked.
e) Definition of "connected person"
Concerns have been raised that the definition of "connected person" u/s 102
(5) is too broad and ambiguous. The committee recommends that it may be
clarified that:-
"Connected person" would include the definition of "associated
enterprise" given in section 92A, the definition of ,,relative in section 56
and the "persons" covered u/s 40A(2)(b).
f) Concern regarding application of section 96(2)
Concerns have been raised in various fora that section 96(2) provides that an
arrangement shall be presumed to have been entered into, or carried out, for
the main purpose of obtaining a tax benefit, if the main purpose of a step in,
or a part of the arrangement is to obtain a tax benefit, notwithstanding the fact
that the main purpose of the whole arrangement is not to obtain a tax benefit.
In view of this provision where only a part of the arrangement is to obtain a
tax benefit, the tax authorities will treat the whole arrangement as an
impermissible arrangement.
In order to allay the apprehensions of the taxpayers in this regard, the
committee recommends that it must be clarified in the Rules that :-
Where only a part of the arrangement is impermissible, the tax
consequences of "Impermissible Avoidance Arrangement" will be
limited to only that part of the arrangement.
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g) Illustrative cases under GAAR
The committee felt that terms like, "Misuse or abuse", "bona fide purpose" and
"lacks commercial substance" may be explained by illustrations. However it
may be clarified that it should be only an indicative list and not an exhaustive
list. The committee has recommended a few illustrative cases, which are
given in Annexure-E. The guidelines provided through examples are based
on specific facts in the particular example. Whether GAAR may be invoked in
any particular case would depend on the specific facts of that case.
********************************
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Annexure-A
FORM FOR MAKING THE REFERENCE TO THE COMMISSIONER BY THE ASSESSING
OFFICER FOR INITIATING THE PROCEEDINGS U/S 144BA(1) rws 95 OF THE INCOME
TAX ACT, 1961
1 Name and Address of the Assessee
2 PAN
3 Status
4 Particulars of Assessing Officer
5 Assessment year(s) in respect of which the proceedings u/s
144BA (1) are proposed to be invoked :
(a) Assessment Years pending in scrutiny
(b) Other assessment years proposed to be covered
6 Provide a factual matrix of the "arrangement" entered into by
the assessee
7 Is there any "Tax Benefit" as defined in section 102(11) ?
8 If yes, provide the approximate quantum thereof assessment
year wise.
9 Is "Tax Benefit" the "main purpose" or one of the "main
purposes" of the "arrangement" ?
10 Brief facts of the "Tax Benefit"
11 Has the assessee been confronted with the details of the "Tax
Benefit"? If yes, provide the gist of the reply furnished by the
assessee on "Tax Benefit"
12 If "Tax Benefit" is the "main purpose" or one of the "main
purposes" specify which other condition, out of the following is
satisfied giving details how the conclusion has been arrived at:
(a) Creates rights, or obligations, which are not ordinarily
created between persons dealing at arms length;
(b) Results, directly or indirectly, in the misuse, or abuse, of
the provisions of this Act;
(c) Lacks commercial substance or is deemed to lack
commercial substance under section 97, in whole or in part; or
(d) Is entered into, or carried out, by means, or in manner,
which are not ordinarily employed for bona fide purposes.
13 Has the assessee been confronted with the findings given in
column 12 ? If yes, provide the gist of the reply furnished by
the assessee.
14 Detailed reasons for treating the arrangement as
"Impermissible Avoidance arrangement".
15 Consequences likely to arise if arrangement is declared as
"Impermissible Avoidance arrangement"
16 Specify the time barring dates of original assessment or
reassessment
Date: Name & Designation of
Place: Assessing Officer
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Annexure-B
FORM FOR RECORDING THE SATISFACTION BY THE COMMISSIONER OF
INCOME TAX FOR REFERRING THE PROCEEDINGS U/S 144BA(4) rws 95 OF THE
INCOME TAX ACT, 1961 TO THE APPROVING PANEL
1 Name and Address of the Assessee
2 PAN
3 Status
4 Particulars of Assessing Officer
5 Particular of Commissioner of Income
Tax
6 Assessment year(s) in respect of which
the proceedings u/s 144BA (1) are
proposed to be invoked :
(a) Assessment Years pending in
scrutiny
(b) Other assessment years
proposed to be covered
7 Date of receipt of reference from the AO
u/s 144BA (1)
8 Date of issuance of notice, setting out
reasons, by the CIT to the assessee
(copy thereof to be enclosed)
9 Date of receipt of reply from the
assessee and date of hearing provided
to the assessee (copy of reply of the
assessee to be enclosed)
10 Provide a factual matrix of the
"arrangement" entered into by the
assessee
11 Is there any "Tax Benefit" as defined in
section 102(11) ?
12 If yes, provide the approximate quantum
thereof assessment year wise.
13 Is "Tax Benefit" the "main purpose" or
one of the "main purposes" of the
"arrangement" ?
14 Brief facts of the "Tax Benefit"
15 Has the assessee been confronted with
the details of the "Tax Benefit" ? If yes,
provide the gist of the reply furnished by
the assessee on "Tax Benefit"
16 If "Tax Benefit" is the "main purpose" or
one of the "main purposes" specify
which other condition, out of the
following is satisfied giving details how
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the conclusion has been arrived at:
(a) Creates rights, or obligations,
which are not ordinarily created
between persons dealing at
arms length;
(b) Results, directly or indirectly, in
the misuse, or abuse, of the
provisions of this Act;
(c) Lacks commercial substance or
is deemed to lack commercial
substance under section 97, in
whole or in part; or
(d) Is entered into, or carried out, by
means, or in manner, which are
not ordinarily employed for bona
fide purposes.
17 Has the assessee been confronted with
the findings given in column 16? If yes,
provide the gist of the reply furnished by
the assessee.
18 Detailed reasons for treating the
arrangement as "Impermissible
Avoidance arrangement".
19 Consequences likely to arise if
arrangement is declared as
"Impermissible Avoidance arrangement"
20 Specify the time barring dates of original
assessment or reassessment
Date: Name & Designation of
Place: Commissioner of Income Tax
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Annexure-C
FORM FOR RETURNING THE REFERENCE U/S 144BA(5) rws SECTION 95 IN
CASES OF REFERENCES MADE U/S 144BA(4) rws 95 OF THE INCOME TAX ACT,
1961 TO THE ASSESSING OFFICER
1 Name and Address of the Assessee
2 PAN
3 Status
4 Particulars of Assessing Officer
5 Assessment year(s) in respect of which
the proceedings u/s 144BA (1) are
proposed to be invoked.
6 Date of receipt of reference from the AO
u/s 144BA (1)
7 Reasons for not agreeing with the
reference from the AO u/s 144BA (1)
Date: Name & Designation of
Place: Commissioner of Income Tax
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Annexure-D
GAAR Note for Guidelines
1.0 While introducing the provisions of General Anti Avoidance Rule (GAAR) in the
Income-tax Act, it was mentioned in the Explanatory Memorandum to the Finance Bill,
2012 that the question of substance over form has consistently arisen in the
implementation of taxation laws. In the Indian context, judicial decisions have varied.
While some courts in certain circumstances had held that legal form of transactions can
be dispensed with and the real substance of transaction can be considered while
applying the taxation laws, others have held that the form is to be given sanctity. There
are some specific anti-avoidance provisions, but, prior to introduction of GAAR, general
anti-avoidance has been dealt in specific cases only through judicial decisions. In an
environment of moderate rates of tax, it is necessary that the correct tax base be
subject to tax in the face of aggressive tax planning. Internationally, several countries
have codified the "substance over form" doctrine in the form of General Anti Avoidance
Rule (GAAR) and are administering statutory GAAR provisions.
1.1 The General Anti Avoidance Rule (GAAR) is a codification of the proposition that
while interpreting the tax legislation, substance should be preferred over the legal form.
Transactions have to be real and are not to be looked at in isolation. The fact that they
are legal does not mean that they are acceptable with reference to the meaning in the
fiscal statute. Where there is no business purpose, except to obtain a tax benefit, the
GAAR provisions would not allow such a tax benefit to be availed through the tax
statute. These propositions have otherwise been part of jurisprudence in direct tax laws
as reflected in various judicial decisions. The GAAR provisions codify this ,,substance
over ,,form rule.
1.2 The basic criticism of a statutory GAAR which is raised worldwide is that it
provides a wide discretion and authority to the tax administration which can cast an
excessive tax and compliance burden on the taxpayer without commensurate remedies.
One of the methods by which this can be addressed is to provide guidance on what the
provisions entail and how they would be administered. These guidelines are meant to
provide explanations and clarity regarding the GAAR provisions.
2. Tax avoidance vs Tax Evasion
2.1 Tax evasion is generally the result of illegality, suppression, misrepresentation
and fraud. Tax avoidance is the result of actions taken by the assessee, none of which
or no combination of which is illegal or forbidden by the law itself. The GAAR provisions
do not deal with cases of tax evasion. Tax evasion is clearly distinct from tax avoidance
and is already prohibited under the current provisions of the Income-tax Act.
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3. Tax avoidance vs Tax mitigation
3.1 ,,Tax mitigation is a situation where the taxpayer takes advantage of a fiscal
incentive afforded to him by the tax legislation by actually submitting to the conditions
and economic consequences that the particular tax legislation entails. An example of
tax mitigation is the setting up of a business undertaking by a taxpayer in a specified
area such as a Special Economic Zone (SEZ). In such a case the taxpayer is taking
advantage of a fiscal incentive offered to him by submitting to the conditions and
economic consequences of the SEZ provisions in the Income-tax Act e.g., setting up the
business only in the SEZ areas and export from the SEZ area. Tax mitigation, as
distinct from tax avoidance, is allowed under the tax statute. The GAAR provisions also
do not deal with case of tax mitigation.
4. Analysis of the GAAR provisions
4.1 The provisions relating to GAAR appear in Chapter X-A (sections 95 to 102) of
the Act. The provisions allow the tax authority to, notwithstanding anything contained in
the Act, declare an ,,arrangement which the assessee has entered into, as an
,,impermissible avoidance arrangement. Once an ,,arrangement has been declared as
an ,,impermissible avoidance arrangement, the consequence as regards the tax liability
would also be determined.
4.2 The provisions give a wide definition of the term ,,arrangement. An ,,arrangement
means any step in or a part or whole of any transaction, operation, scheme, agreement
or understanding, whether enforceable or not. It also includes the alienation of any
property in such a transaction etc. The onus of proving that there is an
impermissible avoidance arrangement is on the Revenue.
4.3 An ,,arrangement would be an ,,impermissible avoidance arrangement if,
(a) its main purpose is to obtain a ,,tax benefit, and,
(b) it also has one of the following characteristics:
(i) it creates rights and obligations, which are not normally created
between parties dealing at arms length;
(ii) it results in misuse or abuse of the provisions of the tax law;
(iii) it lacks commercial substance;
(iv) it is carried out by means or in a manner which is normally not
employed for an authentic (bona fide) purpose.
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A ,,tax benefit has been defined to mean
(i) a reduction or avoidance or deferral of tax or other amount payable under
the Act or as a result of a tax treaty;
(ii) an increase in a refund of tax or other amount that would be payable
under the Act or as a result of tax treaty; or
(iii) a reduction in total income including an increase in loss.
The term "tax benefit" would be the benefit, quantified in terms of tax liability, arising to
any party to the arrangement on account of such arrangement.
4.4 The onus of proving that
(A) there is an arrangement,
(B) the arrangement leads to a `tax benefit',
(C) the main purpose or one of the main purposes of the `arrangement'
is to obtain a `tax benefit', and
(D) the arrangement has one of the characteristics listed at (i) to (iv) at
(b) of 4.3 above
is on the revenue.
5. Flow chart of GAAR provisions
There is an `arrangement' (Onus:Revenue)
First
condition
There is a `tax benefit' (Onus:Revenue) Second condition
The main purpose or one of the main purposes of the arrangement is
to obtain a tax benefit (Onus:Revenue)
Third condition
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Not at Misuse / Lacks Not ordinarily
abuse of tax commercial employed for bona
arm's-length provisions substance fide purposes
OR OR OR
Fourth condition
(Onus : Revenue)
Impermissible Avoidance Arrangement
Consequences may be determined by*
Dis- Treating Dis- Treating Re- Treating Looking
regarding/ the regarding connecte allocating place of through
imper- any d parties accruals, residence, an
Combining/ missible accommo as one expenses situs of arrange
arrange dating and the etc. assets or ment by
recharacte ment as if party or same of transac- dis-
rising it had not treating person tion regarding
whole/ been them and different corpo-
carried any other from that rate
part of the
out party as provided in structure
imper-
one and the
missible
the same arrange-
arrange-
person ment
ment
* For this purpose equity, debt, expenses, accrual or receipt, relief or rebate may be re-
characterised.
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Annexure-E
Illustrative cases where GAAR provisions will be considered
applicable or not applicable
Example 1:
Facts:
A business sets up an undertaking in an under developed area by putting in substantial
investment of capital, carries out manufacturing activities therein and claims a tax
deduction on sale of such production/manufacturing. Is GAAR applicable in such a
case ?
Interpretation:
There is an arrangement and one of the main purposes is a tax benefit. However, this is
a case of tax mitigation where the tax payer is taking advantage of a fiscal incentive
offered to him by submitting to the conditions and economic consequences of the
provisions in the legislation e.g., setting up the business only in the under developed
area. Revenue would not invoke GAAR as regards this arrangement.
Example 2:
Facts:
A business sets up a factory for manufacturing in an under developed tax exempt area.
It then diverts its production from other connected manufacturing units and shows the
same as manufactured in the tax exempt unit (while doing only process of packaging
there). Is GAAR applicable in such a case ?
Interpretation:
There is an arrangement and there is a tax benefit, the main purpose or one of the main
purposes of this arrangement is to obtain a tax benefit. The transaction lacks
commercial substance and there is misuse of the tax provisions. Revenue would invoke
GAAR as regards this arrangement.
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Example -3 :
Facts:
A foreign investor has invested in India through a holding company situated in a low tax
jurisdiction ,,X. The holding company is doing business in the country of incorporation,
i.e. ,,X, has a Board of Directors that meets in that country and carries out business with
adequate manpower, capital and infrastructure of its own and therefore, has substantial
commercial substance in the said country ,,X. Would GAAR be invocable or would the
arrangement be permissible ?
Interpretation:
In view of the factual substantive commercial substance of the arrangement, Revenue
would not invoke the GAAR provisions.
Example -4:
Facts:
An Indian company has set up a holding company in a low tax jurisdiction outside India
which has set up further subsidiary companies which pay dividends to the holding
company and such dividends are not repatriated to the Indian company. Would the
deemed dividend be treated as income using GAAR?
Interpretation:
Declaration/repatriation of dividend is a business choice of the companies and GAAR
provisions would not apply. Based on further facts such as the degree of Indian
Ownership, the location of the subsidiaries (in low tax jurisdictions) and the nature of
income (most of the income being passive income like interest, dividend etc.), many
jurisdictions have anti-deferral and avoidance provisions in the form of Controlled
Foreign Company (CFC) provisions. Specific anti-deferral/anti-avoidance provisions is
proposed in the Direct Taxes Code Bill, 2010. Accordingly, GAAR would not be invoked
in such a case.
Example -5:
Facts:
The merger of a loss making company into a profit making one results in losses off
setting profits, a lower net profit and lower tax liability for the merged company. Would
the losses be disallowed under GAAR ?
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Interpretation:
As regards setting off of losses, the provisions relating to merger and amalgamation
already contain specific anti-avoidance safeguards and therefore, GAAR would not be
invoked.
Example -6:
Facts:
A choice made by a company between leasing an asset and purchasing the same
asset. The company would claim deduction for leasing rentals rather than depreciation
if it had their own asset. Would the lease rent payment be disallowed as expense under
GAAR ?
Interpretation:
GAAR provisions, would not, prima facie, apply to a decision of leasing (as against
purchase of an asset). However, if it is a case of circular leasing, i.e. the taxpayer
leases out an asset and through various sub-leases, takes it back on lease, thus
creating a tax benefit without any change in economic substance, Revenue would
examine the matter for invoking GAAR provisions.
Example -7:
Facts:
A company has raised funds from an unconnected party through borrowings, when it
could have issued equity. Would the interest be denied as an expense deduction under
GAAR ?
Interpretation:
A number of jurisdictions have specific thin capitalization rules to deter erosion of the
tax base through excessive interest payments. There is no specific provision dealing
with this (thin-capitalization) in the I.T. Act. An evaluation of whether a business should
have raised funds through equity instead of as a loan should generally be left to
commercial judgment and GAAR would not be attracted. Interest payments to
connected parties would be subject to transfer pricing provisions. However, based on
whether the payments are made to connected parties, the source of funds in the case of
the connected parties and the location of these connected parties in low tax
jurisdictions, the arrangement could be examined under GAAR provisions.
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Example -8:
Facts:
A large corporate group has created a service company to manage all its non core
activities. The service company then charges each company for the services rendered
on a cost plus basis. Can the mark up in the cost of services be questioned using
GAAR.
Interpretation:
There are specific anti avoidance provisions through transfer pricing as regards
transactions among related parties. GAAR will not be invoked.
Example -9:
Facts:
A company sets off losses in the stock market against gains which is aimed at
balancing the portfolio.
Interpretation:
Sale/purchase through stock market transactions where the buyer and seller are
anonymous to each other would not come under GAAR provisions. GAAR provisions
could be invoked based on specific facts where transactions are not anonymous i.e.
parties are related to each other or a transaction has been entered into through a pre-
arrangement between unrelated parties who have been brought together by an
intermediary like a broker in order to adjust profit and losses between themselves.
Example -10:
Facts
,,Y company, a non- resident, and ,,Z company, a resident of India, form a joint venture
company ,,X in India. ,,Y, incorporates a 100%subsidiary ,,A in country ABC of which ,,Y
is not a resident. The India-ABC tax treaty provides for non-taxation of capital gains in
the source country and country ABC charges a minimal capital gains tax in its domestic
law. ,,A is also designated as a "permitted transferee" of Y. "Permitted transferee"
means that though shares are held by ,,A, all rights of voting, manageme nt, right to sell
etc., are vested in ,,Y. As provided by the joint venture agreement, 49% of X`s equity is
allotted to company ,,A (being 100% subsidiary and "permitted transferee" of ,,Y) and
the remaining 51% is allotted to the ,,Z company. Thereafter, the shares of ,,X held by
,,A are sold by ,,A to ,,C (connected to the ,,Z group).
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Interpretation
The controlling rights of company ,,A were with ,,Y. A direct transfer of these shares by
company ,,Y to company ,,C would have attracted capital gain s tax in India read with the
relevant treaty of Ys country of residence. The company ,,A was interposed with main
purpose of taking advantage of India-ABC treaty. The arrangement results in misuse or
abuse of tax provisions. Revenue would invoke GAAR as regards this arrangement.
Example -11:
Facts:
Company ,,A, is incorporated in country ABC as a wholly owned subsidiary of company
,,B which is not a resident of ABC or of India. The India-ABC tax treaty provides for non-
taxation of capital gains in the source country and country ABC charges a minimal
capital gains tax in its domestic law. Some shares of an Indian Company ,,C were
acquired by ,,A. The entire funding for investment by ,,A in ,,C was done by ,,B. ,,A has
not made any other transaction. These shares were subsequently disposed of by ,,A,
thus resulting in capital gains which ,,A claims as not being taxable in India by virtue of
the India- ABC tax treaty.
Interpretation:
The beneficial ownership vests with the connected company ,,B which had played a
crucial role in the transaction conducted by ,,A. Though the legal ownership ostensibly
resides with the ,,A, the real and beneficial owner of the capital gains is the ,,B Company
which controls the connected company ,,A. This is an arrangement which has been
created with the main purpose of avoiding capital gains tax in India through misuse or
abuse of tax provisions. Hence it is impermissible arrangement. Revenue would invoke
GAAR as regards this arrangement.
Example -12:
Facts:
An Indian Company ,,A, is a closely held company and its major shareholders are
connected companies ,,B ,C and ,,D. ,,A was regularly distributing dividends but
stopped distributing dividends from 1.4.2003, the date when Dividend Distribution Tax
(DDT) was introduced in India. ,,A allowed its reserves to grow by not paying out
dividends. As a result no DDT was paid by the company. Subsequently, all its
shareholders buyback of shares was offered by the Indian Company ,,A to its
shareholder company ,,B based in country ABC and the other shareholders C and D
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who are not resident of ABC. The India-ABC tax treaty provides for non-taxation of
capital gains in the source country and country ABC charges very low capital gains tax
in its domestic law. The buyback offer was only accepted by the entity B. The
accumulated reserves of A were used to buyback the shares from the B entity.
Interpretation:
The arrangement is a colourable device designed to avoid tax in India. No dividends
were distributed by A since 1.4.2003, the day the Dividend Distribution Tax was
implemented for non bona fide purpose. Thus ,,A obtained tax benefit by no t declaring
dividend and passing this on as exempt capital gain in the hands of connected company
B. The buyback of shares was accepted onlyby connected company B and not by the
connected companies C and D as they would have invited capital gains tax by
accepting such offer. Revenue would invoke GAAR as regards this arrangement.
Example -13:
Fact:s
The Shares of ,,V, an asset owning Indian company, was held by an Indian Company
,,X. ,,X was in turn held by two companies ,,E and ,,C, incorporated in country ABC. The
India-ABC tax treaty provides for non-taxation of capital gains in the source country and
country ABC charges very low capital gains tax in its domestic law. The Company ,,X
was liquidated by consent and without any Court Decree. This resulted in transfer of the
asset/shares from company ,,X, to companies ,,E and ,,C. Subsequently companies ,,E
and ,,C sold the shares to ,,A which was incorporated in country ABC. The companies
,,E and ,,C claimed benefit of tax treaty and the resultant gain of the transaction was
claimed not to be taxable.
Interpretation:
The chain of events bring out the fact that the asset that was situated in India and held
by an Indian Company was transferred by liquidation of the Indian Company by an
arrangement so as to misuse or abuse the tax provisions . Revenue would invoke
GAAR as regards this arrangement.
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Example -14:
Facts
A foreign bank ,,Fs branch in India arranges loan for Indian borrower from ,,F banks
branch located in a third country. The loan is later assigned to ,,F banks branch in XYZ
country to take benefit of withholding provisions of India-XYZ treaty (India-XYZ Treaty
provides no source based withholding tax on interest to a bank carrying out bona-fide
business.)
Interpretation
Since there is no withholding provision on interest earned by XYZ residents under the
India-XYZ treaty, the above arrangement of finalizing the loan from one country and
assigning it to another country has been made to avoid withholding provisions. This is a
misuse of tax treaty and thus will be treated as an "impermissible avoidance
arrangement". Revenue would invoke GAAR with regard to this arrangement.
Example -15:
Facts
Under the provisions of a tax treaty between India and country XYZ, any capital gains
arising from the sale of shares of an Indian company would be taxable only in XYZ, if
the transferor is a resident of XYZ. There is further provision condition under the treaty
that gains from alienation of shares issued by an Indian company wherein for more than
an interest of XYZ in the capital stock of that Indian company can be taxed in India. A
company resident in XYZ owns more than X % shareholding in an Indian Company. It
sells shares of that Indian Company (being less than X % interest each at short intervals
thus, cumulatively transferring more than "X"%. It thus escapes liability for capital gains
tax in India even though it owns more than X% interest in the Indian company.
Interpretation
The above arrangement of splitting the same transaction into many transactions at short
intervals below the threshold limit could amount to abuse of tax laws and deemed to be
lacking commercial substance and hence would be an "impermissible avoidance
arrangement". Revenue would invoke GAAR with regard to this arrangement.
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Example -16:
Facts:
Company ,,A is a non resident company in country R and is wholly owned by company
,,X in country T. Company ,,X is a financial company with substantial reserves and
looking for investments in India. Company ,,X uses its subsidiary company ,,A to route its
investment in an Indian company ,,B whereby company ,,A purchases the shares of
company ,,B. After sometime, company ,,A sells the shares of company ,,B to another
company ,,C and realizes capital gains. As per the provisions of relevant DTAA Protocol
between country R and India, a shell/conduit company is not eligible for capital gains
exemption in India. However, a company shall not be deemed to a shell/conduit
company if its total annual expenditure on operations in country R is equal to or more
than Rs. 1,00,00,000/- in the immediately preceding period of 24 months from the date
the gains arise. Company ,,A claims that capital gains are not taxable in India as it is not
a shell company as per the relevant DTAA Protocol and that it incurred
Rs. 1,20,00,000/- (Rs. 40,00,000/- as license fees and local office expenses,
Rs. 80,00,000/- as interest payments to ,,X company, its parent holding company) as
business expenses as per P&L A/C to show its economic presence in country ,,R as it
claimed expenditure exceeding the limit prescribed therein and for it not to be
shell/conduit company.
Interpretation:
Company ,,A has incurred only Rs. 40,00,000/- on operations in country ,,R. Interest
payments of Rs. 80,00,000/- outside country ,,R cannot be taken into account for the
purposes of computation of Rs. 1,00,00,000/- limit of expenses incurred on operations
in country ,,R. Company ,,A will be deemed to be a shell/conduit company. The treaty
benefit may be denied under LOB clause of the treaty itself. As it is an arrangement for
claiming benefits of DTAA and it lacks economic substance, therefore, Revenue may
also invoke GAAR with regard to this arrangement.
Example -17:
Facts:
An Indian company is in the business of import and export of certain goods. It
purchases goods from Country A and sells the same in country B. It sets up a
subsidiary in Country X - a zero/ low tax jurisdiction. The director of the Indian company
finalizes the contracts in India but shows the documentation of the purchase and sale in
Country X. The day to day management operations are carried out in India. The goods
move from A directly to B. The transactions are recorded in the books of subsidiary in
country X, where the profits are tax exempt.
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Interpretation:
A company is camouflaging the sale and purchase transactions as X country based
transactions. By this arrangement, the Indian company has obtained a tax benefit. The
substance or effect of the arrangement as a whole is inconsistent with, or differs
significantly from, the forms of its individual steps and hence, lacks commercial
substance. Revenue would invoke GAAR with regard to this arrangement.
Example -18:
Facts:
A company ,,A in country ,,X invests in a company ,,B situated in country ,,R. Country ,,R
has a provision of residence based taxation of capital gains in its tax treaty with India.
,,B further invests the funds in equities in India and earns capital gains. ,,B does not
have substantive commercial substance in country ,,R.
Interpretation:
If ,,A invests directly in India, it does not get benefit of treaty and has to pay capital gains
tax in India. By routing the funds through ,,B in country ,,R, the payment of capital gains
tax in India has been avoided. This is an impermissible avoidance arrangement and
revenue would invoke GAAR with regard to this arrangement.
Example -19:
Facts
An employee of a private limited company ,,A is to receive a bonus or salary. The
employee subscribes for preferential shares of the employer. The preferential shares
are purchased by a connected company of ,,A, or are redeemable at a premium that
reflects a portion of the employees annual salary or bonus, after a period of one year.
In this manner, the employee receives the income as capital gain.
Interpretation
The acquisition of the preferential shares is part of an arrangement designed to avoid
the tax that would have been required to be paid on salary. By this arrangement, there
is a tax benefit and there is a misuse of the tax provisions. The Revenue would invoke
GAAR with regard to this arrangement.
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Example -20:
Facts:
,,A company had a disputed claim with ,,Z company. ,,A transferred its actionable claims
against ,,Z for an amount which was low, say, for example 10 % of the value of the
actionable claim against ,,Z to a connected concern ,,B by way of a transfer instrument.
,,B transferred such claim to ,,C company and ,,C further gifted it to ,,D company,
another connected concern of ,,A. Upon redemption of such actionable claims, ,,D
showed it as a capital receipt and claimed exemption.
Interpretation:
The transfer of actionable claims in the manner as detailed above to a connected
concern is a colourable device which lacks commercial substance. The income in the
instant case belongs to A. Revenue would invoke GAAR as regards this arrangement.
Example -21:
Facts:
`A` company borrowed money from a company `B` and used that to buy shares in three
100% subsidiary companies of `A`. Though the fair market value of the shares was
Rs. Y, `A` paid Rs. 6Y for each share. The amount received by the said subsidiary
companies was transferred back to another company connected to `B`. The said shares
were sold by ,,A for Rs. Y/5 each and a short-term capital loss was claimed and this was
set-off against other long-term capital gains.
Interpretation:
By the above arrangement, the tax payer has obtained a tax benefit and created rights
or obligations which are not ordinarily created between persons dealing at arms length.
Revenue would invoke GAAR with regard to this arrangement.
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