General Anti Avoidance Rule (GAAR) - An Indian and International Perspective
Internationally, tax avoidance has been recognized as an area of concern and several countries have expressed concern over tax evasion and avoidance. The main aim of the research paper is to study the GAAR regulations and its effect on Indian society. 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. For this purpose the authors have first defines tax avoidance and tax evasion as prevalent at present in various judicial pronouncements. Further for the purpose of implementation and consequences the authors have thrown light on section 95 – 102 of the Finance Act, 2012. The paper also attempts to compare the Indian law with other GAAR laws of various countries. The authors conclude with the negative note that any avoidance of tax to be declared impermissible would over burden the tax payers. Hence the stringent should be amendment for providing better view.
"Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however, unappreciative the Commissioners of Inland Revenue or his fellow tax gatherers may be of his ingenuity, he cannot be compelled to pay an increased tax.”
“It can be very well said that when a person is born there are two things certain which would occur in his life span, one is his death and the other is the burden of tax on that person.” Tax is an amount which the government charges on every person in return of service provided by the government. The services may be in terms of infrastructure, security, maintaining rule of law, and many others. The government is accountable for each and every action which he takes, whether it may or may not be in the interest of citizen. Constitution envisages the Government to impose tax. Article 265 of the constitution says that, “No tax shall be levied or collected except by authority of law.” Thus constitution gives all power to the government to levy and collect tax from the people of India. The federal structure of our constitution can be very well be depicted in the taxing statutes. The taxes of local nature are levied and collected by the state government and the taxes which involves income from more than one state is been collected by the central government.
Levying and collecting the tax is the right of the government and paying the tax is the duty of the people. It is the general presumption that each and every person liable to pay tax must reasonable pay tax within the provisions of the tax statutes. The person escaping the liability of paying tax which he is legally liable to pay would be termed as tax evasion which would be termed as illegal under the Indian Laws. Person lowering his liability to pay the tax under the four corners of the law would not be illegal and would be termed as Tax avoidance. But the General Anti Avoidance Rules (GAAR) which has been introduced by the Finance Act, 2012 envisages that any arrangement or planning, which involves any tax benefit, whether directly or indirectly would be an impermissible agreement and any tax benefit from such arrangement would be taxable as per the provisions of the Act. This paper highlights the various issues relating to tax avoidance, permissible tax avoidance and also what should be the impermissible tax avoidance. This paper would highlight the various provisions of GAAR and also the various judicial pronouncements regarding the taxing nature, comparing the GAAR provision of various countries and also the advantages and disadvantages of GAAR.
The issue as to whether reduction in tax liability through a transaction or a series of transactions is 'tax planning' or 'tax avoidance' has been the subject matter of debate both in India and overseas for the past several decades. Although, the Judiciary has attempted to define the principles for determining tax avoidance, the most recent being the case of Vodafone International Holdings B.V. v. Union of India ., however considering the mindset of revenue authorities, the introduction of and the powers prescribed under the proposed anti-avoidance provisions are likely to have significant implications, both positive and negative.
The tax authorities have time and again expressed their desire to introduce reforms that would act as a deterrent to the use of sophisticated weapons of tax avoidance spanning across various jurisdictions. Further, the question of 'substance over form' has consistently arisen in the course of implementation of tax laws. At present, India has specific anti-avoidance provisions engraved both in the domestic tax laws and in some of the tax treaties through the 'limitation of benefits' clauses. However, in a bid to curb tax avoidance and enforce the concept of 'substance over form', the Indian revenue policymakers propose the introduction of one of the most significant contemporary tax reforms - the General Anti Avoidance Rules ("GAAR"). Although originally forming a part of the Direct Taxes Code ("DTC"), however, given the postponement of DTC, GAAR is a part of the tax reforms which was introduced through the Union Budget 2012.
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 scope and language of the proposed GAAR provisions under the Union Budget 2012 are very similar to the GAAR provisions specified in the DTC. The Revenue authorities will be bestowed with widespread powers to disregard and re-characterize any tax avoiding transaction and income accruing there from. Further, the Finance Bill 2012 proposes the introduction of sub-section 2A to section 90 which would enable the provisions of GAAR (proposed to be introduced through Chapter X-A in the Income-tax Act, 1961) to override the provisions of the tax treaties signed by India. While the revenue authorities may be viewing GAAR as a means to checking tax leakages, one could criticize the sweeping nature of the provision as it provides wide discretion to the tax authorities and is likely to be prone to misuse.
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.
Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner. Sectors that provide a greater opportunity for tax avoidance tend to cause distortions in the allocation of resources. Since the better-off sections are more endowed to resort to such practices, tax avoidance also leads to cross-subsidization of the rich. Therefore, there is a strong general presumption in the literature on tax policy that all tax avoidance, like tax evasion, is economically undesirable and inequitable. On considerations of economic efficiency and fiscal justice, a taxpayer should not be allowed to use legal constructions or transactions to violate horizontal equity.
Black's Law Dictionary states that tax avoidance is the "minimization of one's tax liability by taking advantage of legally available tax planning opportunities";
In the past, the response to tax avoidance has been the introduction of legislative amendments to deal with specific instances of tax avoidance. Since the liberalization of the Indian economy, increasingly sophisticated forms of tax avoidance are being adopted by the taxpayers and their advisers. The problem has been further compounded by tax avoidance arrangements spanning across several tax jurisdictions. This has led to severe erosion of the tax base. Further, appellate authorities and courts have been placing a heavy onus on the Revenue when dealing with matters of tax avoidance even though the relevant facts are in the exclusive knowledge of the taxpayer and he chooses not to reveal them.
In view of the above, it is necessary and desirable to introduce a General Anti Avoidance Rule which will serve as a deterrent against such practices. This is also consistent with the international trend.
The Judicial View On Tax Avoidance
"My Lords, the highest authorities have always recognised that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so within the law, and that he may legitimately claim the advantage of any expressed terms or any omissions that he can find in his favour in taxing Acts. In so doing, he neither comes under liability nor incurs blame."
Planning is the formulation of a system which in its implementation is designed to achieve a specific result. While economic planning is the privilege of the State, tax planning is that of the subject. In general, tax planning aims to reduce the outflow of cash resources made available to the government by way of taxes so that the same may be effectively utilized for the benefit of the individual or the business, as the case may be. It involves arranging one's financial affairs by intelligently anticipating the effects of tax laws on the arrangements that have been adopted.
Way back in 1936, the Appellate Court in IRC v. Duke of Westminster , held that a citizen has the legal right to dispose of his capital and income so as to attract upon himself the least amount of tax. Avoidance of tax is not evasion and carries no ignominy. It was observed that "given a document of transaction is genuine the court cannot go behind it to some supposed underlying substance ".
W T Ramsay v. Inland Revenue Commissioners was a significant departure from the Westminster principle. In the instant case, the House of Lords considered a tax avoidance scheme which consisted of a series or a combination of transactions each of which was individually genuine but all of which as a whole resulted in tax avoidance. The House laid the principle that the fiscal consequences of a preordained series of transactions, intended to operate as such, are generally to be ascertained by considering the result of the series as a whole. It is not to be ascertained by dissecting the scheme and considering each individual transaction separately. The dictum in Ramsay was echoed in Inland Revenue Commissioners v. Burmah Oil Co. Ltd
The Westminster principle is followed in India the Supreme Court held that the avoidance of tax liability is not prohibited. A taxpayer may resort to a device to divert the income before it accrues to him. Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income Tax Act. Legislative injunction in taxation statutes may not, except on peril of penalty, be violated, but it may lawfully be circumvented.
In Union of India v. Azadi Bachao Andolan (Azadi Bachao Andolan case), it was argued that any tax planning which results in avoidance must be struck down in the light of McDowell. Rejecting this argument, the court upheld the legitimacy of tax planning. The Apex court referred to the Privy Council judgment in Bank of Chettinad Ltd v. CIT which accepted the principle laid down in Duke of Westminster The judgment was the law when the Constitution came into force. The legal position continues by virtue of Article 372 by which all laws in force in the territory of India immediately before the commencement of the Constitution shall continue in force until altered or repealed or amended by a competent Legislature or other competent authority. Hence the principle laid down in the Westminster case is still applicable unless reversed by a Supreme Court verdict or an Act of Parliament. The Court observed as follows: "We are unable to agree with the submission that an act which is otherwise valid in law can be treated as non-est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interests, as perceived by the respondents."
The Hon’ble Supreme Court in A Raman’s case 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.”
The expression ‘tax avoidance’ is used to describe every 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 reasons.
Justice Chinnaapa Reddy emphatically said, "But, surely, it is high time for the judiciary in India too to part its ways from the principle of Westminster and the alluring logic of tax avoidance. We now live in a welfare State whose financial needs, if backed by the law, have to be respected and met. We must recognise that there is behind taxation laws as much moral sanction as behind any other welfare legislation and it is pretence to say that avoidance of taxation is not unethical and that it stands on no less a moral plane than honest payment of taxation. In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord approval to it."
The Apex Court in Azadi Bachao Andolan Case held that “If the court finds that notwithstanding a series of legal steps taken by an assesse, the intended legal result has not been achieved, the court might be justified in overlooking the intermediate steps, but it would not be permissible for the court to treat the intervening legal steps as non-est based upon some hypothetical assessment of the real motive of the assesse. In our view, the court must deal with what is tangible in an objective manner and cannot afford to chase a will-o-the-wisp.”
The Carter Commission Report (Canada, 1966) states that tax avoidance is "every attempt by legal means to reduce tax liability which would otherwise be incurred by taking advantage of some provision or lack of provision in the law"
The landmark Helvering v. Gregory judgment says "any one may arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes."
DTC condemns tax avoidance on moral, ideological and economic grounds. However, payment of taxes may not be as sacrosanct as it is considered, which is well articulated in the observation of Sabyasachi Mukharji, J. in Commissioner of Wealth Tax, Gujarat-II, Ahmedabad v. Arvind Narottam:
"It is true that tax avoidance in an under-developed developing economy should not be encouraged on practical as well as ideological grounds. One would wish, as noted by Reddy, J. that one could get the enthusiasm of Justice Holmes that taxes are the price of civilization and one would like to pay that price to buy civilization. But the question which many ordinary taxpayers very often in a country of shortages with ostentious consumption and deprivation for the large masses ask, is does he with taxes buy civilization or does he facilitate the wastes and ostentiousness of the few. Unless wastes and ostentiousness in Government's spending are avoided or eschewed, no amount of moral sermons would change people's attitude to tax avoidance."
The McDowell case said that “it is open to the Income Tax officer in a given case to lift the corporate veil for finding out whether the purpose of the corporate veil is avoidance of tax or not. It is one of the functions of the assessing officer to ensure that there is no conscious avoidance of tax by an assesse, and such function being quasi-judicial in nature, cannot be interfered with or prohibited.”
Thus the principle enunciated in the case of Duke of Westminster was been overruled in the case of McDowell and the Azadi Bachao Andolan case overruled the McDowell’s case which said that Westminster still holds a good law.
The Vodafone Case And Its Tax Planning
In Vodafone International Holdings BV v. Union of India , Hutchinson International (non-resident company) held 100% shares of CGP Investments Holdings Ltd. (non-resident company) which in turn held 67% shares in the Indian company Hutchinson-Essar. Hutchinson-Essar was a joint venture between Hutchinson International and Essar. Vodafone International Holdings BV (non-resident company) acquired the entire share capital of CGP Investments Holdings Ltd. from Hutchison International. This resulted in an indirect transfer
of 67% shareholding in Hutchinson-Essar to Vodafone.
The question which arose was, whether the income accruing to Hutchinson as a result of the transaction could be deemed to accrue or arise in India by virtue of S.9 of the Income Tax Act. The Income Tax Department issued Vodafone a show cause notice asking why action should not be taken against it for failing to deduct tax at source under S.195 of the IT Act while making payment of the consideration to Hutch. The validity of the show-cause notice was challenged by Vodafone in a writ petition before the Bombay High Court.
The High Court held that the writ petition challenging the show-cause notice was premature as an alternative remedy was available to the petitioner. Vodafone appealed in the Supreme Court. In the instant case, indisputably, CGP share was transferred offshore. Both the companies were incorporated not in India but offshore. Both the companies have no income or fiscal assets in India, leave aside the question of transferring, those fiscal assets in India. Tax presence has to be viewed in the context of transaction in question and not with reference to an entirely unrelated transaction. Section 195, in our view, would apply only if payments made from a resident to another non-resident and not between two non-residents situated outside India. In the present case, the transaction was between two non-resident entities through a contract executed outside India. Consideration was also passed outside India.
That transaction has no nexus with the underlying assets in India. In order to establish a nexus, the legal nature of the transaction has to be examined and not the indirect transfer of rights and entitlements in India. Consequently, Vodafone is not legally obliged to respond to Section 163 notice which relates to the treatment of a purchaser of an asset as a representative assesse.
The Court held that: “the demand of nearly Rs.12,000 cores by way of capital gains tax, in my view, would amount to imposing capital punishment for capital investment since it lacks authority of law and, therefore, stands quashed.”
Hence the Vodafone Case could be referred as of the best case in relation to tax avoidance within the four corners of the law, which saved the company from being getting into a trap of a deterrent amount of tax of Rs. 12,000 cores, which would otherwise had liquidated the company.
GAAR Under The Indian Law
For the first time in the Financial Budget given by the Finance Minister Mr. Pranab Mukherjee, the concept of General Anti Avoidance Rules were introduced in the Finance Act, 2012 and which has been assented by the President as well. Sections 95 to 102 under Chapter X-A of the Act deals with the provisions of GAAR and is a code in itself.
The Chapter has its own definition section which shall be applicable to the provisions of the said chapter. Under Section 102 in all 12 words have been defined, out of which two which would be the most useful in understanding the present provisions are
(1) Arrangement: "arrangement" means any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding;
(11) Tax benefit means—
(a) a reduction or avoidance or deferral of tax or other amount payable under this Act; or
(b) an increase in a refund of tax or other amount under this Act; or
(c) a reduction or avoidance or deferral of tax or other amount that would be payable under this Act, as a result of a tax treaty; or
(d) an increase in a refund of tax or other amount under this Act as a result of a tax treaty;
(e) a reduction in total income including increase in loss,in the relevant previous year or any other previous year.
Chapter X-A is titled as General Anti – Avoidance Rule and the very first section under the said chapter talks about the applicability of General Anti Avoidance Rule . The very first section starts with the word ‘Notwithstanding anything contained in the act’, meaning thereby that Section 95 and the conditions followed therein would have an overriding effect over any other provision so provided. Further the section acts as a covering clause for the chapter and states that any arrangement by the assessee ‘may’ be declared to be an impermissible avoidance arrangement and the consequence may be determined subject to the provisions of the chapter. Explanation to the section further widens the scope of the provisions and provides that the provisions of the chapter may be applied at any step or part of the arrangement as if it was applicable to the arrangement as a whole. The word may in the said section confers a discretion on the Revenue Department to come to a conclusion that the arrangement entered by an assessee is of an permissible or impermissible nature.
In absence of any indication as to any divergence from the Income Tax Act, the word assesse would include all the categories of assessee as stated in the Act. The Chapter further provides for defining ‘Impermissible Avoidance Arrangement’ . Sub-section (1) to the said section can be said to include two main ingredients. The first ingredient of which is Purpose. The section categorically states that the main purpose or one of the main purposes is to obtain tax benefit.
The second ingredient under the definition further provides for an inclusive list of things either of which should be there with the first condition. This second condition basically states the benefits (which otherwise would not arise) that would result from the said avoidance arrangement. The list includes:-
(a) Creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length;
(b) Results directly or indirectly, in the misuse, or abuse, of the provisions of the Act;
(c) Lacks commercial substance or is deemed to lack commercial substance under section 97, in whole or in part; or
(d) Is entered into, or carried out, by means or in a manner, which are not ordinarily employed for bona fide purposes.
Sub-section (2) provides as to what would be said to be included as an Purpose for the arrangement under Sub-Section (1). It states that any arrangement whether in the main purpose or in any step of the arrangement, the objective of which is to obtain text benefit, the whole arrangement shall be presumed for obtaining such tax benefit. The presumption under this section shall be assumed unless an intention contrary has been shown by such persons obtaining tax benefit.
The chapter further under section 97 defines when an Arrangement can be said to lack commercial substance. The said section is more like a deeming provision, which states that An arrangement shall be ‘deemed’ to lack commercial substance if firstly, the substance or effect of the arrangement as a whole, is inconsistent with or differs from, the form of its individual steps; Secondly it would also be deemed to lack commercial substance if it includes round trip financing; an accommodating party; elements that have effect of offsetting or canceling each other’ or a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction. Sub-Section (4) provides for the facts that shall be immaterial for the purposes of determining the lack of commercial transaction in the arrangement. It again provides for three things that shall not be looked at which are
(a) The period for time for which the arrangement exists;
(b) The fact of payment of taxes, directly or indirectly, under the arrangement;
(c) The fact that an exit route is provided by the arrangement.
Round trip financing is basically defined as an action that attempts to inflate transaction volumes through the continuous and frequent purchase and sale of a particular security, commodity or asset. Round trip trading is used to refer practice of a business selling an unused asset to another company while agreeing to buy-back the same asset for about the same price . Act also provides for a definition of round trip financing for the purposes of the chapter under sub-section (2) which states that:
For the purposes of sub-section (1), round trip financing includes any arrangement in which, through a series of transactions—
(a) Funds are transferred among the parties to the arrangement; and
(b) Such transactions do not have any substantial commercial purpose other than obtaining the tax benefit (but for the provisions of this Chapter), without having any regard to—
(A) whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement;
(B) The time, or sequence, in which the funds involved in the round trip financing are transferred or received; or
(C) The means by, or manner in, or mode through, which funds involved in the round trip financing are transferred or received.
The provisions also make a reference to the word accommodating party. Section 97 under sub-section (3) defines accommodating party. The definition makes reference to both direct and indirect participation of an individual provided such is for the purpose of direct and indirect tax benefits. The section further also provides that for the purpose of a particular party to be accommodating party it is not necessary that the person is a connected person in relation to any party to the arrangement. Such accommodating parties may be disregarded or such accommodating party and any other party may be treated as one and the same person in determining the existence of a tax benefit [99(ii)(iii)]. Any in case of any parties so connected in relation to each other they may be treated as one and the same person [99(i)].
Section 98 Consequence of impermissible avoidance arrangement.—(1) If an arrangement is declared to be an impermissible avoidance arrangement, then the consequences, in relation to tax, of the arrangement, including denial of tax benefit or a benefit under a tax treaty, shall be determined, in such manner as is deemed appropriate, in the circumstances of the case, including by way of but not limited to the following, namely:—
(a) Disregarding, combining or recharacterising any step in, or a part or whole of, the impermissible avoidance arrangement;
(b) Treating the impermissible avoidance arrangement as if it had not been entered into or carried out;
(c) Disregarding any accommodating party or treating any accommodating party and any other party as one and the same person;
(d) Deeming persons who are connected persons in relation to each other to be one and the same person for the purposes of determining tax treatment of any amount;
(e) Reallocating amongst the parties to the arrangement—
(i) any accrual, or receipt, of a capital or revenue nature; or
(ii) any expenditure, deduction, relief or rebate;
(i) The place of residence of any party to the arrangement; or
(ii) The situs of an asset or of a transaction, at a place other than the place of residence, location of the asset or location of the transaction as provided under the arrangement; or
(g) Considering or looking through any arrangement by disregarding any corporate structure.
(2) For the purposes of sub-section (1),—
(i) any equity may be treated as debt or vice versa;
(ii) any accrual, or receipt, of a capital nature may be treated as of revenue nature or vice versa; or
(iii) any expenditure, deduction, relief or rebate may be recharacterised.
Section 100 and 101 are effective provision and states that applicability and makes a provision for framing of guidance, meaning thereby it provides that the provision shall apply in addition to, or in lieu of, any other basis for determination of tax liability; and such application of the provisions shall be in accordance to the guidelines and the condition as may be prescribed.
Comparison With Other Countries
In the case of Vodafone International Holdings B.V. v. Union of India S.J Kapadia CJI., stated that: “Tax avoidance is a problem faced by almost all countries following civil and common law systems and all share the common broad aim that is to combat it. Many countries are taking various legislative measures to increase the scrutiny of transactions conducted by non-resident enterprises. Australia has both general and specific anti avoidance rule (GAAR) in its Income Tax Legislations. In Australia, GAAR is in Part IVA of the Income Tax Assessment Act, 1936, which is intended to provide an effective measure against tax avoidance arrangements. South Africa has also taken initiative in combating impermissible tax avoidance or tax shelters. Countries like China, Canada etc. have also taken remedial measures.
i. United States of America
The situation of GAAR in the United State is reflected in the following passage from American Jurisprudence :
"The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether to avoid them, by means which the law permits, cannot be doubted. A tax-saving motivation does not justify the taxing authorities or the courts in nullifying or disregarding a taxpayers otherwise proper and bona fide choice among courses of action, and the state cannot complain, when a taxpayer resorts to a legal method available to him to compute his tax liability, that the result is more beneficial to the taxpayer than was intended. It has even been said that it is common knowledge that not infrequently changes in the basic facts affecting liability to taxation are made for the purpose of avoiding taxation, but that where such changes are actual and not merely simulated, although made for the purpose of avoiding taxation, they do not constitute evasion of taxation. Thus, a man may change his residence to avoid taxation, or change the form of his property by putting his money into non-taxable securities, or in the form of property which would be taxed less, and not be guilty of fraud. On the other hand, if a taxpayer at assessment time converts taxable property into non-taxable property for the purpose of avoiding taxation, without intending a permanent change, and shortly after the time for assessment has passed reconverts the property to its original form, it is a discreditable evasion of the taxing laws, a fraud, and will not be sustained."
ii. Canadian Statute
A 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
On June 18, 1987, the Minister of Finance for Canada issued a White Paper on Tax Reform which included a proposal to enact a new general anti avoidance rule to deal with tax avoidance arrangements. In response to strong criticism of the need for such a general anti-avoidance rule and of its particular form in the White Paper, the Minister of Finance, on December 16, 1987 proposed an amended version of the rule. This version essentially expanded the business purpose test into a non-tax purpose test, defined and expanded the possible ambit of the tax consequences which might result from the rule's application and limited its application to exempt from its ambit genuine transactions with economic substance that are consistent with the object and purpose of the Act. Some 12 months after the original draft legislation, the new general anti-avoidance rule ("GAAR") was included as new section 245 of the Act in the detailed Notice of Ways and Means Motion of June 13, 1988. It became effective on September 13, 1988.
The Intention of the Legislator
Subsection 245(2), the charging provision of the GAAR, provides that, “when a transaction is an avoidance transaction, the tax consequence to a person shall be determine as is reasonable in the circumstance in order to deny a tax benefit that, but for the section, would result, directly or indirectly, from the that transaction or from a series of transactions that includes that transaction”
The terms “tax benefit” and “tax consequence” are both broadly defined under section 245(1). A “tax benefit” is any reduction, avoidance or deferral of tax in Canada or other amount payable or an increase in a refund of tax or other amount under the Act. The term “tax consequence” is also defined and includes an amount payable or refundable to a person, or any other amount that is relevant for the purpose of computing such an amount. This definition represents an expansion of the Whit Paper’s array of possible tax adjustments by envisaging adjustment for the amount which has no immediate impact on income or tax.
Recently, the Canadian Supreme Court had, in the case of Copthorne Holdings Ltd. v. Canada 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 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”. Providing further guidelines, the Court emphasized that the 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.
iii Australian Statute
Tax 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 Legislation
Australia’s GAAR was introduced in 1981 and is contained in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936). General Anti-Avoidance Rules India and International perspective 13 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, including the ordinary provisions and SAAPs, but when objectively 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. The three key conditions which must be satisfied for Part IVA 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.
iv Chinese Statute
Chinese law also includes GAAR in their statutes. The GAAR in the Chinese statute is found in Article 47 of the Enterprise Income Tax Law. It states that “If an enterprise enters into any business arrangement without bona fide commercial purposes that result in a reduction of taxable revenue or income, the tax authority is entitled to make adjustments based on reasonable methods."
The term "business arrangements without bona fide commercial purposes" is defined under Article 120 of the Enterprise Income Tax Regulations to refer to "arrangements whose primary purpose is to reduce, avoid or defer tax payments." The term "tax avoidance arrangements" is defined to include those that result in an abuse of tax incentives, abuse of tax treaties, abuse of a company's legal form, or avoidance of tax through using a tax haven, and other arrangements without bona fide commercial purposes.
Purpose for GAAR
One possible motivation was to empower the Chinese State Administration of Taxation (SAT) to combat cross-border tax planning. Tax avoidance has been closely associated in China with foreign investors, especially multinational corporations.
Although the Enterprise Income Tax Law and Regulations include some well-known specific anti-avoidance rules, such as transfer pricing, thin capitalization, controlled foreign corporations and anti-tax-haven rules, the drafters were concerned with the types of avoidance transactions that can circumvent the application of these rules. China's tax base, hence its national interest, would be harmed by such transactions.
The main purpose of the GAAR is to combat "hidden" or "unforeseeable" tax avoidance transactions by supplementing the application of specific anti-avoidance rules. "No matter how airtight the tax law system is, loopholes always exist.” The perception is that multinational companies are engaged in aggressive tax planning to avoid Chinese taxes. The GAAR provision is located in Chapter Six of the Enterprise Income Tax Law. There is a sense that the inclusion of the GAAR in Chapter Six helps complete China's anti-avoidance legislation on paper, enhancing the scientific value of the legislation.
The Chinese GAAR seems to signal some changes as well. It on one hand sends a signal to taxpayers, especially taxpayers conducting cross-border transactions, that China takes tax avoidance seriously. On the other hand, the enactment of the GAAR arguably signals to taxpayers that tax avoidance is permissible as long as it does not offend the GAAR. In other words, transactions that have bona fide commercial reasons, even if they result in tax savings, are valid. That may encourage taxpayers to seek professional tax assistance in compliance and planning and to expect more certainty and transparency in tax assessment.
Pros And Cons Of GAAR In India
The concept of GAAR is premature for the Indian Economy and the tax payers of India. Look at the present situation in India the tax payers are given an option to avoid the tax by way of smart planning within the four corners of the taxing statute. The Implementation of GAAR would be a hindrance to the tax planning which has always been allowed for the purposes of paying the minimum payable tax.
Comparing the provisions of GAAR with other country it can be derived that they Indian provisions are harsh compared to any other country. This would primarily affect the whole country but would majorly affect the lower strata of the country, which forms a majority in Indian society. This would create an unnecessary burden of tax on the shoulders of the people.
Instead of completely avoiding tax it would be desirable to provide at least certain category as permissible tax avoidance rather than forming a general segment of tax avoidance. Such a segment should be divided into permissible tax avoidance and abusive tax avoidance. The aim of the provisions should be to curb abusive planning and not planning itself.
It is the foremost duty of each and every taxpayer to pay tax, but the intention of the legislator should not be such which would be detriment to the interest of tax payer by compelling him to pay more than what actually he is liable to pay.
Thus the GAAR provisions should be implemented but not in such a wider sense rather narrowing it down to illegal tax avoidance.
The authors also agree to the views as recommended that:
• Providing a healthy framework based on the principal of sound legal jurisprudence to come to a conclusion of abusive transaction. The design of GAAR should be by reference to ‘business- purpose test’ with emphasis on the different concepts of the economic substance associated with the categories of tax avoidance behaviour, such as tax evasion, acceptable tax avoidance and abusive tax avoidance rather than narrow the scope to the aspect of a tax benefit test.
• Incorporate a substance over form rule where a transaction or a series of transactions are entered into to judge the authenticity and purpose of the transaction rather than teleological apply the tax benefit provision, surpassing all other aspects of the transaction.
The above mentioned points should also be considered while enacting the GAAR provision which would be for the holistic purpose of the society.
Acceptable And Unacceptable Tax Avoidance
Every country seeks to tax the income generated within its territory on the basis of one or more connecting factors such as location of the source, residence of the taxable entity, maintenance of a permanent establishment, and so on. A country might choose to emphasise one or the other of the aforesaid factors for exercising fiscal jurisdiction to tax the entity. Depending on which of the factors is considered to be the connecting factor in different countries, the same income of the same entity might become liable to taxation in different countries. This would give rise to harsh consequences and impair economic development. In order to avoid such an anomalous and incongruous situation, the Governments of different countries enter into bilateral treaties, Conventions or agreements for granting relief against double taxation. Such treaties, conventions or agreements are called double taxation avoidance treaties, conventions or agreements.
Lord Goff explained the meaning of “unacceptable tax avoidance” in Ensign Tankers and held that unacceptable tax avoidance typically involves the creation of complex artificial structures by which, as though by the wave of a magic wand, the taxpayer conjures out of the air a loss, or a gain, or expenditure, or whatever it may be, which otherwise would never have existed. This, of course, led to further debate as to what is “unacceptable tax avoidance” and “acceptable tax avoidance”.
The Recommendations of Parthasarathi Shome Committee
The recent report of the Expert Committee on general anti avoidance rules ("GAAR") has evoked positive sentiments across the industry. The Committee has recommended that GAAR should be deferred for 3 years. It has also suggested that income from sale of listed securities should be fully exempt from tax. Investors from Mauritius and Singapore may also look forward to more certainty on entitlement to tax treaty benefits. While the Committee’s recommendations have largely met investor’s expectations, additional clarity is still required on a few aspects regarding the application of GAAR in India.
The GAAR Committee has recognized the right of taxpayers to mitigate taxes through arrangements that are not abusive, contrived or artificial. GAAR should therefore be used as a last resort and not a first recourse. As a measure of fairness, it has been proposed that existing investments should be grandfathered. The Committee is in favour of a targeted approach to GAAR with abundant safeguards, which is a positive step in addressing investor concerns.
The deferral of GAAR is extremely important considering that India is far behind other countries that have introduced GAAR on parameters such as global corruption perception (rank 95), ease of doing business (rank 132) and ease of paying taxes (rank 147). It is necessary to address these systemic deficiencies before introducing GAAR.
Restrict Gaar To Abusive, Artificial And Contrived Arrangements
The Committee has recommended that GAAR should only apply to abusive, artificial and contrived arrangements. This qualitative threshold underscores the taxpayer’s right to plan his affairs and mitigate taxes. For instance, if a taxpayer has to choose between various economic alternatives available under law, he is justified in choosing that alternative which creates the least tax burden. It substantially shifts the focus of GAAR to more complicated tax avoidance strategies and will help ensure objectivity through a targeted approach, which will benefit both taxpayers and the Revenue.
The Committee has made a number of additional recommendations in this regard: GAAR should only be invoked in cases where ‘the main purpose’ (and not ‘one of the main purposes’) of the arrangement is to obtain tax benefit. The focus is therefore on the dominant object of the arrangement.
a. The Government should issue a negative list of arrangements where GAAR cannot be invoked. This would include intra-group transactions, business reconstruction, share buybacks, dividend distribution, choice of funding through debt or equity and setting up of units in special economic zones.
b. GAAR cannot be invoked in situations where specific anti avoidance rules (like transfer pricing) are applicable.
c. As a quantitative threshold, only cases where the tax benefit exceeds INR 3 crore may be scrutinized under GAAR.
The Expert Committee was constituted by the Prime Minister in response to the grievances expressed by investors when GAAR was incorporated into India’s tax legislation earlier this year (for implementation from April 1, 2013). The Committee provided its well-conceived review of GAAR under able chairmanship of Mr. Parthasarathi Shome, a reputed economist and tax policy expert.
The recommendation given by the GAAR committee can be partially accepted. The recommendation to issue a negative list of arrangements where the provision of GAAR cannot be invoked will be a positive step helping a bonafide person for not being getting trap into the stringent provisions of GAAR. Also the deferred period of 3 years is also a positive recommendation as it would help the existing law to be amendment so as it would be consistent with the laws of other country on GAAR, to meet there international standards.
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