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GAAR Conundrum

Gagan Deep Singh 
on 17 March 2015

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When Budget 2015-16 was rolled out by our Honorable Finance Minister Mr. Arun Jaitley then plethora of flak faced by our Government from opposition and critics  that this budget was pro-industrialists and anti-poor and in their argument  they cited an example of GAAR(General Anti Avoidance Rule) ” GAAR has been deferred in this budget till April 2017 which main purpose is to catch the evaders who avoids the tax by various means i.e. through shell companies or tax heaven countries or other dubious means  “.

Common man start pondering that this budget is really anti poor because Govt. on one hand has not increased exemption limits for middle class people and on other hand providing benefit to corporate by not implementing GAAR. But one thing I notice that not only common man but even most of the finance professionals don’t know what’s the rationale behind GAAR deferment for last so many years and what are provisions regarding which tug war has been going on between Govt. and Industry.  In this article I have addressed GAAR conundrum and why its implementation in current form can soar tax terrorism.

GAAR IN SIMPLE TERM

GAAR is basically a set of rules designed to give Indian authorities the right to scrutinize and tax transactions which they believe are structured solely to avoid taxes.

Tax avoidance is a practice of using legal means to pay the least amount of tax possible. This is different to tax evasion which is the practice of using illegal methods to avoid paying tax.  

Tax avoidance is using the tax law to obtain a tax advantage that the government never intended. It frequently involves contrived, artificial transactions that serve no purpose other than to reduce tax liability. Tax planning involves using tax reliefs for the purpose for which they were intended. 

Example:

Facts:

A business sets up a factory for manufacturing in an under developed tax exempt area(like Northern Eastern Estates). 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.

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. 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 as cited in above example.

VAGUE DEFINITION OF GAAR

Notwithstanding anything contained in the act, the provisions allow the tax authority to 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. The provisions give a wide definition of the term “arrangement”.

1. 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.

2. 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.

The onus of proving that there is an impermissible avoidance arrangement is on the Revenue.

Interpretation: As per above definition, GAAR provisions can be applied to practically any transaction that leads to a tax saving. So if an Indian company restructures its business units in a way that leads to tax savings, Indian tax officials could potentially question whether the restructuring was done simply to avoid taxes by citing it is not at arm’s length price or for bonafide purpose.

OVERRIDES TAX TREATIES IN CASE OF FII’s

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(GAAR) to such FII or to the non-resident investors of the FII.

Interpretation: GAAR would not apply to sebi-registered FIIs that do not take any benefit under double taxation avoidance agreements (tax treaties) entered by India with other countries, and have invested in listed or unlisted securities.

Some of the hardest hit by this provsion could be money managers who invest in India via tax havens like Mauritius, Switzerland, Luxemberg etc. To avoid double taxation, the investment company will have to show it has “commercial substance” in the country it is trading through.

APPROVING PANEL

To invoke GAAR provisions approving panel will be constituted which will comprise of three members, out of which two members should be of the level of Chief Commissioner of Income Tax and the third member should be an officer of the level of Joint Secretary or above from the Ministry of Law.

Interpretation:  Since majority of members in approving panel (CCIT) directly belong to tax administration it may lead to conflict of interest which may result in invoking frivolous issues during the pressure of raising revenue.

MINIMUM THRESHOLD LIMIT


GAAR can be invoked only if the value of tax benefit obtained due to the arrangement in the relevant assessment year is at least Rs ___ Core. (Yet not cleared)

KEY CONCERNS OF INDUSTRY

1. Would GAAR apply when there are Special Anti-Avoidance Rules (SAARs) in the Income Tax Act?

2. Create a 'negative list' of transactions, specifying the cases which will be outside the purview of GAAR.

3. The benefits of favorable jurisdictions would be taken away under GAAR.

4. There should be a framework laid down  on how GAAR will be implemented. 

5. Create a special cadre of GAAR-trained tax administrators.

Conclusion

After decoding the various provisions it is clear that GAAR cannot be implemented in its original form which may give ample powers to tax administration without accountability. The key point is not whether GAAR should be introduced, but rather how it is implemented. Honorable Finance Minister has done a right thing by deferring it and implementing it after making consensus with Industry. Moreover, it was also made clear in this budget that transaction that would take place before 31st March 2017 would not come under GAAR ambit.

About the Author

CA Gagan Deep Singh

Email : gagandeepsingh435@gmail.com


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