Indian government makes various provisions under Income Tax act, 1961 for revenue collection, some provisions are beneficial to the tax payers, and some are not beneficial to the tax payers.
A tax payer has to follow all the provisions of the act whether they are beneficial to them or not.
Due to certain loopholes in framing provisions of the act many tax payer try to misuse or abuse the provision of the income tax act and as a result government lose the revenue.
To stop tax payers from such misuse or abuse of provision of the income tax act, government usually amend the provisions of income tax act or make counter provision which is called as Specific Anti avoidance rules (SAAR) (some example of SAAR are clubbing of income, section 50C/43CA, transfer pricing, section 68 to 69D). To avoid again and again amending income tax act, Chapter X-A has been introduced in income tax act 1961 which is the General Anti Avoidance Rules.
Strategy for reducing tax liability
(not permissible - illegal way of not paying tax)
(Law is silent on whether it is permissible or not)
Due to increase in aggressive and legitimate tax planning by tax payer in India, government was losing the revenue collection. Some of the cases of such tax planning are, UOI v. Azadi bachao andolan (263 ITR 706)(SC), Vodafone International Holdings B.V. v. UOI (341 ITR1)(SC).
- Tax avoidance should not be colourable device (colourable device means real transaction is different then as it appears)
- If Tax avoidance is colourable device then GAAR empowers Assessing officer (AO) to 'lift the veil” in order to see the real transaction and may treat transaction as impermissible.
History of GAAR:
- In India, GAAR was originally proposed in the Direct taxes code 2009.
- It was introduced by Finance Minister, on 16 March 2012 during the Budget 2012 and was deferred for implementation from 1/4/2016.
- During the 2015 Budget presentation, Finance Minister announced that GAAR will be implemented w.e.f 1/4/17.
- Many countries like Australia, Canada, New Zealand, South Africa, China, France, Germany, etc. had also adopted GAAR before India.
Non applicability of GAAR:
As per rule 10U(1) : GAAR is not applicable in following cases:
a. An arrangement where the tax benefit in the relevant AY arising, in aggregate, to all the parties to the arrangement does not exceed Rs. 3 Cr.
b. a Foreign Institutional Investor (FII)
- who is an assessee under the Act;
- who has not taken benefit of an agreement referred to in section 90 or section 90A as the case may be; and
- who has invested in listed securities, or unlisted securities, with the prior permission of the competent authority, in accordance with the Securities and Exchange Board of India (Foreign Institutional Investor) Regulations, 1995 and such other regulations as may be applicable, in relation to such investments;
c. Non-resident in relation to investment made by him by way of offshore derivative instruments or otherwise, directly or indirectly, in a FII
d. Any income accruing or arising to, or deemed to accrue or arise to, or received or deemed to be received by, any person from transfer of investments made before the 1st day of April, 2017 by such person.
Analysis of rule 10U(1)
- If tax benefit for particular AY to all the parties is up to Rs. 3 Cr. then GAAR is not applicable.
- GAAR is not applicable to FII.
- GAAR is not applicable to NR for investment through FII.
- GAAR is not applicable to income from transfer of investment which was made before 1/04/2017, this is called grandfathering of investment made before 01/04/2017. It is to be noted that grandfathering is available only for investments and not for arrangements.
Applicability of GAAR:
1. As per Section 95 : Notwithstanding anything contained in the act, an arrangement entered into by an assessee may be declared to be impermissible avoidance arrangement and the consequence in relation to tax arising there from may be determined subject to the provision of chapter X-A.
Analysis of Section 95
- Section 95 is enabling section and it overrides the other provisions of income tax act.
- Impermissible avoidance arrangement is defined under section 96
- Consequence of Impermissible avoidance arrangement is given under section 98
2. GAAR is applicable:
- From Assessment Year 2018-19.
- To all transactions whether domestic or international.
- To both personal and corporate taxation
3. The provisions of GAAR override the provisions of Double Taxation Avoidance Agreement (DTAA).
4. Application can be made to Authority of advance ruling for obtaining ruling whether proposed transaction fall under GAAR or not. Ruling obtained will be binding on applicant, transaction in relation to which ruling is obtained, and IT authorities
Impermissible Avoidance Arrangement (IAA)
IAA is defined under section 96 as follow:
1. An IAA means an arrangement, the main purpose of which is to obtain a tax benefit, and it-
- Creates rights, or obligations, which are not ordinarily created between persons dealing at arm' s length;
- Results, directly or indirectly, in the misuse, or abuse, of the provisions of this act;
- Lacks commercial substance or is deemed to lack commercial substance under section 97, in whole or in part; or
- Is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.
2. An arrangement shall be presumed, unless it is proved to the contrary by the assessee, 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.
Analysis of Section 96:
If arrangement carried out by the tax payer is having its main purpose of Tax benefit (it is not necessary that purpose of whole arrangement is for tax benefit even if a step in, or a part of arrangement is for tax benefit) and any one of the condition out of a to d as given above is satisfied then such arrangement can be treated as IAA.
Onus is on the AO to show that a particular arrangement is IAA.
For Section 96(1)(a) - example for right or obligation not ordinarily created is:
Goods sold by giving huge discount to a particular customer, which is not ordinarily given to any other customer. So there is a right to customer of discount, which is not ordinarily created.
For Section 96(1)(b) - some examples of misuse or abuse are:
In case of any income to be received by the assessee from its client for service provided to client is received in form of gift from them on the occasion of his/her marriage. Showing income as marriage gift instead of sale turnover. Since gift received on occasion of marriage is not chargeable to tax.
For taking deduction under section 80C exceeding the limit prescribed under section 80C, insurance premium up to limit under section 80C is paid by assessee and balance is paid by spouse or children of assessee, so assessee will get deduction for the amount paid by him/her and balance paid by spouse or children will be available as deduction to them under section 80C.
For Section 96(1)(c) - Deemed to lack commercial substance is defined under section 97(1).
For Section 96(1)(d) - example for arrangement not ordinarily employed for bona fide purposes is:
Interest payment on loan taken is not at the rate fixed but which depend on the profit of the business, in short it is just a payment of profit and not interest, this is called non ordinary arrangement where purpose is different than actual. Instead of taking loan it would have been introduced as capital contribution in business. Actual purpose of amount of loan is to make capital contribution and become partner in business. In given case lender is having same advantages of partner.
Deemed to lack commercial substance:
As per Section 97(1) an arrangement shall be deemed to lack commercial substance, if-
a. The substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part; or
b. It involves or includes-
- Round trip financing;
- An accommodating party;
- Elements that have effect of offsetting or cancelling 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; or
c. it involves the location of an asset or of a transaction or of the place of residence of any party which is without any substantial commercial purpose other than obtaining a tax benefit (but for the provisions of this Chapter) for a party; or
d. it does not have a significant effect upon the business risks or net cash flows of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained (but for the provisions of this Chapter).
As per Section 97(2) for the purposes of section 97(1), round trip financing includes any arrangement in which, through a series of transactions-
- Funds are transferred among the parties to the arrangement; and
- Such transactions do not have any substantial commercial purpose other than obtaining the tax benefit( but for the provisions of this chapter),
Without having regard to-
- 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
- The time, or sequence, in which the funds involved in the round trip financing are transferred or received; or
- The means by, or manner in, or mode through, which funds involved in the round trip financing are transferred or received.
As per section 97(4) for the removal of doubts, it is hereby clarified that the following may be relevant but shall not be sufficient for determining whether an arrangement lacks commercial substance or not, namely:-
- The period or time for which the arrangement (including operations therein) exists;
- The fact of payment of taxes, directly or indirectly, under the arrangement;
- The fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement.
Analysis of Section 97:
As per Section 97(1)(a) if substance of the arrangement is different from its form then such arrangement will be declared as IAA. For E.g. transaction is formed to be stated as sale & lease back transaction, but in substance it is only a make and believe story.
For Section 97(1)(b) read with Section 97(2) some examples of round trip financing are:
Funds are transferred among parties - In case of group companies where some companies are profitable and some are loss making, then this group makes an arrangement where one profitable company will obtain loan from bank and subsequently will give interest free loan to another group company which is loss making. Interest paid by profitable company will be claimed as interest expenses for business purpose by such profitable company.
Transaction without substantial commercial purpose - company X one of the company of group company, purchased shares from company Y (company in same group) at higher rate and sell it to another company Z (which is also in same group) at lower rate. Company Z sold those shares in market at higher rate. Main purpose of this arrangement was to provide loss to X and gain to Z. In this arrangement X suffered capital loss and Z realized capital gain. There was no commercial purpose for entering sales and purchases of shares between the group companies.
Whether or not fund involved in round trip financing is traceable. - X Ltd. the profitable company takes loan from bank even though it has sufficient fund available, X Ltd. use the bank loan amount for business and subsequently gives loan out of its available fund to Y Ltd. (sister concern) loss making company at lower/free rate of interest (it is irrelevant whether loan given by X Ltd. to Y Ltd. is out of available funds and bank loan is used in business which is traceable).
Time or sequence is not relevant for fund involved in round trip financing.
- X Ltd. obtains loan from bank, keeps it for 6 months and then transfers the fund to sister concern.
- X Ltd. gives loan to sister concern. Thereafter, after 3 months obtains loan from bank.
Mode of transfer is irrelevant for fund involved in round trip financing. - X Ltd. purchased land from Y Ltd. (sister concern) at stamp value (since stamp value was too less than fair value) and sold land in market at market value, and all this transaction was carried out through register deed. If AO declare this arrangement as IAA then assessee cannot contend that all transaction are done through registered deed and they are genuine.
For section 97(1)(b) example for accommodating party is:
Company X is incorporated in Hong Kong which is having its 100% subsidiary company in India Y Ltd., X is having only investment in Y Ltd and no business is carried out by company X. Company Z of Netherlands had acquired 100% share of company X, this result in indirect sale of investment in Y Ltd to company Z. In this case accommodating party is company X, and if X was not there than Z would have purchased Y Ltd directly. (this example is similar to Vodafone case)
For section 97(1)(b) example of elements that have offsetting or cancelling each other is:
Mr. X has a house. He gifts the house to wife of Mr. Y. and Mr. Y gifts the house to minor child of Mr. X.
For section 97(1)(b) example of disguises the source/ownership is:
Mr. X who has income on which tax is not paid, deposit that income in bank of foreign country and routed back that income to India in form of foreign investment (by way of third person) in a company in which Mr. X has substantial interest this is called disguises the ownership.
For section 97(1)(c) - selecting location of asset/transaction for tax benefit :
Selecting location of asset/transaction out of India or in Tax freezone so as to avoid Taxes.
For section 97(1)(d) - no effect on business risk or net cash flow :
Unused asset is transferred but risk related to that asset is not transferred, only benefit of asset is transferred. Like asset is transfer but maintains, rent, rates, insurance and all other expenses related to asset is borne by the transferor only and income generated from asset is received by transferee.
Consequences of Impermissible Avoidance Arrangement:
As per section 98(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 -
- any accrual, or receipt, of a capital nature or revenue nature; or
- any expenditure, deduction, relief or rebate;
f. treating -
- the place of residence of any party to the arrangement; or
- 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.
As per Section 98(2) For the purposes of sub-section (1), -
- any equity may be treated as debt or vice versa;
- any accrual, or receipt, of a capital nature may be treated as of revenue nature or vice versa; or
- any expenditure, deduction, relief or rebate may be recharacterised.
Procedure for treating arrangement as IAA is given in section 144BA of Income Tax act, 1961.
1. AO makes reference to commissioner of income tax (CIT) or Principal CIT (PCIT)
At any stage of assessment or reassessment proceedings before AO, AO having regard to the material and evidence available, considers that it is necessary to declare an arrangement as IAA and to determine consequence of such an arrangement within the chapter X-A, then AO may make reference to CIT/PCIT.
In short if AO during assessment/reassessment proceeding considers that section 95 is to be invoke and is having all material and evidence, then AO may make reference to CIT/PCIT.
2. Hearing before CIT/PCIT
If CIT/PCIT is of opinion that the provisions of Chapter X-A are required to be invoked, then CIT/PCIT will issue a notice to the assessee, setting out the reasons and basis of such opinion, allowing assessee to submit objections, and giving opportunity of being heard. For filing objection or giving opportunity of being heard should not exceed 60 days.
If no objection is raised by assessee then CIT/PCIT as deems fit will declare arrangement as IAA.
If objection is raised by assessee then CIT/PCIT will after hearing assessee
- If CIT/PCIT is satisfied then arrangement will not be declared as IAA.
- If CIT/PCIT is not satisfied then CIT/PCIT will make reference to Approving panel.
3. Hearing before Approving Panel
On receipt of reference Approving panel will issue such direction as it deems fit, opportunity of being heard will be given to assessee and AO.
Before issue of any direction approving panel may:
- Direct CIT to make further inquiry and furnish report on such inquiry.
- Call for and examine such record as it deem fit.
- Require the assessee to furnish such document as it may so direct.
4. Appeal to Income Tax Appellate Tribunal (ITAT)
If assessee is aggrieved due to the direction of approving panel then assessee can make an appeal to ITAT
Disclaimer: This article is based on the provisions of income tax act in force, at time of preparation of this article. Examples given in this article is as per the interpretation of the provision of income tax act, 1961 by the author, people may interpret this provision in any other manner also.
Tags :Income Tax