Loophole Games

by Smarak Swain

General Contents

Preface	v
About the Author	vii
Detailed Contents	xi
Introduction: “Don’t be Evil�	1

Part I: Profit Suppression

1. Deferral of Revenue	13
2. Exploiting the Mercantile System of Accounting	20
3. Manipulating Segmental Accounts	28
4. SPV and JDA Structures	35
5. Characterisation of Revenue as Capital Receipt	45
6. Rate Arbitrage	51

Part II: Gain Suppression

7. Avoiding Tax through Capital Receipts	63
8. Capital Loss Harvesting	75
9. Structuring through Non-compete Fees	81
10. Bonus Stripping	89

Part III: Profit Shifting

11. Intra-Group Services	97
12. Thin Capitalisation	108
13. IP Migration Strategies	115
14. Cost Sharing Arrangements Used for Tax Avoidance	127
15. Restructuring into a Contract Manufacturer	133
16. Structuring of Sourcing and Procurement Activities	145
17. The Dummy’s Guide to Structuring	153

Part IV: Base Erosion

18. Permanent Establishment Manipulations	167
19. Taxing the Cloud	179
20. Structuring of OTT Business	188
21. Circumventing the Equalisation Levy	194
22. Migrating HNWIs and Professionals	206

Part V: Sham Transactions

23. Use of Third Party Intermediaries	217
24. Colouring Loans as Finance Lease	224
25. Employer-Employee Collusion	235
26. Tax Avoidance through Merger & Acquisition	243
27. Saving on Dividend Tax	256
28. More sham characterisations	269

Part VI: Trends in Blatant Evasion

29. Shell Companies	279
30. Tax Evasion through Stock Exchanges	294
31. Under-Invoicing and Over-Invoicing	308
32. Hawala	318
33. Tax Havens	349
34. Exchange of tax information	366

Detailed Contents

Preface	v
About the Author	vii
General Contents	xi
Introduction: “Don’t be Evil�

Part I: Profit Suppression

1. Deferral of Revenue	�
Booking revenue as advance	14
Delhi High Court catches revenue deferral strategy of Ansal Builders	15
Recognising revenue on project completion	18
2. Exploiting the Mercantile System of Accounting	20
Scheme: Related party payments followed by write off	20
Validity of the scheme	21
Litigation risk in the scheme	22
Scheme: Exploiting loopholes in accounting standards	23
Validity of the scheme	24
Case of Ballast Nadam Dredging	25
Case of Consolidated Construction Consortium Ltd	26
3. Manipulating Segmental Accounts	28
Transfer pricing analysis of segmental P&L	29
Mispricing transactions with LTUs	31
Overpricing expenses on a specific activity to claim greater deduction	34
4. SPV and JDA Structures	35
Using SPVs to defer capital gains tax	35
Tax incidence	36
Implications under GAAR	37
Use of SPV to avoid capital gains	38
Validity of the model	40
JDA route to tax deferment	42
JDA and accommodation entries	44
5. Characterisation of Revenue as Capital Receipt	45
Colouring remuneration as compensation for damage to capital assets	47
Characterisation of sale consideration as compensation for loss of business	48
How India Today’s editor availed of a tax-free reward	48
Taxability of capital receipts after introduction of Section 56(2)(x)	50
6. Rate Arbitrage	51
Economics of dual tax rate regime	51
Standard deductions on income from house property	54
Royalty income from abroad	55
Colouring business income as capital gains	56
Exploiting presumptive taxation system	57
Misusing regime for new manufacturing companies	59

Part II: Gain Suppression

7. Avoiding Tax through Capital Receipts	63
Extinguishment of rights	64
Case of land aggregators	64
Using self-generated intangible assets to avoid capital gains	65
Carbon credits	71
Sham transactions involving capital receipts	73
Generating loss in related party transactions	75
8. Capital Loss Harvesting	75
Advanced methods of generating capital loss	76
When the Jindal Group lost on loss	78
Case of Vishishth Chay Vyapar	79
Case of AAA Portfolios	80
Characterisation issues	81
9. Structuring through Non-compete Fees	81
How tax avoidance happens by use of non-compete agreements?	83
When Macmillan Group exited from its Indian business	86
10. Bonus Stripping	89
Tax planning or tax evasion?	91
Validity of the scheme	91

Part III: Profit Shifting

11. Intra-Group Services	97
ActionAid’s Investigations into Sweet Nothings	98
Cases from Panama Papers and Paradise Papers	102
Validity of the strategy	103
Beerfest at AAR	105
12. Thin Capitalisation	108
Modus operandi	108
Incentive for thin capitalisation	109
Approaches to discourage thin capitalisation	110
Thin capitalisation rules in various countries	110
Tax avoidance after thin capitalisation rules	113
13. IP Migration Strategies	115
Royalty model	115
Validity of the method	117
Back-to-back licensing model	118
Software IP migration model	119
Political response to IP migration	120
History of IP migration	120
The 2017 tax reforms	122
India’s response to IP migration	123
Tally Solutions case	125
Issue of Jungle Book’s copyright	126
14. Cost Sharing Arrangements Used for Tax Avoidance	127
Validity of the modus	129
Apple’s structuring arrangements	129
Cases of Amazon and Microsoft	130
15. Restructuring into a Contract Manufacturer	133
Validity of the strategy	136
Taxing the transfer of business at the time of restructuring	137
Testing PE exposure of offshore principal	139
Testing POEM of offshore principals	140
“Brutal tax evasion� charge on Sun Pharmaceuticals	140
16. Structuring of Sourcing and Procurement Activities	145
Corporate structures for sourcing	146
ActionAid’s Allegations against H&M	150
Case of Li & Fung	152
17. The Dummy’s Guide to Structuring	153
HQ and its Contractors	153
Sourcing companies and intermediate trading companies	155
Marketing and selling activities	157
Haven shopping	157
Treaty shopping	159
Flipside of BEPS-style structuring	161

Part IV: Base Erosion

18. Permanent Establishment Manipulations	167
Splitting up contracts	169
Commissionaire arrangements	171
Limited attribution of profits to PEs	173
Employer of record intermediary to avoid service PE	174
Spanish Armada versus Artificial Avoidance of PE	175
19. Taxing the Cloud	179
Nexus issues of e-ticketing businesses	180
Nexus in case of e-tailing and marketplace models	183
Characterisation issues	184
New concept of Digital PE	185
20. Structuring of OTT Business	188
Validity of the model	190
Efforts to establish PE	191
21. Circumventing the Equalisation Levy	194
Old business model	195
Introduction of equalisation levy	197
New business model	199
Validity of the model	201
Google India’s AdWords program	202
Equalisation levy on e-commerce operators	204
Conclusion	205
22. Migrating HNWIs and Professionals	206
Tax advantage for HNWIs	206
Whether harmful tax practices?	210
Base erosion of professionals	213

Part V: Sham Transactions

23. Use of Third Party Intermediaries	217
Other reasons for using the modus operandi 221
Validity of the scheme	221
Orphan Trusts 221
24. Colouring Loans as Finance Lease	224
Loan simplicitor versus finance lease	224
Validity of the scheme	226
Case of Hathway Investments	227
Case of IndusInd Bank	229
Case of Avasarala Technologies	232
Structuring aircraft leases through Ireland	233
25. Employer-Employee Collusion	235
Abetment of employees’ tax fraud by employer	235
Validity of the schemes	236
Interest-free loans	237
Employee Stock Options	237
ESOP taxability for employees	238
ESOP taxability for employer	239
ESOP as a tool for artificially avoiding taxes	242
26. Tax Avoidance through Merger & Acquisition	243
Treatment of mergers under Indian Tax Laws	243
Merger between related parties	246
Validity of the modus	247
When NCLT smells something fishy in a merger proposal	248
Acquisition of loss-making company	251
Unintended consequences of Section 79	253
27. Saving on Dividend Tax	256
Treaty Shopping	258
The case of Molinos Argentina	259
Lack of beneficial ownership transparency	261
Intra-group services	261
Buy-back of shares	263
Merger and acquisition to escape DDT	265
Conversion of company into LLP	266
Payment of dividend as business expense	267
Equity recast as debt	269
28. More sham characterisations	269
The Cullen strategy	271
Use of a conduit	272
Accounting tricks	273

Part VI: Trends in Blatant Evasion

29. Shell Companies	279
A forensic auditor’s guide to shell companies	280
(a) Phony directors and phony addresses	280
(b) Incorporation in a bunch	282
(c) Unclear beneficial ownership or benami ownership	282
(d) Curious back-to-back entries in bank account	283
An evolutionary history of shell companies	283
Shell companies after 2015	289
Shell companies post 2020	292
30. Tax Evasion through Stock Exchanges	294
Bogus long-term capital gains	295
Bogus capital loss	298
Validity of the modus	299
Mixing bogus LTCG with IPO scam	300
Tax evasion through F&O Trades	301
Case of Rakhi Trading	304
31. Under-Invoicing and Over-Invoicing	308
Trade mispricing	311
Vicious cycle of Africa’s poverty	314
Butterfly effects of trade mispricing	316
32. Hawala	318
Defining Hawala	320
Hundi under the British India	329
Migration and rise of modern Hawala systems	333
Global Hawala Networks	337
Modus operandi of settlement of accounts in Global Hawala Networks	340
Trade	341
Physical movement	343
Formal channels	344
Miscellaneous methods	345
Investigating Hawala	346
33. Tax Havens	349
Top tax havens	349
The American way 351
Dubai: The Den of Smugglers 353
British spiderweb 355
Swiss Banks: Helping innocent evaders since 1815 356
Sandwich with Single Malt 358
Offshore advantage	359
Effects of Tax Havens	363
34. Exchange of tax information	366
Evading the glare of EOI	368
Challenge to India’s EOIR on bank accounts in Switzerland	369
Challenge to India’s EOIR on bank accounts in the US	370