There has been deep discussion and debate surrounding the proposed General Anti-Avoidance Rules ever since it was first contemplated under the Direct Taxes Code. The Income-tax Act included only Specific Anti-Avoidance Rules to counter specific misuse or abuse of the Act to avoid or reduce tax liability. After GAAR was included in Finance Bill 2012 for implementation from April 1, there were strong reactions and its implementation has been deferred by a year.
The key provisions are ambiguous. If a taxpayer enters into an arrangement — in part or whole or any step therein — to obtain a tax benefit, the arrangement may be deemed an impermissible avoidance agreement if it creates artificial rights or obligations, results directly or indirectly in the misuse or abuse of the Act, lacks commercial substance or lacks bona fides.
The ambiguity remains in the recently released draft guidelines for the implementation of GAAR. The guidelines do suggest curbs against abuse to ensure the rules are not applied indiscriminately by revenue authorities. Largely, however, the guidelines have not succeeded in providing clarity. The guidelines would be finalised after obtaining suggestions from the public and the Prime Minister’s Office.
Substance over Form
Indian courts have, over the years, laid down the general parameters and principles for categorising transactions as tax avoidance. These bright-line tests have not always been consistent. However, courts have typically frowned on cases which create artificial rights and obligations, and colourable transactions. In many cases, Vodafone for example, the Apex court concluded that the transaction was not colourable and approved it. It is likely that under GAAR, any transaction lacking commercial substance will be treated as impermissible avoidance arrangement. In other words, the ‘substance over form’ doctrine can be applied as it is now provided under law. It is important that the transactions are real and are not looked at in isolation. If a series of transactions are interposed without any commercial purpose and only to obtain a tax benefit, then GAAR can be invoked to treat them as impermissible avoidance arrangements.
The draft guidelines also provide 21 illustrations of transactions/ arrangements where the applicability of GAAR has been examined. Although the examples cover a reasonably wide range of scenarios, some lack consistency. In one such example, there is an investment with adequate manpower, capital, infrastructure and the Board meeting takes place in the outside jurisdiction. The guidelines state that under this situation, it will be seen as constituting commercial substance. However, in another example, even when there is adequate capital invested by the holding company in its subsidiary, it is clarified that GAAR would be invoked as the beneficial ownership vests with the connected company.
Divergent illustrations are likely to cause greater confusion among taxpayers and investors, and the Government needs to address this.
Telling the difference
It is important for the taxpayer to understand clearly the difference between tax avoidance, evasion and mitigation. While tax avoidance is the consequence of a series of legal arrangements that are not prohibited by law, tax evasion is the result of actions tainted by fraud, concealment, misrepresentation and illegality. As tax evasion is already prohibited under law, GAAR provisions do not deal with them. One welcome clarification relates to tax mitigation, which is a situation where the taxpayer takes advantage of a fiscal incentive afforded by tax law by adhering to the conditions and economic consequences it entails. A business undertaking set up in an SEZ is an example of this. It has been clarified that such acts of tax mitigation would not come under the GAAR scanner.
Learning from the UK
Let’s take a look at a consultation document released by the British government in June as a follow-up to an earlier Study Group Report published last November on the introduction of GAAR in that country. The document combines clarity with a collaborative approach. Clearly, those engaging in artificial and abusive avoidance schemes must be deterred. However, a well-designed legislation can be created — through collaborative consultation — to provide certainty on the tax treatment of transactions without resulting in undue costs for business and the revenue.
The consultation document also suggests setting up an advisory panel with an independent expert. There is no such independent member in the Indian panel. Moreover, the UK panel will publish opinions of the advisory panel, enabling taxpayers and professionals to calibrate their response to tax planning.
Another key advantage there is that the reference to the panel can be made either by the taxpayer or the revenue. In India, however, the reference is restricted to revenue and only at the time of assessment or during re-assessment. It would help if the panel clarifies on the applicability of GAAR before a taxpayer embarks on transactions.
While the panel’s directive is binding on revenue in India, in the UK it is proposed to provide opinions only.
Thus the use of vague terminology such as commercial substance, bona fide purpose and misuse or abuse is not helpful in providing greater clarity on GAAR in India. Even the examples do not provide conclusive information.
The Indian guidelines certainly call for a thorough review before final implementation.
M. Lakshminarayanan is a Partner with Deloitte Haskins & Sells