General Anti-Avoidance Rules (GAAR) found their place for the first time in the draft Direct Taxes Code in 2009. Thereafter, a modified version formed part of the Direct Taxes Code Bill, 2010.
GAAR was statutorily introduced by the Finance Act 2012, to be effective from April 1, 2013.
GAAR received a poor response from investors and taxpayers, who feared that its provisions were too wide and gave unbridled powers to tax authorities, who may disregard existing arrangements, leading to possible harassment and litigation.
Prime Minister Manmohan Singh constituted an expert committee led by Parthasarathi Shome to finalise the guidelines on GAAR after taking into account stakeholders’ views. The panel has come up with some well thought-out recommendations.
One significant recommendation relates to differentiating between tax mitigation, tax avoidance, and tax evasion — there is a thin, but important line between the concepts.
Tax mitigation is understood as a taxpayer’s act of using a fiscal incentive available under tax laws — such as, setting up a business undertaking in a Special Economic Zone to take advantage of a fiscal incentive.
The committee recommends that GAAR cannot be invoked in tax-mitigating situations. It has recommended an illustrative negative list for GAAR invocation, such as:
Selection of one of the options offered in law — for instance, payment of dividend or buyback of shares; setting up a branch or a subsidiary; or funding through debt or equity.
Amalgamations and demergers as approved by the High Court.
Tax avoidance is not defined in taxing statutes — it constitutes taxpayers’ actions that are neither illegal nor forbidden by law. Taxpayers consider it their legitimate right to arrange their affairs in such a manner that they need to pay the least possible tax.
The committee recommends that GAAR should be applicable to certain cases of tax avoidance that are abusive, artificial and contrived. The ‘substance over form’ doctrine — where the law is followed in form but not in spirit, resulting in unintended consequences — has been recommended while invoking GAAR.
Importantly, the committee has sought to allay taxpayers’ fears by specifying that GAAR should be invoked only if the main purpose of arrangement is to obtain tax benefit [and not if ‘one of the main purposes’ was so].
Tax evasion is unlawful and is the result of illegality, suppression, misrepresentation and fraud, which are dealt with separately by law.
Taking into account the Supreme Court’s observations in the Vodafone case, the committee has recommended that factors such as the period for which the operations exist, payment of taxes, and whether an exit route is provided by the arrangement may not be sufficient (instead of being totally irrelevant as provided in Section 97 of the Act) to exclude an arrangement from the commercial substance test. It may, however, be relevant in the consideration of other aspects of GAAR.
The panel also recommended grandfathering all investments made and existing on the commencement date of GAAR (‘Grandfathering’ refers to a situation whereby the provisions of new laws will not be applicable to past transactions, but only to fresh transactions).
With this, investors and existing taxpayers can be pretty sure that on exit they will not be subject to GAAR for the existing investments.
The differentiation of transactions for the applicability of GAAR will restore investors’ faith in India, and the implementation of GAAR under such circumstances would ease the Government’s burden. However, it now depends on the spirit in which the Government accepts the recommendations.
Anju Dodeja, Manager, contributed to the article
Sandeep Chaufla is Executive Director Direct Tax, PwC India.