The proposed General Anti-Avoidance Rules (GAAR) in the Finance Bill 2012 is essentially the Government's response to aggressive tax-planning arrangements. Tax planning versus tax avoidance has always been a matter of debate, with the recent Vodafone ruling by the Apex Court also supporting the taxpayer's right to plan for taxes.

GAAR, in its proposed form, provide revenue authorities sweeping powers to declare an arrangement as ‘impermissible avoidance agreement' where the main purpose or one of the main purposes is to obtain tax benefit and the transaction inter alia lacks commercial substance or results directly or indirectly in the misuse or abuse of the tax law. The proposed provisions essentially borrow from known principles such as lifting of the corporative veil, the substance over form test and thin capitalisation rules.

Countries such as Australia, Canada and South Africa have codified GAAR as part of the domestic legislation and India appears to have drawn from such countries' experiences with some modifications. As with most new legislation, there are some open issues with GAAR as well.

First, and most important, for the revenue authorities to be perceived as fair, the burden of proof should be on them to establish, with facts, why the transaction attracts GAAR. Instead, and contrary to the recommendations of the Standing Committee on DTC, the Finance Bill puts the onus on the taxpayer to demonstrate that the transaction is not primarily for tax benefit. This will create a lot of uncertainty and could potentially lead to a dangerous trend of the Revenue questioning almost every transaction that results in tax saving.

Second, the measure of judging a transaction as ‘impermissible' is subjective and the condition of “tax benefit being the main purpose or one of the main purposes” could ring in every corporate action. After all, corporate actions could not be so undertaken as to yield maximum tax liability!

The Mauritius factor

The other important feature is the stated treaty-override effect of invoking GAAR. Internationally, investments are structured through holding-company jurisdictions, and India, in particular, has seen the extensive use of Mauritius as the intermediate jurisdiction through which inbound investments are made. Similarly, outbound investments are also increasingly made through such intermediate jurisdictions, including Mauritius. The India-Mauritius Treaty does provide certain benefits on account of the capital gains tax exemption in India. Would GAAR completely take the sheen out of such Mauritius structures? Is it fair to unilaterally annul benefits conferred under a bilateral Tax Treaty?

Interestingly, the Supreme Court had in the Azadi Bachao Andolan case endorsed tax planning through the use of Mauritius as an investment holding jurisdiction in the absence of express anti-avoidance or Limitation of Benefits provisions under the India-Mauritius Treaty. This position was reaffirmed by the Supreme Court in Vodafone, provided the corporate structure is genuine.

The next question is: what provides adequate commercial substance? Given the far-reaching powers and consequences of invoking GAAR, it is imperative that objective rules are laid down on what the Government believes as adequate. It is expected that the Central Board of Direct Taxes would lay down guidelines to bring clarity on certain aspects of GAAR and set out objective conditions for its fair implementation. Taxpayers will find respite if the minimum threshold of tax benefit that attracts GAAR is specified.

It is imperative that the administrative machinery for the implementation of GAAR is objective and the wide powers granted should not be wielded with the sole objective of garnering higher revenue collections. GAAR must necessarily be administered transparently and with abundant prudence, in order to ensure it does not act as a deterrent to foreign investment.

(The author is Associate Director – Tax practice, Ernst & Young.)

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