[Opinion] GAAR vs. SAAR – The Thin Line Between Tax Avoidance and Tax Planning

Parnashree Banerjee – [2025] 175 taxmann.com 870 (Article)

1. Introduction

The debate between tax avoidance and tax planning (definitely implying to direct taxation), is as old as the legal framework regulating taxation. While tax avoidance is strategically reducing or minimising tax liability by exploiting or taking advantages of inherent loopholes in the applicable law, tax planning is the arrangement of financial activities to minimise tax incidence of a particular assessee by making use of all beneficial provisions of the law. The primary difference in tax avoidance and tax planning lies in the ‘intent’ of the taxpayer behind adopting either of the ways. Tax avoidance by leveraging legitimate tax strategies and structuring operations to maximise tax benefits, such as forming entities in tax-friendly jurisdictions or using transfer pricing strategies, wealthy assessees’ and corporate assessees’ reduce their tax burdens by way of tax avoidance. Whereas tax planning is a design to calculate the tax liability for the net taxable income, with respect to the financial activities of an assessee for a particular financial year; by an ethical, rightful as well as lawful means, which does not defeat the intent of any provisions of taxation laws.

In the landmark case of Union of India vs. Azadi Bachao Andolan, the Supreme Court of India had clearly stated that every taxpayer has the freedom to organise their financial matters in a way that maximises their benefits. The said decision was a much needed clarity that legitimised tax planning with legal sanctity, by not only following but also clarifying the ratio laid down in the landmark judgment of Mc Dowell & Co. Ltd. v. CTO that has held that

“Tax Planning may be legitimate provided it is within the framework of law. Colourable Devices cannot be part of tax planning…”

The facts and circumstances surrounding McDowell’s case make it clear that the principle established in that case does not impinge upon the freedom of citizens to conduct their affairs as they see fit, within the boundaries of the law. Citizens retain the liberty to engage in trade, activities and plan their affairs prudently, provided such actions are not deemed as a colorable device. A colourable device, essentially means a scheme or method designed to circumvent the law under the guise of legitimacy. Such devices may be described as dubious methods or subterfuges disguised with a facade of legitimacy. The McDowell’s decision thus does not curtail genuine business planning but only targeted actions aimed at exploiting legal loopholes in an impermissible manner.

Following the same stride, in the case of Vodafone International Holdings B.V. v. Union of India, the Supreme Court of India observed with nuanced clarity that:

“The contention by the department that there exists a conflict between the Azadi Bachao Andolan case (mentioned above) and the McDowell & Co. Ltd. case (also mentioned above), and that Azadi Bachao is no longer valid law, is not acceptable. While tax evasion using deceptive tactics and dubious means is not allowed, it cannot be generalised that all tax planning is illegitimate.”

These landmark decisions have thus established a well-settled legal position by reinforcing the importance of legitimate tax planning over the use of deceptive strategies for illegal tax evasion. However with the advent of time and the continuously evolving business climate globally, changing laws and rates of taxation in India, transactions designed to exploit tax laws rather than serving genuine commercial purposes was becoming rampant in the garb of legitimate tax planning. It was at this critical point that figuring out a workable legal method, judicial or statutory, that could be used to draw a line between tax avoidance and tax planning was the need of the hour. Thus the Specific Anti Avoidance Rules (SAAR) and the General Anti Avoidance Rule (GAAR) were introduced in the Income Tax Act, 1961, as potent tools to combat aggressive tax planning that are colourable and to ensure tax compliance for those who actively seek to avoid it. “SAAR” and “GAAR”, two interconnected approaches in curbing tax avoidance, yet mutually exclusive, their interplay is crucial in navigating the complex landscape of tax avoidance and tax planning, often raising questions about their overlap, application criteria and the practical implications for taxpayers and tax authorities alike. While SAAR targets specific transactions or arrangements deemed abusive, GAAR serves as a broader safeguard against arrangements lacking commercial substance primarily for obtaining tax benefits.

2. General Anti Avoidance Rule (GAAR)

GAAR didn’t just arrive in the Indian tax framework out of nowhere. It came after years of debate, frustration, high-profile disputes and growing global momentum around the idea that it was time to plug the legal leaks in tax systems that were being quietly drained by sophisticated avoidance schemes. The first time GAAR formally entered the tax conversation in India was through the Direct Taxes Code Bill of 2009. The idea behind invoking GAAR was that the government recognised that increasingly artificial arrangements were being used to shift profits and claim tax benefits in ways that were difficult to challenge under existing laws. It wasn’t until during the times of then Finance Minister Pranab Mukherjee that GAAR was actually introduced vide the Finance Bill, 2012. On enactment of the Finance Act, 2012, introduction of GAAR in India was deferred till 1st April, 2014. Introduction of GAAR was not welcomed with open arms. In fact, the announcement of GAAR caused a significant uproar. Domestic businesses were worried about uncertainty. Foreign investors were alarmed about the power it seemed to hand over to Indian tax authorities. The global financial community, already overwhelmed and intimadated about retrospective amendments in the Vodafone case, saw GAAR as another unpredictable move by the Indian government.

Amid this backlash, implementation was postponed—not once, but multiple times. On 28th June, 2012, draft GAAR Guidelines were released by the Government of India. On 13th July, 2012, an expert committee was constituted to review and rework GAAR guidelines. On 1st September, 2012, the Committee’s report was published. Finally the Finance Act, 2013 introduced GAAR in the Income Tax Act, 1961 w.e.f. 1st April, 2017, although initially it was to be effective from 1st April, 2016 which was later deferred by a year. Originally scheduled for April 2012, it was finally made effective five years later.

Chapter X-A of the Income Tax Act, 1961 includes GAAR provisions from sections 95-102, which have an overriding effect on the other provisions of the Income Tax Act, 1961. GAAR is applicable to transactions, notwithstanding any other provisions of the Income Tax Act, 1961.

GAAR applies to any arrangement that is considered an Impermissible Avoidance Arrangement (IAA). Furthermore, under its provisions certain transactions are deemed to lack commercial substance. GAAR is not merely restricted to cross-border transactions but also applies to domestic arrangements. Once the Revenue authorities decide to treat an arrangement as an IAA, the onus to prove otherwise is on assesses’. Consequently, assessees’ are required to substantiate the commercial reasons for such arrangements and that availing tax benefit was not the main purpose for these transactions. IAA applies to only those transactions where “the main purpose” is to obtain a tax benefit in addition to satisfaction of at least one of the four tainted elements tests. The four tainted element tests are:

• Creation of rights or obligations (not ordinarily implemented) between persons dealing at arm’s length.
• Results, directly or indirectly, in misuse or abuse of the provisions of the Act.
• Lacks commercial substance or is deemed to be deficient in commercial substance in whole or in part.
• Is entered or carried out in a manner not ordinarily employed for bona fide purposes.

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