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Are you GAAR ready?

March 16, 2017[2017] 79 taxmann.com 161 (Article)
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Introduction

1. After a five year long wait the Government is now empowered to examine a taxpayer's arrangements for accordance of tax laws. It is intriguing to note that these new set of rules could have far reaching consequences. The myth that General Anti-Avoidance Rules (GAAR) should normally apply only to structuring arrangements needs to be busted. This article navigates though the GAAR provisions in a lucid manner and explains how this could impact every business.

General Anti-Avoidance Rules: An introduction

2. Simply put, GAAR empowers the tax officer to review an arrangement entered into by the tax payer. On review, if the tax officer believes that the arrangement has been entered into for obtaining a tax benefit he/she can declare the transaction to be "impermissible avoidance arrangement".

There are following four principles under which the tax officer can test as to whether the transaction is an impermissible avoidance arrangement:

  creates rights, or obligations, which are not ordinarily created between persons dealing at arm's length;
  results in directly or indirectly, in the misuse, or abuse of the provisions of this Act;
  lacks commercial substance or is deemed to lack commercial substance in whole or in part; or
  is entered into, or carried out by means or in a manner, which is not ordinarily employed for bona fide purposes.

In the event a transaction falls into any one of the above categories then GAAR kicks in. There is also further guidance on what is commercial substance. These four principles are so broad based that they cover good ground on what is GAAR able.

Whom does it apply to?

3. It applies to all! Individuals, Hindu Undivided Families (HUF), Trusts, Partnership Firms, Limited Liability Partnership (LLP), and, of course, to corporate taxpayers. There is a threshold of INR 30 million prescribed and only when this is breached the tax officer can take action.

International tax practice

4. There is a growing concern amongst the revenue offices in many countries that taxpayers structure transactions to reduce the tax costs. The Base Erosion and Profits Shifting (BEPS) project of the Organization for Economic Cooperation and Development ("OECD") seeks to tackle this issue.

The BEPS Action plans have come out with various recommendations on the issue, both to address it within the international treaty framework (for example, introducing the principle purpose test, limitation of benefits clause, amending the permanent establishment clause, etc.) and in the domestic tax law context (for example, controlled foreign corporation rules, equalization levy, etc.).

Many countries have also implemented General Anti-Avoidance Rules in their domestic tax laws: United Kingdom, China, South Africa, Australia, Canada, Brazil.

GAAR: The Indian anti-abuse provisions

5. The reality of the GAAR provision is that the canvas is larger than one would have thought. A routine transaction that a company is executing could come under the GAAR scanner. Let us review a few situations to understand whether GAAR could be triggered?

  Investing in India, using an intermediary holding jurisdiction, which has a lower tax rate than India. Today, with the amendment of tax treaties with Singapore, Mauritius and Cyprus, the existing investments are grandfathered. Hence, going forward, an investor may not avail of any significant advantages from an India perspective for such investment. However, if he invests using these jurisdictions for other reasons (say, ease of parking funds) this technically cannot be questioned under GAAR.
  If a company chooses to repatriate profits via buyback instead of repatriating via a dividend route, can that be questioned by tax office for GAAR? The effective tax rate of repatriating profits via a dividend route is different from a repatriation using a buyback. It also depends on the residential status and the person to whom the profits are distributed. In these cases, can the tax officer use the GAAR powers to ensure that the taxpayer pays tax at the highest level in each scenario by re-characterizing?
  In a merger exercise, the Court approves of a merger scheme. A merger can be executed for various reasons. If one of the steps or a part in a merger results in a tax benefit to the taxpayer, can the tax authorities test the commercial substance of the merger? The immediate answer is that yes, it can be invoked. However, the CBDT has clarified that where tax aspects of the scheme are explicitly and adequately considered by the Court, GAAR will not apply to such an arrangement.
  The drive to execute transactions at fair market value. Many of the amendments proposed vide Budget 2017, also drive towards a fair value based method of executing transactions. For instance, transfer of shares of an unlisted private company at a value lower than fair market value was taxable as income from other sources in the hands of the recipient of such shares. Going forward, the transferor can also be subject to capital gains. There are two levels of taxes on the same transaction. Does it mean that we are driving to a system where everything necessarily has to be done at fair market value in order to avoid multiple level of tax costs?

Conclusion

Although clarification has been issued on many matters, yet there are a few technical nuances that will need to be tested in practice, like the example on "expressly and adequately" considered by the Court in a merger/demerger scheme. It will be prudent for companies to immediately review their transactions, even if it is routine and take an informed call on whether GAAR can be invoked? Else, after consumption of a transaction, a taxpayer would not want to be in a position with litigation and additional tax costs which were not budgeted for.

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