The courts have attempted to provide some distinction between unacceptable tax evasion and acceptable tax avoidance, which is increasingly referred to as tax planning. However, there certainly exists a grey area between legitimate tax avoidance/planning and illegal tax avoidance and the distinction has become increasingly blurred, in view of varying and often conflicting views of the courts. This leads to increase in uncertainty in the tax system, which is something businesses do not want.

To prevent aggressive tax avoidance, which the Government believes undermines the integrity and equity of the system, General Anti-avoidance Rule (GAAR) has been inserted vide Section 112 of the new Direct Taxes Code (DTC).

Proposed GAAR

The DTC has made an endeavour to eliminate the fine distinction between tax avoidance and tax evasion. The Discussion Paper prefacing DTC, released by the Government, echoes the above objective in these words: “Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues…” It is intended that the GAAR should apply to any “arrangement” entered into by a person if the same can be regarded as an “impermissible avoidance arrangement”.

The GAAR has defined a transaction as an “arrangement” to mean any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes any of the foregoing involving the alienation of property.

The expression “impermissible avoidance arrangement” has also been defined under Section 113 of the DTC to mean a step in, or a part or whole of, an arrangement, whose main purpose is to obtain a tax benefit and it,-

creates rights, or obligations, which would not normally be created between persons dealing at arm’s length;

results, directly or indirectly, in the misuse, or abuse, of the provisions of the DTC;

lacks commercial substance, in whole or in part; or

is entered into, or carried out, by means, or in a manner, which would not normally be employed for bona fide purposes.

These definitions of “arrangement” and “impermissible avoidance arrangement” are very wide and there is a genuine apprehension in the mind of the taxpayer that it might even encompass bona fide commercial transactions.

DTC seeks to empower Commissioners to declare an arrangement as impermissible if the same has been entered into with the objective of obtaining tax benefit and which lacks commercial substance. The arrangements covered by GAAR include round trip financing, lifting of corporate veil, etc.

The burden of proof has been shifted on to the taxpayer to establish that obtaining a tax benefit was not the main purpose of the arrangement, else the arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or part of the arrangement is considered to be for availment of tax benefit, regardless of the fact that the main purpose of whole arrangement may not be to obtain a tax benefit.

The DTC proposes to prescribe penalties and prosecution for non-compliance with the tax laws. Several provisions have been spelt out in the DTC which bestow tremendous powers on the revenue authorities to initiate due diligence exercise of the international transactions relating to tax offences and penalise the tax-evaders as well.

On invoking the GAAR, the Commissioner may determine the tax consequences by amending, disregarding or re-characterising the arrangement. Furthermore, the GAAR would override the applicable tax treaty and the directions of the Commissioner would be binding on the assessing officer.

Key Operational Concerns

The proposed mechanics of GAAR are riddled with difficulties; few of them are discussed herein:

GAAR would apply to certain transactions which the Commissioner presumes to be motivated by tax avoidance. The GAAR would take effect by deeming the commercial transaction to be for the main purpose of obtaining tax benefit, and it has been left to the taxpayer to demonstrate otherwise.

The Commissioner has also the powers to disregard, re-characterise, combine transaction, etc. Effectively, the Commissioner can lift the corporate veil to ascertain the “substance” of the transaction as and when desired. Therefore, instead of imparting certainty, which is one of the stated purposes behind DTC, more uncertainty would be introduced into the tax system, which will lead to further litigation.

The proposed GAAR places no burden on the revenue authorities to justify its use of the rule to impose tax where it cannot otherwise bring the taxpayer’s arrangements within the clear taxing words of the Act. The revenue authorities should be required to show, as a gateway to its imposition of tax under the GAAR, that the taxpayer’s arrangements fall within the scheme of DTC so as to prima facie give rise to a charge to tax.

Although, the introduction of GAAR is in line with the similar provisions found by several other jurisdictions in the world, for instance Canada, Australia, South Africa, and New Zealand, however, to understand the nuances, the Commissioners should be trained and have exposure to such prevailing practices in other jurisdictions.

The powers of invoking and implementing GAAR need to be moderated with suitable checks and balances to avoid its misuse and abuse. If the general anti-avoidance provisions are invoked in casual manner they would cause tremendous inconvenience and hardship to genuine and bona fide taxpayers, and undermine the confidence, faith and trust of the taxpayer in the tax administration.

Several jurisdictions have enacted a separate appeal mechanism wherein the taxpayer, who is served a notice about the invocation of GAAR, may appeal against such decision within the specified time of such notification. This not only provides an efficacious remedy but considerably reduces uncertainty. However, no such separate provisions relating to the notice and appeal is found place in the DTC.

The practical consequences of a GAAR along the lines proposed are likely to restrict the freedom of the parties to enter into commercial transactions in a tax-efficient manner.

Although, it has been explicitly provided that a transaction would fall outside of the rule if it was carried out for commercial and economic reasons, but, it is impossible for businesses to know what their tax liability is, what legal transactions are impermissible till the time the due diligence exercise is completed by the revenue authorities in respect of the transactions which have been entered into, and uncertainty creeps in with respect to the impact of GAAR and the consequences thereof.

The contours and the phraseology of GAAR induces an element of subjectivity due to the fact there is a possibility of the same being subject to different interpretation by various revenue officers, tax professionals and taxpayers.

Besides that, the legislation has been over-prescriptive as to how transactions are to be re-characterised by GAAR. It has gone beyond principles laid down in Ramsay, in as much as any step in a transaction and not the transaction as a whole can be ignored or re-characterised and applies even to transactions undertaken for bona fide business purposes, resulting in incidental tax benefit or advantages.

In light of the above key concerns, if GAAR, as prescribed under Section 112 of the DTC, is enacted, it is bound to result in great uncertainty in respect of both the domestic as well as international transactions. This may also affect the decisions of many foreign investors to invest in India.

It may be, therefore, advisable to have appeal mechanism and/or advance ruling mechanism to act as a curb on the unbridled powers given to the Commissioner to invoke GAAR. Perhaps, an authority akin to the Advance Ruling Authority (AAR), may be constituted which can be approached by the taxpayers for obtaining pre-clearance in relation to the proposed transactions, from the perspective of GAAR, which would be binding on the tax authorities.

Although constitution of a separate authority may help in avoiding long drawn and expensive litigation, it may result in delay in the fructification of commercial transactions. However, this may be a lesser evil compared to living with uncertainty till the assessment is concluded and, thereafter, going through the ordeal of time consuming and expensive litigation.

As the whole idea of revamping the DTC is to have less of litigation and more of simplification, the uncertainty cropping up due to the present form of GAAR and the discretion sans accountability provided to the Commissioners may defeat the above purpose.

It may not be a bad idea to study the experiences of other jurisdictions where the GAAR has been introduced, its effectiveness in curbing tax evasion and its impact on investment climate, before rushing in with a legislation which could be premature and ahead of its time in the case of developing economies like India.