General Anti-Avoidance Rules may sail through

With the proposed Direct Taxes Code (DTC) likely to miss its kick-start date of April 1, all eyes are on the Budget 2012 and the proposals which it is likely to make to further the cause of tax reforms.

The Finance Minister has his task cut out of striking the right balance between the need to generate tax revenues on one hand and revive dwindling economy on the other. With the recent trends indicating an aggressive approach by the Government in tackling tax avoidance, anti-abuse proposals may steal this year's show. Few of such measures, already proposed under the DTC, but which the Government may not be keen to defer till the DTC comes into effect, may find a place in the Budget.

Although the Government has filed a review petition in the Supreme Court against the ruling in the case of Vodafone, it may not like to wait for its outcome without doing anything further.

Certainty and stability

The Court had observed that certainty and stability form the basic foundation of any fiscal system and that concepts such as ‘limitation of benefits' and ‘look through' are matters of policy. It added that it is for the Government of the day to have them incorporated into the tax laws. One may expect the Budget to take a cue from this and bring in proposals empowering the tax authority to ‘look through' a transaction to identify its substance over form and characterise the transaction accordingly for tax purposes.

One such proposal could be the General Anti Avoidance Rules (GAAR) to deal with aggressive tax planning devices used to circumvent tax laws. Already proposed in the DTC, these may find their way into the Budget, with or without modifications, at one go or in phases.

In its present form, GAAR provides sweeping powers to the tax authority to brand any arrangement entered into by a person (not necessarily entered into after GAAR becomes effective) as an impermissible avoidance arrangement and re-characterise it according to its substance, if its main purpose is to obtain a tax benefit and it lacks commercial substance. It is for the taxpayer to prove otherwise.

Capitalisation rules

The Budget may also provide for thin capitalisation rules. It is worthwhile to note that according to a press report this is one of the proposals which is under significant consideration by the Parliamentary Standing Committee examining the DTC.

The DTC proposal to tax indirect transfer of capital asset by non-residents is generally expected to find place in this Budget which would make sure that the tax authority no longer takes the tax hit in ‘Vodafone-type' transactions. One would hope that these proposals will only have prospective effect.

As a further fallout of the Vodafone episode, one may see expansion of capital gains tax to cover transfer of certain contractual rights emanating from a Share Purchase Agreement, such as put and call options, right of first refusal, etc, and widening the scope of tax withholding provisions to include offshore transactions between two non-residents.

Tackling price manipulation amongst associated enterprises is a priority area for the Government. The Budget may expand the reach of transfer pricing provisions to certain domestic transactions as well, apart from introducing proposals to meet the challenges of the growing intangible economy and various complex cost-sharing arrangements. The Budget may also make provisions for Advance Pricing Arrangements which are already proposed in the DTC.

Extension of tax benefit

Apart from this, the industry may desire the Budget to address certain other issues, such as extension of tax benefits in respect of expenditure incurred on scientific research on approved in-house R&D facility beyond March 31, restoration of tax benefits hitherto available to the SEZ sector, limited extension of tax holiday to units in the power industry, restoration of exemption from MAT in respect of certain critical infrastructure businesses and widening of scope of investment-linked and/or profit-linked tax holidays for new businesses related to the infrastructure sector.

One can, therefore, expect the Budget to address areas that need urgent attention, with a focus on widening the tax ambit and plugging tax avoidance, especially in the context of transactions involving foreign entities. One would, however, have to wait and watch to know what the Budget will ultimately offer various stakeholders.

(The author is Tax Partner, Ernst & Young)

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