The GAAR conundrum

Updated on: Apr 27, 2012
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General Anti Avoidance Rules use four basic conditions to arrive at the conclusion of impermissibility.

A Netherlands company invested in an Indian company through the Mauritius route a couple of years ago to avail the double taxation avoidance agreement treaty benefits on capital gains tax. It is in the process of investing in another infrastructure venture in India.

While the investment through Mauritius was a proven strategy for the company as in the case of most other foreign institutional investors, the recent Budget proposals necessitate a reconsideration of its investment planning. It is pertinent to note here that Mauritius has been the single largest investment route to India for most of the last 15 years to avoid capital gains tax in India.

It would be relevant to look into the details of the recent Vodafone judgment of the Supreme Court as well as the introduction of GAAR vis-à-vis investment decision. The tax authorities, in the case of Vodafone, decided that gains arising to a foreign company from sale of shares of foreign holding company indirectly holding Indian assets to another foreign company were subject to tax.

Recently, the Supreme Court held that for a transaction of sale of capital asset to be taxable in India, the capital asset ought to be situated in India, and there should have been transfer of the asset.

To get around this decision, the Finance Bill proposed clarificatory amendments in the definition of ‘capital assets,' ‘transfer,' ‘deemed income,' in Sections 2(14), 2(47), 9(1), etc, such that that any transfer of asset outside India which has underlying value in India will be subject to taxes in India retrospectively. These amendments need to be analysed along with the proposed provisions of GAAR (General Anti-Avoidance Rules) which further tighten the rope.


Australia first introduced GAAR way back in 1981. Countries such as Germany, France, followed suit. The UK and the US have shown more caution in their approach to GAAR. Implementation in the UK is backed by more of a ‘let the courts decide' kind of attitude.

GAAR empower revenue authorities to deny tax benefits arising out of an arrangement which does not have commercial substance. The ‘form over substance' theory underlines the requirement that any arrangement must have a commercial purpose/substance and should not be merely an instrument that reaps tax benefits.

So how is an arrangement concluded to be impermissible under GAAR? GAAR use four basic conditions or critical tests to arrive at the conclusion of impermissibility. Any arrangement would be considered impermissible if it creates rights/obligations which would not be created if the transaction was implemented at arm's length; the arrangement results in misuse or abuse of the code; lacks commercial substance; and is carried out by means not adopted for bona fide purposes. These conditions form the tests failing any one of which could make an arrangement impermissible.

The assessing officer can make a reference to the commissioner for invoking GAAR, and on receipt of reference the commissioner will give an opportunity of hearing to the taxpayer. If he is not satisfied with the reply of the taxpayer, the matter will be referred to an approving panel consisting of three members who can decide on whether an arrangement is impermissible and the arrangement would then be disregarded to deny tax benefits. Additionally to check abuse of treaty provisions, a treaty override has been provided when transactions are subject to GAAR.

The conditions/tests are wide as well as vague and could lead to inappropriate use of the provisions. The extent to which GAAR can be invoked include questioning even the salary structure of employees' compensation packages. The onus lies on the taxpayer to prove that there is no tax benefit and the transaction is not an avoidance transaction. Every taxpayer is entitled to a measure of tax avoidance wherein he can regulate his tax affairs so as to minimise overall effective tax rate, but evasion which is construed to be illegal in any part of the world is usually dealt with vigorously by the tax authorities.

While the intention of the Government in tax legislation is laudable, unless the anomalies are addressed from inception and a proper road map is laid for fair implementation and governance, increased and protracted litigations cannot be avoided. Litigations increase the cost of tax collection and would negate the canon of economy.

Considering these facts in the background, the Netherlands company needs to plan its strategy as the foreign direct investment coming to India through Mauritius without “substantial commercial presence” will be subject to capital gains tax in India.

An economics professor was succinct when he said that the difference between tax evasion and tax avoidance was “seven years in jail.” One hopes a hurried implementation of GAAR will not serve to wipe out that difference.

(The author is a Coimbatore-based chartered accountant.)

Published on November 15, 2017

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