Tax landscape has changed forever

Not many thought the General Anti-Avoidance Rule would be introduced in Budget 2012, especially as this was supposed to be the last budget before the Direct Tax Code is rolled out and no major changes were expected; even the standing committee on DTC had not yet made its recommendations to the Finance Minister.

Naturally, the introduction of GAAR was greeted with shock and fear by various stakeholders. Moreover, additional factors such as retrospective amendments and the current economic environment have added to the worries.

Following representations to the Government on the potential fallout of these provisions, the matter has been deferred to FY 2013-14. In the meantime, a committee has been constituted to frame rules and guidelines for the implementation of GAAR and it will submit its report by May 31. It is worth noting that Finance Minister Mr Pranab Mukherjee, in his opening remarks on the discussion on Finance Bill 2012, indicated material changes in GAAR on these lines:

Onus of proof has been shifted to revenue instead of taxpayer;

Induction of an independent member in the rank of joint secretary or above from the Law Ministry on the GAAR panel to bring in objectivity and transparency;

Advance ruling would be permitted to determine whether a particular arrangement/ transaction will attract GAAR or not.

Do the above measures help remove the unease over GAAR? Although they provide temporary relief to taxpayers, in practice, however, the commercial substance of a transaction has gained more traction than before. Let us look at some recent rulings where tax arrangements have been looked into rather than taken on face value to determine the true intent of the transactions.

In a recent case, the Authority for Advance Rulings had held that as the company had not declared dividend since April 2003, the buyback of shares by the Mauritius company that will not be liable for capital gains tax under the India-Mauritius treaty is nothing but a colourable device to avoid tax. In a nutshell, the buyback of shares was re-characterised as a dividend and liable for tax in India.

In another ruling, the AAR lifted the corporate veil to disregard two legal entities (holding and subsidiary company) and treated them as one. This was primarily because the power vested in the holding company to manage the affairs of the subsidiary company exceeded its rights as a shareholder of the company. In the same ruling on the sale of Compulsory Convertible Debentures, any realisation exceeding the face value of the CCD has been treated as interest instead of capital gain. This was on account of a pre-agreed arrangement in which the investor was entitled to a specific rate of return on investment and, therefore, the instrument to an extent did not carry the risk element of equity investment.

Going by the recent rulings and the tax department's attempt to dissect the entire arrangement to find the true meaning, it appears that the mere form of transaction on face value may not cut ice with the authorities. In the past too, the judiciary has looked at the substance in certain transactions and applied the principles emanated from McDowell's ruling; therefore, there may be nothing new in the above rulings, which may not necessarily be adopted across the board for all transactions. Nevertheless, the timing of the rulings and the current tax environment signifies that, going forward, the commercial justification and implementation of transactions would be critical to minimise differences of opinion with tax authorities.

While we await the detailed rules for GAAR, there will continue to be speculation on when and how GAAR will be implemented, or even whether it will be implemented at all. In the midst of this turbulence, thinking will veer towards whether one should take advantage of the cooling period/ deferment to reorganise business affairs and become better prepared for GAAR, or is it more advisable to wait and watch. While this cooling period appears to be a final chance, any related reorganisation will require sensitive navigation and careful assessment of the risks and rewards involved.

As we continuously track developments, the last few months have made one thing clear — the tax landscape in India has changed forever; there is greater global integration and a swift shift towards substance over form. Even without GAAR, any tax planning without adequate substance and commercial rationale will carry its own set of enhanced risks.

Girish Vanvari is Partner and Alok Mundra is Director, KPMG

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