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The Finance Bill, 2012, has fast-forwarded the General Anti-Avoidance Rules (Gaar) provisions from the Direct Taxes Code (DTC) and made them effective April 1, 2012.
The avowed objective of the Gaar provisions is to codify the doctrine of 'substance over form' where the real intention of the parties and purpose of an arrangement is taken into account for determining the tax consequences, irrespective of the legal structure of the concerned transaction or arrangement.
It essentially comes into effect where an arrangement is entered into with the main purpose or one of the main purposes of obtaining a tax benefit and which also satisfies at least one of the following four tests:
(a) the arrangement creates rights and obligations that are not at arm's length,
(b) it results in misuse or abuse of provisions of tax laws,
(c) lacks commercial substance or is deemed to lack commercial substance, or
(d) it is not carried out in a bona fide manner.
Thus, if the tax officer believes that the main purpose or one of the main purposes of an arrangement is to obtain a tax benefit and even if one of the above four tests are satisfied, he has powers to declare it as an impermissible avoidance arrangement and recharacterise the entire transaction in a manner that is more conducive to maximising tax revenues.
There are many troubling aspects of this provision that will make doing business in India even more challenging, than what it already is from a tax perspective. What are the issues?
It is presumed that obtaining tax benefit is the main purpose of the arrangement unless otherwise proved by the taxpayer. This is an onerous burden that under a fair rule of law should be discharged by revenue and not the taxpayer.
In fact, the Parliamentary Standing Committee on DTC has specifically recommended that the onus of proving the existence of a tax-avoidance motive and a transaction lacking commercial substance should rest with the revenue invoking Gaar and not shifted to the taxpayer.
This is essentially to ensure that the revenue authorities exercise proper discretion, proper application of mind and gather enough credible data and evidence before attempting to invoke far-reaching provisions such as Gaar.
An arrangement will be deemed to lack commercial substance under Gaar if it involves the location of an asset or of a transaction or of the place of residence of any party that would not have been so located for any substantial commercial purpose other than obtaining tax benefit.
This again is an amazingly wide provision that provides a great weapon in the armoury of the tax authorities to challenge almost every inbound or outbound transaction with respect to India, made through any of the favourable tax treaties that India has entered into.
In fact, in one of the replies by the finance ministry to the Standing Committee on DTC, it has made it clear that "the Gaar provisions with check treaty shopping by the taxpayer for avoidance of payment of tax in India".
Therefore, will revenue authorities from now onwards seek to question for inbound investments made from Mauritius or Singapore? It must be noted that under the prevailing laws of Mauritius and Singapore, there are enough commercial requirements that have been provided for, and if the taxpayer in India is required to once again demonstrate 'substantial commercial purpose' for the investment, it gives rise to considerable uncertainty in respect of such transactions.
Again, the Parliamentary Standing Committee on DTC has specifically noted that the tax treaty override (without any objective parameters under Gaar) could raise concerns about the certainty of benefits conferred under the treaties and affect India's credibility as a reliable treaty partner.
Hence, tax treaty provisions should be made to prevail over Gaar to provide for this certainty. Similarly, the flexibility of Indian multinationals to organise their businesses outside of India through overseas holding companies may get impaired due to this requirement under Gaar and, to that extent, make Indian MNCs less competitive than MNCs from other countries.