Deloitte - General Anti-Avoidance Rules

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					    General Anti-Avoidance Rules
    India and International perspective

Executive summary                      4
Pre GAAR concept                       6
Pre GAAR concept – India experience    8
GAAR concept                          10
International experience              11
India Regime                          17
Way forward                           23

                                           General Anti-Avoidance Rules India and International perspective   3
Executive summary

“Tax avoidance like tax evasion, seriously
undermines the achievements of the public
finance objective of collecting revenues in an
efficient, equitable and effective manner1.”
                                 Internationally, tax avoidance has been recognized as an    provision may undermine the common denominator
                                 area of concern and several countries have expressed        in determination of a tax avoidance scheme, i.e., the
                                 concern over tax evasion and avoidance. This is also        principle that though the taxpayer is free to choose the
                                 evident from the fact that either nations are legislating   most tax efficient method, the commercial justification
                                 the doctrine of General Anti-Avoidance Regulations in       for the choice taken and tax consideration (benefit) is
                                 their tax code or strengthening their existing code.        not the only reason.

                                 In India, the proposed Direct Tax Code 2010 (DTC            Considering the goals of tax avoidance legislation,
                                 2010 or Code) seeks to address the issues relating          namely, deferral, re-characterization, elimination and
                                 to tax avoidance and evasion by bringing in General         shifting, India would need to address the issue in the
                                 Anti-Avoidance Rules (GAAR) in addition to various          proper perspective so that the provisions and their
                                 transaction-specific Special Anti-Avoidance provisions.     implementation do not become a law onto themselves.
                                                                                             In the circumstances, one should be aware of some
                                 The Discussion paper issued along with the proposed         issues relating to the promulgation of a General Anti-
                                 new tax code states that tax avoidance arrangements         Avoidance Rule, in terms of it being receptive to:
                                 adopted by taxpayers span across several tax
                                 jurisdictions, and it is desirable to introduce GAAR that   •	 Providing	a	robust	framework	based	on	sound	legal	
                                 would serve as a deterrent to the use of increasingly          jurisprudence and principles to address the issue
                                 sophisticated forms of tax avoidance by taxpayers.             of abusive transactions, which tend to ride on the
                                 The paper also states that the appellate authorities           shortcomings of the tax system. As indicated by
                                 and Courts have cast a heavy onus on the revenue               many international tax theorists and practitioners,
                                 authorities for dealing with matters of tax avoidance,         the design of GAAR should be by reference to ‘busi-
                                 especially when the relevant facts are in the exclusive        ness-purpose test’ with emphasis on the different
                                 knowledge of the taxpayer who chooses not to reveal            concepts of the economic substance associated with
                                 them.                                                          the categories of tax avoidance behavior, such as
                                                                                                tax evasion, acceptable tax avoidance and abusive
                                 The introduction of GAAR regulation recognizes that it         tax avoidance rather than narrow the scope to the
                                 may not always be feasible for the judiciary to address        aspect of a tax benefit test.
                                 the unforeseen implications of transactions carried out     •	 Incorporate	a	substance	over	form	rule	where	a	
                                 for tax purposes and also the need to provide some             transaction or a series of transactions are entered
                                 semblance on the matter of tax avoidance. However,             into to judge the authenticity and purpose of the
                                 where tax benefit is to be considered as the sole              transaction rather than teleologically apply the tax
1   Discussion paper on Direct
                                 criterion (as is currently recognized under the proposed       benefit provision, surpassing all other aspects of the
    Taxes Code 2009              new Code) for determining tax avoidance, such a                transaction.

•	 The	issue	of	bilateral	tax	treaty	override	by	way	of	      This paper outlines some of the nuances relating to
   bringing the same under the relevant treaties in           General Anti-Avoidance Rule by examining the historical
   terms of limitation of benefits clause. In the absence     perspective for tax avoidance generally and in India. The
   of the same, it may result in violation of international   concept of GAAR, international experience on GAAR
   principles of treaty interpretation.                       legislation in some jurisdictions, the proposed provisions
•	 Striking	a	balance	between	wide	coverage	and	              under the Direct Tax Code followed by a comparison
   uncertainty – it is imperative that the Government         with other countries, few instances on the applicability
   issues detailed guidelines on inherent principles and      of the GAAR provisions, and the way forward for both
   on the type of transactions/arrangements they may          the authorities and the taxpayers have been covered in
   consider as ‘avoidable transaction’. A mechanism           the paper.
   similar to an advance ruling may be considered to
   avoid uncertainty, protracted litigation and disputes.

                                                                                         General Anti-Avoidance Rules India and International perspective   5
Pre GAAR concept

Internationally and in India, a constant debate has          ‘Legal substance’ would refer to characterization which           2   Carter Commission in
been raging over the issue of tax avoidance. Over            emerges from a close study of the rights and obligations
                                                                                                                               3   Lord Nolan in IRC v.
the years, the term ‘tax avoidance’ has come to be           in a legal relation whereas ‘Economic substance’ has
understood as arranging affairs with the main object         different interpretations as propounded by various
                                                                                                                               4   Lord Templeman
or purpose of obtaining tax advantage while prima            jurisdictions:                                                    5   Simon in Latilla v. I.R.C. (11
facie fully intending to comply with the law in such         •	 ‘Real	economic	substance’	–	This	is	the	American	                  ITR Suppl. 78, 79) (HL)
respect. Some principles underlying the meaning of               notion under which the Economic substance
‘tax avoidance’ are:                                             is determined by looking at both objective and
                                                                 subjective factors to see if there is any potential
•	 The	expression	‘tax	avoidance’	is	used	to	describe	           for profit other than tax savings, or if there is any
   every attempt by legal means to prevent or reduce             meaningful change in the economic position of the
   tax liability, which would be otherwise incurred,             taxpayer. Under this doctrine, a transaction lacking
   by taking advantage of some provision or lack of              economic substance will be ignored. In Gregory
   provision in the law. It pre supposes the existence           vs Helverig (1934) - US, the Court outlined that
   of alternatives, one of which would result in less            “it does not follow that Congress meant to cover
   tax than the other. Moreover, motive would be an              such a transaction. The meaning of a sentence
   essential element of tax avoidance. A person who              may be more than that of the separate words, as
   adopts one of the several possible courses to save tax        a melody is more than the notes, and no degree of
   must be distinguished from a taxpayer who adopts              particularity can ever obviate recourse to the setting
   the same course for business or personal reasons2.            in which all appear, and which all collectively create.
•	 A	course	of	action	designed	to	conflict	with	or	defeat	       If what was done here was what was intended by
   the	evident	intention	of	Parliament3.                         [the statute], it is of no consequence that it was all
•	 Where	it	reduces	the	incidence	of	tax	borne	by	an	            an elaborate scheme to get rid of income tax, as it
   individual taxpayer contrary to the intentions of             certainly was… [But] the purpose of the section is
   Parliament4.                                                  plain enough; men engaged in enterprises… might
•	 Tax	planning	may	be	legitimate,	provided	it	is	within	        wish to consolidate, or divide, to add to, or subtract
   the framework of law. Colorable devices cannot be             from, their holdings. Such transactions were not to
   part of tax planning and it is wrong to encourage or          be considered as realizing any profit, because the
   entertain the belief that it is honorable to avoid the        collective interests still remained in solution.
   payment of tax by resorting to dubious methods. It
   is the obligation of every citizen to pay their taxes        In other words, the benefit of the objective tax result
   honestly without resorting to subterfuges5.                  would be denied, where the transaction did not
•	 Further,	Courts	in	India	have	broadly	indicated	             change the economic position, apart from the tax
   that if some device has been used by a taxpayer to           benefit, nor did it reflect any facet of the business,
   conceal the true nature of the transaction, it is the        which could be considered as lacking economic
   duty of the taxing authority to unravel the device           substance, and was not “the thing which the statute
   and determine its true character. However, the legal         intended”.”
   effect of the transaction cannot be displaced by
   probing into the ‘substance of the transaction’.          •	 Step	Transaction	plus	business	purpose	–	This	UK	
                                                                version combines step transactions doctrine and
Considering these continuing difficulties of classifying        business purpose doctrine and enables the courts to
transactions as being acceptable within the framework           overlook the step transactions that serve no business
of law or not, a need is being felt to move towards a           purpose. This could be evolved from the various
structured approach to address the issue of avoidance           juridical	pronouncements	made	by	the	UK	courts	with	
both from a legal and economic point.                           regard to transaction considered as entered into with
                                                                the objective of tax avoidance.
Thus, ‘tax avoidance’ could be said to transact between
substance over form of a transaction, the issue being of        In	Duke	of	Westminster	vs	IRC,	their	Lordships	held	that	
whether it is legal or economic substance.                      the Act is to receive a strict or literal interpretation and

   that a transaction is to be judged not by its economic
   or commercial substance but by its legal form.

   In Ramsay vs IRC, their Lordships watered down
   the economic substance theory on the ground
   that it could be invoked only when the purposive              Further,	the	OECD	leaves	it	to	the	individual	countries	
   interpretation approach is adopted. The principle             to introduce anti-abuse legislation, which they consider
   outlined herein came to be considered as a general            could be applied without interference by the Model
   rule of statutory construction, not a separate judicial       Convention or the bi-lateral tax treaty between the
   doctrine.                                                     countries inter-se. However, the OECD Commentary on
                                                                 Article 1 of the Model Tax Convention also clarifies that
The common denominator which can be found in most                a general anti-abuse provision in the domestic law in
countries is that if a taxpayer has multiple avenues             the nature of ‘substance over form rule’ or ‘economic
available to structure his transaction, he is free to            substance	rule’	would	not	be	in	conflict	with	the	treaty.	
choose the most tax-efficient avenue, provided a level           In other words, the general anti-abuse rule would
of commercial justification for the same exists, and tax is      override the provisions of the tax treaty.
not the only reason.
                                                                 Hence, the underlying principle emanating from
In respect of international recognition to the concept,          international experience in respect of tax avoidance and
the Vienna Convention provides that international                where GAAR legislation has not been enacted is the
agreements are to be interpreted in ‘good faith’. In case        recognition that the contentious issue of determining/
any international agreement/treaty leads to unintended           establishing the doctrine of substance over form would
consequences	like	tax	evasion	or	flow	of	benefits	to	            have to be established through an examination of the
unintended person, it is open to the signatory to take           legal substance, the legal form, or the real economic
corrective steps to prevent abuse of the treaty. Such            substance of the transaction. This has also been duly
corrective steps are consistent with the obligations             adapted under Indian jurisprudence as outlined in the
under the Vienna Convention.                                     section below.

                                                              General Anti-Avoidance Rules India and International perspective   7
Pre GAAR concept
India experience

6   CIT v. A. Raman and Co,      Indian tax laws, though providing for specific anti-          Westminster,	and	took	the	view	that	tax	planning	was	
    [1968] 67 ITR 11 (SC)
                                 avoidance measures, do not have any general anti-             legitimate so long as it was strictly within the four corners
7	 	 ank	of	Chettinad	Ltd.	v.	
                                 avoidance rules or regulations. The Courts have over the      of the law and any ‘colorable’ device or dubious methods
   CIT	[1940]	8	ITR	522	(PC)
                                 years drawn out the general parameters and principles         to minimize tax incidence were not legally permissible.
8   McDowell and Co. Ltd. v.
    Commercial Tax Officer,      in outlining whether a transaction or scheme would be
    [1985]154 ITR 148 (SC)       considered as tax avoidance/tax evasion or tax planning       It appears that there is no single approach towards the
9   Union of India v. Azadi      under the tax laws, as outlined below, though the             issue of substance over form. A clear tendency exists
    Bachao	Andolan,	[2003]	
    263 ITR 706 (SC)
                                 uncertainty continues.                                        for Revenue authorities to try and counter any kind of
                                                                                               undesired outcome (in their eyes) of a certain piece of
                                 The Hon’ble Supreme Court (SC) in A Raman’s case6             legislation by applying the substance over form doctrine.
                                 observed that:                                                However, while examining a legally valid transaction, the
                                 “...the law does not oblige a trader to make the maximum      Revenue authorities should proceed objectively and not
                                 profit that he can get out of his trading transactions.       hypothetically attribute ‘motives’ behind the taxpayer’s
                                 Income which accrues to a trader is taxable in his hands.     action.
                                 Income which he could have, but has not earned, is not
                                 made taxable as income accrued to him. Avoidance              We	have	witnessed	a	contentious	journey	for	
                                 of tax liability by so arranging commercial affairs that      determining whether the affairs planned by the taxpayer
                                 charge of tax is distributed is not prohibited. A taxpayer    were legitimate to be strictly within the four corners of
                                 may resort to a device to divert the income before it         the law or was a colorable device or dubious method
                                 accrues or arises to him. Effectiveness of the device         entered into with a purpose to minimize tax incidence
                                 depends not upon considerations of morality, but on the       leading up to the decision9 wherein the SC reiterated
                                 operation of the Income-tax Act. Legislative injunction       and continued to enshrine the principles as laid out in
                                 in tax statutes may not, except on peril of penalty, be       Duke	of	Westminster	as	under:
                                 violated, but may lawfully be circumvented....”
                                                                                               “...With respect, therefore, we are unable to agree with
                                 Further,	in	Bank	of	Chettinad’s	case7,	the	Hon’ble	Privy	     the view that Duke of Westminster’s case (1936)
                                 Council	(PC)	stated	that:	                                    AC 1 (HL); 19 TC 490 is dead, or that its ghost has been
                                 “...the tax authority is entitled and is indeed bound         exorcised in England. The House of Lords does not
                                 to determine the true legal relation resulting from           seem to think so, and we agree, with respect. In our
                                 a transaction. If the parties have chosen to conceal          view, the principle in Duke of Westminster’s case (1936)
                                 by a device the legal relation, it is open to the tax         AC 1 (HL); 19 TC 490 is very much alive and kicking in
                                 authorities to unravel the device and to determine the        the country of its birth. And as far as this country is
                                 true character of the relationship. But the legal effect of   concerned, the observations of Shah J. in CIT v. Raman,
                                 a transaction cannot be displaced by probing into the         (1968) 67 ITR 11 (SC) are very much relevant even
                                 substance of the transaction...”                              today...” and

                                 Another important Indian case8 addressing the substance       “...It thus appears to us that not only is the principle
                                 over form question reiterated the principles laid down        in Duke of Westminster’s case (1936) AC 1 (HL); 19 TC
                                 by the House of Lords in the decision of Duke of              490 alive and kicking in England, but it also seems to

While examining a legally valid transaction, the
Revenue authorities should proceed objectively and not
hypothetically attribute ‘motives’ behind the taxpayer’s
have acquired judicial benediction of the Constitutional     shares in an Indian company. In the matter before
Bench in India, notwithstanding the temporary                the	Bombay	High	Court,	it	was	observed	that	the	
turbulence created in the wake of McDowell’s case            domestic tax law recognizes the right of a taxpayer to
(1985) 154 ITR 148 (SC).”                                    plan his transactions to reduce the incidence of tax.
                                                             In the absence of statutory provisions to the contrary,
Further,	the	SC	in	Azadi	Bachao	Andolan’s	case	observed	     instruments and legal structures which are utilized for a
that:                                                        bonafide business purpose do not permit an enquiry by
•	 The	contention	that	the	Double	Taxation	Avoidance	        the authorities into the underlying economic interest.
   Convention (DTAC) between India and Mauritius             However, the parties cannot conceal the nature of
   is ultra vires is not acceptable — even if the DTAC       their legal relationship by adopting a structure which is
   is susceptible to ‘treaty shopping’ on behalf of the      different from the legal character assumed by them.
   residents of third countries.
•	 A	tax	treaty	or	convention	must	be	given	a	liberal	       Considering the background to the ongoing tussle, the
   interpretation. A holistic view has to be taken in this   intention of the Government in proposing to legislate
   regard.                                                   GAAR provisions could be drawn from the principle
•	 An	act,	which	is	otherwise	valid	in	law,	cannot	be	       for recognizing the continuum of Courts addressing
   treated as non-est merely on the basis of some            unforeseen implication of transactions under the tax
   underlying motive (supposedly resulting in some           provisions and in the circumstances, to provide a vision
   economic detriment or prejudice to the national           to an assumed obscure state of affairs.
   interest, as perceived by the respondents).
                                                             However, it needs to be seen how the principles
However, the Revenue authorities have over the years         enshrined through judicial pronouncements (being
challenged various forms of transactions entered into        principle based or purposive) would continue to be
by taxpayers, specifically with regard to cross-border       followed under the proposed GAAR regime as is
transactions. The recent example being in the case           proposed under DTC 2010, wherein the distinction
of the purchase of shares by Vodafone International          between tax avoidance and tax evasion is being sought
of a foreign company, which held directly/indirectly         to be obliterated.

                                                                                        General Anti-Avoidance Rules India and International perspective   9
GAAR concept

 “A broad spectrum GAAR carries a real risk of
undermining the ability of business and individuals to
carry out sensible and responsible tax planning and that
on the other hand introducing a moderate rule which
does not apply to responsible tax planning, and is
targeted at abusive arrangements would be beneficial.”
Legislatures in various countries are moving towards           better legislation, giving clearer signal to taxpayers,      10 T Edgar: ‘Designing and
                                                                                                                               Implementing a Target
promulgating General Anti-Avoidance Rules to address           better tools to the judiciary and an improved basis for         Effective General Anti-
the ongoing debate between illegal evasion and ‘legal’         enhanced cooperation between taxpayers and revenue              Avoidance Competence’
avoidance, or what is termed as ‘acceptable’ and               authorities.	Further,	the	only	true	solution	to	avoidance	   11 David Duff-Relationships,
‘unacceptable’ avoidance of tax.                               is to have a more principle based tax system, but this          Boundaries	and	Corporate	
                                                                                                                               Taxation: Compliance
                                                               requires more than mere changes to wording and that             and Avoidance in Era of
According to legal experts, the implementation of              further work is clearly needed on forms of drafting             Globalization
GAAR has led to difficulties in various jurisdictions. In      (rather than just pick and implement), both at the               E
                                                                                                                            12	 	 ditorial	Comment:	Beyond	
spite of that, none of the jurisdictions have shown signs      specific and meta levels.                                        Boundaries:	Developing	
                                                                                                                                Approaches to Tax
of dispensing with the provisions; in fact, they have                                                                           Avoidance and Tax Risk
revised the concept when judicial pronouncements have          Further,	in	the	recently	released	“A	study	to	consider	          Management
refused to recognize the same.                                 whether	a	GAAR	rule	should	be	introduced	into	the	UK	
                                                               Tax System”, it has been stated:
However, GAARs should not be relied upon to address            “....that introducing a broad spectrum GAAR would
foreseeable methods of tax avoidance occasioned                not be beneficial for the UK tax system. This would
by statutory difference in the tax treatment of similar        carry a real risk of undermining the ability of business
transactions or relationships10. In these circumstances,       and individuals to carry out sensible and responsible
to the extent that the avoidance is considered                 tax planning and that on the other hand introducing
unacceptable, the preferred response for legislature           a moderate rule which does not apply to responsible
is to either amend the specific provisions at issue or         tax planning, and is targeted at abusive arrangements
introduce a specific anti-avoidance to preclude their use      would be beneficial for the UK Tax system....”
for unacceptable tax avoidance11.

In dealing with the issue of tax avoidance through a
legislative code or judicial principles, it is imperative to
provide clarity in dealing with the situation. This may be
through a purposive interpretation of legislation so as
not to offend the rule of law where such a general rule
could be considered to be on the boundary of having
no limits.

As	stated	by	Judith	Freedman12 in summarizing the
findings in the stated publication, there is a need for

International experience

      Canada                                                           following principles to guide the interpretation of the
      General                                                          •	 While	the	economic	substance	of	a	transaction	
      A taxpayer is entitled to structure affairs so as to                 might be relevant at various stages of GAAR analysis,
      minimize tax within the confines of the law. However,                ‘economic substance’ has little meaning in isolation
      tax planning (or tax minimization) must be contrasted                from the proper interpretation of specific provisions
      with tax evasion, which may render the taxpayer liable               of the Act. Accordingly, any argument that is
      to fines or imprisonment. Some forms of tax planning                 based on notions of ‘economic substance’ must be
      are restricted through the use of specific anti-avoidance            considered in light of the specific provisions being
      provisions, more generally abusive planning, is checked              examined.
      through a statutory GAAR.                                        •	 A	finding	of	misuse	or	abuse	is	possible	in	the	
                                                                           following situations:
      Background of legislation                                            – the taxpayer uses specific provisions of the tax
      Canadian tax laws contain GAAR provisions since 1988.                    laws in order to achieve an outcome that those
      Explanatory	notes	issued	by	the	Federal	Department	of	                   specific provisions seek to prevent;
      Finance	in	1988	stated	that	the	rule:	                               – a transaction defeats the underlying rationale of
                                                                               the provisions that are relied upon; or
      “ intended to prevent abusive tax avoidance                    – an arrangement circumvents the application of
      transactions or arrangements but at the same time is                     certain provisions, such as specific anti-avoidance
      not intended to interfere with legitimate commercial and                 rules, in a manner that frustrates or defeats the
      family transactions. Consequently, the new rule seeks to                 ‘object, spirit or purpose’ of those provisions.
      distinguish between legitimate tax planning and abusive          •	 Abuse	is	not	established	if	it	is	reasonable	to	
      tax avoidance and to establish a reasonable balance                  conclude that an avoidance transaction was within
      between the protection of the tax base and the need for              the ‘object, spirit or purpose’ of the provisions that
      certainty for taxpayers in planning their affairs....“               confer the tax benefit.

      Trigger event                                                    Recently, the Canadian Supreme Court had, in the case
      If a transaction is an ‘avoidance transaction’, the Canada       of Copthorne Holdings Ltd. v. Canada, 2011 SCC 63,
      Revenue Agency (CRA) may deny the tax benefit that               observed that the general anti-avoidance rule scheme
      would otherwise result. An avoidance transaction                 is set out in the Act and requires that three questions
      is any transaction that would otherwise result in a              be decided: (1) was there a tax benefit; (2) was the
      direct or indirect tax benefit, or that is part of a series      transaction giving rise to the tax benefit an avoidance
      of transactions that would otherwise result in a tax             transaction; and (3) was the avoidance transaction
      benefit.	For	GAAR	purposes,	a	transaction	includes	an	           giving rise to the tax benefit abusive.
      arrangement or event. However, a transaction will not
      be considered to be an avoidance transaction if it can           The Court further observed that “in order to determine
      reasonably be considered to have been undertaken or              whether a transaction is an abuse or misuse of the Act,
      arranged primarily for bonafide purposes other than to           a court must first determine the object, spirit or purpose
      obtain the tax benefit.                                          of the provisions that are relied on for the tax benefit,
                                                                       having regard to the scheme of the Act, the relevant
      Even if a transaction is an avoidance transaction, GAAR          provisions and permissible extrinsic aids.
      will apply only if the transaction results in a misuse or
      an abuse of the provisions of tax laws. In other words,          While an avoidance transaction may operate alone to
      GAAR applies only to transactions that lack a bonafide           produce a tax benefit, it may also operate as part of
      non-tax purpose and that result in a misuse or abuse of          a series of transactions that results in the tax benefit.
      the tax laws.                                                    While the focus must be on the transaction, where it is
                                                                       part of a series, it must be viewed in the context of the
      The Canadian Supreme Court in the case of Canada                 series to enable the court to determine whether abusive
      Trustco Mortgage Co. [2005] SCC 54 established the               tax avoidance has occurred. In such a case, whether a

                                                                    General Anti-Avoidance Rules India and International perspective   11
     transaction is abusive will only become apparent when          Further,	where	corporate	reorganization	takes	place,	
     it is considered in the context of the series of which it is   the GAAR does not apply unless there is an avoidance
     a part and the overall result that is achieved.                transaction that is found to constitute an abuse. Even
                                                                    where corporate reorganization takes place for a tax
     The analysis will lead to a finding of abusive tax             reason, the GAAR may still not apply. It is only when
     avoidance: (1) where the transaction achieves an               a reorganization is primarily for a tax purpose and is
     outcome the statutory provision was intended                   done in a manner found to circumvent a provision of
     to prevent; (2) where the transaction defeats the              the Income Tax Act that it may be found to abuse that
     underlying rationale of the provision; or (3) where the        provision. And it is only where there is a finding of
     transaction circumvents the provision in a manner that         abuse that the corporate reorganization may be caught
     frustrates or defeats its object, spirit or purpose. These     by the GAAR.
     considerations are not independent of one another and
     may overlap”.                                                  Procedural requirements
                                                                    In Canada Trustco, the Canadian Supreme Court laid
     Providing	further	guidelines,	the	Court	emphasized	that	       down the following procedural principles:
     the transaction may have a tax purpose, but that does          •	 The	onus	is	on	the	taxpayer	to	refute	the	following	
     not necessarily mean that the tax purpose will always be           (on a balance-of-probabilities basis):
     the primary reason for the transaction.                            – the assertion that a tax benefit results from the
                                                                           transaction. It is not permissible, however, for the
     However, where a transaction takes place primarily for a              CRA to take the position that more tax would
     non-tax purpose, there will be no avoidance transaction.              have been paid if the taxpayer had engaged in
     In the absence of an avoidance transaction, the fact that             some other transaction or that the amount of tax
     a transaction may have a secondary tax benefit purpose                paid is less than some notional amount that the
     will	not	trigger	the	GAAR.	Whether	the	transactions	are	              CRA believes should have been paid; and
     between parties at arm’s length or not at arm’s length             – the assertion that the transaction was an
     should be immaterial (Stubart Investments Ltd. v. The                 avoidance transaction. The taxpayer might be able
     Queen, [1984] 1 S.C.R. 536).                                          to refute this assertion by showing a bonafide and
                                                                           primary non-tax purpose for the transaction.
                                                                    •	 If	there	is	a	tax	benefit	and	an	avoidance	transaction,	
                                                                        the burden then falls on the CRA to establish that
                                                                        there is abusive tax avoidance.


                                                                    Tax avoidance generally involves a series of artificial or
                                                                    contrived transactions undertaken with the objective of
                                                                    reducing a taxpayer’s tax liability without committing
                                                                    either criminal or taxation offences. Tax avoidance can
                                                                    take a variety of forms, such as reducing or diverting
                                                                    assessable income, increasing deductions and offsets,
                                                                    deferring the payment of tax, manipulating business
                                                                    structures, or altering the type and nature of transactions.

                                                                    Background of legislation
                                                                    Australia’s GAAR was introduced in 1981 and is
                                                                    contained	in	Part	IVA	of	the	Income	Tax	Assessment	Act	
                                                                    1936 (ITAA 1936).

John Howard, the then Treasurer, described the                Is there a scheme?
objective of GAAR in these terms:                             A ‘scheme’ for these purposes is defined broadly as:
                                                              a) any agreement, arrangement, understanding,
“The proposed provisions embodied in a new Part                   promise or undertaking, whether express or implied
IVA seek to give effect to a policy that such measures            and whether or not enforceable, or intended to be
ought to strike down blatant, artificial or contrived             enforceable, by legal proceedings; and
arrangements but not cast unnecessary inhibitions on          b) any scheme, plan, proposal, action, course of action
normal commercial transactions by which taxpayers                 or course of conduct.
legitimately take advantage of opportunities available
for the arrangement of their affairs.”                        It may comprise many steps or parts and is not
                                                              necessarily limited to the step that produced the tax
In his speech, the then Treasurer reaffirmed the limited      benefit.	Furthermore,	for	any	given	scenario,	it	is	
scope of the new legislative solution “In order to confine    possible that a number of schemes may be identified
the scope of the proposed provisions to schemes of            within the total steps undertaken.
the “blatant” or “artificial” variety, the measures in this
Bill are expressed so as to render ineffective a scheme       Is there a benefit?
whereby a tax benefit is obtained and an objective            A tax benefit is obtained in any of the following cases
examination, having regard to the scheme itself and to        where the event would not have occurred but for the
its surrounding circumstances and practical results, leads    scheme:
to the conclusion that the scheme was entered into for        •	 an	amount	is	not	included	in	assessable	income,	
the sole or dominant purpose of obtaining a tax benefit.”         including amounts which are converted from
                                                                  assessable income to capital gains eligible for
The Australian GAAR is a provision of last resort, i.e. it        discount treatment;
should not apply unless the taxpayer’s claim is otherwise     •	 a	deduction	is	allowed;
allowable. It, therefore, counters schemes that strictly      •	 withholding	tax	is	not	payable;
satisfy the technical requirements of the tax law,            •	 property	is	disposed	off	under	a	dividend	stripping	
including	the	ordinary	provisions	and	SAAPs,	but	when	            scheme;
objectively viewed, are considered to be conducted            •	 a	foreign	tax	offset	is	allowed;	or	
or carried out with the sole or dominant purpose of           •	 a	capital	loss	is	incurred.
obtaining a tax benefit.
                                                              What is the purpose?
If certain conditions are met, the provisions allow the       The GAAR will only apply where at least one person
Commissioner to cancel all or part of any tax benefits        who entered into or carried out the scheme did so for
which a taxpayer derives from the scheme.                     the sole or dominant purpose of enabling a taxpayer to
                                                              obtain a tax benefit. In order to ascertain the purpose
The	three	key	conditions	which	must	be	satisfied	for	Part	    of the scheme the following eight matters should be
IVA to apply are: (i) there must be a ‘scheme’, (ii) there    considered:
must be a ‘tax benefit’ obtained in connection with the       1) the manner in which the scheme was entered into or
scheme, and (iii) it must be reasonable to conclude that at       carried out;
least one person entering into the scheme did so for the      2) the form and substance of the scheme;
‘sole or dominant purpose’ of obtaining a tax benefit.        3) the time at which the scheme was entered into and
                                                                  the length of the period during which the scheme
On 18 November 2010, the Australian Government                    was carried out;
released	for	public	comment	a	Discussion	Paper	that	          4)	 the	income	tax	result	that,	but	for	Part	IVA,	would	be	
deals with the review of the existing anti-avoidance              achieved by the scheme;
rules. The paper deals with possible improvements to          5) any change in the financial position of the relevant
both the general and specific anti-avoidance provisions           taxpayer that has resulted, will result, or may
with a view to simplify as well as improve the operation          reasonably be expected to result, from the scheme;
of these provisions.

                                                                                         General Anti-Avoidance Rules India and International perspective   13
6) any change in the financial position of any person
   who has, or has had, any connection (whether of a
   business, family or other nature) with the relevant
   taxpayer, being a change that has resulted, will result
   or may reasonably be expected to result, from the
7) any other consequence for the relevant taxpayer,
   or for any person referred to in (6), of the scheme       This provision does not apply where the right to
   having been entered into or carried out; and              income is transferred for a period of less than 7 years;          P
                                                                                                                           13	 	 S	LA	2005/24	‘Application	
                                                                                                                               of General Anti-avoidance
8) the nature of any connection (whether of a business,      the parties to the transfer are associated and the                Rule’
   family or other nature) between the relevant taxpayer     consideration for the transfer is less than an arm’s length   14 Section 102CA ITAA 36
   and any person referred to in (6).                        consideration; the transfer is then disregarded for tax           S
                                                                                                                           15	 	 ection	102B	ITAA	36
                                                             purposes and so the transferor remains assessable on              S
                                                                                                                           16	 	 ection	46A	and	B	ITAA	36
Procedure for applying GAAR                                  the income15.
The	Commissioner	of	Taxation	has	released	Practice	
Statement13 which provides detailed guidelines for tax       Foreign tax credit schemes
officers	on	the	practical	application	of	Part	IVA.	          Schemes entered into after 13 August 1998 to
                                                             acquire or generate foreign tax credits that can be
Interaction between the GAAR and other provisions            used to shelter low-taxed foreign-sourced income
of the Taxes Acts                                            from Australian tax. A specific power is provided
The	operation	of	Part	IVA	of	ITAA	1936	is	not	limited	       to the Commissioner to amend a foreign tax credit
by any other provisions of ITAA 1936, ITAA 1997, or          determination.
the International Tax Agreements Act 1953 (ITAA 53),
wherein all tax treaties are enacted as schedules.           Dividend stripping
                                                             Dividend stripping is not defined in the legislation. The
Specific Anti-Avoidance Rules                                essence of dividend stripping is that value is taken out
There are a number of specific rules in the ITAA             of a company in the form of a dividend, normally an
1936 and ITAA 1997 targeted at certain schemes               abnormally large dividend which clears all the current
that are regarded as impermissible by the Australian         and accumulated profits out of the company, in order to
Government. Examples of these (on a non-exhaustive           achieve a tax benefit.
basis) are outlined below:
                                                             In case of dividend stripping arrangement, the
Alienation of income                                         Commissioner is allowed to cancel the tax benefits
A right to income arising out of the ownership of            derived by shareholders who sell their shares before
property	can	be	transferred.	Where	the	right	to	income	      a dividend is declared. The share-dealing company in
is transferred but the property giving rise to the income    such a situation is also denied a rebate in respect of the
is retained by the transferor, the consideration received    dividend. A rebate is also denied where the purchaser of
for the transfer of the right to income is assessable as     the shares is not a share-dealing company but seeks to
income14.                                                    claim the loss on the shares as a capital loss16.

                               Dividend streaming                                               GAAR audits and adjustments must be reported level
                               The	scope	of	Part	IVA	includes	franking	credit	trading	          by level up to the State Administration of Taxation for
                               and dividend streaming schemes where one of the                  approval.
                               purposes of the scheme is to obtain a franking credit
                               benefit17.	Franking	credit	schemes	involve	the	disposition	      Specific Anti-Avoidance Rules
                               of shares or an interest in shares where the elements            Apart from GAAR, China has specific rules concerning:
                               described in the provision exist.                                •	 Transfer	pricing
                                                                                                •	 Thin	capitalization
                               Where	the	company	and	the	person	receiving	the	                  •	 Controlled	foreign	companies
                               dividend or distribution are parties to the scheme, the          •	 Recognition	of	a	beneficial	owner	for	treaty	purposes
                               Commissioner has a choice as to whether:
                               •	 to	post	a	debit	to	the	company’s	franking	account;	           Impact on treaty usage
                                   or                                                           Under Article 58 of the EITL, treaty provisions prevail in
                               •	 to	deny	the	franking	credit	benefit	to	the	recipient	of	      case	there	is	a	conflict	with	the	provisions	of	the	EITL.	
                                   the dividend or distribution.                                Accordingly, absent any provision in a particular treaty to
                                                                                                the contrary and depending on the specific application
                               The amount of debit to franking account is the amount            of the GAAR provision to the particular transaction,
                               that the Commissioner considers reasonable in the                this could be read to mean the provisions of that
                               circumstances, i.e. not being an amount larger than              treaty will prevail over the GAAR provisions of the EITL.
                               the debit to the franking account occasioned by the              However, this issue has not yet been tested to date, and
                               payment of dividend.                                             accordingly, whether such a reading of the law will be
                                                                                                accepted remains unclear.
                                                                                                However, it may be noted that in many, if not most
                               Time since in statute                                            cases, it is likely that GAAR would be applied to alter the
                               The new EITL18, which came into effect on 1 January              facts to which Chinese law would be applied, and as
                               2008, includes a general anti-avoidance provision                such	a	conflict	in	so	far	as	the	treaty	is	concerned	would	
                               (Article 47 of the EITL).                                        not arise.

                               What are the trigger events                                      It should be noted that the more recent treaties
                               Article	47	of	the	EITL	provides:	“If	an	enterprise	engages	      concluded by China include provisions specifically
                               in a business arrangement without bonafide commercial            stating that domestic GAAR would operate to counter
                               purposes that results in reducing its taxable revenue or         transactions without justified commercial purpose but to
                               taxable income, the tax bureau has the right to make             take advantage of the treaty benefits.
                               adjustments based on reasonable methods.”
                                                                                                South Africa
                               The tax authorities may initiate a GAAR audit of
                               enterprises that enter into the following arrangements:          General
                               •	 abuse	of	tax	incentives;                                      GAAR operates as one of the measures to counter tax
                               •	 abuse	of	treaties;                                            avoidance, and is generally considered as a residual
                               •	 abuse	of	the	corporate	structure;                             measure, which may apply in addition to or as an
                               •	 use	of	tax	havens	for	the	avoidance	of	taxes;	and             alternative to any other or specific anti-avoidance
                               •	 other	business	arrangements	without	bonafide	                 provision.
                                  commercial purposes.
                                                                                                Background of legislation
                               Procedure for applying GAAR                                      During 2006, the Income Tax Act 50 of 1962 was
                               Tax authorities identify potential cases for investigation       amended to enable the South African Revenue Service
17 Section 177EA ITAA 36       based on the information submitted by taxpayers or               (SARS) to more effectively combat tax avoidance in
18 Enterprise Income Tax Law   gathered through their own channels.                             South Africa. Section 103(1), the general anti-avoidance

                                                                                             General Anti-Avoidance Rules India and International perspective   15
provision, was repealed and the GAAR was introduced.           •	 the	presence	of	round	trip	financing;
The	GAAR	is	contained	in	Part	IIA	of	Chapter	III	of	the	       •	 the	presence	of	an	accommodating	or	tax-indifferent	
Income Tax Act and specifically applies to impermissible          party (described as a party for whom the amounts
avoidance arrangements as defined.                                received from the arrangement are not subject to
                                                                  normal tax, or the tax liability is significantly offset by
A provision against tax avoidance applies where:                  an expenditure incurred by that party in terms of the
•	 an	impermissible	avoidance	agreement	has	been	                 arrangement);
   entered into with its sole or main purpose being to         •	 the	presence	of	elements	which	have	the	effect	of	
   obtain a tax benefit; and                                      offsetting or cancelling each other.
•	 in	the	context	of	business:
   – it was entered into or carried out in a manner            Further developments
       that would not normally be employed for                 The SARS have recently released a ‘Draft Comprehensive
       bonafide business purposes other than for               Guide to the General Anti–Avoidance Rule’ which
       obtaining a tax benefit; or                             provides for guidance to revenue authorities on
   – it lacks commercial substance;                            interpretation and application of GAAR.
•	 in	the	context	other	than	business,	it	was	entered	
   into or carried out by means or in a manner not             Broadly,	in	interpreting	the	provisions	relating	to	GAAR,	
   normally employed for a bonafide purpose, other             the guideline provides that a tax benefit may be denied
   than obtaining a tax benefit; or                            under the GAAR if such tax benefit would misuse or
•	 it	has	created	rights	or	obligations	which	would	not	       abuse the object, spirit or purpose of the provisions
   normally be created between persons dealing at              of the Income Tax Act that are relied upon for the
   arm’s length, or it would result directly or indirectly     tax benefit. It would require a purposive approach
   in the misuse or abuse of the provisions of the             to interpret the provisions of the Income Tax Act,
   Income Tax Act.                                             which is already the accepted approach to legislative
                                                               interpretation in South Africa. The introduction of the
Tax consequences                                               misuse or abuse test is specifically directed at ensuring
If the above requirements are met, South African               that the remedy provided by the section is advanced and
revenue authorities may:                                       that the mischief against which the section is directed is
•	 disregard,	combine	or	re-characterize	the	                  suppressed. As a result, a mere literal interpretation of
    arrangement or any step thereof;                           the provisions will no longer safeguard a taxpayer who
•	 disregard	any	accommodating	or	tax-indifferent	             applies the provisions in the Income Tax Act in a context
    party or treat this party and any other party as one       or manner which is not intended by the Income Tax Act.
    and the same person;
•	 deem	the	parties	who	are	connected	persons	in	              Although it is accepted that where the substantive tax
    respect of each other as one and the same person;          provision is clearly articulated and free from ambiguity,
•	 re-allocate	any	income,	receipt	or	accrual	of	a	capital	    a departure from the ordinary meaning of the language
    nature or expenditure;                                     used is not required. The misuse or abuse requirement
•	 re-characterize	any	income	of	a	capital	nature	as	          in the GAAR nevertheless requires that the intention of
    income of a revenue nature;                                the legislator is considered in determining whether the
•	 treat	the	transaction	as	if	it	has	not	been	carried	out,	   provisions of the Income Tax Act are applied in a manner
    or in any other manner that in ‘revenue authorities’       which is intended.
    view is adequate for the prevention or diminution of
    the tax benefit.                                           Further,	the	purpose	test	under	the	GAAR	is	a	more	
                                                               objective test, wherein the sole or main purpose of the
Trigger event                                                  arrangement itself is the relevant purpose and no longer
The presence of certain criteria is considered as              the subjective purpose of the taxpayer.
indicative of tax avoidance. These include:
•	 the	legal	substance	of	the	arrangement	as	a	whole	
   is inconsistent with, or differs significantly from, the
   legal form of its individual steps;

India Regime

      Proposed GAAR – DTC 2010                                              d) a transaction which is conducted through one or
      Under the Code, GAAR will be invoked if the following                    more persons and disguises the nature, location,
      conditions are satisfied:                                                source, ownership or control of funds; or
      a) The taxpayer should have entered into an                           e) an expectation of pre-tax profit which is
         arrangement.                                                          insignificant in comparison to the amount of the
      b) The main purpose of the arrangement should be to                      expected tax benefit.
         obtain a tax benefit and the arrangement:
         i) has been entered into, or carried out, in a manner          The concepts of ‘round trip financing’ and
              not normally employed for bonafide business               ‘accommodating party’ will be defined in the Code.
         ii) has created rights and obligations which would             Tax consequences of impermissible avoidance
              not normally be created between persons dealing           arrangements
              at arm’s length;                                          If the conditions specified above are satisfied,
         iii) results, directly or indirectly, in the misuse or         the Commissioner will be empowered to declare
              abuse of the provisions of this Code; or                  the arrangement as an impermissible avoidance
         iv) lacks commercial substance, in whole or in part.           arrangement and determine the tax consequences
                                                                        of the taxpayer as if the arrangement had not been
      Meaning of arrangement                                            entered	into.	For	this	purpose,	he	may:
      An ‘arrangement’ will mean any transaction, conduit,              i) disregard, combine, or re-characterize any steps
      event, trust, grant, operation, scheme, covenant,                      in, or parts of, the impermissible avoidance
      disposition, agreement or understanding, including all                 arrangement;
      steps therein or parts thereof, whether enforceable or            ii) disregard any accommodating party or treat any
      not. Therefore, if the motive behind individual steps is               accommodating party and any other party as one
      to obtain a tax benefit, but the overall scheme is not so,             and the same person;
      the individual steps will nevertheless be treated as an           iii) deem persons who are connected persons in relation
      arrangement and the GAAR may be invoked.                               to each other to be one and the same person for
                                                                             purposes of determining the tax treatment of any
      An arrangement will also include any interposition of an               amount;
      entity or transaction where the substance of such entity          iv) re-allocate any gross income, receipt or accrual of a
      or transaction differs from the form given to it.                      capital nature, expenditure or rebate amongst the
      Lack of commercial substance                                      v) re-characterize any gross income, receipt or accrual
      The lack of commercial substance, in the context of an                 of a capital nature or expenditure;
      arrangement, shall be determined, but not limited to, by          vi) re-characterize any multi-party financing transaction,
      the following indicators:                                              whether in the nature of debt or equity, as a
      i) The arrangement results in a significant tax benefit                transaction directly among two or more such parties;
           for a party but does not have a significant effect           vii) re-characterize any debt financing transaction as an
           upon	either	the	business	risks	or	the	net	cash	flows	             equity financing transaction or any equity financing
           of that party other than the effect attributable to the           transaction as a debt financing transaction;
           tax benefit.                                                 viii)treat the impermissible avoidance arrangement
      ii) The substance or effect of the arrangement as a                    as if it had not been entered into or carried out
           whole differs from the legal form of its individual               or in such other manner as the Commissioner in
           steps.                                                            the circumstances may deem appropriate for the
      iii) The arrangement includes or involves:                             prevention or diminution of the relevant tax benefit;
           a) round trip financing;                                          or
           b) an ‘accommodating party’, as defined;                     ix) disregard the provisions of any agreement entered
           c) elements that have the effect of offsetting or                 into by India with any other country under section
               cancelling each other;                                        265.

                                                                     General Anti-Avoidance Rules India and International perspective   17
                An arrangement declared as an impermissible avoidance         GAAR – Tax Treaty
                arrangement shall be presumed to have been entered            It has been provided that the GAAR provisions would
                into or carried out for the main purpose of obtaining         apply to a taxpayer notwithstanding that the treaty
                a tax benefit unless the party obtaining the tax benefit      provisions are more beneficial. Considering the
                proves that obtaining a tax benefit was not the main          approaches as outlined before (under the Vienna
                purpose of the avoidance arrangement.                         Convention and the OECD wherein the underlying
                                                                              principle would be that GAAR could override the provi-
                Procedure for applying GAAR                                   sions of a treaty), it is important to note that OECD
                The power to invoke GAAR is bestowed only upon the            Commentary on Article 1 of the Model Tax Convention
                Commissioner	of	Income	Tax	(CIT).	For	this	purpose,	the	      also clarifies that a general anti-abuse provision in the
                Code empowers him to call for such information as may         domestic law in the nature of ‘substance over form rule’
                be necessary. He is also required to follow the principles    or	‘economic	substance	rule’	would	not	be	in	conflict	
                of natural justice before declaring an arrangement as an      with the treaty.
                impermissible avoidance arrangement. He will determine
                the tax consequences of such impermissible avoidance          However, as enshrined in the Vienna Convention19,
                arrangement and issue necessary directions to the             “every	treaty	in	force	is	binding	upon	the	parties	to	it	
                Assessing Officer for making appropriate adjustments.         and	must	be	performed	by	them	in	good	faith”,	‘Pacta	
                The directions issued by him will be binding on the           sunt servanda’ is based on good faith. This entitles states
                Assessing Officer.                                            to respect obligations. This good faith basis of treaties
                                                                              implies that a party cannot invoke provisions of its
                Key issues                                                    domestic law as a justification for a failure to perform.
                The key issues / implications under the proposed GAAR
                are:                                                          Thus, if a legislature unilaterally enacts new domestic tax
                •	 Tax	avoidance	has	been	widely	defined	with	the	            laws which are contrary to an existing treaty, without
                   objective to encompass a number of circumstances           the treaty having been amended or terminated, such
                   and instances of tax avoidance, leading to                 action is violation of international law and also violates
                   uncertainty and extensive litigation.                      the principles of ‘pacta sunt servanda’. This type of
                •	 GAAR	can	be	invoked	where	obtaining	a	tax	benefit	         treaty violation is known as ‘treaty override’.
                   is the ‘main purpose’, and it is not clear as to what is
                   meant by ‘main purpose’; the courts would be left to       Further,	according	to	rules	of	legislative	interpreta-
                   decide whether in the given facts the main purpose         tion, specific legislation overrides general legislation.
                   of the transaction/arrangement was to obtain tax           Therefore, changes of a domestic law generally, which
                   benefit.                                                   could be the case with GAAR, may not affect the treaty.
                •	 Where	an	adjustment	is	made	(invoking	GAAR),	it	is	        Considering the same, in the absence of an anti-avoid-
                   not clear whether the full effect of the same would        ance provision under the treaty, it remains to be seen
                   be given to ensure that there is no double taxation.       whether the provisions would be able to override the
                •	 The	onus	of	proving	that	an	arrangement	has	not	been	      treaty.
                   carried out for the main purpose of obtaining a tax
                   benefit is with the taxpayer, while the tax authorities    Specific anti-abuse rules
                   may not have any evidence of tax avoidance.                In addition to the GAAR provisions, the Code provides
                •	 There	is	no	cut-off	date	for	applicability	of	GAAR	        for specific anti-avoidance rules to deal with some of
                   provisions to any arrangement and, therefore, where        the following circumstances. These are similar to the
                   the impact of past arrangements continues in Direct        provisions under the Income-tax Act, 1961:
                   Tax Code regime; the same may still be covered by          i) Certain payments deemed to be dividend [Clause
                   GAAR irrespective of the fact that the arrangement              314(4) r.w 314(81)];
                   has been approved by the tax officer or subjected to       ii) Clubbing of income arising to other person by virtue
                   judicial review.                                                of a transfer without transfer of the asset [Clause
19 Article 27                                                                 iii) Denying tax benefits to a business formed by

        splitting up, or the reconstruction or a business        vis-à-vis other countries (discussed in the preceding
        already in existence [Schedule 11, 12 & 13];             sections) indicates that the provisions are broadly on
iv)     Denying tax benefits to a business formed by             the lines incorporated by South Africa. However, the
        transfer to a new business of machinery or plant         South African draft guidance indicates that “in essence,
        previously used for any purpose [Schedule 11, 12,        a tax benefit may be denied under the GAAR if such
        13];                                                     tax benefit would misuse or abuse the object, spirit or
v)      Expenditure incurred in relation to income not           purpose of the provisions of the Income Tax Act that
        includible in total income [Clause 18];                  are relied upon for the tax benefit. This clearly requires
vi)	    Payment	to	associated	persons	in	respect	of	expend-      a purposive approach to interpreting the provisions
        iture [Clause 115];                                      of the Income Tax Act, which is already the accepted
vii)    Transfer of shares to a firm or closely held company     approach to legislative interpretation in South Africa”.
        without or for inadequate consideration [Clause
        58(2)(j)];                                               Further,	as	indicated	under	South	Africa	GAAR,	the	
viii)   Carry forward and set off of losses in the case of       purpose test is a more objective test, wherein the sole
        certain companies [Clause 66];                           or main purpose of the arrangement itself is the relevant
ix)     International transactions not at arm’s length           purpose and no longer the subjective purpose of the
        [Clause 116];                                            taxpayer.
x)      Transactions resulting in transfer of income to non-
        residents [Clause 119];                                  Thus, in implementation, one would need to adapt the
xi)     Avoidance of tax in certain transactions in securities   principle	that	the	“tax	benefit”	would	misuse	or	abuse	the	
        [Clause 120].                                            object, spirit or purpose of the provisions of the Income
                                                                 Tax Act. However, under the proposed law in India, even
Comparison of the proposals with legislation in                  where the main purpose of a step in the transaction, or
other jurisdictions                                              the part of a transaction is to obtain a ‘tax benefit’, the
A comparison of the proposed Indian GAAR provisions              arrangement would be presumed to be carried out with

                                                                                             General Anti-Avoidance Rules India and International perspective   19
the main purpose of obtaining a tax benefit. Though the        two-part inquiry.
provisions indicate the establishment of main purpose, it      •	 The	first	is	to	interpret	the	provisions	giving	rise	to	
is unclear as to the methodology of determining the main          the tax benefit to determine their object, spirit and
purpose.	Further,	the	absence	of	simultaneous	business	           purpose which would be the question of law.
purpose or a bonafide purpose test and the mere                •	 The	second	is	to	examine	the	factual	context	of	a	
presence of a tax benefit give rise to the presumption that       case in order to determine whether the avoidance
the avoidance arrangement was designed and entered                arrangement defeated the object, spirit or purpose
into solely or mainly to obtain a tax benefit. This may also      of the provisions under consideration. This would
lead to greater onus on the taxpayer to establish that            generally be a question both of law and fact, in
the main purpose was not the ‘tax benefit’. Hence, it is          which the onus will be upon the Commissioner to
imperative that the criterion of ‘tax benefit’ should not         assess the factual element of the case.
be made the sole purpose and object of invoking GAAR
provisions.                                                    Further,	it	may	also	be	relevant	to	consider	the	recent	
                                                               report	on	introduction	of	GAAR	in	the	UK	for	some	of	the	
As such, it may be appropriate to adopt the approach           methodologies and rules being suggested in this respect.
adapted under the Canadian provisions wherein it
is stated that an avoidance transaction means any              Hence, considering the intent of introducing GAAR,
transaction                                                    there is a likelihood in implementing the provision
a) that, but for this section, would result, directly or       by underplaying the object, spirit and purpose of the
    indirectly, in a tax benefit, unless the transaction       provisions and the arrangement based on the facts
    may reasonably be considered to have been                  of the case. In the circumstances, it may be advisable
    undertaken or arranged primarily for bonafide              to appreciate and adapt the two part inquiry in terms
    purposes other than to obtain the tax benefit; or          of the provisions and the arrangement rather than
b) that is part of a series of transactions, which             restrict it to determining whether the main purpose of
    series, but for this section, would result, directly or    the	arrangement	was	a	‘tax	benefit’.	Further,	a	single	
    indirectly, in a tax benefit, unless the transaction       objective test may undermine the importance of looking
    may reasonably be considered to have been                  into the objective and purpose of the legislation, which
    undertaken or arranged primarily for bonafide              may not be the intention of the legislation itself.
    purposes other than to obtain the tax benefit.
                                                               Case study in respect of applicability of the
It is further provided that the provisions would be            proposed provisions
applicable to a transaction only if it may reasonably be       (Cases considered from the Canadian authorities
considered that the transaction would result directly or       circular)
indirectly in a misuse of the provisions of any one or
more of the Act, treaty etc., or would result directly or      Case 1
indirectly in an abuse having regard to those provisions.      •	 A	corporation	transfers	property	used	in	its	business	
                                                                  to a related corporation to permit the deduction of
Thus, under Canadian law and as even interpreted by               non-capital losses of the related corporation. All of
their Courts, the misuse or abuse test would involve a            the shares of the two corporations have been owned

It may be advisable to appreciate and adapt the two part
inquiry in terms of the provisions and the arrangement
rather than restrict it to determining the whether main
purpose of the arrangement was a ‘tax benefit’.
   by the same taxpayer during the period in which the             Case 4
   losses were incurred.                                           •	 A	taxable	company	has	agreed	to	purchase	all	of	
•	 Where	the	transaction	could	be	considered	as	consistent	           the shares of an operating company, which is also a
   with the scheme of the Act, it may be argued that the              taxable Indian company The purchaser incorporates
   GAAR provisions would not be infringed. However, if a              a holding company which borrows the purchase
   transfer of a property or other transaction is undertaken          price and pays the vendor for the shares. The holding
   to avoid a specific rule, such as a rule designed to               company and the operating corporation amalgamate
   preclude the deduction of losses after the acquisition of          so that the interest payable on the monies borrowed
   control of a corporation by an arm’s length person, such           to acquire the shares can be deducted in computing
   a transfer would be a misuse of the provisions of the              the income from the business of the amalgamated
   Act and be subject to provisions of the Act.                       corporation.
•	 Thus,	genuine	corporate	reorganization	should	not	              •	 Generally,	leverage	of	debt	by	Indian	companies	and	
   be affected.                                                       subsequent amalgamation should not be considered
                                                                      as abusive under GAAR. However, the implication
Case 2                                                                of provisions of Section 14A could be considered to
•	 A	company	has	property	with	an	unrealized	capital	                 bring the same under a ‘tax benefit’ and hence under
   gain that it wishes to sell to a third party. A related            GAAR provisions.
   corporation, a wholly owned subsidiary has a net
   capital loss. Instead of selling the property directly to       Case 5
   the third party and realizing a capital gain, the person        •	 A	taxable	Indian	company	merges	with	another	
   transfers the property to the related corporation. The             taxable Indian company that is a shell company.
   related corporation sells the property to the third                Upon merger, the shareholders who controlled the
   party and reduces the resulting taxable capital gain               predecessor receive common shares of the merged
   by the amount of its net capital loss.                             company and the minority shareholders of the
•	 Where	the	provisions	of	the	Act	provide	that	the	sale	             predecessor receive redeemable preferred shares
   to a related corporation should be at arm’s length,                that are immediately redeemed. The sole reason
   it could be argued that the transaction may not                    that the minority shareholders receive shares instead
   infringe the provisions as in determining the cost in              of cash is to cause the merger to comply with the
   the hands of the related corporation, the cost to the              requirements of the Act.
   company would be considered.                                    •	 Structuring	of	company	reorganization	through	
•	 Thus,	the	transfer	of	property	by	holding	company	                 redeemable preference shares should not be covered
   to subsidiary company or vice versa under Indian                   by GAAR.
   regulations should not be impacted.
                                                                   Case 6
Case 3                                                             •	 A	taxable	Indian	company	has	a	subsidiary	that	is	
•	 An	individual	provides	services	to	a	corporation	with	             sustaining losses and needs capital to carry on its
   which he or she does not deal at arm’s length. The                 business. The subsidiary would not be able to obtain
   company does not pay salary to the individual because              any tax savings in the year. The holding company
   payment of salary would increase the amount of loss                borrows the money from a bank and subscribes to
   that the company will incur in the year.                           the shares of the subsidiary and claims a deduction
•	 There	may	be	a	provision	in	the	Act	requiring	salary	to	           for the interest.
   be paid in these or any circumstances; the failure to pay       •	 Generally,	based	on	judicial	precedents,	the	interest	
   salary is, therefore, not contrary to the scheme of the            would be deductible for the holding company.
   Act read as a whole.                                               However, the implication of provisions of Section
•	 In	the	circumstances,	in	the	Indian	context,	the	taxpayer	         14A could be considered to bring the same under a
   may choose to determine the terms of transactions                  ‘tax benefit’ and hence under GAAR provisions.
   which are not expressly prohibited under the terms of
   the Act.

                                                                General Anti-Avoidance Rules India and International perspective   21
     Case 7                                                       Case 9
     •	 A	non-resident	company	has	an	Indian	subsidiary.	         •	 A	non-resident	company	has	an	Indian	subsidiary.	
        The subsidiary has substantial reserves and the              The subsidiary has substantial reserves and the Indian
        non-resident company desires to cash out by selling          subsidiary desires to repatriate surplus cash through
        to an unrelated party. The gains on sale would be            buy back of its shares and no tax is paid in India on
        substantial and subject to higher rate of tax. The           the profits repatriated for the reason that the capital
        subsidiary distributes the reserves as dividend,             gain on buy back of shares is exempt in India under
        which reduces the valuation of the company. The              the applicable treaty of the non-resident.
        non-resident then sells the subsidiary.                   •	 The	shares	may	be	bought	back	by	the	Indian	
     •	 The	payment	of	the	dividend	and	the	consequent	              subsidiary for a number of reasons, namely, to
        DDT on such dividend should not be construed as              increase holding of resident shareholders, increase
        covered under GAAR.                                          the earnings per share or to pay surplus cash not
                                                                     required	by	business,	etc.	Further,	the	provisions	
     Case 8                                                          of the proposed Code also specifically provide that
     •	 A	non-resident	company	has	an	Indian	subsidiary.	            distribution of profits through a scheme of buy back
        The subsidiary has been capitalized by nominal               of shares under the applicable provisions of the
        capital only and it has taken substantial borrowings         Companies Act shall not be deemed as dividend.
        from group companies and/or third parties                    Accordingly, the buyback of shares should not be
        (non-residents/residents) such that the debt is several      subject to GAAR provisions merely because no Indian
        times the equity for the Indian subsidiary. A question       tax has been paid in the transaction.
        may arise on the deductibility of interest paid by
        the Indian subsidiary for the reason that it is thinly
     •	 Under	the	current	income	tax	law,	there	are	no	
        specific provisions for disallowance of interest on the
        basis that the taxpayer is thinly capitalized, However,
        under the proposed GAAR provisions (where tax
        benefit is the purpose) coupled with the transfer
        pricing provisions (arm’s length principle), the tax
        authorities may consider disallowance of interest
        provided the conditions are satisfied. However, it
        is relevant to note that countries have adopted
        thin capitalization rules based on the principle of
        either the fixed ratio approach or the arm’s length
        approach or the safe harbor approach.

Way forward

The GAAR provisions are like a double-edged sword             •	 Detailed	guidelines	to	be	provided	on	the	lines	of	the	
and would need to be judicially invoked by the revenue           Canadian law with relevant examples illustrating the
authorities.                                                     reasons and analogy in applying GAAR provisions.
                                                              •	 GAAR	should	not	be	judged	on	the	basis	of	a	single	
As discussed earlier, the Courts in India have examined          transaction,	but	on	a	series	of	transactions.	Further,	
the issue of tax avoidance and laid down the principles          where no ‘tax benefit’ arises under the whole series
as to what constitutes tax avoidance. In light of the            of transactions, the same should not be subject to
various judicial precedents, the tax authorities in India        GAAR evaluation, even though a part of the series
tend to raise the issue of tax avoidance and deny relief         may result in ‘tax benefit’.
to the taxpayer. Given the uncertainties involved in such     •	 Corresponding	adjustments	to	be	provided	in	the	
application, it is imperative for the proposed GAAR to           hands of the parties to the transaction.
be successful; it should not impact genuine business
transactions or promote uncertainty. One of the key           Procedural
objectives for introducing the Direct Tax Code is to          •	 If	CIT	finds	a	transaction,	which	comes	under	the	
simplify the language to enable better comprehension             purview of GAAR, the same may be referred to an
and remove ambiguity to foster voluntary compliance,             independent quasi-judicial body.
thus reducing litigation. However, the scope of GAAR             The CIT and taxpayer can make submissions and the
provisions in the present draft could cause massive              ruling by the quasi-judicial body can be final.
uncertainty and lead to extensive litigation as potential     •	 Threshold	limit	should	be	around	Rs	150	million	on	
legitimate tax planning could also become the target of          the lines of transfer pricing assessment.
GAAR.                                                         •	 Provision	of	Advance	Ruling	facility	-	existing	
                                                                 definition under the Code to be widened to include
In this connection, it would be imperative that the              GAAR.
guidance note to be formulated should be sensitive to
the issue of addressing avoidance from the prospect           Treaty and other provisions
of upholding the rule of law, the object and purpose          •	 Treaty	override	could	be	implemented	through	
of the legislation, rather than be construed as law in           protocol with the respective countries providing
itself and giving a free rein to administrative or judicial      for limitation of benefits and beneficial ownership
discretion. Some suggestions on reframing/modeling the           principles therein.
provisions on the basis of international experience may       •	 It	may	be	more	appropriate	to	provide	for	thin	
be adopted:                                                      capitalization rules which could also be covered
                                                                 under transfer pricing provisions than allowing the
Legislation                                                      same to be covered under GAAR.
•	 Our	model	could	be	based	on	the	Canada	model	-	
   the principles laid down by Canada Supreme Court           In this context, we may refer to what Chris Evans, has
   to be adhered.                                             written	in	his	Article	“Containing	Tax	Avoidance:	Anti-
•	 The	tax	benefit	on	the	transaction	should	not	be	          Avoidance Strategies (2008)” –
   the only criterion. If the transaction is done where
   tax benefit and commercial benefit are present, the        It may be too cynical to assume “the existence of tax                 C
                                                                                                                                20	 	 .H.	Gustafson,	“The	
                                                                                                                                    Politics	and	Practicalities	of	
   transaction should not be covered by GAAR.                 avoidance as a constant and perpetual motivation                      Checking Tax Avoidance
•	 The	provisions	could	be	made	applicable	in	respect	        for every taxpayer”20, but there is no doubt that tax                 in the United States” in G.
   of transaction where entering into the transaction         avoidance is widespread and that it presents a major                  S. Cooper, Tax Avoidance
                                                                                                                                    and the Rule of Law,
   and the cause and effect of the transaction occur          problem for those concerned with public finance                       (Amsterdam:	IBFD,	1997),	
   after the date of implementation.                          issues. There is some evidence that the aggressive retail             at p 376.

                                                                                         General Anti-Avoidance Rules India and International perspective       23
marketing of tax avoidance products and schemes may          personal social responsibility – and the reputational          I
                                                                                                                        21	 	.	Richardson,	“Reducing	
                                                                                                                            Tax Avoidance by Changing
have been constrained in recent years, but avoidance         damage that excessive and egregious avoidance
                                                                                                                            Structures,	Process	and	
activity is by its nature opportunistic and ad hoc. Simply   activity can attract – remains the ultimate deterrent,         Drafting” in G. S. Cooper,
raising the price of avoidance (through successful           notwithstanding the impressive arsenal that can be             Tax Avoidance and the Rule
                                                                                                                            of	Law,	(Amsterdam:	IBFD,	
containment, increased regulation and constrained            available to those who seek to counter avoidance.
                                                                                                                            1997), at p 327.
supply) will not choke off demand.
                                                             Beyond that we should also perhaps be mindful
Indeed, no single response or approach – whether             that two of the traditional goals of public finance –
administrative, legislative or judicial – can adequately     simplicity and equity – have critical roles to play in
or effectively contain avoidance activity. Such              determining social responses to avoidance activity.
containment only begins to occur where strategies            In recent years, these two goals may have been less
drawn from all three spheres complement each other           prominent in tax reform than the efficiency goal that
by operating in combination. As Sir Ivor Richardson          lends itself to easier economic measurement and
astutely pointed out some years ago, current                 evaluation.
requirements for a comprehensive and integrated
approach go beyond a more traditional analysis where         It is paradoxical that the more complex that the
“the legislature … exerts control of tax avoidance           tax regime becomes (often in attempts to contain
through special and general anti-avoidance provisions;       avoidance activity), the more likely it will be that
the revenue administration contributes in administering      opportunities for avoidance will arise. Avoidance
those provisions and exercising discretions; and the         activity thrives in complexity and uncertainty. And
judiciary is expected to strike the right balance between    where that complexity exacerbates the natural
acceptable and unacceptable tax planning through its         interaction (sometimes mediated by intermediaries)
interpretation and application of tax legislation21.”        between the taxpayer and the revenue authority such
                                                             that it becomes frictional rather than cooperative,
Ultimately, however, corporate and personal taxpayers        there will almost inevitably be a higher probability of
themselves have to take responsibility for the level         avoidance activity.
of avoidance and the degree of acceptance of such
behaviour that exists at any time in any society. The        It may be relevant for taxpayers to examine the
revenue authority, the legislature and the judiciary         transactions/arrangements entered into, so that
can play a role in shaping the demand for, and supply        the same do not fall within the boundary of being
of, tax avoidance activity, but such issues belong, in       considered as impermissible avoidable transactions
the final analysis, in the realms of moral and ethical       entered into with the object of obtaining a tax benefit.
behaviour of the taxpayers themselves. Corporate and


        General Anti-Avoidance Rules India and International perspective   25

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