Tax Thoughts

The hidden dangers of GAAR

Mr. Arvind Datar (Senior Advocate)
Feb 27, 2017

In a little over four weeks, the provisions of Chapter-XA incorporating the General Anti Avoidance Rules (GAAR) will come into force.   The sections are of particular concern as they are capable of extremely wide interpretations and confer almost unfettered power to determine what is as an “impermissible avoidance arrangement”.  Of particular concern are sections 96(2), and 102(10).  The former reads:

(2) An arrangement shall be presumed, unless it is proved to the contrary by the assessee, to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit.

The   words “tax benefit” are extremely critical to the entire Chapter and section 102(10) defines this expression to mean:

          (10)   “tax benefit” includes, --

(a) a reduction or avoidance or deferral of tax or other amount  payable under this act; or

(b) an increase in a refund of tax or other amount under this act; or

(c) a reduction or avoidance or deferral of tax or other amount that would be payable under this act, as a result of a tax treaty; or

(d) an increase in a refund of tax or other amount under this act as a result of a tax treaty; or

(e) a reduction in total income; or

(f) an increase in loss,

In the relevant previous year or any other previous year;

A simple perusal of both these provisions indicate the enormous potential for harassment of assessees.  

There is no doubt that the transfer pricing provisions, the provisions for reopening assessments under section 147/148, and the powers of revision under section 263 are widely abused. Despite categorical pronouncements of the Supreme Court and the High Courts, demands are made  in complete disregard of judicially recognized limitations.  The tragedy is that no officer is accountable if he makes a demand contrary to a binding court decision on these points.   The reopening has to be done in very limited cases as set out in the proviso to section 147.   But examples abound wherein this power has been exercised in a most arbitrary and capricious manner.  The standard safeguards like getting approval  of the Chief Commissioner are meaningless as these approves are routinely granted.

Thus, we have a background on aggressive and arbitrary application of the statutory provisions  and the sole object seems to be to generate more demands of tax against assesses and leave them to their fate.   It is then for the hapless assessee to knock at the doors of the ITAT or the High Courts to try and obtain relief.    

The provisions of  section 96(2) which have been reproduced above point out that even if one step in a scheme or plan results in a tax benefit, it can be treated as an “impermissible avoidance arrangement”.  Shockingly, the definition of  “tax benefit” in section 102(10) includes any reduction in tax payable under this Act, a reduction or avoidance of tax payable as a result of  tax treaties and even more shockingly, any reduction in total income.  

The Indian GAAR is different from the UK GAAR which applies only if the main purpose is to obtain tax advantage.    In section 96(2), the non-obstante clause at the end of the sub-section dangerously provides that the Indian GAAR will apply even if the main purpose is not to obtain tax benefit.   Such a provision enables the Department to virtually attack any transaction and seek to levy higher amount of tax.

The potential for gross misuse can be illustrated by the following examples:-

Example No.1:    A company wants to expand its production capacity.   It can either set up a new plant or take over a sick unit manufacturing the same goods.   As a result of the merger, the loss of the sick company will potentially reduce its liability.   Under GAAR, such a merger can be treated as an “impermissible avoidance arrangement”.   The CBDT circular on GAAR, issued on 27.01.2017, brazenly points out that even if the scheme  is approved by the Courts/NCLT, the Department can  ignore it if the Courts/NCLT has not “explicitly and adequately” considered the tax implications – see the answer to Question No.8.   This is highly objectionable.   Under the Companies Act, 2013, a merger cannot be completed without notice to the Income-tax Department.  Past experience shows that every merger is objected to if it results in some tax reduction.  If the courts approve it, the remedy of the Department is to go on appeal to the higher forum and not invoke GAAR.

Example No.2:     Suppose a company sets up a unit in Special Economic Zone and  one of the objectives is to take advantage of the tax exemption.   Can this corporate decision be effectively nullified by GAAR?

Example No.3:    An investment is made from Mauritius with the intention of taking the benefit of a treaty.   Can the Department ignore the treaty provisions and invoke GAAR?

The answer to Q. No.3 seems to suggest that GAAR will not “interplay” (did the CBDT mean “interfere”?) with the rights of the tax payer to choose a method of implementing a transaction.  But this answer is meaningless because of the wide language of sections 96(2) and 102(10).  Will the Department refrain from interfering even if the assessee’s legitimate choice results in lower taxes?

These are troubling questions which require grave consideration. An aggressive and abusive application of  GAAR will seriously impact foreign direct investment and also domestic investment.   It is urgently necessary to clarify that GAAR will not apply in cases where mergers are approved by court or where benefits that are legitimately  permissible under the Act are taken advantage of, or  where there is a reduction in tax as a consequence of international tax treaties.

The words “impermissible avoidance arrangement” by definition means that there are permissible avoidance arrangements.    It is imperative that the CBDT issues guidelines setting out such permissible arrangements which will not attract GAAR.   One hopes that this is not a pious hope and that the horrible track record of transfer pricing is not replicated with GAAR.   The General Anti-Avoidance Rules, require general anti-abuse guidelines.      

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(*The writer is a Senior Advocate of the Supreme Court of India and Madras High Court)

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