GAAR and Its Implications

General Anti-avoidance Rule (GAAR) is a concept which generally empowers the Revenue Authorities in a country to deny the tax benefits of transactions or arrangements which do not have any commercial substance or consideration other than achieving the tax benefit. Denial of tax benefits by the Revenue Authorities in different countries, often by disregarding the form of the transaction, has been a matter of conflict between the Revenue Authorities and the taxpayers.

It is common for taxpayers to arrange their affairs in a way that will give them tax benefits, which are through genuine and legitimate actions. Over the past few years it has been noticed that the Revenue Authorities have attempted to deny tax benefits, whether under the tax treaty or domestic law, by disregarding the form and looking through the transactions. However, genuine transactions consummated in a tax efficient manner need to be distinguished from sham transactions or colourable devices used for evading tax.

The approach of Revenue Authorities has resulted in protracted litigation and uncertainty. The Revenue Authorities’ attempts in this regard have not succeeded in most cases, especially in the Supreme Court, the most recent being in the Vodafone case.

These rules are primarily targeted at arrangements or transactions made specifically to avoid taxes. These were originally proposed in the Direct Taxes Code but brought forward in the budget for the current year.

The crux of the GAAR rules is that authorities can deny tax benefit to any business arrangement or a transaction, termed ‘impermissible avoidance arrangement’, if they feel it has been primarily entered into to avoid taxes. More than 30 nations have introduced GAAR provisions in their respective tax codes.

What are the key concerns?

The provisions are very broadbased and could be applied to most tax-saving arrangements. Although the intent was to largely tax investments routed through particular countries looking to take advantage of India’s tax treaty, the law could apply to even domestic transactions.

Experts felt that the rules gave powers to tax officers to question any domestic transactions that involved tax saving.

What are the safeguards in the draft?

The guidelines say the rules will apply only above a certain monetary threshold to give relief to small taxpayers. All action under GAAR will be time bound, and a three-member panel will ensure that only genuine cases are taken up.

The onus to prove an agreement is impermissible will lie with the tax department. If an assessing officer finds that only a part of the tax arrangement is impermissible then GAAR will apply only to that part and not to the entire transaction.

What is the implication for foreign investors?

The draft rules clarify that if a foreign institutional investor pays tax in accordance with the domestic laws then GAAR will not be invoked against the FII and its non-resident investors.

But if an FII decides to take the benefit of a tax treaty India has with another country then GAAR provisions may be invoked in the case of that FII but its non-resident investors will be spared. This means that those investing in India through participatory notes will not face action under GAAR.

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