Tanishka Tiwari
Published on: February 3, 2024 at 22:10 IST
Assesses often seek ways to avoid paying taxes, leading to various techniques. Tax avoidance and tax evasion are the two most common tax-saving activities identified worldwide. Assesses the use of legislative weaknesses to circumvent the objective of taxation and avoid paying taxes.
Tax avoidance is an agreement formed to circumvent the law’s intent by exploiting flaws in the tax regulations. It refers to discovering new techniques or technologies for avoiding paying legally permissible taxes. This can be accomplished by modifying the accounts to prevent violating tax regulations while reducing tax incurrence. Tax evasion was once deemed legal, but it is now classified as a felony in some situations. Tax avoidance is intended to delay, transfer, or eliminate tax liabilities. Investing in government programmes, such as tax credits, privileges, deductions, and exemptions, can reduce tax liabilities without violating the law.
Tax evasion is the immoral activity of minimising taxes by hiding income, misrepresenting expenses, or reporting reduced income. Tax avoidance is lawful as long as legal procedures are utilised, but tax evasion is forbidden due to purposeful deceit. Illegal tax methods include concealing income, manipulating accounts, disclosing false costs for deductions, misrepresenting personal spending as company expenses, overstating tax credits or exemptions, suppressing earnings and capital gains, and more. This can lead to inaccurate income disclosure for the organisation. Tax evasion is a criminal offence that carries legal consequences. This includes deliberate distortion of critical facts.
- Hide related documents.
- Not keeping comprehensive records of all transactions.
- Making false assertions.
Internationally, tax evasion has been identified as a source of concern. Several governments have voiced concern about tax evasion and avoidance. This is also demonstrated by governments either incorporating General Anti-Avoidance Regulations into their tax codes or tightening their current codes. India has also attempted to address tax avoidance and evasion concerns by enacting the General Anti-Avoidance Rule (GAAR) and other transaction-specific Special Anti-Avoidance rules.
To reduce revenue losses, several governments have particular anti-tax evasion legislation. Tax avoidance refers to organisations aiming to decrease their tax burden on the government. According to India’s Income Tax Act of 1961 requirements, the General Anti-Avoidance Rules were implemented in India following the Vodafone-Hutchison-Essar merger. The Vodafone case, which has become the biggest sensation in Indian tax history, is one of the main reasons for the establishment of GAAR. This transaction happened in the Cayman Islands. The government alleges that over USD 2 billion in taxes were lost. In the ensuing lawsuit, the Supreme Court found in favour of Vodafone. GAAR is finally in force as of April 1, 2017.
The General Anti-avoidance Rule (GAAR) allows a country’s Revenue Authority to withhold tax benefits for transactions that lack business substance and are solely for tax purposes. The necessity for a GAAR is typically explained by a desire to enhance the tax system’s integrity.
We know taxes collected from individuals, organisations, and other entities account for most of the government’s revenue. Everyone wants to gain from the taxes levied on them. They frequently engage in fraudulent behaviour to avoid paying taxes. The Indian government introduced the General Anti-Avoidance Rule (GAAR) to combat tax evasion and leakage. The government of India implemented the GAAR rule in response to the well-known Vodafone International case.
What is GAAR?
The General Anti-Avoidance Rule (GAAR) is an anti-tax avoidance rule in India designed to reduce tax evasion and prevent revenue leakage. It comes into effect on April 1, 2017. The GAAR regulations are based on the Income Tax Act of 1961. GAAR detects aggressive tax planning, particularly those transactions or business arrangements, to avoid tax. It is primarily focused on decreasing revenue losses that happen to the government owing to active tax evasion methods adopted by firms. The Vodafone case, the most enormous sensation in Indian taxation history, is one of the primary reasons for the GAAR structure. GAAR becomes implemented in the evaluation year 208-19.
Tax avoidance, a type of abusive tax planning that complies with the letter but not the spirit of the law, falls somewhere between the two extremes of tax planning and tax evasion. For example, a transaction structured with the sole intention of tax benefit but no substantial business consideration. Furthermore, complicated structures were used to establish firms in tax jurisdictions to profit from double taxation avoidance agreements (DTAAs), a practice known as treaty shopping. The goal of GAAR is to prevent such activities.
The anti-tax evasion campaign gained traction when both industrialised, and developing countries felt the effects of tax dodging. Soon, it was discovered that tax evasion leads to weak public finances and unfair enrichment of the wealthy at the expense of the poor. This culminated in the Base Erosion and Profit Shifting (BEPS) initiative, which is led by Organisation for Economic Cooperation and Development (OECD) members and involves over 100 nations working together to adopt BEPS measures to combat tax evasion.
The GAAR is a broad regulation based on fundamental principles to prevent tax evasion in unpredictable situations. In contrast to comprehensive standards, specialised anti-avoidance rules (SAAR) exist. The SAAR is a collection of laws that target particular “known” tax avoidance methods. They have a limited scope of applicability and do not allow tax officials any discretion.
GAAR differs from specialised anti-avoidance rules (SAAR). SAAR identifies particular cases of tax evasion and sets forth the resulting consequences. Examples of SAAR include provisions in the Income Tax Act 1961, such as transfer pricing, dividend stripping, and a cap on interest payments to overseas parent firms. However, in this game of cat and mouse, revenue has always been on the receiving end, and the wayward taxpayer is well ahead of the revenue department.
The GAAR is a valuable instrument for governments to deter tax evasion, but has certain drawbacks. The GAAR generates confusion regarding tax implications for both company and non-business transactions. Tax uncertainty and practical issues might hinder both local and international investment.
The essence of GAAR
GAAR may be characterised as the legislative codification of the “substance” versus “form” rule for examining a particular transaction and piercing the form. GAAR might be characterised as a provision allowing a tax inspector to reject a transaction constructed by an unethical taxpayer that would have been legal if GAAR had not existed. The requirements of GAAR apply to an impermissible avoidance arrangement (IAA), simply an agreement meant to avoid tax.
To determine an IAA, examine the following factors:
- The objective of the arrangement is to achieve a tax benefit;
- It is not at arm’s length price;
- It lacks commercial substance;
- It violates tax legislation; and
- It is not done in a usual manner.
Under the current laws, if the principal aim of a leg of the transaction or a portion of it is tax advantage, there is a presumption that such an arrangement is for tax avoidance, even if the overall goal of the central arrangement is not tax avoidance. The assessee must refute this assumption, which can be a challenging undertaking. Once GAAR has been applied, the entire or a portion of the transaction might be nullified or re-characterised.
Furthermore, the General Anti-Avoidance Rule (GAAR) possesses a non-obstante provision, which can supersede all other provisions of the Income Tax Act, 1961, including the Specific Anti-Avoidance Rule (SAAR). Concerns have been expressed that general rules should not be permitted to override them in situations where specific rules are in operation. Nevertheless, the government has embraced a different approach, and recently, the Central Board of Direct Taxes (CBDT) issued a clarification on 27th January 2017. This clarification explicitly stated that SAAR alone is inadequate in addressing all instances of abuse; therefore, GAAR and SAAR can coexist. This development has further exacerbated the anxieties of taxpayers and their advisors.
Therefore, does this indicate that under the GAAR regime, a company is restricted from engaging in tax planning and is compelled to opt for the most disadvantageous option invariably? The answer to this query is a resounding “no.” However, it is incumbent upon the taxpayer to substantiate that the arrangement possesses commercial substance and that pursuing tax advantages is not the sole determining factor.
It is intriguing that most multinational corporations operating in India, who are already subject to GAAR in foreign jurisdictions, exhibit greater apprehension than domestic companies. There has been a considerable outcry regarding the potential misuse of GAAR provisions. Consequently, procedural safeguards have been implemented as a three-tier mechanism to curtail arbitrary actions. This system commences with the asdescribeder, followed by the principal commissioner of income tax, and ultimately culminates with the approving panel, which includes a retired high court judge. A timeframe of six months is allowed to determine the applicability of GAAR.
The multi-tier decision-making process is also advantageous from a revenue perspective. It is a fact that there is a powerful interest group that vociferously complains and accuses the tax system of being oppressive at the slightest provocation. Such a procedural safeguard is expected to foster confidence among the evaluating officers in scrutinizing the arrangements.
Whether GAAR can enforce more ethical business practices remains to be seen, but it will undeniably impact companies’ internal operations. For example, in-house legal and taxation departments must collaborate closely to maintain communication while establishing any arrangement. They would also need caution in internal corporate communication through emails, telephone calls, etc., as these records can be used as detrimental evidence against the company.
Since the responsibility would lie with the taxpayer to demonstrate the commercial substance in the transaction, an appropriate series of documents would need to be maintained to challenge the assumption of an Impermissible Avoidance Arrangement invoked by the revenue department.
Provisions related to GAAR under Indian Laws
Chapter X-A of the Income Tax Act, 1961, address the idea of GAAR & it and range from Sections 95 to 102 of the Act. The GAAR was established by then-Finance Minister Pranab Mukherjee during the 2012 budget session. Article 265 of India’s Constitution empowers the government to charge or collect taxes from its citizens. It is usually assumed that every citizen must pay a reasonable tax under the requirements of tax legislation. Under Indian law, anyone who avoids paying taxes is considered an evader. Tax avoidance attempts to reduce an organisation’s responsibility to pay government taxes.
Section 95 of the Act addresses the applicability of the provision. It specifies that, despite any content within the legislation, an agreement made by a taxpayer can be declared as an impermissible avoidance arrangement. The resulting tax consequences can be determined under the provisions outlined in this chapter. The Explanation to Section 95 also clarifies that these provisions apply to the entirety of the arrangement or any individual step or aspect of it.
Furthermore, Section 96 of the legislation defines an impermissible avoidance arrangement (IAA) as an arrangement formed to obtain a tax benefit. This arrangement involves the creation of rights and obligations that are not typically established between parties acting at arm’s length. Additionally, it may involve misusing the provisions outlined in the legislation, either directly or indirectly. Furthermore, an arrangement can be deemed to lack commercial substance, either in whole or in part, or it may have been made through means or methods not typically employed for bona fide purposes.
Section 96 also established a presumption that an arrangement was entered into or carried out for the primary purpose of obtaining a tax benefit, even if a step in, or a part of, that arrangement is to obtain a tax benefit. This means that even if one part of the arrangement is to obtain a tax benefit, the entire arrangement will be considered to be made for the same purpose. Still, this presumption is rebuttable, so evidence can be provided to rebut this presumption.
The term “lack commercial substance” is defined in Section 97 of the Act as an arrangement that occurs under certain conditions where the appearance of forms carries more significance than the actual substance. This includes arrangements that involve actions such as round-trip financing and an accommodating party, as well as elements that offset or cancel each other out.
Furthermore, it encompasses transactions conducted through one or more individuals and conceals the value, location, source, ownership, or control of funds that are the subject of the transaction. Additionally, it covers situations where the location of an asset, a transaction, or the place of residence of any party lacks any substantial commercial purpose other than obtaining a tax benefit.
Notably, such arrangements do not significantly impact the business risks or net cash flows of any party involved, except for the effects attributed to the tax benefit that would be obtained.
Analysis
Tax avoidance refers to the lawful exploitation of the tax system to minimize the amount of tax one must pay. This is achieved through legal means, such as identifying loopholes and gaps in tax and other laws, which legislators should have foreseen.
The General Anti-Avoidance Rule (GAAR) only comes into play when taxpayers have one or more legitimate transaction methods and can choose how to proceed. These provisions are based on the principle of “substance over form,” wherein tax authorities disregard the legal structure of an arrangement and instead focus on its actual substance.
This is done to prevent the use of artificial structures for tax avoidance. However, it is essential to note that this doctrine is highly subjective and uncertain. The Bombay High Court’s decision in the case of Provident Investment Co. Ltd. v. CIT1 recognised that disregarding the legal position in favor of examining the substance of a matter introduces an element of uncertainty and discretion, which may not align with the transparent and objective nature of the law.
The application of the provisions is inherently unpredictable and uncertain due to its chilling effect on taxpayers’ positions, which, though lawful, aim to minimize tax liability in a manner perceived as unfavorable by the tax administration. The provisions bestow extensive authority on the tax authority to invoke GAAR arbitrarily, as it fails to distinguish between legitimate tax minimization and abusive tax avoidance.
Moreover, no legislative or administrative safeguards are in place to protect genuine taxpayers from the abusive utilization of GAAR by the Tax Authority. A mere examination of the provisions reveals that it grants arbitrary power to the Tax Authorities to implement it, and the definition of IAA lacks objectivity. Both of these aspects contribute to a dictatorial approach, which infringes upon Article 14 of the Constitution of India, as highlighted by the Supreme Court in the case of Maneka Gandhi v. Union of India,2 wherein it was stated that “Article 14 aims to eliminate arbitrary State action and ensures fairness and equal treatment.” The provisions also appear to contradict the principles of the “doctrine of the rule of law.”
In the case of S.G. Jaisinghani v. Union of India,3 the Court has underscored the paramount importance of the absence of arbitrary power as the fundamental cornerstone of the rule of law, upon which our entire constitutional framework is built. Within a legal system guided by the rule of law, any discretion granted to executive authorities must be strictly limited within clearly defined boundaries. From this perspective, the rule of law implies that decisions should be based on established principles and rules, and, as a general rule, these decisions should be foreseeable and transparent to the citizens. Conversely, a decision that lacks any guiding principle or rule is inherently unpredictable and starkly contrasts a decision made under the rule of law.
A core principle of the rule of law is that laws must possess an unambiguous nature, devoid of any arbitrary decision-making, to allow individuals to anticipate and plan their future actions. This principle finds particular expression in taxation, wherein taxpayers should ideally be able to predict or at the very least retrospectively identify, the tax consequences of their activities following regulations established through parliamentary procedures.
Hence, the provision of GAAR, which may grant the government seemingly unrestricted authority to alter the tax treatment of a transaction, can be perceived as enabling a form of taxation by administrative decree or analogy, or even the imposition of an irrefutable tax. Any law or rule that is vague, perplexing, convoluted, or imprecise is likely to mislead or confuse those intended to be governed by it, and frequent revisions would render it nearly impossible for the general public to make long-term plans and judgments.
Certainty and predictability undeniably hold great importance in the realm of taxation. In contrast, the provisions bestow authorities with the power to go beyond the legality of a transaction and exercise discretionary authority over its subject matter or arrangement.
In the case of I.R. Coelho v. State of Tamil Nadu,4 it was determined that the principle of the rule of law is an integral component of the fundamental framework of the Constitution of India. Due to the unpredictable, uncertain, and arbitrary nature of the General Anti-Avoidance Rule (GAAR) provisions, they violate the rule of law, a fundamental aspect of the Constitution. Consequently, these provisions must be invalidated for their breach of the rule of law, as they lack predictability, certainty, and fairness.
The promotion of GAAR provisions as a comprehensive solution to perceived treaty abuses implies their application to alter the outcome that would have been achieved through adherence to the explicit terms of the treaty. The Double Taxation Avoidance Agreement (DTAA) is a bilateral accord between two nations that aims to facilitate and encourage economic trade and investment by preventing double taxation.
It is a well-established legal doctrine, as outlined in Section 90(2) of the Income Tax Act and confirmed by the recent landmark ruling of the Supreme Court in Engg. Analysis Centre of Excellence (P) Ltd. v. CIT,5 that provisions or articles of the DTAA that offer more significant advantages shall prevail over inconsistent provisions within the Income Tax Act. To circumvent the implications of Section 90(2), the legislature has introduced an additional sub-section (2-A) that states, “Without regard to the provisions of sub-section (2), the provisions of Chapter X-A of the Act shall apply to the taxpayer, even if such provisions are not advantageous to them.”
The Delhi High Court, in the case of DIT v. New Skies Satellite BV,6 has held that no amendment, whether retrospective or prospective, can be interpreted in a manner that alters the operation of the terms of an international treaty. Domestic law remains static about a Double Taxation Avoidance Agreement (DTAA). Despite the supremacy of the Court, it expressed that Parliament does not have the authority to modify the conditions of a treaty through domestic legislation. In this judgment, the Delhi High Court also recognized that the provisions of the Vienna Convention on the Law of Treaties, 1969 (VCLT) are widely accepted as a component of customary international law. According to Article 39 of the VCLT, a treaty can only be amended through agreement between the parties.
The Delhi High Court emphasized that this norm is deeply ingrained in customary international law and cannot be violated. This notion is further supported by Article 51(c) of the Indian Constitution, which results in the legislative authority of Parliament being constrained. Article 253 of the Constitution empowers Parliament to enact laws for the whole or any part of the territory of India to implement any treaty, agreement, or convention with other countries or any decision made at an international conference, association, or other body. Section 90(2) of the Act exemplifies this power to implement DTAAs. Similarly, Section 90(2-A) of the Act illustrates the exercise of powers under Article 246, possibly in conjunction with Entry 97 of the Union List. Article 253 contains the phrase “Notwithstanding anything in the foregoing provisions of this chapter.” The non-obstante clause signifies that Article 253 precedes Articles 245 and 246.
The decision rendered by the High Court of Andhra Pradesh in the case of Sanofi Pasteur Holding SA v. Deptt. of Revenue7 was in line with the ruling of the Canadian Supreme Court in the matter of R. v. Melford Developments lnc.8 The High Court opined that once a law is enacted under Article 253, it holds supremacy over all other laws, and a subsequent statute, typically enacted under the powers conferred under Article 246, cannot amend a law made under Article 253.
The Court emphasized that upholding this principle is crucial to preserving the sanctity of international obligations, as failure would frequently allow domestic law to modify a country’s international obligations. Therefore, it is impermissible to amend a law made under Article 253 through a subsequent statute enacted under Article 246. Any modification to a treaty can only be accomplished through mutual agreement between the concerned parties, to prevent the subversion of the treaty’s purpose and objectives by unilateral domestic legislation.
Conclusion
GAAR, due to its inherent characteristics, possesses the capacity to result in substantial ambiguity and legal proceedings. Consequently, it becomes imperative to establish sufficient safeguards to ensure that GAAR is implemented impartially and equitably.
It is anticipated that the Government will promptly issue unambiguous and comprehensive guidelines that elucidate the various facets of GAAR, encompassing the circumstances under which they will or will not be invoked, as well as how the GAAR provisions will be employed (in terms of their ramifications). These guidelines should incorporate practical examples that address contentious issues, providing direction for taxpayers and tax authorities. Indeed, the statute stipulates that the GAAR provisions will be applied following prescribed “guidelines.”
To introduce certainty in the GAAR system, taxpayers may contemplate employing various dispute resolution methods, such as seeking private rulings from the Authority for Advance Ruling, entering into advance pricing agreements, and, in appropriate cases, resorting to mutual agreement procedures when formulating their litigation strategy. Specific methods may offer expedited and more efficacious resolutions to potential tax disputes while mitigating the risk of protracted and burdensome legal proceedings, which are prevalent in India.
Undoubtedly, tax systems have always been influenced by the possibilities for evasion and administration challenges. However, if not modified, the GAAR provisions will only create uncertainty and ambiguity for taxpayers. These provisions can be likened to a double-edged sword, giving tax authorities the power to arbitrarily invoke any transaction, which may burden legitimate transactions without adequate safeguards. Despite the clarification provided by the Central Board for Direct Taxes, there remain uncertainties surrounding the provisions in various aspects. Sufficient safeguards must be put in place to ensure the effective implementation of the GAAR provisions. Alternatively, the “limitation of benefits” clause, a particular Anti-Avoidance Rule, can be considered an alternative method. Ultimately, it is the Court’s responsibility to interpret and assess the provisions based on constitutional parameters. Until then, the Government and authorities must provide adequate safeguards and guidelines.
References
- General Anti Avoidance Rule (GAAR) provisions in India – Taxmann
- Understanding basics of General Anti-Avoidance Rule (GAAR) (taxguru.in)
- Slide 1 (pwc.com)
- General Anti Avoidance Rule (GAAR) (prsindia.org)
- Critical Analysis of GAAR in Light of the Constitution of India and DTAA | SCC Blog (scconline.com)
- GAAR as a Deterrent to Tax Avoidance | Economic and Political Weekly (epw.in)
Endnotes
1. 1953 SCC OnLine Bom 35
2. (1978) 1 SCC 248
3. AIR 1967 SC 1427
4. (2007) 2 SCC 1
5. (2022) 3 SCC 321
6. 2016 SCC OnLine Del 796
7. 2013 SCC OnLine AP 422
8. 1982 SCC OnLine Can SC 89