Source:Wikipedia

This paper is authored by Abhinav Bishnoi, final-year law student at Institute of Law, Nirma University. 

Abstract

The General Anti-Avoidance Rule (GAAR) is an anti-tax avoidance law that came into effect in India on 1st April 2017 to curb tax evasion, tax mitigation and tax leaks. The provisions of the same are in Income Tax Act, 1961. After the liberalization of the Indian economy, there has been an increase in the number of sophisticated tax avoidance methods by the taxpayers and several spanning tax jurisdictions even worsen the situation. It made it infeasible for the judiciary alone to understand the unforeseen implication of transactions carried out for tax purposes. The Vodafone case was one of the biggest sensations of Indian taxation history and was also one of the reasons behind the formation of GAAR. Tax avoidance or tax evasion seriously undermines the achievements of the public finance objective of collecting revenue in an equitable, effective, and efficient manner. But there always has been a debate around the globe that whether the reduction in tax liability through a transaction or a series of transactions is tax planning or tax evasion.  

We will study the effect GAAR within the country has on corporate tax avoidance behaviour. We will in this paper also study the Vodafone case and the situation prior to the implementation of GAAR. The author hypothesizes that after the GAAR rules came into effect there has been economically increase in the aggregate tax collection and a decrease in firm-level tax avoidance. The GAAR rules provide the authorities with wide discretionary power that would have significant implications, both positive and negative. The arbitrary use of GAAR by the authorities will demotivate the investors and drive them away from investment in the economy. Hence a proper balance is required to be made between conflicting interests of tax planning and revenue collection. The research methodology used here by the author is doctrinal in nature and the paper will be beneficial for the academicians, students and people belonging to the law, tax, and corporate field.   

 

Introduction

The importance of the General Anti-Avoidance Rule (GAAR) has emerged with disappointment due to low tax collection by the Multinational Corporations (MNC) and thereby leading to less revenue of the nations and this problem was highlighted during the global pandemic in 2008-09. At that time, they need for revenue for public expenditure was all-time high and the majority of the MNC were paying even less than 1% of the global profit and this lead to the rise of several questions in Parliament.[1] GAAR basically enabled the tax authorities to question these MNC about their intra-corporate structure which is set up with an intention to minimise tax within the sphere of law or practise tax avoidance. Australia was the first country to introduce GAAR in 1981 which allowed challenging the tax structures over there[2].

The GAAR are general set rules and not any situation or country-specific, where is the government or tax authorities of any country is of the view that there should be more tax collection upon which the government has the right, but which is not be received and the company is avoiding paying the tax then the country can implement these rules on that company. GAAR also prevents any misuse of the treaty signed by any country with other countries, which generally happens to be a double taxation avoidance agreement. Likewise, there are provisions that deal with specific situations or specific avoidance and is called SAAR (Specific Anti-Avoidance Rules)[3].

 

GAAR and India

India had spent quite a few years re-examining and formulating GAAR for India. It was reintroduced by the government as the expert committee suggested the former one to be really harsh over the companies. Section 95-102 of the Income Tax Act were amended by the Finance Act, 2012 were the GAAR provisions and the main purpose was to obtain the tax benefit as defined under section 102(10) of the act.

The income tax authorities were given sweeping powers under the GAAR provisions and after its advancement, India saw a slump in the stock market and also added pressure upon the already down rupees as many foreign investment institutes were withdrawing from India.[4] Therefore, in order to mitigate this situation, the following amendments were added such as[5]:

· The onus of proof was shifted upon the tax authorities that why the GAAR provisions were applicable and thereby reducing the abuse of power. 

· The taxpayers also had the remedy to approach the Authority of Advance Ruling [section 245(N)] in order to determine that whether the GAAR provisions are applicable or not.

· GAAR Approving panel is a panel of independent members in order to ensure transparency and objectivity while applying its provisions. It shall be consisted of 2 non-tax department people and one retired judge of High Court as chairman and its decision shall be binding. 

The Shome Committee Report under the chairmanship of Dr Parthasarthy Shome conducted various consultations with the various stakeholders and general public in order to re-evaluate the rules of GAAR. It said that the purpose of GAAR is to obtain tax benefit, then only the impermissible avoidance arrangement shall be arranged and not whole arrangement as mentioned under section 96(2). The Assessing officer must make a reference to the Commissioner of Income Tax before invoking GAAR. Who then will listen to the tax payer side of argument and if still he is satisfied to apply then the matter shall be referred to the Approving Panel. Which will then make a further inquiry into the matter and pronounce final award which can be challenged before the appellate tribunal. There should be a difference between tax avoidance and tax mitigation and GAAR shall only be invoked in cases of abuse of tax arrangements. They also recommend a deferred time period of 3 years to make the taxpayers and tax authorities better understand the law. In matters of SAAR, the GAAR provisions shall not be invoked. Also, not in case when there is a benefit clause mentioned in any tax treaty GAAR shall not be invoked. GAAR would not be applicable to the non- resident companies investing in FII in India. And to remove the capital gains tax on transfer of listed securities[6].    

The expert committee formulated made the following recommendation to prevent the misuse of GAAR:

· The threshold limit is to be set up to provide relief to the small taxpayers.

· The time limit shall also be prescribed to minimise the business hindrance

· Set up of an approval panel for further supervision of the provisions

· The prescription shall be given by the tax authorities in order to maintain consistency all together in the procedure for invoking GAAR provisions. And also, the instances when the GAAR provisions will not be used.   

When GAAR came to India, it received an unwelcoming response. But after the Shome committee recommendations were adopted and amendments were made in the Finance Bill 2012, the situation was stabilised amongst the taxpayers.

But there are certain misses in these provisions, such as the time period is too long to help gain any confidence, i.e., 6 months with the Authority of Advance Ruling to obtain ruling. Also, the ‘grandfathering clause’ is troublesome as grandfathering of the arrangements would confer protection perpetuity. It should rather make arrangement where the resident and non-resident shall be grandfathered so that in the exist of such provisions GAAR can be invoked.[7]

 

The corporate structure of multinational companies

In the modern era of globalisation and privatisation, the companies which operate in various countries operate their management under a structure. There happens to a parent company and many of its subsidiary companies in every country where they operate. The parent company does not have to get itself registered in that country and the subsidiary works as a part of the parent company[8]. Therefore, all the profits gained by the subsidiary company will not be taxed where it operated but where it is registered. This is what a double taxation avoidance agreement does. The host country has not to be supposed to get any tax from the business carried out by the non-resident company who is registered in the country and paying tax there with which that country has a tax treaty. Such treaties lead to the round-tripping of the money from tax heaven.[9]

  

Challenges faced  

· Round tripping: It basically means that all the money that leaves a country through various means, makes its way back as a form of investment in the same country. This mostly used to be the black money used for stocks manipulation. Income Tax authorities have said such investment is nothing but the round-tripping of money and could attract GAAR. Another example, a parent company in India will buy the shares of its subsidiary company registered in Dubai (which is a tax heaven as it has no tax policy for corporations which is under their jurisdiction but does no business, such as no income tax). Now the subsidiary company will be benefitted and will give this money back to the parent company in the form of loan, over this loan the parent company will be benefitted by way of tax deduction laws over loan in India.

· Transfer Pricing: There have been many cases of transfer pricing in the very set up of such MNC, which is nothing but a method of tax evasion. In this, the goods or the services are sold within the same entity and also adjust the price accordingly. The subsidiary company purchases the assets from the parent company to ensure fair pricing of the assets transferred, normally at a higher price and likewise pay more consideration also. The GAAR is the technique by which the tax authorities keep a tab over the companies and prevent such operations.[10]

· Treaty shopping:  The following phenomena is again widely used by companies to avoid tax. In this, the tax treaty signed by 2 countries, the company from any other country forms a shell company and get it registered there in order to minimise the tax jurisdiction.[11]

 

Vodafone case study

This is a very intersecting case in the Indian tax history as the question arose regarding the tax liability accruing on the transaction when a non-resident company acquire shares of the resident company through indirect means.

In this case, there happens a transaction between Vodafone International Holding (a Dutch company) and Hutchison Telecommunication International Limited (based in Hong Kong) in which Vodafone procures all the shares of CGP investment limited from Hutchison in 2007. CGP had 67% control over Hutchison Essar Limited (an Indian company) through different means. Now through this transaction Vodafone the control over CGP and its subsidiaries. It also acquired cell communication in various circles of India. Later Vodafone even bought a 67% stake in Hutchison Telecommunication International Ltd as well as the Indian telecom company Hutch Essar Ltd. So, the telecom company in India that Hutch use to control through CGP (a Cayman Island company) has now been controlled by Vodafone.

The tax authorities were not sure how to unbundle the value of the assets of the company arising from shareholding. The Income Tax department issues show-cause notice to Vodafone company on why the capital gain tax that was about Rs 7,990 crore for the following transaction was not being paid as it had an impact on aberrant or indirect transfer of assets in India. The tax authorities were saying that Vodafone should deduct the tax at source before making the payment to Hutchison.[12]

Vodafone filed a petition before the Bombay High Court and the HC gave the judgement in favour of the government and ordered the company to pay the tax. The matter went into appeal before the Supreme Court of India.[13]

The main issue before the Supreme Court was that the transfer of assets through this transaction between two non-resident companies, outside India, is the transfer of underlying assets in order to avoid tax and that whether section 195 of the IT Act would have extra-territorial application. The SC in 2012 held that the contentions of the Vodafone were correct, and they are not liable to pay tax as per the Income Tax Act 1961. Court held that a company is a different legal entity than form its shareholders and management. A holding company cannot be held liable for its subsidiary’s action. The transaction of the company shall not be looked at in isolation but as a whole. Also, to promote strategic foreign direct investment in India, a holistic approach must be needed. The sale of shares is not a sale of assets. The court adopted the look at approach. Tax planning is not illegal or impermissible. Because in the year 1990’s Hong Kong-based Hutchison company invested in India along with Essar limited. The transaction was with the intent to invest in India and not to avoid tax. the transaction has no nexus with India as two non-resident companies have executed the deal outside India and consideration is also paid and received outside India[14].

The government then made an amendment to the Financial Act and gave the tax authorities the power to tax retrospectively. They inserted section 9(1)(1) of the Finance Act of India, 2012 which says that any arise in income by direct or indirect means over the transfer of assets in India. Later Vodafone invoked clause 9 of the Bilateral Investment Treaty (BIT) that was signed between India and the Netherland in 1995. This treaty was about investment protection and security for the investors of both countries in order to promote investment. It also ensured fair and equitable treatment to the companies so investing in the territory of the other. Vodafone said that this treaty can be invoked as the VIH is a Dutch company. And thereby the case went for arbitration before the Permanent Court of Arbitration, Hague. The court passed the award in favour of Vodafone and said that the new amendment in the tax law is in violation of the treaty between India and the Netherlands. The Indian government challenged this award before the High Court of Singapore. The court also passed the award in favour of Vodafone and also directed the Indian government to reimburse a sum of 40 crores as compensation.[15]   

 

Effect of the Vodafone case

The Cairn’s Dispute is also on the similar lines, where a company incorporated in the UK named, Cairn UK Holding Limited had acquired Cairn India Holding Limited in 2006, which is incorporated in Jersey. Cairn Jersey owned a subsidiary in India and subsequently, Cairn acquired the business in India. The tax authorities challenged it for not paying the capital gains tax and currently, the matter is before the Delhi High Court. The doctrine of Stare Decisis which says that to abide by the precedents is prevalent in common law countries.[16]

The government should not make retrospective laws as said by many critics and also maintain the mutual agreement signed with other countries in order to maintain clarity in the tax laws and to gain foreign investment. There are also many uncertainties in the present tax laws to deal with such matters effectively. A liberal tax policy would attract more FDIs.[17]   

 

Apprehension

The GAAR provide the tax authorities with a wide power that can be used arbitrarily against the companies upon whom the government has the suspicion of working unethically to avoid tax. This hinders the business environment and there is the apprehension of uncertainty in the new tax regime.[18] There are discretionary powers in the hands of the tax authorities to invoke GAAR. Section 72 A of the Act gives the power to carry forward and set off the losses of the company getting acquired by the other company or getting amalgamated to company with the conditions such as maintaining a prescribed level of production or maintaining the major portion of the amalgamating company. Hence, there is the wisdom of the legislation as per which under certain conditions the companies have to function. Even the provisions of transfer pricing would apply[19]. In order to cure the treaty shopping India is introducing LOB (Limitation of Benefit) which will limit the benefit of DTAA (Double Tax Avoidance Agreement) to only legitimate residents. It will deny the benefit to the non-qualified people or entities who are not residents of the agreeing counties. There are basically 5 approaches in this:

1. Objective test

2. Beneficial look

3. Channel test

4. Exclusion test

5. Subject to test

The arbitrary use of GAAR will thrive away from the ease of doing business. The government shall try to mitigate the uncertainties in order to boost the confidence of the investors.

 

Conclusion

The complexity and diversification in the current international tax arrangement it is the need of the hour to have unified set of goals to prevent tax evasions. A collaborative approach is what would be better than an isolated one. The tax regime should be fair, neutral and transparent in nature and it should thrive to facilitate trade, business and investment.[20]

The Indian tax laws has witnessed frequent amendments which would be foster bringing lack of clarity and which lead to lot of litigations. Even going for retrospective tax law will even lowered down the public confidence in terms of investing in India. India should foster to maintain the consistency in the tax laws and provide proper clarity in them. Also, there should be fair and transparent tax mechanism and a proper redressal mechanism against the authorities for the arbitrary use of GAAR provisions, which shall be redressing the problem within a stipulated time. [21]

Every, mature economy has introduced GAAR provisions in their country and their tax revenue is flourishing even brighter. Hence it is well proven that GAAR provisions by themselves are not draconian or unclear and invoking these provisions will leave our tax laws richer on theory and principle. If the Shome committee report makes the GAAR even more acceptable, then the recommendations must be conceptualized. If the laws are more liberal and taxpayer friendly it will be much better in the long run as it provide more safeguard to them and taxpayers will have confidence in the law and will not run away from it.  


[1] Kujinga, Benjamin T. “Factors That Limit the Efficacy of General Anti-Avoidance Rules in Income Tax Legislation: Lessons from South Africa, Australia, and Canada.” The Comparative and International Law Journal of Southern Africa, vol. 47, no. 3, Institute of Foreign and Comparative Law, 2014, pp. 429–59, http://www.jstor.org/stable/43894817.

[2] Mallya, Vivek. “On India’s Capacity in GAAR.” Economic and Political Weekly, vol. 47, no. 46, Economic and Political Weekly, 2012, pp. 4–5, http://www.jstor.org/stable/41720363.

[3] Mukhopadhyay, Sukumar. “Lightening the Burden of GAAR.” Economic and Political Weekly, vol. 47, no. 45, Economic and Political Weekly, 2012, pp. 17–19, http://www.jstor.org/stable/41720345.

[4] KRISHNASWAMY, R., and K. KANAGASABAPATHY. “Sustainability Issues in India’s Balance of Payments.” Economic and Political Weekly, vol. 48, no. 18, Economic and Political Weekly, 2013, pp. 127–29, http://www.jstor.org/stable/23527318.

[5] Talreja, Anil. “Changing Tax Reforms in India – What Next?” National Law School of India Review, vol. 24, no. 2, Student Advocate Committee, 2013, pp. 75–88, http://www.jstor.org/stable/44283763.

[6] Kumar, Y. Shiva Santosh. “India’s Taxation Regime: Perspectives on the Proposed Changes.” National Law School of India Review, vol. 23, no. 2, Student Advocate Committee, 2012, pp. 28–43, http://www.jstor.org/stable/44278804.

[7] Talreja, Anil. “Changing Tax Reforms in India – What Next?” National Law School of India Review, vol. 24, no. 2, Student Advocate Committee, 2013, pp. 75–88, http://www.jstor.org/stable/44283763.

[8] Steenkamp, Lee-Ann, et al. “Tapping into a Quarter-Century’s Judicial Experience with the Canadian General Anti-Avoidance Rule (GAAR): Some Insights for South Africa.” The Comparative and International Law Journal of Southern Africa, vol. 49, no. 3, Institute of Foreign and Comparative Law, 2016, pp. 477–505, https://www.jstor.org/stable/26367612.

[9] Arshu John & Linesh Lalwani, General Anti-Avoidance Rules (GAAR): An Indian and International Perspective, 26 NLIU Law Review 16-18, (2019)

[10] Jain, Sunil. “The Direct Taxes Code, 2010 — Ushering in Controlled Foreign Corporation Rules in India.” National Law School of India Review, vol. 23, no. 2, Student Advocate Committee, 2012, pp. 22–27, http://www.jstor.org/stable/44278803.

[11] MUKHOPADHYAY, SUKUMAR. “General Anti-Avoidance Rule in Income Tax Law.” Economic and Political Weekly, vol. 47, no. 22, Economic and Political Weekly, 2012, pp. 24–28, http://www.jstor.org/stable/23214999.

[12] Andharia, Prateek. “Section 9 of the Income Tax Act, 1961: Defaced and Defiled?” National Law School of India Review, vol. 25, no. 1, Student Advocate Committee, 2013, pp. 119–37, http://www.jstor.org/stable/44283624.

[13] Swaminathan, K., and Gouri Puri. “A Realist’s Account of the Bombay High Court’s Decision in the Vodafone Case.” National Law School of India Review, vol. 23, no. 1, Student Advocate Committee, 2011, pp. 99–107, http://www.jstor.org/stable/44283742.

[14] Parthasarathi Shome, Addressing Tax Avoidance: Cross country experience and an Indian case study, LSE Law, Society and Economy Working Ppaer 6/2019

[15] SMIT, HAN, and THRAS MORAITIS. “PLAYING AT SERIAL ACQUISITIONS: THE CASE OF VODAFONE.” Playing at Acquisitions: Behavioral Option Games, STU-Student edition, Princeton University Press, 2015, pp. 43–72, http://www.jstor.org/stable/j.ctt9qh0nc.8.

[16] Shroff, Vandana, et al. “India.” The International Lawyer, vol. 45, no. 1, American Bar Association, 2011, pp. 521–35, http://www.jstor.org/stable/23644029.

[17] Mallya, Vivek. “On India’s Capacity in GAAR.” Economic and Political Weekly, vol. 47, no. 46, Economic and Political Weekly, 2012, pp. 4–5, http://www.jstor.org/stable/41720363.

[18] RAO, M. GOVINDA, and R. KAVITA RAO. “Taxes and Death Are Inevitable, but GAAR Is Avoidable.” Economic and Political Weekly, vol. 47, no. 43, Economic and Political Weekly, 2012, pp. 10–13, http://www.jstor.org/stable/41720290.

[19] Rajesh Begur & Priyesh Sharma, India: GAAR: A threat to commercial tax structuring, Mondaq (10 November 2021, 10 AM), https://www.mondaq.com/india/tax-authorities/560496/gaar-a-threat-to-commercial-tax-structuring

[20] Ostwal, T. P., and Vikram Vijayaraghavan. “Anti-Avoidance Measures.” National Law School of India Review, vol. 22, no. 2, Student Advocate Committee, 2010, pp. 59–103, http://www.jstor.org/stable/44283791.

[21] Sambamurthi, Vijay. “RECENT DEVELOPMENTS IN INDIAN LAW: IMPACT ON PRIVATE EQUITY TRANSACTIONS.” National Law School of India Review, vol. 28, no. 1, Student Advocate Committee, 2016, pp. 44–60, http://www.jstor.org/stable/44283664.