By Chaahat Khattar
Edited by Namrata Caleb
“Every man is entitled to order his affairs so that tax attaching under the appropriate Acts is less than it otherwise would be” (IRC v Duke of Westminster)”
India has a corporate tax rate of 34% and Cayman Islands has a corporate tax rate of 0%. So in which country a firm with sufficient funds and some really sharp accountants will like to divert its income through? Naturally if resources permit, answer will be Cayman Islands.
General Anti-Avoidance Rules (commonly referred to as GAAR) were first introduced in the Direct Taxes Code (“DTC”) in 2009 to curb impermissible avoidance agreement entered into by a person to avoid taxes. To expedite the process of introduction of GAAR, Finance Bill 2012 proposed a new Chapter X-A in the extant income tax law- Income Tax Act 1961. Due to negative feedback and lot of debates, introduction of GAAR has been postponed till April 2016.
There are four broad categories through reduction in tax liability by a firm can be labeled- Tax Evasion, Tax Avoidance, Tax Mitigation and Tax Planning.
Tax Evasion is an illegal way that deals with hiding income or information from tax authorities to reduce or evade tax liabilities, Tax Mitigation is a situation in which the tax payer takes advantage of a fiscal incentive offered to him by legislation to reduce or go away with certain tax obligations (Special Economic Zones are a good example to understand tax mitigation), Tax Planning is nothing but planning your income and tax liability structure in a way to reduce tax obligations and Tax Avoidance refers to legal avoidance/reduction of tax liability by taking advantage of some provision or lack of provision in the law.
GAAR as its name suggest, deals with tax avoidance. GAAR empowers the Revenue Department to declare a tax benefit availed by a firm as void and invalid.
For GAAR to be invoked over any firm following conditions need to be sufficed-
- Main purpose of the arrangement or agreement is to obtain a “tax benefit”;
- It has rights and obligations which are not covered under arm’s length ambit;
- The arrangement lacks commercial substance; and
- The arrangement or transaction seems different and looks unauthentic.
Importantly, GAAR can only be imposed where a firm is taking advantage from the Double Taxation Avoidance Agreement (“DTAA”) that India might be having with any other nation and the minimum tax benefit obtained to come under the ambit of GAAR is INR 3 Million. Also, GAAR will not apply to Foreign Institutional Investors (“FII”) that choose not to take any treaty benefits. In case a part of arrangement is impermissible, GAAR will be restricted to the tax consequence of that part which is impermissible and not to the whole arrangement.
Let us understand the implications of GAAR through an example now.
Suppose, there is a business X involved in manufacturing of mobiles phones based out of India. Business X also has a subsidiary in Bulgaria named as Business Y. We know Bulgaria has a corporate tax rate of 10% and India has a DTAA with Bulgaria. Business X now shows in its books that in India it has just installed the software in the phones but Business Y that is based in Bulgaria has done the real manufacturing. It does so by simply transporting phones through Bulgaria. In such a case, the major chunk of tax obligation of Business X comes out to be in Bulgaria. The Revenue Department while assessing the income of Business X, can invoke GAAR by claiming that Business X has taken undue advantage of tax treaty just to claim tax benefits and moreover there is no transparency or showcase of “substance over form”.
Clearly, GAAR will help the Revenue Department in not only correctly assessing the income of the businesses but will also prohibit the firms from taking unethical routes to reduce their tax obligations. GAAR can also help the Revenue Department as well as the judicial bodies such as Supreme Court of India and High Courts of India to take more technically sound and proven decisions in cases such as of Azadi Bachao Andolan, McDowell & Co. and the much talked about Vodafone International Holdings.
GAAR although is a very powerful tool but it has its own flaws.
- India is struggling with weakening rupee and moderate investments through FII and FDI routes and in such a case, GAAR can be another deterrent for cash inflows in the nation;
- We already have International Taxation and Transfer Pricing regulations in the country. So imposition of GAAR looks like an added burden for the taxpayer and too much power in the hands of Revenue Department;
- When Specific Anti-Avoidance Rules (“SAAR”) could not prove to be successful then a more comprehensive and broaden concept’s success seems highly questionable;
- Scope of GAAR is too wide and in can well lead to lot of uncertainties both for the Revenue as well as the taxpayers; and
- On one side, Government is brightening the routes for foreign investments by introducing Advance Pricing Agreements and Safe Harbors and on the other imposing GAAR, sounds like an in house confusion.
In a nutshell, GAAR is undoubtedly a positive move towards internationalizing and stream lining our decades old tax structure. But just the way the Shome Committee had recommended, GAAR needs much more clarification and moreover training for the Revenue Department for not using GAAR as a double edged sword against the tax payers. As far as imposition of GAAR is concerned, it should be introduced in a phased manner by expanding the portfolio and ambit of SAARs leading to comprehensive GAAR in long term. GAAR in its present form is more oriented towards the Revenue whereas it should include recommendations from all the stakeholders.
Chaahat Khattar is an ardent economist and is working with an international consultancy firm. He is an MBA and pursuing Masters in Business Laws. He is also a Harvard University alumnus and a certified financial modeller. He has keen interest and experience in authoring research papers and case studies and have contributed to various renowned journals. Chaahat can be reached at [email protected]