Final Report on General Anti Avoidance Rules (GAAR)

The Expert Committee has submitted its Final Report on General Anti Avoidance Rules (GAAR) in Income-tax Act, 1961. The Report is very comprehensive and apart from giving an in-depth explanation of what the GAAR provisions are, it also has a number of examples of transactions which would be affected by GAAR.

 

Executive Summary

 

Recommendations for Amendments in the Act, Guidelines, and Clarifications through Circular

 

Countries impose taxes of various types with the objective of raising revenue for Government spending. Taxpayers may be expected to minimize their tax liabilities by arranging their affairs in a manner that is termed tax efficient i.e. through tax mitigation. This does not include tax evasion. It has been universally accepted that tax evasion through falsification of records or suppression of facts is illegal. Tax reduction through legal means, on the other hand, is increasingly considered a matter of right by taxpayers. The courts also tend not to frown upon this emergent approach of tax payers. This could perhaps be considered a paradigm shift in the approach towards taxability, and has given rise to the grey area of tax avoidance which is perceived by tax authorities as strictly legal in form but perhaps not in substance i.e. a business arrangement to avoid tax may not reflect its embedded legislative intent.

Various authorities, have, therefore, felt that tax reduction through unethical means should not be allowed, particularly when headline rates of tax have been significantly reduced. This has led to the introduction of anti-avoidance rules in tax statutes across tax jurisdictions internationally. Vide Finance Act, 2012, India introduced the General Anti-Avoidance Rules (GAAR) in the Income-tax Act, 1961. These GAAR provisions were analyzed and, based on inputs received from various stakeholders, a number of recommendations are being made by the present Committee. The recommendations are for amendment in the Act, for guidelines to be prescribed under Income-tax Rules, 1962, and for clarifications and illustrations through circular. They are summarized in these categories as under.

1. Recommendations for amendments in the Income-tax Act, 1961

The Committee makes the following recommendations for amendment in the Act-

(i) The implementation of GAAR may be deferred by three years on administrative grounds. GAAR is an extremely advanced instrument of tax administration – one of deterrence, rather than for revenue generation – for which intensive training of tax officers, who would specialize in the finer aspects of international taxation, is needed. The experience with international taxation such as transfer pricing, as well as the thin training module in specialized fields for Indian tax officers, increasingly in contrast to international benchmarked modules, tends to result in administrative challenges, as strongly pointed out by most stakeholders. This does not guarantee that an environment of certainty can be regenerated with an immediate application of GAAR, however modified. To note, the tax expenditure for not implementing GAAR (after a requisite threshold is applied) would be minimal. Hence GAAR should be deferred for 3 years. But the year, 2016-17, should be announced now. In effect, therefore, GAAR would apply from A.Y. 2017-18. Pre-announcement is a common practice internationally, in today‘s global environment of freely flowing capital.

(ii) The Government should abolish the tax on gains arising from transfer of securities, being equity shares or units of equity oriented mutual funds, which is subject to securities transaction tax (STT), whether in the nature of capital gains or business income, to both residents as well as non-residents.

In the present tax regime of taxation of listed securities being equity shares and units of equity oriented funds-

(a) there is a transaction tax as well as capital gains tax (on short term gains);

(b) there is a tax incentive for treaty shopping;

(c) taxpayers prefer round tripping of funds due to tax arbitrage between resident and non-residents (using favourable jurisdictions);

(d) taxpayers and revenue litigate on characterization of income as capital gains or business income as rates of tax are different for capital gains and business income;

(e) the fund managers prefer to stay out of the country lest their presence should constitute permanent establishment for foreign investors; and

(f) it is advantageous to trade outside in offshore derivatives having underlying assets in India.

 

Currently, the revenue on account of short term capital gains taxation under section 111A of the Act is very small as compared to overall direct taxes collection. On the other hand, such a measure—abolishing the tax on short term capital gains—may provide a big boost to capital markets, and, in turn, help attracting investments.

(iii) The Act should be amended to provide that only arrangements which have the main purpose (and not one of the main purposes) of obtaining tax benefit should be covered under GAAR.

(iv) Section 97 of the Act should be amended to include a definition of ―commercial substance‖ as under –

―An arrangement shall be deemed to be lacking commercial substance, if it does not have a significant effect upon the business risks, or net cash flows, of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained but for the provisions of this Chapter.‖

(v) The definition of ―connected person‖ may be restricted to ―associated person‖ under section 102 and ―associated enterprise‖ under section 92A.

(vi)The section 97(2) may be amended to provide that the following factors:

(i) the period or time for which the arrangement (including operations therein) exists;

(ii) the fact of payment of taxes, directly or indirectly, under the arrangement;

(iii) the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement,

are relevant but may not be sufficient to prove commercial substance. These factors will be taken into account in forming a holistic assessment to determine whether an arrangement lacks commercial substance.

(vii) As regards constitution of the Approving Panel (AP), the Committee recommends that –

(i) The Approving Panel should consist of five members including Chairman;

(ii) The Chairman should be a retired judge of the High Court;

(iii) Two members should be from outside Govt. and persons of eminence drawn from the fields of accountancy, economics or business, with knowledge of matters of income tax; and

(iv) Two members should be Chief Commissioners of income tax; or one Chief Commissioner and one Commissioner. In case any of these two officers is the jurisdictional officer of the taxpayer or is in the chain of command of the concerned Assessing Officer, he should be replaced by another officer of the same rank for that particular case.

(v) Appropriate mechanism may be provided to ensure confidentiality of information of the taxpayer becoming available to the members outside the Government.

The AP should be a permanent body with a secretariat. It should have a two year term. In the first AP that is to be appointed, one Chief Commissioner and one external member from a specified field would be appointed to a one-year term. This should ensure an overlap among members in future AP‘s. If there is any need for further representation from particularly specialized fields, an updated roster of specialists should be maintained from which any additional member may be drawn in an individual GAAR case.

A decision of the AP should occur by a majority of members.

(viii) Where anti-avoidance rules are provided in a tax treaty in the form of limitation of benefit (as in the Singapore treaty) etc., the GAAR provisions should not apply overriding the treaty. As specific treaty override has been provided in the Act (through amendment of section 90 and 90A of the Act vide Finance Act, 2012) for the purposes of application of provision of GAAR, this recommended change would require amendment of the Act.

2. Recommendations for guidelines to be prescribed under Income-tax Rules

The Committee makes the following recommendations for incorporation in guidelines to be prescribed under sections 101 and 144BA of the Act in the Income-tax Rules, 1962 –

(i) The GAAR provisions should be subject to an overarching principle that –

(1) Tax mitigation should be distinguished from tax avoidance before invoking GAAR.

(2) An illustrative list of tax mitigation or a negative list for the purposes of invoking GAAR, as mentioned below, should be specified-

(i) Selection of one of the options offered in law. For instance –

(a) payment of dividend or buy back of shares by a company

(b) setting up of a branch or subsidiary

(c) setting up of a unit in SEZ or any other place

(d) funding through debt or equity

(e) purchase or lease of a capital asset

(ii) Timing of a transaction, for instance, sale of property in loss while having profit in other transactions

(iii) Amalgamations and demergers (as defined in the Act) as approved by the High Court.

(3) GAAR should not be invoked in intra-group transactions (i.e. transactions between associated persons or enterprises) which may result in tax benefit to one person but overall tax revenue is not affected either by actual loss of revenue or deferral of revenue.

(4) GAAR is to be applicable only in cases of abusive, contrived and artificial arrangements.

(ii) A monetary threshold of Rs 3 crore of tax benefit (including tax only, and not interest etc) to a taxpayer in a year should be used for the applicability of GAAR provisions. In case of tax deferral, the tax benefit shall be determined based on the present value of money.

(iii) All investments (though not arrangements) made by a resident or non-resident and existing as on the date of commencement of the GAAR provisions should be grandfathered so that on exit (sale of such investments) on or after this date, GAAR provisions are not invoked for examination or denial of tax benefit.

(iv) Where SAAR is applicable to a particular aspect/element, then GAAR shall not be invoked to look into that aspect/element.

(v) The Foreign Institutional Investor (FII) is the taxable unit for taxation in India. Accordingly, the Committee makes the following recommendations-

(a) Where an FII chooses not to take any benefit under an agreement entered into by India under section 90 or 90A of the Act and subjects itself to tax in accordance with domestic law provisions, then, the provisions of Chapter X-A shall not apply to such FII;

(b) All investors above the FII stage should be excluded from the purview of GAAR as otherwise it may result in multiple taxation of the same income. Whether an FII chooses or does not choose to take a treaty benefit, GAAR provisions would not be invoked in the case of a non-resident who has invested, directly or indirectly, in the FII i.e. where the investment of the non-resident has underlying assets as investments made by the FII in India. Such non-residents include persons holding offshore derivative instruments (commonly known as Participatory Notes) issued by the FII.

(vi) Where only a part of the arrangement is impermissible, the tax consequences of an ―impermissible avoidance arrangement‖ will be limited to that portion of the arrangement.

(vii) While determining the tax consequences of an impermissible avoidance arrangement, corresponding adjustment should be allowed in the case of the same taxpayer in the same year as well as in different years, if any. However, no relief by way of corresponding adjustment should be allowed in the case of any other taxpayer.

(viii) A requirement of detailed reasoning by the Assessing Officer in the show cause to the taxpayer may be prescribed in the rules.

(ix) The tax audit report may be amended to include reporting of tax avoidance schemes above a specific threshold of tax benefit of Rs. 3 crores or above.

(x) The following statutory forms need to be prescribed:-

a. For the Assessing Officer to make a reference to the Commissioner u/s 144BA(1) (Annexe-8)

b. For the Commissioner to make a reference to the Approving Panel u/s 144BA(4) (Annexe-9)

c. For the Commissioner to return the reference to the Assessing Officer u/s 144BA(5) (Annexe-10)

(xi) The following time limits should be prescribed that -

i) in terms of section 144BA(4), the Commissioner (CIT) should make a reference to the Approving Panel within 60 days of the receipt of the objection from the assessee with a copy to the assessee;

ii) in the case of the CIT accepting the assessee‘s objection and being satisfied that provision of Chapter X-A are not applicable, the CIT shall communicate his decision to the AO within 60 days of the receipt of the assessee‘s objection as prescribed under section 144BA(4) r.w.s. 144BA(5) with a copy to the assessee.

iii) no action u/s 144BA(4) or 144BA(5) shall be taken by the CIT after a period of six months from the end of the month in which the reference under sub-section 144BA(1) was received by the CIT and consequently GAAR cannot be invoked against the assessee.

 

3. Recommendations for clarifications and illustrations through circular

The GAAR provisions in the statute as well in the rules should be explained through a circular as discussed in the Report with categorical clarification on the following issues:-

(i) GAAR shall apply only to the income received, accruing or arising, or deemed to accrue or arise, to the taxpayers on or after the date GAAR provisions come into force. In other words, GAAR will apply to income of the previous year, relevant to the assessment year in which GAAR becomes effective, and subsequent years.

(ii) Where Circular No. 789 of 2000 with respect to Mauritius is applicable, GAAR provisions shall not apply to examine the genuineness of the residency of an entity set up in Mauritius.

(iii) When the AO informs the assessee in his initial intimation invoking GAAR, he should include how the factors listed in section 97(2) have been considered (after amendment as recommended).

 

4. Other recommendations

The Committee has made the following recommendations in respect of tax administration:-

(i) The administration of Authority for Advance Ruling (AAR) should be strengthened so that an advance ruling may be obtained within the statutory time frame of six months.

(ii) Until the abolition of the tax on transfer of listed securities, Circular 789 of 2000 accepting Tax Residence Certificate (TRC) issued by the Mauritius authorities may be retained.

(iii) While processing an application under section 195(2) or 197 of the Act, pertaining to the withholding of taxes,

(a) the taxpayer should submit a satisfactory undertaking to pay tax along with interest in case it is found that GAAR provisions are applicable in relation to the remittance during the course of assessment proceedings; or

(b) in case the taxpayer is unwilling to submit a satisfactory undertaking as mentioned in (a) above, the Assessing Officer should have the authority with the prior approval of Commissioner, to inform the taxpayer of his likely liability in case GAAR is to be invoked during assessment procedure.

There is a responsibility on the payer of any sum to a non-resident under Indian tax laws in the form of a withholding agent of the Revenue as well as representative assessee of the non-resident payee. The payer is required to undertake due diligence to ascertain the correct amount of tax payable in India and, in case of any default, it becomes the payer‘s liability to pay. Inquiries in the case of the GAAR under consideration in the UK indicated that UK has not addressed this issue. In any case, the UK follows a residence based principle of taxation unlike India which follows the source based principle. Hence, some assurance of collection may be necessary in the Indian case.

(iv) To minimize the deficiency of trust between the tax administration and taxpayers, concerted training programmes should be initiated for all AO‘s placed, or to be placed, in the area of international taxation, to maintain officials in this field for elongated periods as in other countries, to place on the intranet details of all GAAR cases in an encrypted manner to comprise an additive log of guidelines for future application.

It would be perspicacious as indicated above, for Government to postpone the implementation of GAAR for three years with an immediate pre-announcement of the date to remove uncertainty from the minds of stakeholders. A longer period of preparation should enable appropriate training at the AO and Commissioner levels. It would also enable taxpayers to plan for a change in the anti-avoidance regime that would allow legitimate tax planning reflecting a proper understanding of the new legislation and guidelines, while eschewing dubious tax avoidance arrangements.