AN INSIGHT INTO GENERAL ANTI-AVOIDANCE RULES (GAAR)

Study Circle Meet, Bangalore Branch of SIRC – April 5, 2017

By: Sandeep Jhunjhunwala, FCA

BACKGROUND

• Lets say a company has a policy to help employees reach home on time for a better work life balance

• The policy states "Employees who stay beyond 20 km from the office can leave 30 minutes early"

• Some employees bend the rules in their favour - change of address on records, just to leave early

• System implemented with a good intent quickly abused

• Case of public transport – Seats reserved for elderly, taken by sturdy

• Similarly, a law designed for specific purpose can get undermined by elements that seek loopholes to create an unfair advantage for themselves!

WHY GAAR?

APPLICABILITY OF GAAR

Tax Evasion Generally the result of illegality, suppression, misrepresentation and fraud

Deliberately misrepresenting/ declaring less income, profits or gains than the amounts actually earned, or overstating deductions

GAAR provisions do not deal with cases of tax evasion. Tax evasion is clearly distinct from tax avoidance and is already prohibited under the current provisions of the Income-tax Act, 1961

Tax Avoidance Result of actions taken by the assessee, none of which individually or collectively is illegal or forbidden by the law itself

Diversion of production from one unit to another under developed tax exempt unit

GAAR applies to tax avoidance which is an impermissible avoidance arrangement

Tax Mitigation Situation where the taxpayer takes advantage of a fiscal incentive afforded by the tax legislation by actually following the conditions and economic consequences that the particular tax legislation entails

Setting up of a business undertaking by a taxpayer in a specified area such as an SEZ/ EOU

Tax mitigation, as distinct from tax avoidance is allowed under the tax statute. GAAR provisions do not deal with cases of tax mitigation

NEED FOR GAAR

Counter any tax avoidance practices/ schemes which result in a serious loss of revenue to tax authorities

Codify the principle of ‘substance over form’

Examine cases of aggressive tax planning with use of sophisticated structures

Taxpayer should not be allowed to use legal constructions/ transactions to violate horizontal tax equity

Plugging loopholes that may possibly result in tax avoidance

Critical examination of inbound/ outbound transactions and check cases of treaty shopping

JUDICIAL BASED GAAR

Vodafone International Holdings BV vs UOI -

2012

Azadi Bachao

Andolan vs UOI - 2003

Arvind Narottam -

1988

McDowell vs CIT -1985

CIT vs Raman & Co - 1967

Tax planning within the framework of law is fine, but "colorable device" suppressing the true nature of transaction for tax avoidance cannot be part of tax planning

• Revenue precluded from questioning the commercial necessity or justification of a transaction provided that such transactions was not colorable or prohibited

• An Act otherwise legal cannot be treated as non-est on the basis of some underlying substance

Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited

No amount of moral sermons would change people's attitude to tax avoidance

• No conflict between Mc Dowell and Azadi Bachao Andolan

• Preferred "look at" over "look through"

• Substance over form test

• The Supreme Court of India has categorically held [Rash Lal Yadav vs State of Bihar (1994) 5 SCC 267] that fairness and reasonableness must be the pivotal touchstones to check exercise of wide discretion vested with administrative authorities -

a test which squarely applies to tax administration in the wake of wide powers conferred by the statutory GAAR

"6. … If the statute confers drastic powers it goes without saying that such powers must be exercised in a proper and fair manner. Drastic

substantive laws can be suffered only if they are fairly and reasonably applied. In order to ensure fair and reasonable application of such

laws courts have, over a period of time, devised rules of fair procedure to avoid arbitrary exercise of such powers. True it is, the rules of

natural justice operate as checks on the freedom of administrative action and often prove time-consuming but that is the price one has to

pay to ensure fairness in administrative action. And this fairness can be ensured by adherence to the expanded notion of rule of natural

justice. Therefore, where a statute confers wide powers on an administrative authority coupled with wide discretion, the possibility of its

arbitrary use can be controlled or checked by insisting on their being exercised in a manner which can be said to be procedurally fair"

• Failure to provide such detailed rules discerning fairness and controlling the discretion of field formations may demonstrate

violation of constitutional norms with a high degree of probability of being declared arbitrary and thus unenforceable

• In this backdrop, even with the entrustment of wide powers with the tax officers to challenge artificial corporate structures by applying GAAR, taxpayers may seek to test waters by putting the competence of the officers to test. Such challenges are not unheard of in India and have a fair bit of success as well [Azadi Bachaoo Andolan, Vodafone International, Walfort Share & Stock Brokers etc, wherein the arguments of the taxpayers have been accepted]

CONSTITUTIONAL LAW PERSPECTIVE

Anti avoidance doctrines developed by, and demolished by, judicial precedents from time to time

Generally, personality driven and perceptions on these doctrines vary from judge to judge – No discernable unanimous principle

Many of the judgements are subjective [considered economic factors such as FDI and economic growth etc]

Subsequent interpretations of judicial doctrines, laid down by the Courts, sometimes even more unpredictable which gave difficult task for the lower courts to effectively apply these doctrines

Not always feasible for the judiciary to address the unforeseen implications of transactions carried out every time for tax purposes

Sophisticated tax avoidance forms always a pace ahead of legislative amendments

NEED FOR LEGISLATIVE/ STATUTORY GAAR OVER AND ABOVE JUDICIAL GAAR

GAAR – AROUND THE WORLD

• Anti abuse provisions such as:

- GAAR

- Controlled Foreign Corporation (CFC) - To prevent tax evasion, on account of setting up of offshore companies in jurisdictions with little or no tax

- Thin Capitalization Rules - Debt-equity ratio more than normal for taking undue tax advantage on interest payouts

Prevalent in many economies such as the United States, United Kingdom, Germany, Japan, Australia, New Zealand, Brazil, Russia, Sweden and many others

• Countries where GAAR exist:

Australia (1915) France (1941) Sweden (1981) China (2008) South Korea (1990)

United Kingdom (2013)

The Netherlands (1924)

Germany (1977) Singapore (1988) Indonesia (2008) Italy (1997) India (2017)

Canada (1988) Brazil (1988) Ireland (1989) Belgium (2012) South Africa (1941)

GAAR – AROUND THE WORLD

Countries Australia China South Africa

Year introduced 1981 2008 1941 (amended in 2008)

Trigger event Taxpayer entering into a scheme for "sole or dominant purpose" of obtaining a tax benefit

Enterprise entering into arrangements without reasonable commercial purpose resulting in a deduction of taxable revenue or income.

Following factors relevant :a) Form and substanceb) Time of establishment and

duration of arrangementc) Manner of implementationd) Inter connect between various

components of the arrangement

e) Financial impact; and f) Tax consequences

Sole or main purpose of the avoidance arrangement is to obtain a tax benefit and contains one or more of the following tainted elements:

(a) Entered into or carried out in a way not normally employed for bona fide business purpose;

(b) Lacks commercial substance, in whole or in part;

(c) Not at an arm’s length; and(d) Results in direct/ indirect

misuse/ abuse of provisions of South Africa Income Tax Act

GAAR – AROUND THE WORLD

Countries Australia China South Africa

Burden of Proof Onus on taxpayer

If taxpayer fails to establish objective facts under various prescribed categories from which a reasonable person would not conclude that its dominant purpose of entering or carrying out the scheme was to obtain a tax benefit, it is deemed to have failed to discharge its statutory onus to proof

Taxpayer to prove that the arrangement has reasonable commercial purpose

Onus on proving that the arrangement is tainted lies on Revenue

Tax payer to prove that tax avoidance was not the sole or main objective

Treaty vs GAAR GAAR to override treaties Treaty to prevail No specific provision

March 16, 2012

February 1, 2017

Finance Act 2017 - GAAR to be implemented with effect from

April 1, 2017

June 28, 2012

September 1, 2012

September 30, 2012

July 17, 2013September

23, 2013

Finance Bill 2012 proposed GAAR into the domestic tax law

Expert Committee under the chairmanship of Dr Parthasarathi

Shome submitted draft report on its recommendations on GAAR

Finance Act, 2013 deferred GAAR to go-live with effect from April 1, 2016. Amendments made to the

GAAR provisions

GAAR Committee issued draft guidelines regarding implementation

of GAAR

Expert Committee submitted its Final Report on GAAR

GAAR Rules notified

EVOLUTION OF GAAR IN INDIA

June 22, 2016

CBDT issued notification amending GAAR rules

– Indian GAAR modelled on South African GAAR guidelines– GAAR provisions were first time introduced in the Direct Taxes Code 2009– On May 14, 2015 (vide Finance Act 2015), GAAR was proposed to be effective from AY beginning April 1, 2018– February 29, 2016 - the Finance Minister reiterated the intent of the Government to implement GAAR with effect from April 1, 2017– CBDT issued Circular 7 of 2017 dated January 27, 2017 clarifying few aspects of GAAR

FRAMEWORK OF GAAR

FRAMEWORK OF GAAR

Section/ Rule Overview

Sec 95 Applicability of GAAR

Sec 96 Impermissible avoidance arrangement

Sec 97 Determinants for lack of commercial substance

Sec 98 Consequences of impermissible avoidance arrangement

Sec 99 Treatment of connected person and accommodating party

Sec 100 Application of Chapter X-A

Sec 101 Framing of Guidelines

Sec 102 Definitions

Sec 144BA Administration

Rule 10U Exclusions from applicability of Chapter X-A

Rule 10UA Determination of consequences of Impermissible avoidance arrangement

Rule 10UB Notices and forms

Rule 10UC Time Limits

Arguably the conferment of such wide powers upon tax administration

has created apprehension of exploitation and vindictiveness

though the law conceives guidelines (Section 101) to curb opportunistic behavior by the members of the tax

administration

Applies to all assessees (corporate/ non-corporate/ resident/

non-resident)

Applicable to all arrangements (business or non-business) so long as

the conditions required to invoke GAAR are met

Section 96 - Impermissible Avoidance Arrangement

• An arrangement, the main purpose of which is to obtain a tax benefit and it – [PRIMARY CONDITION]

Creates rights/ obligations not ordinarily created between persons dealing at arm’s length; or

Results, directly or indirectly, in misuse, or abuse of provisions of the Act; or

Lacks or is deemed to lack commercial substance, in whole or in part; or

Is entered into, or carried out, by means or in a manner, which are not ordinarily employed for bona fide purpose

• Arrangement presumed to been entered into, or carried out, for the main purpose of obtaining tax benefit even if -

The main purpose of a step in the arrangement is to obtain tax benefit; or

The main purpose of a part of the arrangement is to obtain tax benefit

Notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit

Onus on the Assesse to prove

the contrary. An anti-abuse

provision that shifts the burden

of proof on the assessee goes

against the fundamental

principle of "innocent unless

proven guilty"

FRAMEWORK OF GAARA

t least 1 o

f 4

tainted

elemen

ts p

resent

BURDEN OF PROOF

Country Burden of proof on? Country Burden of proof on?

Australia Taxpayer Poland Shared

Belgium Tax Authority Russia Taxpayer

Brazil Taxpayer Singapore Taxpayer

Canada Shared South Korea Taxpayer

China Taxpayer South Africa Shared

France Tax Authority Sweden Taxpayer

Germany Shared Switzerland Shared

Indonesia Shared UK Tax Authority

Ireland Taxpayer USA Taxpayer

Italy Tax Authority Mexico Tax Authority

Japan Tax Authority The Netherlands Tax Authority

No global consistency

In some countries in survey (Canada, Germany, Indonesia, Poland, South Africa, Switzerland and Turkey), the

burden of proof is shared

Whatever approach a country takes on this matter, it is utmost important

for taxpayers to have the right documentation in place

Section 97 - Arrangement deemed to lack commercial substance

• Substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part

• Involves or includes round trip financing

• Involves or includes an accommodating party

• Involves or includes elements that have effect of offsetting or cancelling each other

• Involves or includes a transaction conducted through one or more person and disguises the value, location, source, ownership or control of funds

• Involves the location of an asset or of a transaction or the place of residence of any party, which does not have a substantial commercial purpose other than obtaining a tax benefit

• Does not have significant effect upon business risks/ net cash flows other than that attributable to tax benefit that would be obtained

Factors for determining lack of commercial substance

Period or time for which the arrangement exists

Payment of taxes, directly or indirectly, under the arrangement

Exit route provided by the arrangement

Relevant but not sufficient factors

FRAMEWORK OF GAAR

Section 97(2) - Round Trip financing

FRAMEWORK OF GAAR

Includes any arrangement in which through a series of transactions,

- Funds are transferred among the parties- Without any substantial commercial purpose except for obtaining the tax benefit

Without having any regard to:

- Tracing of funds among the parties;- Time or sequence of movement of funds among the parties; or- Means or manner or mode in which funds are transferred or received

Section 97(3) - Accommodating Party

A party to an arrangement shall be an accommodating party, if the main purpose of the direct or indirect participation of that party in the arrangement, in whole or in part, is to obtain, directly or indirectly, a tax benefit for the assessee whether or not the party is a connected person to any party to the arrangement

Section 98 - Consequences of impermissible avoidance arrangement

• Denial of tax benefit (under treaty or the Act)

• Disregarding/ combining /re-characterising any step in, or a part or whole of the arrangement

• Treating the arrangement as if it had not been entered into or carried out

• Disregarding any accommodating party or treating any accommodating part and any other party as one and the same person

• Deeming connected persons as one and the same

• Reallocating income, expense, relief, rebate, etc amongst the parties

• Re-assign place of residence/ situs of asset or transaction (to other than what has been provided under the arrangement)

• Disregarding the corporate structure (“look through")

• Re-characterize equity-debt, income, expenses, relief, rebate etc

FRAMEWORK OF GAAR

Rule 10U - What is excluded from the purview of GAAR?

Arrangement where the tax benefit in the relevant AY arising, in aggregate, to all the parties to the arrangement does not exceed

INR 30 million [Rule 10U(a)]

who is an assesse under the Act

FII who has not taken benefit of a Treaty

who has invested in listed securities, or unlisted securities, with the prior permission of the competent authority, in

accordance with the SEBI FII Regulations

Investments made by a non-resident by way of offshore derivative instruments or otherwise, directly or indirectly in a FII

Any income accruing or arising to, or deemed to accrue or arise to, or received or deemed to be received by any person from

transfer of investments made before April 1, 2017

– Without prejudice to the above, GAAR shall apply to any arrangement, irrespective of the date on which it has been

entered into, in respect of the tax benefit obtained from the arrangement on or after the April 1, 2017

GAAR RULES

Finance Act 2015 – Memorandum to Finance Bill 2015

March 31, 2017

GAAR provisions to be made applicable to the income of FY

2017-18 and subsequent years

Investments made up to March 31, 2017 are

proposed to be outside the purview of GAARGAAR will not apply

GAAR will apply

Structures prior to April 1, 2017 to also be GAAR compliant – Main purpose being tax benefit and tainted element test in a way is

tested retrospectively??

WHAT IS GRANDFATHERED?

SECTION 144BA - ADMINISTRATION (1/2)

Tax Officer

Commissioner Tax Payer

Refers arrangement to the Commissioner

If opines to invoke GAAR, notice issued

Furnishes Objection

Approving Panel –3 member bench

Tax Payer

Provides opportunity of being heard if further inquiry is required

Hearing -Satisfactory

Tax Officer

Appeal before ITAT

Yes

No

Issues directions (time limit of 6 months applies)

Issues Final Assessment order

GAAR not to be invoked

Yes

Matter referred to the Approving Panel

No

Constitution of Approving Panel – 3 Members – Retired/ current HC judge, IRS not below PCIT/ CCIT and academic/ scholar. To be constituted for a period of 1-3 years. To have the powers of AAR as specified under Section 245U of the Act.

At any stage of assessment or reassessment proceedings

Having regard to material and evidence available

Hearing -Satisfactory

GAAR not to be invoked

SECTION 144BA - ADMINISTRATION (2/2)

Tax Payer

Tax officer

Approving Panel – 3 member bench

Hearing Satisfied

No GAAR

Appeal before ITAT

Commissioner

Hearing Satisfied

No GAAR

1. Tax Officer to consider arrangement as impermissible

avoidance arrangement

2. Tax officer to refer arrangement to the Commissioner

3. Commissioner to issue notice to tax payer and tax payer

to furnish objections

4. Opportunity of hearing to the tax payer

5. No GAAR – if the Commissioner is satisfied

6. Reference to the Approving panel - if not satisfied

7. Approving panel to give opportunity of being heard

8. No GAAR – If approving panel is satisfied

9. Approving panel not satisfied – Issues directions to tax

officer. Tax Officer to compute the consequences and

pass the final assessment order

10. Appeal where assessment is framed invoking GAAR -

Tribunal

1

2

3

4

5

6

7

8

9

10

SOME OPEN POINTS

• Section 97(4) of the Act provides that factors such as period or time for which the arrangement exists, payment of taxes and thefact that an exit route is provided by the arrangement may be relevant but shall not be sufficient for determining whether anarrangement lacks commercial substance or not

– Change in financial position of the taxpayer or the party connected?

• Section 97(1) of the Act provides for a condition that an arrangement shall also be considered to be lacking commercial substance, if it does not have a 'significant' effect upon business risks, or net cash flows apart from the tax benefit

– The term "significant" needs to be defined appropriately to avoid potential litigation

• Section 90(2A) provides that the provisions of GAAR should apply to the taxpayer even if such provisions are not beneficial

– DTAA is a bilateral agreement entered between two sovereign governments

– Article 27 of the Vienna Convention - a Government cannot invoke its internal law as a justification for its failure to perform the DTAA; a unilateral amendment in the domestic law of any particular country cannot override a DTAA

– India Indonesia tax treaty renegotiated in 2012/ India Korea tax treaty renegotiated in 2015 - Provisions of tax treaty shall not prevent a Contracting State from application of its domestic law/ measures concerning tax avoidance or evasion

SOME OPEN POINTS

• Section 144BA(6) of the Act - Directions issued by the Approving Panel shall be binding on the taxpayer and the Commissioner andno appeal under the Act shall lie against such directions

– Direction issued by the Approving Panel is as per the provisions; taxpayer should be provided with a right to appeal against such directions

• As per the notified Rules, the provisions of GAAR shall not apply to an arrangement where the tax benefit arising to all the parties to the arrangement in the relevant AY does not exceed INR 3 crore in aggregate

– This threshold limit should be further enhanced so as to capture only highly sophisticated structures

• A distinction between tax mitigation and tax avoidance should be made to ensure that legitimate business choices do not result in the invocation of GAAR

– To ensure clarity, as recommended by the Shome Committee, an illustrative negative list of such instances where GAAR cannot be invoked should be issued

– Need for broad basing the scope of guidelines

• Impact on tax withholding and Section 163 liability (who may be regarded as agents)

CLARIFICATIONS VIDE CIRCULAR NO 7 OF 2017

CIRCULAR NO 7 OF 2017

GAAR may also apply as may be necessary along with SAARs in the context of such transactions/ structures as considered necessary

GAAR will not apply only where the LoB conditions "sufficiently address" the tax avoidance element(s) in a transaction/ structure

GAAR will not interfere with the taxpayer’s right to select a method of undertaking a transaction

A large corporate group has created a service company to manage all its non-core activities.

The service company then charges each company for the services rendered on a cost plus basis.

Can the mark up in the cost of services be questioned using GAAR?

GAAR shall not be invoked merely on the ground that the entity is located in a tax efficient jurisdiction. If the jurisdiction of the FPI is finalised based on non-tax commercial considerations and the main purpose of the arrangement is not to obtain tax benefit, GAAR will not apply.

CIRCULAR NO 7 OF 2017

View 1:

There are specific anti-avoidance provisions through transfer pricing as regards transactions among related parties. GAAR should not be invoked.

As per the views of Bowman A.C.J. in the Canadian case Geransky vs The Queen [2001] 2 CTC 2147 at Paragraph 42:

"The Income-tax Act is a statute that is remarkable for its specificity and replete with anti-avoidance provisions designed to counteract specific perceived abuses. Where a taxpayer applies those provisions and manages to avoid the pitfalls the Minister cannot say "Because you have avoided the shoals and traps of the Act and have not carried out your commercial transaction in a manner that maximizes your tax, I will use GAAR to fill in any gaps not covered by the multitude of specific anti-avoidance provisions"

View 2:

As per the Circular, the provisions of GAAR could apply along with SAAR. In situations of tax avoidance (even after the applicability of transfer pricing provisions), GAAR could be invoked

CIRCULAR NO 7 OF 2017

Grandfathering benefit related clarifications:

• Compulsorily convertible instruments: Shares issued post March 31, 2017 in relation to

instruments compulsorily convertible from one form to another (such as compulsorily

convertible debentures, compulsorily convertible preference shares), acquired before April 1,

2017, would be grandfathered if the terms were finalised at the issue of such instruments

• Bonus shares: Bonus shares issued in respect of shares issued prior to April 1, 2017 would be

eligible for grandfathering benefit in the hands of the same investor

• Share split or share consolidation: Shares coming into existence by way of split or consolidation

of shares issued prior to April 1, 2017 will be eligible for grandfathering benefit

• Scope of "investment" for grandfathering benefit: Reference has been drawn to accounting

standards wherein "investment" is defined to mean assets held by an enterprise for earning

income by way of dividends, interest, rentals and for capital appreciation. Accordingly, lease

contracts and loan arrangements are not an ‘investment’ and, hence, outside the purview of

grandfathering benefits.

Shares of A Ltd, issued on April 28, 1992 to F Co

A Ltd, merges with B Ltd on November 2018 and accordingly new shares issued to F Co

Whether grandfathering will apply to new shares issued by B Ltd in the course of a merger where the shares of the A Ltd has been grandfathered?

CIRCULAR NO 7 OF 2017

GAAR not to apply on transaction/ structure held as permissible by a ruling of the Authority for Advance Rulings (“AAR”) or approved by other authorities such as the National Company Law Tribunal (“NCLT”) or a Court where the authority has "explicitly and adequately considered" tax implications before approving the transaction/ structure – Deemed approval under Companies Act, 2013?

Application of GAAR where taxpayer opts to claim DTAA benefits in the year of gain and opts to get governed by provisions of the Act in the year of loss - GAAR provisions are applicable if the arrangement is an impermissible avoidance arrangement. The scope of GAAR provisions does not deal with admissibility of a claim under the tax treaty or the Act in different years.

Safeguards to invoke GAAR - GAAR is to be invoked only in deserving cases and adequate safeguards in terms of two-step vetting procedure for invoking GAAR are already put in place, ie firstly the PCIT/ CIT will have to satisfy himself about invoking GAAR, and secondly, the same will have to be approved by the Approving Panel chaired by a person who is or has been a High Court judge –DRP experience!!

No corresponding adjustment will be made in the hands of another taxpayer where consequences of GAAR are applied in case of a particular taxpayer. This is because corresponding adjustment across different taxpayers could militate against deterrence of GAAR

For evaluating whether main purpose of an arrangement is to obtain tax benefit, the tax benefit arising in Indian jurisdiction should only be considered. Tax benefit will have to be seen as tax year specific and also after taking into account the impact on all the parties to an arrangement. GAAR is with respect to an arrangement or part of the arrangement and limit of INR 30 million cannot be read in respect of a single taxpayer only.

Rule of consistency will be followed by the authorities across all the assessment year provided the facts remain the same

CIRCULAR NO 7 OF 2017

Penalty provisions are not automatic and depend on the facts and circumstances. No blanket exemption is available under the Act from the levy of penalty. Taxpayer can, under the normal provisions of the Act which provide for waiver of penalty in certain circumstances, apply for the same (Section 273A of the Act)

No exemption to long-standing structures

• Multilateral Instrument ("MLI") to modify bilateral tax treaties, released by the OECD as part of its project on Base Erosion and Profit Shifting ("BEPS") provides that as a minimum standard, countries should implement at least one of the following measures in its treaties:

– Principal purpose test ("PPT") only (a general anti-abuse rule based on the principal purpose of transactions or arrangements)

– PPT supplemented with either a simplified or a detailed LOB provision, or

– Detailed LOB provision supplemented by a mechanism to deal with conduit arrangements not already dealt with in tax treaties

• Given its enabling nature and flexible form, MLI provides various alternatives in its provisions concerning treaty abuse and limitation of benefits. Signatories to the convention may elect to opt in any of these alternatives in respect of their tax treaties.

• It would be interesting to see if such PPT 'sufficiently addresses' the abuse as envisaged by GAAR and whether GAAR would still be applicable to the transaction even after MLI is in force

• Legal nature of Guidelines/ rules/ Circulars - Same force as a statute, if not inconsistent; Binding on tax authority and approving panel (even if it deviates from statute) but not on Courts/ taxpayers – Is Circular 7 a further guideline under Section 101 of the Act?

THE TAKEAWAYS

SPECIFIC ANTI AVOIDANCE RULES

• "Known" would constitute something which may already have happened or which could foreseeably happen in respect of tax avoidance

• Also known as Targeted Anti avoidance Rules (TAAR)

• SAAR lays down specific situations or conditions for invocation

• SAAR provides certainty to the tax payer and are intended not to grant any discretion to tax authorities at the same time

• Have limited scope of application and hence have inherent limitations in curbing all possible cases of tax evasion. The tax authorities cannot possibly make SAAR’s for all situations of Tax avoidance.

• SAAR being specific help reduce time/ cost involved in tax litigation

SPECIFIC ANTI AVOIDANCE RULES (SAAR)

SAAR – Set of rules to counter specific abusive behavior/ malpractices by an assessee, which are "known"

SAAR

Section under the Act Provision relating to

Section 2(22) Deeming certain transactions with shareholders/ their related parties as dividend

Section 14A Disallowance of expense incurred for earning exempt income

Section 40A(2) & 92 Disallowance of expenditure paid to specified related parties in excess of fair market value

Section 50C Deeming the sale consideration in case of transfer of land and building at less than fair value

Section 56(2) Treating any transfer of property at nil or inadequate consideration as income of recipient.

Section 60 To club income where there is transfer of income without transfer of assets

Section 61 To target revocable transfer of assets

Section 64 To club income of specified persons in the income of the assesse in certain cases

SAAR

Section under the Act Provision relating to

Section 79 Carry forward and set off of losses in the case of certain companies

Section 80IC and similar other provisions

No tax benefits to a business formed by splitting up, or the reconstruction or a business already in existence/ Denying tax benefits to a business formed by transfer to a new business of machinery or plant previously used for any purpose

Section 93 To counter avoidance of income-tax by transactions resulting in transfer of income to non-residents

Section 94 To target avoidance of tax by certain transactions in securities, such as dividend stripping

In respect of abuse of tax treaties or treaty shopping, the anti-avoidance works through ‘ Limitation of Benefit’ clause, which is there in treaties signed by India with many countries

CAPITAL STRUCTURE – GAAR ANALYSIS

GAAR analysis

• High debt equity ratio – Applicability of thin

capitalization norms and Revenue Authorities seeking

to recharacterise debt as equity and interest on debt

and dividends

• Consequent disallowance of interest as dividends are

not tax deductible

• DDT could be levy on interest paid under Section 115O

of the Act

• MAT is levied on book profits computed as per the

Companies Act, 2013, disallowing interest in computing

book profits would be against the computation

mechanism prescribed under the IT Act

In defence

• Use of debt instead of equity left to commercial

judgement of taxpayer

• GAAR provisions not applicable to an FII entity subject

to not availing treaty benefits. Consequently no

re-characterization possible in the case of FII entities.

However, Revenue Authorities may seek to make a

unilateral recharacterisation and disallow interest in the

hands of the SPV

• Strong merits to argue that unilateral recharacterisation

should not apply

• Even if interest is recharacterised as dividends and

disallowed, tax on dividend should be applied as per

the DTAA ie 10 per cent in the case of India Singapore

DTAA

BEPS ACTION PLAN 4 VS SECTION 94B

• Finance Act 2017 has introduced the concept of limitation on interest deductions

• In line with the OECD's BEPS Action Plan 4

Sl No

Proposedprovisions

BEPS Action Plan 4 Section 94B of he Act

1 Approach Recommend interest to EBIDTA ratio (10 -30 percent) and supplements ‘worldwide group ratio rule’

Interest to EBIDTA ratio of 30 percent

2 Threshold forapplication

Recommended, amount not specified Interest payments must exceed INR 10 Million

3 Carry forward ofdisallowed interest

Discussed but period not specified Allowed for 8 years

4 Deemed interest fromAE

Not specifically covered, however guarantee fee is considered as interest equivalent

Recognized deemed interest from AE based on guarantee/ money deposit by borrower’s AE with Lender

5 Exclusions Discussed need of specific rules for banking and insurance companies

Excludes banking and insurance companies

Company A

(Lender)

Country B

Country A

Company B

(Borrower)

Equity 10Loan 90

Particulars No SAAR Under SAAR

Pre-tax and pre-interest taxable profit 15.00 15.00

Deduction of interest payments (9.00) (4.50)

Post interest taxable profits 6.00 11.50

Tax @ 30 percent 1.80 3.45

Interest allowable as per Section 94B of the Act

Illustration:

• Company A, establishes group affiliate Company B with an

investment of 10 in equity capital and a loan of 90 from

Company A at a 10 percent interest rate

• Company B generates pre-tax and pre-interest income of

15 for a year and must pay interest to Company A at 10

percent ie a total interest payment of 9

• As per proposed Section 94B of the Act, deductions for

payments of interest is limited by reference to interest to

EBIDTA ratio of 3:10

• Then, interest on debt in excess of 0.3 the EBIDTA will be

denied. In such case, interest of 4.5 (15*0.3) would only

be allowed

Repay (90) + 10% interest (9)

ILLUSTRATION

CARRY FORWARD OF LOSSES (SEC 79)

Specific Anti-Abuse Rule

• Section 79 introduced to curb taxpayers’ attempt at transferring losses incurred by a corporate entity by means of transfer of shareholding

• Restricts carry forward and set off of losses in the hands of a closely held company, if the shares of such company carrying at least 51 percent of voting power are not beneficially held by persons who beneficially held such shares on the last day of the previous year in which the loss was incurred.

What is required is there shall be no change beyond 51 percent in voting power as against shareholding

• In addition to third party deals, corporate restructuring is also impacted by provisions of this section

Yum Restaurants (India) Pvt Ltd vs ITO, ITA Nos 349

and 388 of 2015 (Delhi)

• Piercing corporate veil to identify beneficial

ownership not permitted

• Judgement states that there was nothing to

state that there was any agreement or

arrangement that the beneficial owner is the

ultimate holding company

CIT vs AMCO Power Systems Ltd [2015] 379 ITR 375

(Karnataka)

• Expression 'not less than 51 percent of voting

power' indicates that only voting power is

relevant and not shareholding pattern

Intention of Section 79 of the IT Act

• Benefit of carry forward and set-off of business losses for previous years of a company should not be misused by any new owner, who may purchase the shares of the Company, only to get the benefit of set-off of business losses of the previous years, which may bear profits in the subsequent years after the new owner takes over the Company

ISSUE

• A Co and B Co are equity shareholders of Sub Co with equal voting rights

• Further infusion of funds in either of the following forms:

• CCDs/ OCDs

• CCPS/ OCPS

• Preference shares

• Equity Shares with Differential Voting Rights ("DVR")

Mechanics

• CCDs/ OCDs : Until actual conversion into equity shares (subject to

conversion terms) no voting power exists

• CCPS/ OCPS/ Preference shares : Although there is change of total

shareholding, no voting rights (except in the case of default in payment of

dividend for two years)

• Equity Shares with DVR : The terms of issue could be worded in such a

manner that no voting rights are provided to the shareholder

A Co

Current Shareholding and Voting rights

B Co

Sub Co

Shareholding in Red Voting rights in Green

Shareholding and Voting rights post issue of CCPS/ OCPS/ Preference shares/ Equity shares with DVR

A Co B Co

Sub Co

Shareholding and Voting rights post issue of CCDs/ OCDs

A Co B Co

Sub Co

Implication on voting rights pursuant to further infusion

51%

51%

49%

49%

C Co

35%

51%

25%

49%

40%

Nil

51%

51%

49%

49%

C Co

Nil

Nil

Issue of CCPS/OCPS/ Preference Shares/ Equity shares with DVR

Issue of CCDs/ OCDs

Potential GAAR Impact

• In the presence of SAAR, would GAAR be applicable in such cases?

• Where the terms of CCDs/ OCDs are such that it contains a flavour of

equity shares, would the nomenclature of the instrument be disregarded

and treated as equity shares, counted for the purpose of voting rights?

• Could issue of equity shares with DVR where initially no voting rights are

provided, however, a clause is mentioned that the terms as to voting are

alterable, be looked at as equity shares with voting rights and the issue be

considered as a transaction to avoid loosing the benefit of Section 79?

ISSUE

Possible Solution

• Terms of issue relevant to voting rights to be loosely worded apart from

having a strong commercial substance

A Co

Current Shareholding and Voting rights

B Co

Sub Co

Shareholding and Voting rights post issue of CCPS/ OCPS/ Preference shares/ Equity shares with DVR

A Co B Co

Sub Co

Shareholding and Voting rights post issue of CCDs/ OCDs

A Co B Co

Sub Co

51%

51%

49%

49%

C Co

35%

51%

25%

49%40%

Nil

51%

51%

49%

49%

C Co

Nil

Nil

Issue of CCPS/OCPS/ Preference Shares/ Equity shares with DVR

Issue of CCDs/ OCDsShareholding in Red Voting rights in Green

TYPICAL OFFSHORE FUND STRUCTURE

Offshore

Fund

(“Fund”)

• Fund setup as a Singapore company/ GBC1 company as per

Mauritius Laws to carry out investment activities in and outside

India

• Capital structure is designed in such a way that one class of

shares are held by General Partners, second class of shares by

Limited Partners and third class of shares are carry shares

Mechanics

Investment

Manager

(“IM”)

• Fund managed by its Board of Directors and enters into a

Investment management agreement with the Investment

Manager (“IM”)

• IM remunerated for the services to be rendered to the Fund and

it also receives investment advice from the IA

Investment

Advisor

(“IA”)

• IA shall provide non-binding investment advice to the IM on

entering into a contractual agreement

• IA will not have authority to take decisions on behalf of IM or to

enter into contracts on behalf of, or to otherwise bind the Fund/

IM, and will not act as an agent or manager of Fund/IM

• IA would be compensated for the services at arms' length on a

cost plus margin basis

IM

IA

Singapore/ Mauritius

India

Typical Offshore Fund Structure(Plain vanilla structure)

Portfolio Companies

Investment

Fund

POEM VS GAAR

Impact

• Since the rules of Place of Effective Management (“POEM”) shall not be

applicable to IM and therefore the income of IM/ offshore fund shall not

be liable to tax, would GAAR be applicable?

• Assuming the conditions as provided in Section 9A of the Act are complied

with, the IM would not be considered to constitute a business connection

in India. Accordingly, as the conditions for applicability of Section 9A of the

Act, has been specifically addressed, the provisions of GAAR should not be

applicable.

IM

IA

Singapore/ Mauritius

India

Typical Offshore Fund Structure(Plain vanilla structure)

Portfolio Companies

Investment

Fund

Mechanics

INVESTMENT IN PORTFOLIO COMPANIES

S CoM Co

Mauritius Singapore

Equity/ CCDs

Equity/ CCDs

Fund• Typical private equity investment structure entailing

equity investment from a Mauritius Company (“M Co”)

• Investment in the form of Compulsorily Convertible

Debentures (“CCDs”) from a Singapore Company (“S

Co”) in portfolio companies in India

Setup

Income• Distribution from portfolio companies:

o Dividend shall be receivable by M Co after

deduction of Dividend Distribution Tax (“DDT”)

o Interest shall be receivable by S Co, taxable at a

beneficial rate of 15 percent as per India-Singapore

Treaty/ 7.5 percent as per India-Mauritius

Interest

Portfolio Companies

Impact

• Can the CCDs be re-characterised as Equity?

– If yes, will the interest paid be treated as dividend and DDT along

with penalty payable?

• Look though approach under GAAR provisions

• Challenges in establishing place of residence of the Fund/S Co/ M Co in

the structure in light of the specific GAAR provisions on place of residence

• Whether the main purpose of the structure was to obtain treaty benefit

on interest income and therefore the provisions of GAAR to apply?

INVESTMENT IN PORTFOLIO COMPANIES

S CoM Co

Mauritius

Equity/ CCDs

Equity/ CCDs

Fund

Interest

Portfolio Companies

WITHOLDING OF TAXES

Whether GAAR shall be applicable at the time of withholding taxes?

Fund

Investor A Investor B

Remittance of income

India

Outside India

Key Concerns

• Whether GAAR provisions can be invoked by the Assessing officer while

disposing of an application for determination of a withholding tax

amount under Section 195(2) or 197 of the Act?

• In a case where income to be remitted outside India is exempt by virtue

of treaty benefits, whether GAAR could be invoked on account of a

suspected impermissible avoidance agreement at the withholding stage

itself?

• Any protection to the payer – Section 201 proceedings/ indemnity to be

taken by the payer etc?

CASE STUDIES

Direct conversion of company into an LLP would not be tax neutral if exemptions conditions are not met [Section 47(xiiib)]

In order to circumvent the exemption conditions, the existing Company is merged with a newly formed company and then converted into LLP in the year of merger

Could GAAR be invoked?

Yes, GAAR could be invoked

CASE STUDY I

A Co Ltd

Taxable Conversion

A LLP

A Co Ltd

A LLP

New Co Ltd

Merger

An employee of a private limited company A is to receive a bonus or salary.

The employee subscribes for preferential shares of the employer company. The preferential shares are purchased by a connected company of A and are redeemable at a premium after a period of one year.

The differential consideration reflects a portion of the employee's annual salary or bonus. In this manner, the employee receives the income as capital gains.

Could GAAR be invoked?

The acquisition of preferential shares is part of an arrangement designed

to avoid the tax on salary income. GAAR could be invoked.

CASE STUDY II

A Co Ltd

Purchases shares

After one year

A Co Ltd

Redemption of shares by A Co Ltd/ sale of shares to AE of A Co Ltd

AE of A Co Ltd

UNDER THE GAAR SCANNER

•Corporate gifting of shares/ cross gifts / circuitous gifts

•Externalisation

•Beneficial compensation plans (car lease policy etc)

•Tax Havens/ Preferential tax regimes

•Shell companies

•Share swaps

•Trust schemes

•56(2)(viib) structures – issue of few shares at higher premium to increase the initial NAV; subsequent issue not to trigger 56(2)(viib)

•Creative structures

•Interposed foreign (multiple) entities –for treaty benefits/ twin tier structures

•Reverse Mergers

•Cross Border Mergers

•RE holding structures

•Retrospective mergers (say to claim Section 32AC benefits etc)

•Selective (i) buy back or (ii) rights issue or (iii) bonus issue or (iv) capital reduction

•Use of convertible instruments to meet IRR (fixed returns)

•Treaty Shopping

•Re-domiciling IP outside India

•Section 79 – transfer of shareholding rights but voting rights kept intact to preserve past losses

•Double dip structures

•Assigning of loan to lower tax jurisdiction

•Demerger instead of merger (to avail past losses), Issue of RPS in demerger (so as to delink shareholding), Bonus Debenture structures

•Abuse of SAAR provisions

•Artificial avoidance of Permanent Establishment

HOW WILL DOING BUSINESS CHANGE WITH GAAR? (1/2)

• Right to plan tax affairs is a fundamental right of every taxpayer

• Does introduction of GAAR mean an end to tax planning?

• Does GAAR mean that the taxpayer loses right to choose how a transaction is executed or implemented?

• Instances could be many - having decided to exit a business, does the taxpayer have the right to choose to implement this as either a share sale or a business transfer? And in a business transfer, can he not choose between a slump sale or an itemised sale or a demerger?

• Can a taxpayer entering India, choose an entity being a subsidiary (Company form) or an LLP or to just have a branch?

• Do taxpayers have a choice to consider distribution by way of dividend vs buy-back or capital reduction?

• Does a taxpayer who for good business reasons needs a holding co (or SPV) have the right to choose the most efficient jurisdiction in which to house the SPV?

• Merger of a loss-making company and a profit-making company of a group with the follow-on consequence of a reduced tax liability could be questioned

• In GAAR regime, taxpayers could consider various dispute resolution methods such as private rulings from the Authority for Advance Ruling, advance pricing agreements and Mutual Agreement Procedures while determining litigation strategy

• It calls for a paradigm shift in thinking and in mindset

• Tax will not be seen to be driving businesses any more - it should be business driving tax

• Tax functions to have right skills and capabilities

• Business reasons and commercial rationale will be central to any planning in a GAAR environment

• Real substance-based planning, closely aligned with the taxpayers' business and operating model would increasingly be seen

• Documentation will be the key - Clear and consistent documentation demonstrating the business purpose and intent will acquire critical significance as never before

• It needs to be ensured that robust tax governance procedures (for the entire tax life cycle, ie planning, provisioning, compliance and controversy) are in place to keep enterprise from being unnecessarily exposed to GAAR

• Will stick do the trick?

• Choice Principles (lease vs buying of asset, equity vs borrowing etc) – Mixed Basket – to be carefully tested for GAAR

• Long experience of working of GAAR in other jurisdictions clearly shows that despite GAAR the instances of opportunistic tax-behavior have not declined – will India Inc experience differently?

HOW WILL DOING BUSINESS CHANGE WITH GAAR? (2/2)

ROLE OF PROFESIONALS (1/2)

• Revisit tax positions and test for compatibility with GAAR (may require amending actions at corporate front)

• With GAAR coming into picture, the weighing of commerciality of every any transaction crossing the prescribed monetary

threshold of tax benefit would become the order of the day

• Corporate decisions would need to be tested not just from the perspective of corporate managers but also from a reverse

perspective as to how the tax administration may view (or rather portray) the transaction to be

• Tight-rope situations to tackle GAAR – Contemporaneous documentation will be the key – to demonstrate the business purpose

and intent will acquire critical significance as never before

• It is at the back of documentation that the real intent behind a transaction could be examined and such documentation would

assist in making assertions for defence during a tax scrutiny/ audit

• Receiving an opinion on GAAR – a mere reassurance that the position satisfies the technical requirements of the law or something

more? Adequate disclaimers to cover risks!

ROLE OF PROFESIONALS (2/2)

• Overall, need to examine the below questions regarding those transactions that could potentially result in the application of

GAAR:

– Does the transaction/ structure have a valid commercial purpose (Principal purpose test)?

– Is the transaction/ structure distinctive and complex?

– Is the tax benefit material to the financial statements?

– Could the transaction/ structure be undertaken in a changed manner without drawing the potential application of GAAR?

– Has a technical opinion been obtained that such transaction/ structure will more likely than not (MLTN situation) withstand a

GAAR challenge?

– Is the transaction/ structure defendable in the public eye (reputational ramifications)?

– What is the company's tax risk profile – internationally and locally?

– How comfortable is the company with litigation if it is required to defend the transaction/ structure against GAAR (Risk

appetite)?

• Shome Committee recommendation - Tax audit report may be amended to include reporting of tax avoidance schemes above a

specific threshold of tax benefit of INR 3 crores or above which is considered by the tax auditor as more likely than not to be held

as an impermissible avoidance arrangement under the Act – Likely to come given the manpower shortage at field level?

THE FINALE – HITS AND MISSES

Hit

s •Training of tax officers

•Detailed report of reasons

•Monetary Threshold

•No discrimination

•May increase the attractiveness of India as investment destination

Mis

ses •Larger power to tax authorities

could lead to arbitrary actions

•SAAR and GAAR to apply in parallel

•Onus lies on the assessee to prove that there is no avoidance

•Overrides tax treaties

•Serious institutional failures of judiciary

•May be premature to use GAAR in India unless tax officers are adequately trained to target only ingenuine transactions

RECOMMENDATIONS

• Tax authorities should respect the form of a legitimate business transaction even when such a form allows a reduction of overalltax costs

• What qualifies as a legitimate business decision should be broadly defined in this rapidly changing and technologically driven global market place

• SAAR must be sufficiently clear and precise so that the taxpayer may be certain that a transaction which is in strict accordancewith the law would not be put into question

• Tax authorities should not take it upon themselves to interpret and/ or to apply a clear law according to their expectations (particularly when the administrative interpretation of the law is not published)

• Application of such rules should be limited to exceptional cases in which there is no economic substance and no fundamental business reason for a transaction

• Overarching principle should be that GAAR is to be applicable only in cases of abusive, contrived and artificial arrangements

• If only part of arrangement is impermissible, GAAR applicability to part and not the whole

• To be implemented with consistency, transparency and adherence to principles of natural justice

Sandeep Jhunjhunwala, FCA, ACS, B.Com (H) E: writetosandeepj@gmail.comM: +91 97401 55469

The views in this presentation are personal views of the Presenter. The information contained is of a general nature and is not intended to address the circumstances of any

particular individual or entity. Although, the endeavor is to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date

it is received or that it will continue to be accurate in the future. This presentation is meant for general guidance only and no responsibility for loss arising to any person/ entity

acting or refraining from acting as a result of any material contained in this presentation will be accepted. It is recommended that professional advice be sought based on the

specific facts and circumstances. This presentation does not substitute the need to refer to the original pronouncements.