tax avoidance

TAX AVOIDANCE AND TAX EVASION

IN INDIA

_______________________________________________________________

Subject: Taxation Law

Submitted to:

Dr. Justice S. Rajendra Babu

Course Teacher

Submitted by:

Manju Lata

ID. No. 568

One year LL.M.(Business law)

NATIONAL LAW SCHOOL OF INDIA UNIVERSITY, BANGALORE

TAX AVOIDANCE AND TAX EVASION IN INDIAPage 1

ACKNOWLEDGEMENT

I would like to express my sincere gratitude to Dr. Justice S. Rajendra Babu for enlightening me through his vast intellectual resources which played a pivotal role in the completion of this project. I would also like to thank National Law School of India University Library Staff, for their patient co-operation. I owe a debt of gratitude to all the contributors of this project for providing me their valuable time and insight in completing this work.

Manju Lata

ID no. 568

1st year LL.M. (Business Law)


TABLE OF CONTENT

I. Acknowdgement.........................................................................................................2II. Abstract ......................................................................................................................4

III. Introduction.................................................................................................................5IV. Research methodology.................................................................................................8V. Tax Avoidance v. Tax Evasion....................................................................................9

VI. The measures to curb tax evasion and tax avoidance.................................................12VII. Various onshore and offshore method f tax evasion and tax

avoidance....................................................................................................................22VIII. Further reform suggested regarding the tax avoidance and tax evasion in

India............................................................................................................................27IX. Tax avoidance by multinational companies...............................................................29X. Law commission and other official government report on tax avoidance and tax

evasion........................................................................................................................33XI. Conclusion...................................................................................................................34

XII. Bibliography................................................................................................................36


ABSTRACT

Tax avoidance and evasion are pervasive in all countries, and tax structures are undoubtedly

skewed by this reality. Standard models of taxation and their conclusions must reflect these

realities. This paper first presents theoretical models that integrate avoidance and evasion into

the overall decision problem faced by individuals. Early models of this area focused on tax

evasion, modelled as a gamble against the enforcement capability of the state. More recently,

the literature has examined more general models of the technology of avoidance, with the

additional risk bearing caused by tax evasion either being a special case of this technology or

one aspect of the cost of changing behavior to reduce tax liability. If the cost of evasion and

avoidance depends on other aspects of behavior, the choice of consumption basket and

avoidance become intertwined. The paper then relates the behavior predicted by the model to

what is known empirically about the extent of evasion and avoidance, and how it responds to

tax enforcement policy. The paper then turns to normative analysis, and discusses how

avoidance and evasion affect the analysis of vertical and horizontal equity as well as

efficiency costs; a taxonomy of efficiency costs is presented. Acknowledging the variety of

behavioral responses to taxation changes the answers to traditional subjects of inquiry, such

as incidence, optimal progressivity, and the optimal mix between income and consumption

taxes. It also raises a whole new set of policy questions, such as the appropriate level of

resources to devote to administration and enforcement, and how those resources should be

deployed. Because there are a variety of policy instruments that can affect the magnitude and

nature of avoidance and evasion response, the elasticity of behavioral response is itself a

policy instrument, to be chosen optimally. We The study aimed to investigate why people

evade and avoid taxes in Nigeria. A descriptive research design was employed

in the investigation. e argue that the concept of the marginal efficiency cost of funds is a

useful way to summarize the normative issues that arise, and expand the concept to include

administrative costs, avoidance, and evasion.


INTRODUCTION

“In a society where people are living together as a group or community sharing some

common interest have come together and formed a system which has regulated their activities

and protected the common interest of the society.” Collecting the contribution from the

member to run the regulatory system, which in turn spend such money on the welfare

activities of such society or for the overall public good is in practice in one or the other from

since time immemorial. In ancient days the subject used to pay tax to the monarch and

monarch in turn used to take the responsibility of the protection of life and property of his

subject. This has developed as a system of public finance and collection of contribution from

the public for the common public good is the base line of the tax system all over the world.

In the due course of time this has developed as a great system and gradually different kind of

activities were brought under the purview of this taxation. Today in

almost all the countries collection of tax from its citizens have become the main source of

revenue. Significant growth has led to creation of several developments to handle theses

aspects. as it involves lot of public money , there felt the need of regulation of the system of

collection and administration of the same which has resulted in several enactment and

statutes to monitors the system. Tax can be broadly classified into two types as directs taxes

and indirect taxes. The direct taxes are the taxes where the liability to pay the tax is directly

on the affected person. For example income tax, wealth tax etc. Indirect taxes are the taxes,

where the liability for payment is not directly of the affected person. For example exercise

tax, customs tax, service tax etc. when we talk about tax or revenue collection we generally

come across terms namely tax evasion. The tax evasion is an act on the part of the taxpayer to

minimize the tax liability but breaking the law, i.e., by adapting illegal means. The concept of

tax avoidance is difficult to distinguish from other two. Because tax avoidance is not a clear

concept. It has the component of both tax planning and tax evasion. So, tax avoidance means

planning ones activity in such a way that it should tax burden by taking advantages of the

loopholes in the act. It become problematic issue to determine whether the transaction entered

into by the taxpayer is a tax planning tax avoidance or tax evasion. This is more so because

these terms have not been defined by legislature in precise words and in practice. These is a


very thin different between theses terms and it may not be possible to determine the intention

of the person who is transaction.

In the early days of the operation of tax system the rates of taxes were comparatively low and

the temptation to conceal income was therefore limited. However, increased in the rates of

taxes on one side and strict punishment for evading the tax on the other side had made the

taxpayer to think about way out by which they can minimize the tax liability but still shall not

caught by law1 this process has led to a new avoidance. Dealing with issue of avoidance and

evasion of taxes is a challenging one for judiciary because it involves the interest of both the

parties that is taxpayer and tax collector. The former has a right to arrange his activity in such

a way to attract less tax liability and the later has been given power to collect tax as from the

taxpayer provided both are performing their activity within law. Striking the balance between

the two has been a great task for judiciary through out of the world.

Countries like Australia, Canada, Germany, France, South Africa and china have GAAR

provision; India also needs to introduce such provisions to tackle tax avoidance practices.

However for proper implementation of GAAR, there is a need to study closely the

experiences of other countries. In depth discussions are required for distinguishing between

the tax Evasion and on the one hand and abusive tax avoidance practices on the other.

With regards to the double tax avoidance agreement DTAAs), the inclusive of appropriate

limitation of benefits (LoB) causes between India and other countries needs to be considered.

However, if General Anti Avoidance Rules (GAAR) has an overriding power over LoB

clauses, then appropriate application of GAAR in tax avoidance practices assumes a crucial

role. The role and functioning of the dispute resolution panel would also be vital in this

regards.

In the Era of globalisation and liberalisation, competition among multinational corporations

has increased tremendously as result; there may be a natural tendency for such companies to

try to reduce their tax costs by any affordable means. The challenge lies in framing

appropriate legal provision to tackle such practices in an unambiguous manner. The General

Anti Avoidance Rules (GAAR) is crucial in this regards and a policy option for India is to

learn from other countries experiences (those which have adopted and are practicing GAAR)2

1 Anil kumar Jain,” Tax Avoidance and Tax Evasion: the Indian case” modern Asian Studies, Vol 21 , no.2(1987), at URL: http://links.jstor.orglsici?sici=0026-749X%28198%2921%4A2%C233%ATAATBT%E2.O.CO%3B2-V2 http://www.cbgaindia.org/files/recent_publications/Tax%20Dodging.pdf last visited on November 25,2013


http://www.cbgaindia.org/files/recent_publications/Tax%20Dodging.pdf

Proposes introduce General Anti-Avoidance Rule (GAAR), which would erase the thin line

between tax avoidance and tax evasion. India is not isolated in enacting GAAR in its taxing

legislation. It is an established trend among countries to legislate on GAAR to deny tax

benefits for any arrangement structured with the sole objective of tax avoidance. In India, the

law is settled that tax avoidance is legal and evasion is not. A taxpayer may create a device to

arrange his commercial affairs to minimise his tax liability and its acceptance is based on

operation of law3.A company may choose to avoid taxes by establishing their company or

subsidiaries in an offshore jurisdiction. Tax avoidance reduces government revenue and

brings the tax system into disrepute, so governments need to prevent tax avoidance or keep it

within limits. In the judiciary, different judges have taken different attitudes. As a

generalisation, for example, judges in the United Kingdom before the 1970s regarded tax

avoidance with neutrality; but nowadays they may regard aggressive tax avoidance with

increasing hostility.4

RESEARCH METHODOLOGY

Statement of the Problem:

3 http://articles.economictimes.indiatimes.com/2009-08-19/news/27662841_1_tax-evasion-tax-liability-general-anti-avoidance-rule last visited on november 25,20134 http://en.wikipedia.org/wiki/Tax_avoidance last visited on November 26,2013


http://en.wikipedia.org/wiki/Tax_avoidance

http://en.wikipedia.org/wiki/Offshore_financial_centre

http://articles.economictimes.indiatimes.com/2009-08-19/news/27662841_1_tax-evasion-tax-liability-general-anti-avoidance-rule


Income-tax which is one of the major direct taxes has got much importance due to rising level of income in the recent years. Taxation, besides being a major source of revenue to the government, also serves as means by which government actualize macro-economic objectives in areas of monetary and fiscal policies. It is therefore a major tool used by government to promote economic growth and development. However, these functions have been greatly

impaired due to the menace of tax evasion and avoidance. The continued existence of

these ills makes one thinks that tax administration in India, and of course, lacks of the ability to convert inputs of funds into programme and projects that enhances development. It is the potential defect to government monetary and fiscal policies and the meagre contribution of tax revenue to government coffers that inspires the current study to investigate why people evade and avoid taxes in India.

Aims and Objective of the Study:

The objectives of this study are stated -

To ascertain the causes of tax evasion in India. To ascertain the causes of tax avoidance in India. To ascertain the tax avoidance by the multinational companies To ascertain the various measures to curb tax evasion and tax avoidance in India.

Research Question:

1. How tax avoidance and tax evasion are different each other?2. What are the various onshore and offshore methods of tax evasion and tax avoidance?3. What have been the measures to curb tax evasion that have been introduced so for?4. What further reform required regarding the tax avoidance and tax evasion in India?5. What are the issue of tax avoidance by the multinational companies?6. What are the law commission reports and other official government report for

analysing of these issues?

Scope and Limitation of the Study:

Tax evasion and avoidance are problems faced by every tax system. Hence one cannot possibly undertake a study on tax evasion and avoidance concerning every Tax system. This researchwiltherefore be restricted to why people evade and avoid taxes in India. This restriction is due to time, finance manpower and logistics. These are constraints outside the


control of the researcher. The study is also limited to the necessary data available on demand from the office of the State Board of Internal Revenue.

Hypothesis of the study:

The following hypotheses were framed for the present study:

Taxation, besides being a major source of revenue to the government, also serves as means by which government actualize macro-economic objectives in areas of monetary and fiscal policies. It is therefore a major tool used by government to promote economic growth and development. However, these functions have been greatly impaired due to the menace of tax evasion and avoidance

Research Methodology:

The researcher has used descriptive methodology of research for analyzing the various provisions relating to tax avoidance and tax evasion in India. The researcher will going through Act, Article, Journals and web search for the purpose of analyzing the various provisions. Finding the Statistical Data Report, relating to tax avoidance and tax evasion. Then researcher will use analytical research to appraise the information obtained so as to find the answer of the research question mentioned aforesaid.

Sources of data:

In this research the researcher will rely upon the primary sources which includes the bare act of income tax. The researcher will also rely upon the secondary sources which includes book available in the library and article from various journals and also internet sources.

Mode of Citation:

A uniform method of citation has been used.


Tax Avoidance v. Tax Evasion:

Tax avoidance is generally the legal exploitation of the tax regime to one's own advantage, to

attempt to reduce the amount of tax that is payable by means that are within the law whilst

making a full disclosure of the material information to the tax authorities. Examples of tax

avoidance involve using tax deductions, changing one's business structure through

incorporation or establishing an offshore company in a tax haven.

By contrast tax evasion is the general term for efforts by individuals, firms, trusts and other

entities to evade the payment of taxes by illegal means. Tax evasion usually entails taxpayers

deliberately misrepresenting or concealing the true state of their affairs to the tax authorities

to reduce their tax liability, and includes, in particular, dishonest tax reporting (such as under

declaring income, profits or gains; or overstating deductions).

Tax avoidance may be considered as either the amoral dodging of one's duties to society, part

of a strategy of not supporting violent government activities or just the right of every citizen

to find all the legal ways to avoid paying too much tax. Tax evasion, on the other hand, is a

crime in almost all countries and subjects the guilty party to fines or even imprisonment. Tax

resistance is the refusal to pay the tax for conscientious reasons (because they do not want to

support the government or some of its activities), sometimes breaking the law to do so. Some

donate their unpaid taxes to charity, while others take creative "deductions" such as not

paying a percentage of tax equal to the defence budget. In either case, they typically do not

take the position that the tax laws are themselves illegal or do not apply to them (as tax

protesters do) and they are more concerned with not paying for what they oppose than they

are motivated by the desire to keep more of their money (as tax evaders typically are). Some

have suggested the term tax aversion for people who adopt the techniques of tax avoidance in

the service of tax resistance, thereby doing tax resistance legally.

Judicial doctrines, relying on a purposive construction of tax legislation, are being evolved to

prevent tax avoidance involving circular, self-cancelling transactions or where steps with no

commercial purpose other than the avoidance of tax are inserted into a transaction.

Controversially, in the 2004 Budget, it was announced that 'promoters' and users of certain

tax avoidance schemes would be required to disclose details of the schemes to the Inland

Revenue.5

5 http://albinet.com/articles/offshore-company/taxes last visited on November 26,2013


http://albinet.com/articles/offshore-company/taxes

Tax avoidance is the legitimate minimizing of taxes, using methods approved by the IRS.

Businesses avoid taxes by taking all legitimate deductions and by sheltering income from

taxes by setting up employee retirement plans and other means, all legal and under the

Internal Revenue Code or state tax codes. Tax evasion, on the other hand, is the illegal

practice of not paying taxes, by not reporting income, reporting expenses not legally allowed,

or by not paying taxes owed. Tax evasion is most commonly thought of in relation to income

taxes, but tax evasion can be practiced by businesses on state sales taxes and on employment

taxes. In fact, tax evasion can be practiced on all the taxes a business owes.6

‘Tax avoidance’ and ‘tax evasion’ are terms so frequently referred to in economic and

business relationships today that they constitute part of our conversational language and

people in general use these terms even without knowing their exact meaning and difference.

Whereas tax avoidance implies a situation in which the taxpayer reduces his tax liability by

taking advantage of the loop-holes and ambiguities in the legal provisions, in the case of tax

evasion, facts are deliberately misinterpreted and the tax liability is understated. Thus, while

tax avoidance is perfectly legal and is, at times, referred to as ‘tax planning’, tax evasion is

illegal and, therefore, carries with it the risk of penalties and prosecutions under the tax laws.

As such, the black economy comprises the sum total of all the various methods of

tax evasion but does not include tax avoidance. Accordingly, whereas the consequences of

the two phenomena are different for the taxpayers, both reduce the revenue of the Exchequer

and consequently need to be checked to the greatest extent possible.7

If a serviceman earns Rs.10.0 Lakhs per year, he has very limited scope to avoid tax payment.

He can at best save some money in tax saving schemes and reduce tax liability by at most 20

to 30 thousand rupees. He will have to pay Income tax to the tune of rupees one to two lakhs

as income tax per year. They cannot avoid tax payment but they can if they like, earn bribe up

to any extent to compensate they lose in tax payment. But a manufacturing company earning

profit of more than one corer per year can avoid tax payment completely by using various

tools of tax avoidance suggested by tax officials, tax consultants and Chartered Accountants.

6http://biztaxlaw.about.com/od/businesstaxes/f/taxavoidevade.htm last visited on November 27,2013

7Supra note 1.


http://biztaxlaw.about.com/od/businesstaxes/f/taxavoidevade.htm

http://biztaxlaw.about.com/od/typesofbusinesstaxes/tp/allbiztaxes.htm

http://biztaxlaw.about.com/od/glossaryt/g/taxevasiondef.htm

THE MEASURES TO CURB THE TAX EVASION:

There are three kinds of measures to curb the tax evasion in India which are as fallows-

Legislative Anti- Avoidance Measures

Judicial Anti- Avoidance Measure

Administrative Anti- Avoidance Measures

In India, the proposed Direct Tax Code, 2010 (DTC, 2010) seeks to address miscellaneous

issues, concerned tax evasion and tax avoidance; by bringing in General Anti-Avoidance

Rules (GAAR), in addition to various transaction-specific Special Anti-Avoidance provision.

The concept of GAAR is not new to India since India already has a Judicial Anti-Avoidance

Rule, similar to some other jurisdictions8.The concept of Anti-avoidance rule can better be

understood by classifying the method(s) of its implementation into three categories namely:

(i) measured based upon principles of law interpreted by the judiciary; (ii) General Anti-

Avoidance Rule and lastly (iii) Specific Anti-Avoidance Rule. Discussing each classification

herein under:

1. Measure based upon principles of law interpreted by the Judiciary

Over the years the Hon’ble Supreme Court has tried to save the interests of Tax Authorities

and the Assesses by interpreting the law according to the principles laid down by various

8 Vodafone international v. UOI, (2012) 1 UJ 128. [hereinafter Vodafone]


National as well as Foreign judgments. This includes range of philosophies and debates

regarding ‘substance’ over ‘form’ and 9‘abuse of law’10.

2. General Anti-Avoidance Rule

GAAR, as its name suggests, is a set of general anti-avoidance rules which usually take the

form of a legislative instrument; better to consider it as a ‘catch-all’ for tax avoidance11.The

main triggering incident of attracting GAAR lies in the fact that the tax avoidance schemes

are becoming increasingly complex, therefore, it is getting tougher for the Tax authorities to

determine the path for tax avoidance. To put in simple words GAAR is basically an attempt

to strike down avoidance of taxes that was not understood a probable method of tax evasion

at the time of drafting any taxation statute. The difficulty with having such a broad scheme

has been heavily debated in various countries as and when they grappled with the thought of

introducing GAAR.

3. Specific Anti-Avoidance Rule

The Specific Anti-Avoidance Rule targets reducing specific avoidance practice or

technique12.SAAR is comparatively more specific and helpful in reducing time and costs

involved in litigations compared to JAAR. Unlike GAAR, SAAR does not grant unfettered

discretion upon tax authorities. While SAAR is promulgated to counter a specific abusive

behaviour, GAAR is devised to supplement SAAR and to cover transactions that are not

9 Commissioner of Income-Tax v. A. Raman & Company, AIR 1968 SC 49 [hereinafter A. Raman]; McDowell and Co. Ltd. v. Commercial Tax Officer, (1985) 47 CTR (SC) 126 [hereinafter McDowell]; Union of India & Anr. v. Azadi Bachao Andolan and Anr, [2003] 263 ITR 706 (SC) [hereinafter Azadi Bachao]; Inland Revenue Commissioners v. Duke of Westminster, (1935) All ER 259.; W. T. Ramsay v. Inland Revenue Commissioners, 1982 AC 300; Furniss v. Dawson, (1984) 1 All ER 530; Astall & Anor v. Revenue and Customs, [2009] EWCA Civ. 1010.

10 “Many civil law countries apply the Roman law doctrine of fraus legis. A good example is The Netherlands. Fraus legis resembles the business purpose rule. Under this, the Court disregards any transaction entered for tax avoidance purposes and substitutes it by a ‘normal’ transaction.” T. P. Ostwal and Vikram Vijayaraghavan, “Anti-Avoidance Measures”, 22 Nat’l L. Sch. India Rev. 73 (2010). [hereinafter T. P. Ostwal11 See Id.12 See Id.


covered by SAAR. There are certain instances, where the Indian judiciary has effectively

applied the existing SAAR provisions to counter tax avoidance in absence of GAAR.13

Every discussion needs a critical analysis regarding its merits and demerits and therefore

the discussion is incomplete without discussing the merits and demerits of GAAR. With

this guiding principle the merits and demerits are discussed below:

GAAR: A Necessity

There are multifarious issues regarding GAAR. Several countries have codified GAAR in

their tax statutes so as to check tax evasion by the assesses. GAAR has been a part of the

tax code of Canada since 1988, Australia since 1981, South Africa from 2006 and China

from 200814. The merits of introducing GAAR with regard to Indian perspective are as

follows:

Checking abuse of Double Taxation Avoidance Agreement and in turn protecting the

revenue interest of India

India entered into Tax treaties with over 70 countries to ensure that the income taxed in

one country is not taxed again in the other.15 Mauritius and Singapore are the most

preferred jurisdiction for structuring investments into India in view of liberal business

environment offered by Mauritius and the benefits available to the assesses under the

India-Mauritius Tax Treaty.16

Statistical analysis of the Department of Industrial Policy & Promotion shows that more

than 40% of the Foreign Direct Investment (FDI) or a whopping 62471 million US Dollar

has come to India from Mauritius in the last year itself17. Furthermore referring to the same

13 CIT v. R. K. Abubcker, [2004] 135 Taxman 77 (Mad.); Om Sindhoori Capital Investments Ltd. v. Jt. CIT [2002], 80 ITD 514 (Chennai); VVF Ltd. v. Dy. CIT [IT Appeal No. 673 [Mum. Of 2006, dated 8-1-2010].

14 Raghuvir Srinivasan, Sweating over GAAR, The Hindu, available athttp://www.thehindu.com/business/article3339961.ece. last visited on November 26,2013

15S.S.Khan, The Crux of Mauritius Tax Treaty, available athttp://www.moneymantra.co.in/detailsPage.php?id=2130&title=Banking&wrt=SS%20Khan last visited on November 27, 2013

16 India: Holding Company Planning for Holding Investment, International Tax Review, available athttp://www.internationaltaxreview.com/Article/3068212/India-Holding-company-planning-for-Indian-investments.html last visited on November 28,2013

17 Fact Sheet On Foreign Direct Investment (FDI) from April 2000 to December 2011, available athttp://dipp.nic.in/English/Publications/FDI_Statistics/2011/india_FDI_December2011.pdflast visited on


http://dipp.nic.in/English/Publications/FDI_Statistics/2011/india_FDI_December2011.pdf

http://www.internationaltaxreview.com/Article/3068212/India-Holding-company-planning-for-Indian-investments.html


http://www.moneymantra.co.in/detailsPage.php?id=2130&title=Banking&wrt=SS%20Khan


http://www.thehindu.com/business/article3339961.ece

statistical analysis we can see that FDI index has crossed two digits only with respect to

those capital inflows coming from two tax heavens, viz. Mauritius and Singapore 18.This

heavy inflow must be for some special reason.

Certificate of Residence: essential element in determining tax upon capital-gain

arising to a non-resident

While under Income Tax Act, 1961, capital gains arising to a non-resident on transfer of

shares of an Indian company are generally taxable under the Indian law. However under

the Tax Treaty, such gains arising to a tax resident of Mauritius or Singapore are taxable

only in Mauritius and Singapore respectively. But there is no such legislation which aims

to tax capital-gains neither in Mauritius nor in Singapore. To avail this benefit, the foreign

Company has to prove that it is resident of Mauritius or Singapore. For that purpose of

determining the residential status, CBDT issued a circular 19that a Certificate of Residence

issued by Mauritius or Singapore will be sufficient evidence for accepting the status of

residence as well as ownership for applying the provisions of the treaty. The above circular

was, however, declared invalid by the Hon’ble Delhi High Court which 20was later

reversed by the Hon’ble Supreme Court in the landmark case of Azadi Bachao21 However,

the recent case of Aditya Birla Nuvo Limited v. The Deputy Director of Income-tax,22

Mumbai High Court upsets the settled legal position, and very clearly implies that if the

shares of the Indian company are effectively not owned by a Mauritian company, capital

gains may be charged to tax in India despite a Certificate of Residency issued by Mauritius

Government.

Role of GAAR

Now the question may rise what is the role of GAAR in India. The role comes to play

where there is no Limitation of Benefit article in a DTAA to prevent tax treaty abuse. Even

if there is a specific LOB in a treaty, whether that would prevent the application of

November 20,2013.

18 See Id.

19 Circular No.789 dated 13.4.200020 Shiv Kant Jha v. Union of India (2002) 256 ITR 56321 Azadi Bachao, supra note 8.22 2011(44) SOT 601.


domestic GAAR has also been answered by both OECD Model Convention 23and UN

Model Convention. 24However Shome Committee recommended that where the DTAA

itself has anti-avoidance provisions, such provisions should not be substituted by GAAR

provisions under the treaty override provisions25.

GAAR will provide in those instances a statutory right to the tax authorities to question

any transaction which is not made in ‘good-faith’. Tax treaties are usually governed by the

Vienna Convention26. The provisions of the Vienna Convention clearly emphasise that a

treaty should be interpreted and must be performed by parties to it in ‘good faith’27.Even

the underlying principle of treaty shopping can come under the purview of absence of

good-faith.28 The main problem with treaty shopping is that it breaches the reciprocity of a

Tax treaty entered into between two sovereign nations and instead it extends the Treaty

benefits meant for residents of Treaty partner countries to those of a third parties which is

not signatory to the Treaty and may not reciprocate corresponding benefits. Hence the

importance of GAAR to protect the revenue interest of a nation is unquestionable.

Creating certainty in Indian tax regime

Canadian tax laws contain GAAR provisions since 1988 is intended to prevent abusive tax

avoidance transactions or arrangements but at the same time is not intended to interfere

with legitimate commercial and family transactions.

Consequently, the new rule establishes a reasonable balance between the protection of the

tax base and the need for certainty for taxpayers in planning their affairs....” Hence the

23 “LOB can usefully supplement a domestic GAAR”, Removing the fences, supra note 3 at p. 27.24 “LOB may not provide a comprehensive solution. In case LOB deals with specific abuse (say conduit entities), then the domestic GAAR may also apply to prevent other abuses, not covered by the treaty”, Removing the fences, supra note 3 at p. 27.25 Shome Committee Report, supra note 68.

26 Vienna Convention on the Law of Treaties was signed in Vienna on 23 May 1969 and entered into force on 27 January 1980.

27 See general, Preamble of Vienna Convention, Article 18, Article 26, Article 27, Article 31, Article 46 Vienna Convention on the Law of Treaties, U.N. Doc. A/CONF.39/27, Art. 31(1), (1969).

28 See general, Reuven S. Avi-Yonah & Christiana Hji Panayi, Rethinking Treaty-Shopping Lessons For The European Union, Michigan Law University, available athttp://www.law.umich.edu/centersandprograms/lawandeconomics/abstracts/2010/Documents/10-002aviyonah.pdf last visited on November 28,2013


http://www.law.umich.edu/centersandprograms/lawandeconomics/abstracts/2010/Documents/10-002aviyonah.pdf


GAAR, under the Finance Act, 2012 aimed to create a certainty in taxation laws aftermath

the decision of the Vodafone case. But it also needs further re-consideration before

practical implementation.

GAAR: Is it really a Curse

There are many expert reports available both in electronic media and print media, which

vehemently criticized the idea of introducing GAAR in India’s taxation legislation. But

what we considered to be the relevant arguments against the application of GAAR in

Indian scenario are mentioned below:

Lack of trust factor

India is one of those elite class countries which top tax miseries around the world. 29The

2011 Trust Barometer concludes that India’s informed public has most trust in business

and least trust in Government.30These international think tanks showed that in India the

government efficiency is always subject to scepticism. Hence the implementation of

GAAR in present status will not only give undue advantage to AO’s over the assesses but

will also lack certainty in taxation laws.

Concern over FDI and FII

Another hot debated topic is whether GAAR will affect adversely over FDI and FII in

India. Before providing any view it is better to differentiate both the terms and its

implications over development of a countries economy.

India’s economic investments drastically increased since the landmark economic

liberalisation of 1991. Since then capital inflow started to enter into various forms like

Foreign Direct Investment (FDI), Foreign Institutional Investment (FII), Non-Resident

Indian (NRI) and person of Indian Origin (PIO) investment. Foreign Direct Investment is

one which targets a specific enterprise, with the aim of increasing its capacity/productivity

or changing its management control31. FII on the other hand flows into the secondary

29 2009 Tax Misery & Reform Index, available at http://www.forbes.com/global/2009/0413/034-tax-misery-reform-index.html. last visited on november 28,2013

30 See general, 2011 Edelman Trust Barometre, available athttp://www.indiaprwire.com/downloads/document/201102/19365.pdf last visited on November 29,201331 Do you know the difference between FDI and FII? available athttp://epaper.timesofindia.com/Repository/ml.asp?Ref=RVRELzIwMDgvMDgvMjUjQXIwMDMwMA==&Mode=HTML&Locale=english-skin-custom. Last visited on November 29,2013


http://epaper.timesofindia.com/Repository/ml.asp?Ref=RVRELzIwMDgvMDgvMjUjQXIwMDMwMA==&Mode=HTML&Locale=english-skin-custom


http://www.indiaprwire.com/downloads/document/201102/19365.pdf

http://www.forbes.com/global/2009/0413/034-tax-misery-reform-index.html

market, increasing the overall capital availability in the market, rather than increasing

capital to a particular enterprise.32In other words FDI is an investment that a parent

company makes in a foreign country.33On the contrary, FII is an investment made by an

investor in the markets of a foreign nation.34 So on the face of it; one can say that FDI is

more desirable and economically beneficial for a Nation compared to FII.

Now the question is if the government tries to bring this FII under the purview of tax

legislation and that to those transactions which are not made for bona-fide purpose then

why such a hue and cry is being made. Though the AO must not unnecessarily harass a

genuine tax payer but that does not mean that AO cannot question a transaction or

arrangement solely made for tax evasion.

Recommendations

It is no doubt that the introduction of the GAAR in the present form is likely to create

uncertainty about the tax implications of various business and non-business transaction(s)/

arrangement(s). This would not only create undue hardships for the tax payers but such

provisions could even create a negative environment against the efforts of increasing

domestic as well as foreign inward investments and fear have been proved to be true.

The moot question which arises is whether, at the stage when the developing countries are

trying their level best to attract FDI as well as when there is a economic slowdown, the

approach of introducing the GAAR in the Indian taxation regime is correct or whether it is

better to adopt a targeted approach and expand the scope of SAARs. Another question is in

line of the Vodafone judgment; whether the GAAR, under the Finance Act, 2012 is certain

for the taxpayers? The Supreme Court in Vodafone’s case observed that Foreign Direct

Investment (FDI) “flows towards location with a strong governance infrastructure which

includes enactment of laws and how well the legal system works. Certainty is integral to

rule of law.

Certainty and stability form the basic foundation of any fiscal system. Tax policy certainty

is crucial for taxpayers (including foreign investors) to make rational economic choices in

32 See Id.33 Difference Between FDI and FII, available at Difference Between FDI and FII | Difference Between | FDI vs FII, available at http://www.differencebetween.net / business / difference-between-fdi-and fii/#ixzz25tcrb53G34 See Id.


the most efficient manner. Investors should know where they stand. It also helps the tax

administration in enforcing the provisions of the taxing laws”. Furthermore we would like

to consider Graham Aaronson’s (Queens Council) recommendation to the Government of

UK for the introduction to the UK tax system a narrowly focused GAAR, discussed in

details in Part-IV of this paper35.

The recommendations have therefore been based upon the above circumstances so that the

Indian GAAR is not treated as toothless tiger or as a draconian law:

The most effective safeguard that needs to be introduced before implementing GAAR is

changing the mindset and developing a clear view about its functionaries among tax

authorities. As long as the Government is faced with major dependence on revenue

collections to meet its budgetary obligations (as India usually have deficit budget) and the

target fulfilment remained the most important criteria for appraising officers, it cannot be

expected that GAAR will not be invoked against genuine, bona fide commercial

transaction(s)/ structure(s). Even the Shome Committee acknowledged the same problem

and accepted the fact that indeed a significant trust deficiency is there in the eyes of

Assesses for the Assessing Officers and which need to be eliminated.

In view of the above situation the Committee recommended that: “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”. 36Further the Committee also

recommended that: “It may also be perspicacious as indicated above, for Govt. 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”.37

But considering the government spontaneity and efficiency in India, time period of less

than five years for educating the AO’s and developing database as recommended by the

35Independent study on general anti-avoidance rule published, available at http://www.hm treasury.gov.uk/press_130_11.htm. last visited on November 29,2013

36 Shome Committee Report, supra note 68 at 55.

37 See Id


http://www.hm/

Shome Committee, will be of no use and will only add to undue harassment to the

assesses.

GAAR should be implemented in a narrow manner

As mentioned earlier that there are certain instances, where the Indian judiciary has

effectively applied the existing SAAR provisions to counter tax avoidance as and when it

felt necessary to do so. This approach was balanced and found to be effective and solved

the issues in effective manner providing the desired certainty mentioned in the Vodafone

judgment.

Shifting our view to what Aaronson group of UK recommended for their own country,

standing in state of economic uncertainty and financial crisis. Aaronson stated that “A

general anti-abuse rule narrowly targeted to deter such schemes, while not affecting

responsible tax planning, should lead to a fairer, more principled and ultimately simpler

tax system and I strongly recommend that such a rule should be introduced into our tax

laws”.38

Hence it can be ascertained that GAAR in UK will be drafted in a narrow manner so as to

bring only ‘Tax Evasion’ under its purview not ‘Tax Planning’. The main proposal that

attracted our attention is stated in the Group report which stated that, “In many overseas

GAARs, and indeed in many of the UK’s specific anti-avoidance rules, the approach has

been to target arrangements which have the sole or main purpose of achieving a tax

advantage....I do not consider this to be the right approach for a GAAR that is suitable for

the UK tax regime. The insuperable problem is that the UK tax rules offer, and indeed in

many instances positively encourage, the opportunity for taxpayers to reduce their tax

liability. Taking advantage of this can be described as a form of tax avoidance, but clearly

it is not something to be criticised and therefore it should not be counteracted by a

GAAR.39 Hence if a developed country can be cautious of investors’ sentiment and can be

highly concerned of creating certainty in taxation statue, why India shall be an exception?

38Aaronson recommends ‘narrowly focussed’ GAAR, available athttp://www.accountancyage.com/aa/news/2126444/aaronson-recommends-narrowly-focussed-gaar#ixzz25nEtKsLH. Last visited on November 30,2013

39 Report by Graham Aaronson QC, Gaar Study, pp. 30, 31, available at http://www.hm-treasury.gov.uk/d/gaar_final_report_111111.PDF. [hereinafter Report by Aaronson] last visited on November 30,2013


http://www.hm-treasury.gov.uk/d/gaar_final_report_111111.PDF

http://www.accountancyage.com/aa/news/2126444/aaronson-recommends-narrowly-focussed-gaar#ixzz25nEtKsLH


Hence the arbitrary power of AO’s in GAAR legislation in India shall be reduced and shall

be allowed to implement them as and when it becomes imminent necessary to invoke.

In view of the above discussion it is recommended that the Government should notify the

types of arrangements which are to be considered as tax avoidance arrangement(s). The

proceedings for invoking GAAR provisions should be permitted to be initiated only in the

case of such notified types of arrangement(s). This shall be made subject to modifications

based upon the necessity.

‘Main purpose’ and not ‘one of the main purposes’

In the original version of GAAR in DTC 2009 and DTC 2010, the purpose test required

that the main purpose of the arrangement was to obtain tax benefit. However, the GAAR

provisions introduced through Finance Act, 2012 provides that the main purpose of GAAR

is to obtain tax benefit. Though initially only those arrangements were covered under

GAAR where the sole predominant purpose was to obtain tax benefit which has been

diluted in the recent version of GAAR and made it wider in application by inserting the

term ‘one of the main purposes’. This will not only give unfettered power to the tax

authority but will increase the chance of vexes allegations of tax evasion for genuine tax

payers.

GAAR to support LOB provisions, not to override it

The GAAR provisions should not override treaty provisions, where a specific LOB clause

exists in the tax treaty or LOB conditions are specified through Protocol or Memorandum

of Understanding. In such cases denial of benefits should be governed by the LOB clause.

GAAR should only support LOB, but where there is a specific LOB, GAAR shall not be

invoked.

More than that if shifting onus

With the Amendment of the Finance Act, 2012 onus of initiating and demonstrating that

there is an impermissible avoidance arrangement is shifted upon the Revenue. It is

recommended that the Rules should mention that the AO needs to inform the taxpayer of

his finding along with the information he possesses and his detailed reasons thereof,

instead, of merely asking the taxpayer as to why a particular arrangement should not be

treated as impermissible.

Exclusion from the purview of GAAR


It is also recommended in line of the Shome committe that where a Foreign Institutional

Investor (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 the

domestic law provisions, then, the provisions of Chapter X-A shall not apply to such FII or

to the non-resident investors of the FII40.This will stop undue harassment upon genuine tax

payers41

THE VARIOUS ONSHORE AND OFFSHORE METHOD OF TAX EVASION-

Onshore is in no way synonymous with transparency; and by contrast some supposedly

offshore places are considering opening up. There are numerous ways to evade/ avoid tax and

it is difficult to throw light on all such practices nevertheless some conventional practices of

tax evasion / avoidance can be classified as fallows:

Money laundering Hawala Tax Hevens Transfer pricing Trade mispricing

These process are used to evade /avoid both direct as well as indirect taxes. Whereas money

laundering hawala and trade mispricing are more prone to evasion tax heaven and transfer

pricing are typically used as tax avoidance practices nevertheless the processes are often

interrelated and difficult to distinguish in practices.

1. Money laundering-

The term money laundering is used to refer to the process of showing illegal money as being

generated through legal/ legitimate sources. It literally means washing of illegally obtained

money to hide its true nature or sources. . A working definition was adopted by the Interpol

General Assembly in 1995, which defines it as "any act or attempted act to

conceal/disguise the identity of illegally obtained proceeds so that they appear to

40 Report by Aaronson , supra note 106 at p. 53.

41http://www.aiftponline.org/journal/OCTjournal%202012/IN%20PURSUIT%20OF %20%20KNOWLEDGE.htm last visited on November 18,2013


http://www.aiftponline.org/journal/OCTjournal%202012/IN%20PURSUIT%20OF%20%20KNOWLEDGE.htm


have originated from legitimate sources"'. The term derives from Mafia ownership of

Laundromats in the US. Sometime in the 1930s, Mafia gangsters are believed to have

commercially set up "Laundromats" (self-service washing and drying) equipped with

washing machines and dryers since they were earning large amounts of illegal money

through extortion (practice of obtaining money/information from person(s) by

using force, threats, or other unacceptable methods), gambling and bootlegging

(proceeds from the sale of illicit liquor). These needed to be shown as stemming from a

legitimate source. So, the Mafia gangsters mixed their legitimate businesses with their

illegal earnings and used Laundromats as a front for the purpose.

Why Money Laundering is Problematic?

Unlike the commonly referred to "white money", which is legally sourced;

laundered or "black money" is generated/earned through illegal, criminal activities. A

high prevalence of black money in a country adversely affects its economy and growth,

and is reflected in poor socio-economic indices. In an economy where black money is

widespread, the resources for developmental purposes would also be lacking. One

of the most important consequences of money laundering is rampant tax evasion.

Since the laundered money cannot be sourced, it cannot be taxed either and this means

a substantial loss of public revenue from the most convenient (tax) source of public

finance.

Steps in Money Laundering -

1) Placement: This is the initial step in channelling illicit money into "legal money"

by investing it in the legal financial system by opening up a bank account in the

name of unknown/fake individual(s)/organisation(s) and depositing the money

in that account. This is the most important/fundamental part of money

laundering. In an attempt to protect such activities, methods like "Know Your

Customer" or mandatory record-keeping have been developed by regulatory

authorities.

2) Layering: Having injected illegal money in the financial system, the tax evader

concerned tries to create a omplex layer to confuse auditors and regulatory

authorities. A common practice is to move money to offshore bank accounts


in the name of "shell companies."5 These companies act as legally authorised

companies and operate via fake invoices and balance sheets.

3) Integration : In this stage, the money launderer tries to show the money as

regular business funds. The money launderer does this by depositing money in

banks/financial institutions where privacy is guaranteed (e.g., UBS in Switzerland).

2. Hawala

Hawala is a process of funnelling money from one location to another (usually abroad

or from abroad to the domestic country) through a network of hawala brokers

(service providers facilitating the process for a commission). It is an informal

channel for transferring money and other assets. In Arabic banking jargon, the term

"hawala" means transfer or wire, and has its origins in classical Islamic law. It was used

for financing longdistance trade around the emerging capital trade centres in the early

medieval period. In South Asia, it appears to have developed into a full-fledged

money market instrument, which was only partially replaced by the instruments of

the formal banking system in the first half of the 20th century. Today, hawala is the

dominant channel for migrant workers' remittances to their countries of origin.

A number of economic and non-economic factors have made the hawala system more

attractive than the formal banking system, of which inexpensiveness and less

bureaucratese are the most important. The fees charged by hawala brokers on the

transfer of funds are much lower than that of banks and other formal financial

institutions. Moreover, it is swifter than the formal financial system due to the

simplicity of operations; transactions are done by phone, facsimile and e-mail; and

there is a wide connectivity through a chain of hawala brokers operating in a number of

countries. For instance, a hawala transaction takes place within two days in contrast to

fund transfer by international agencies, where there are delays due to holidays, weekends

etc. Lower social overhead/ sunk cost is another factor for the proliferation of hawala. A

hawala broker operates in a rented storefront as opposed to a bank building (which has

expensive bank vaults and alarm systems) and often shares space -with another

business (e.g., a sari or jewellery shop). The signage for the rented house could

read: "Music Bazaar and Travel Agency" or say "CD/DVD/other electronics"


3. Tax Havens

Tax havens are locations with zero or low tax rates to attract foreign capital and

business. However, there is no precise definition of tax havens. The OECD initially

defined tax havens in terms of countries or territories that have the following features:'

• Zero or low taxes

• Lack of effective exchange of information/lack of tax

information exchange with other countries (even if there is exchange

for fraud money laundering)

• Lack of transparency

• A high degree of bank secrecy

• Lack of real economic activity associated with the income generated.

• Tax havens are small countries

• Population is less than one million

• Tax havens are generally more affluent than other countries

Tax havens, as they exist today, can be classified into three groups: (a) UK

based/British Empire based tax havens (b) European havens (c) New tax havens from

the transitional economies in South America and Africa8.

Most of the major tax havens have developed around two primary geo-political poles. One

pole has evolved with close links to the city of London. This includes British Crown

dependencies such as the Channel Islands, Jersey, and the Isle of Man. The most

significant tax havens are the Cayman Islands, Bermuda, British Virgin Islands, and later

stage independent British Imperial colonies such as Hong Kong, Singapore, the

Bahamas, Bahrain and Dubai. The second pole developed in Europe consisting of

Belgium, the Netherlands, Luxembourg (BENELUX) and Switzerland. The only other

significant tax havens today, which are not part of these two poles, are Panama and, to a


lesser extent, Uruguay.42

4. Transfer Pricing

Transfer price is the price at which goods and services between related companies

are transacted. The main branch of a company is called the parent company and a

number of associated units spread in different countries/locations are called its

subsidiaries. For instance, let us assume that a television company (sayWisco) based in

the US provides teleservices to India. Owing to an increasing demand from people

in India for this teleservice, the US Company decides to set up a subsidiary in India

that will provide teleservices and movies in the country. The parent company then

floats a film production company in India for better facilitation. Now, Wisco has to

make a strategic decision regarding at what price the teleservices would be

provided to its subsidiary in India. This is the transfer price of Wisco.

Since the film production company has to operate in a new country, tie up with new

partners and create brand loyalty where it had no presence before, the parent

company might decide to support the efforts to build a market share by arranging a

suitable transfer price for the India based company. Given the fragile condition of the

start-up company, Wisco might provide a "preferably suitable price" to it compared

to its other already established subsidiaries. This preferably suitable price might be

below, above or equal to the existing market price depending on profit and other

considerations.

But what should the preferably suitable price be?

Asper the Transfer Pricing laws followed by various countries, it should be a fair one,

that is, a price that would be charged between the parent and subsidiary companies, as

if they are "unrelated companies"'. (The normal transaction price that prevails between

two separate companies is called "Arm's Length Price"). However, companies often

42 The history of tax havens" by Ronen Palan, URL: http://www.historyandpolicy.org/papers/policy-paper-92.html and Government of Norway (2009) Commission on Capital Flight from Developing Countries: Tax Havens and Development, Preliminary Report URL: http://www.regieringen.no/upload/UD/Vedlegg/Utvikling/tax_report.pdf. 'See URL: http://www.investorsoffshore.com/asp/story/storyinv.asp?storyname=35965


manipulate the transfer price to escape taxes. For instance, Wisco might charge the

India-based subsidiary price much below the market rate which falls short of the taxable

income. In this manner, MNCs might pay fewer taxes than it should pay under normal

circumstances by charging lower prices (and projecting lesser profits) where tax rates

are high and higher prices and higher profits where tax rates are low.

Theoretically, the concept and practice of transfer price is not illegal. The idea

underlying transfer pricing is optimal allocation of a firm's resources by minimising

costs. The practice can be accepted if transactions between the parent company and

its subsidiaries or between subsidiary firms can be done at the market price. Smaller

manipulations might be tolerated but over the years, transfer prices have been severely

manipulated in order to shift profits to low tax countries from high tax countries'.

Consequently, there are substantial losses of legitimate tax revenues of governments of

different countries.

5.Trade mispricing

Trade Mispricing refers to intentional over invoicing/under invoicing of exports and

imports in order to escape taxes. Trade mispricing occurs when the import or export

price for a particular good is invoiced at a level that either exceeds the market price

(over-invoicing) or is below the market price (under-invoicing).[Note: The term

“mispricing" refers to incorrect invoices by exporters/importers presented to the customs

office in order to hide true amount of trade transactions].

How to Estimate and Capture Unaccounted Money through Trade Mispricing?

As for estimating the amount, there is no official record of the money that leaves

the country through trade mispricing. Hence, it is impossible to find in the official

records of a country. Conceptually, one country's (for example India's) exports to

another country (the US) should be equivalent to US imports from India. One

method to estimate capital flight from India is to tabulate total annual exports of India to

the US (found in official data available in India) and total annual imports of the US from

India (found in official data in the US) during the same period. Some discrepancy

might arise due to "statistical measurement default" (officially entered in any

country’s balance of payments records as "errors and omissions"). The remainder -


the amount accountable to "misinvoicing of exports and/or imports only" -is treated as

capital flight.43

FURTHER REFORM SUGGESTED REGARDING TAX EVASION AND TAX

AVOIDANCE IN INDIA-

In a globalising environment, tax reforms can serve a multitude of needs. They can help

enhance revenue productivity, reduce economic distortions, and help create a stable and

predictable market environment. Given the growing mobility of capital and skilled labour

which raises new tax issues continual reforms also serve, simply, to keep the country up-to-

date with changing conditions. Furthermore, tax reforms can help address equity concerns.

However, unlike in the past, equity in tax policy should not involve reducing the incomes of

the rich, but raising those of the poor. Hence, there needs to be a paradigm shift, away from a

socialistic focus on vertical equity (i.e. the unequal treatment of unequal’s) and towards

horizontal equity (or the equal tax treatment of equals). Until very recently, this

preoccupation with vertical equity in the Indian tax system created enormous incentives for

tax avoidance. While this is starting to change, many reforms remain unfinished. In response

to its changing developmental strategy, India’s tax system, too, has been undergoing

profound changes. Within the framework of a closed and heavily planned economy, the tax

system was based on multiple objectives.

While this system may have been sustainable within a closed economy in today’s globalising

world, it is more critical than ever to put in place an efficient tax system. A competitive tax

environment means that a country’s tax policy must be calibrated on three levels:

architecture, engineering, and management. Paradoxically, an open economy presents bigger

challenges in setting tax rates - since there are fewer ‘degrees of freedom’ available to

policymakers. In such an environment, not only do tax rates impact foreign investment, but

they can also shift the incidence of taxation in unexpected ways. (For instance, studies find

that, in a small open economy, a tax on capital can effectively become a tax on labour.)

Hence, being a large and complex economy, India needs to learn from worldwide best

practices, but apply them judiciously to meet its specific needs. In an increasingly-open

economy such as India’s, there is a need to focus on the efficiency aspect of the tax system

more than ever before. This means minimising three different costs: the cost of collecting

taxes; the compliance costs to taxpayers; and the distortion costs to the economy at large.

43 www.cbgaindia.org/files/recent_publications/Tax%20Dodging.pdf


(One such distortion, in India’s case, is an excessive reliance on tax revenues from the

(largely State-controlled) petroleum sector - which has a cascading impact on other areas of

the economy.) Given that distortions tend to increase with higher marginal tax rates, a simpler

system with lower tax rates is desirable.

Finally, three additional points must be kept in mind while tracking the progress of tax

reforms in India. First, legal reforms are just as important as tax reforms in driving changes in

this area. Second, as the experience of VAT demonstrates, it is critical to have coordinated

reforms, across States, especially in the area of indirect taxation. Third, it will require great

political will to ensure that the existing, discretionary policy and administrative framework is

not further perpetuated.44 Having seen the influence of the tax mix and tax policy on capital

formation, it is necessary to ensure that these policies promote growth with equity. The

various recommendations of the Chelliah Committee, which were implemented in India

during the 1990s, were targeted at removing loopholes in the direct tax system and providing

horizontal equity. However, there are still difficulties with the present income tax system and

the current tax policies do not adequately address issues relating to vertical equity There is a

dilemma as to whether to consider personal income or expenditure on personal consumption

as the base of direct taxation. Taking expenditure as the tax base poses a lesser problem since

it taxes what people take out of the economic production system rather than what they put

into it. Moreover, a progressive expenditure tax falls more heavily on the rich who are using

capital resources to finance their consumption expenditure and, at the same time, it provides

greater opportunity than progressive income tax to finance the development of private

enterprises out of private savings. As the economy moves from the take off stage to the stage

of high mass consumption, it is better to levy tax on personal consumption expenditure, since

it promotes vertical equity. 45

TAX AVOIDANCE BY MULTINATIONAL COMPANIES-

It is now a well-accepted fact that the multinational companies have developed an

unprecedented know-how for minimizing their worldwide tax pressure, multinational

companies doing huge business in a country and virtually not paying any corporation tax has

provoked some concern in the respective governments that something needs to be done. In

44 http://www.cfo-connect.com/title_detail.asp?art_id=265&cat_id=8 last visited on November 28,2013-11-30

45 http://www.chinahomeindia.com/upload/201112/20111201084222719.pdf last visited on November 30,2013


http://www.chinahomeindia.com/upload/201112/20111201084222719.pdf

http://www.cfo-connect.com/title_detail.asp?art_id=265&cat_id=8

this era of liberalized cross border trade and free capital flows, MNCs find themselves in

considerable freedom to choose where they pay tax on profits. There are corporations such as

Google whose commercial value is derived from a piece of intellectual property such as a

search engine algorithm or a drug patent and they are thus able to register their profits in tax

havens. his is how it works – A MNC registers its intellectual property in a subsidiary

company based in a tax haven like Bermuda or Mauritius. This subsidiary then charges

another subsidiary operating in a big country like UK or India a massive fee for the right to

use their intellectual property. Any trading surplus in these countries is thus offset by the cost

of the fee while profits keep accumulating in tax haven the group company. National

Governments are trying to stop this egregious ‘profit shifting’ on their own but is proving to

be a herculean task in the light of very complex global tax loopholes.

A natural solution is to have an international agreement by all countries to tax the profits of

multinational firms collectively and divide the revenues based on the amount of business

done by these companies in various territories. American states have long operated a system

known as “apportionment”. It may sound difficult but in the long run and in the wake of very

widespread tax avoidance by MNCs, this sort of arrangement is perhaps the only viable

solution. 46 In the era of globalization and liberalization, competition among

multinational corporations has increased tremendously. As a result, there may be a

natural tendency for such companies to try to reduce their 'tax costs' by any affordable

means. The challenge lies in framing appropriate legal provisions to tackle such

practices in an unambiguous manner. The General Anti Avoidance Rule (GAAR) is crucial in

this regard, and a policy option for India is to learn from other countries' experiences

(those which have adopted and are practicing GAAR). 47 India today said the stand taken

by the G20 nations that profits of multinational companies should be taxed where economic

activities deriving the profits are performed and where value is created is an "important

landmark" and it validates the country's position.

Multinational companies operating in India will have to pay more tax on royalty they earn from their Indian subsidiary, as the government has announced an increase in the tax on royalty and fee payments made by Indian subsidiaries to foreign parent from 10 to 25 per cent. One of the main

46 http://arvindkumar-ias.blogspot.in/2013/08/tax-avoidance-by-multinational.html last visited on November 28,201347 Supra note 43


http://arvindkumar-ias.blogspot.in/2013/08/tax-avoidance-by-multinational.html

ways tax evasion occurs is through ‘transfer pricing’. This is when goods and services are sold between subsidiaries of the same parent company. These goods and services also include things like intellectual property rights, management services, branding and insurance. The sales take place within the same multinational company.

As long as the subsidiaries of the company charge each other a fair market price – known as an ‘arms length’ price – such transactions are perfectly legitimate. Tax is paid where it should be, in the place where the business is actually taking place. However, by artificially altering the price, the company can increase its costs in a location with high taxes and transfer revenue to a location with low taxes (often a tax haven). This is known as ‘transfer mispricing’, and in many countries (including Australia) it is illegal.48

The methods of tax avoidance by MNCs in developed countries are well documented, although there is a lack of reliable and consistent data, whereas those for developing countries are less well understood. The method revolves around shifting income from higher-tax to lower- or no-tax countries.

Profit shifting strategy

This is achieved by limiting operational activities (and related income) in the higher tax

state, by moving them to a subsidiary located in a lower-tax state.

Transfer pricing-

This is the setting of prices for transactions between companies that are part of the same

MNC. In the past this mainly concerned physical goods but now involves the rights to

use intangible goods, and use of services such as headquarters' support. Over half of

international transactions are inter-company transactions, and are therefore not at "arms-

length" prices, i.e. as if purchased from an unrelated third party. Where the price is

inflated, "abusive transfer pricing" is said to occur. This is one way to move profits

where a subsidiary in a medium or higher-tax jurisdiction buys products from another

group company in a lower-tax country. It is often not obvious how arms-length prices

should be determined. The UK tax authority has around 65 experts in transfer pricing,

Corporate debt-equity

Inter-company loans given from entities in lower-tax states to subsidiary companies in

48 http://taxjustice.org.au/take-action/tax-dodging-within-multinational-companies/ last visited on November 30, 2013


http://taxjustice.org.au/take-action/tax-dodging-within-multinational-companies/

higher-tax countries pass interest income to the lower-tax state, reducing the taxable

profit in the higher-tax country. This profit is further reduced the higher the interest rate

or level of debt. Luxembourg has beneficial tax treatment of interest income.

Payments for intangibles

The pricing should reflect the value of the technology, i.e. how important the technology

is in the creation of the profits An MNC can have a company owning its IPR in a country

where no taxes are payable on licence fees, and then charge its affiliates around the

world for their use.

Shell holding companies

These are found mostly in jurisdictions with an extensive tax-treaty network and offering

low tax rates on dividends and capital gains e.g. Belgium, Ireland, the Netherlands and

Switzerland. The holding company may be a shell company (no real trading, production

or distribution activities) or may have centralised financing, licensing and other

management activities. Shell holding companies are used in multiple ways for tax

planning activities.

Hybrid entities-

These revolve around obtaining a deduction of the same cost, such as loan interest, from

two different countries based on the company’s affiliates’ structures Ireland, for example,

has companies that are legally based in Ireland and another country – typically a tax

haven, such as Bermuda.

The many previous attempts to structure business taxes "fairly and uniformly" have not

brought a solution. Among the elements to resolve are:

2. Factbox: How to tackle corporate tax avoidance, T Bergin, Reuters, 2013.

3. Tax Havens and the Taxation of Transnational Corporations, M Henn, Friedrich-Ebert-

Stiftung, 2013.

conflicts of interest between big and Small countries.

many countries design their tax systems

to attract inward investment. This is a non-holistic approach, normally contrary to

the achievement of a coherent international system.

It’s not just Google…, T Bergin, Reuters, 2013.

The fight against tax fraud and tax evasion, DG Taxation & Customs Union


website, EC.

Commission recommendation on aggressive tax planning, Dec. 2012 EC.

Harmful tax competition, OECD, 1998. developed countries have higher overseas

income from intangibles compared to emerging economies.

International Tax Policy Needed to Counterbalance the Excessive Behaviour of Multinationals, EC Tax Review, 2013. Business groups, including the main US group on international tax (US Council for International Business), say revising PE rules risks creating uncertainty49. The OECD has noted that the anti-avoidance measures (e.g. general anti-avoidance rule (GAAR), Controlled Foreign Company rules (CFC) or thin-capitalisation rules) adopted by many countries in previous decades are too complex, costly and often ineffective.

LAW COMISSION AND GOVERNMENT REPORT REGARDING THE TAX EVASION AND TAX AVOIDANCE IN INDIA-

The Indian tax authorities, meanwhile, chose not to make any tax demands on the basis of

the retrospective taxation provisions. After Mukherjee resigned in July 2012, the prime

minister constituted another committee to rework the GAAR guidelines. This committee

recently recommended in its draft report that (i) the implementation of the GAAR provisions

be deferred until April 1, 2016, (ii) GAAR treaty override provisions not apply in respect of a

tax treaty that includes anti-avoidance provisions in the form of a limitation of benefits

provision (e.g., the Singapore-India treaty), (iii) GAAR provisions not be invoked to examine

whether an entity is a genuine resident of Mauritius when such entity has been issued a tax

residency certificate by the Mauritius Revenue Authority ("MRA") and (iv) capital gains on

listed securities be abolished.

The committee's recommendation that a tax residency certificate issued in Mauritius should

be conclusive proof of residence in Mauritius echoes the law on this point as laid down by the

Supreme Court of India in the Azadi Bachao Andolan case [263 ITR 706 (SC)]. The

Authority for Advance Rulings (a governmental body that provides binding advance rulings

on tax questions brought before it) recently relied on the Azadi Bachao Andolan case to

confirm that a fund incorporated in Mauritius, being the holder of a valid tax residency

certificate issued by the MRA, would be eligible for treaty benefits under the India-Mauritius

DTAA. The Authority rejected the Indian tax authorities' arguments that the fund was

controlled and managed in India since the majority of the fund's board of directors were from 49http://www.europarl.europa.eu/RegData/bibliotheque/briefing/2013/130574/ LDM_BRI(2013)130574_REV1_EN.pdf last visited on November 28, 2013


http://www.europarl.europa.eu/RegData/bibliotheque/briefing/2013/130574/LDM_BRI(2013)130574_REV1_EN.pdf


India and that routing investments through Mauritius constituted a scheme to evade capital

gains tax [Dynamic India Fund, AAR No. 1016 of 2012, decision dated July 18, 2012].

The new finance minister, P. Chidambaram, also directed this committee to review the

retrospective tax provisions, promising that such provisions would not be "rashly"

implemented by tax authorities. The committee recently issued a draft report on this subject,

recommending, inter alia, that (i) the retrospective tax provisions be applied prospectively,

(ii) a transaction involving the sale of shares of an overseas company that derive their value,

directly or indirectly, from Indian assets be taxable in India only where such assets constitute

more than 50% of the global assets of the Indian company and (iii) transfers of minority

shareholdings (defined as less than 26%) and interests in registered foreign institutional

investors ("FIIs") not be taxed. The committee also noted that retrospective application of tax

law should occur only in "exceptional" cases and after due consultation with those affected.50

CONCLUSION

Given the growing magnitudes of public revenue loss because of tax dodging,

governments of different countries are reviewing some of their tax laws, for instance

transfer pricing laws, to minimise tax avoidance practices. The distinction between tax

evasion, tax avoidance and tax planning remains contentious and needs serious

scrutiny. both tax evasion and tax avoidance) is a serious global issue. While taevasion

is relatively straightforward to understand, the nature of tax avoidance is now

increasingly complete requires greater examination. There is a need for raising

awareness around tax issues, promoting a culture of tax compliance, increasing tax

transparency among multinational companies, and increasing international

cooperation between governments on tax matters. Also, capacity enhancement of

tax administration systems of different countries is required to check diverse and

complex tax dodging practices. Coordination between countries with regard to tax laws

is essential; as variations in tax laws in different jurisdictions might enhance

ambiguities, providing scope for further tax dodging. Global accountability and

cooperation of countries with respect to policies like Tax Information Exchange

Agreements (TIEAs) and end of banking secrecy has become crucial in this regard as well

as exchange of essential information regarding national interests. Modification of tax

50http://www.mondaq.com/india/x/202402/Export+controls+Trade+Investment+Sanctions/ Recent+Developments+In+India+Aim+To+Encourage+Foreign+Investment last isited on November 26,2013


http://www.mondaq.com/india/x/202402/Export+controls+Trade+Investment+Sanctions/Recent+Developments+In+India+Aim+To+Encourage+Foreign+Investment


laws of 'tax haven' countries is an important issue. There are a number of 'tax havens',

which may be used to avoid paying taxes by a number of companies, which emerges as

an external factor beyond the scope of Income Tax Authorities. Unless global pressure

is created on 'tax haven' countries to amend their tax laws to impose certain taxes on

offshore transactions and broaden tax bases on such transactions, it is difficult to tackle

tax avoidance practices. There is a need for clear legal guidelines distinguishing tax

evasion, tax avoidance and tax planning, and those indicating what type of strategies

under what circumstances would be taxable or subject to penalty. On the other hand,

there is also a concern that tax laws should not harass honest taxpayers. In the era of

globalization and liberalization, competition among multinational corporations has

increased tremendously. As a result, there may be a natural tendency for such

companies to try to reduce their 'tax costs' by any affordable means. The challenge lies

in framing appropriate legal provisions to tackle such practices in an unambiguous

manner. The General Anti Avoidance Rule (GAAR) is crucial in this regard, and a policy

option for India is to learn from other countries' experiences (those which have

adopted and are practicing GAAR). Countries like Australia, Canada, Germany, France,

South Africa and China have GAAR provisions; India also needs to introduce such

provisions to tackle tax avoidance practices. However, for proper implementation of

GAAR, there is a need to study closely the experiences of other countries. In-depth

discussions are required for distinguishing between 'acceptable' tax avoidance/tax

planning practices on the one hand and abusive tax avoidance practices on the other. With

regard to the Double Tax Avoidance Agreements (DTAAs), the inclusion of appropriate

Limitation of Benefit (LoB) clauses between India and other countries needs to be

considered. However, if General Anti Avoidance Rule (GAAR) has an overriding power

over LoB clauses, then appropriate application of GAAR in tax avoidance practices

assumes a crucial role. The role and functioning of the Dispute Resolution Panel

(DRP) would also be vital in this regard.


BIBLIOGRAPHY:

PRIMARY SOURCES-

Statue-

1. The Income Tax Act, 1961.

SECONDRY SOURCES-

Books-

1 jain.Anil Kumar (1987). Tax Avoidance and Tax Evasion: The Indian Case” Modern Asian Studies, 21, pp 233-255. Doi: 10.1017/S0026749X00013792

2. .” T. P. Ostwal and Vikram Vijayaraghavan, “Anti-Avoidance Measures”, 22 Nat’l L. Sch. India Rev. 73 (2010). [hereinafter T. P. Ostwal]

3. Acharya, Shankar and Associates, Aspects of the Black Economy in India, National Institute of Public Finance and Policy, New Delhi, 1985

4. Ambiranjan, S., Taxation of Corporate Income in India, Asia Publishing House, Bombay, 1961.

5. Bishnoi, Usha, Union Taxes in India, Chugh Publications, Allahabad, 1980.

6. Das Gupta, Arindam and Mookherjee, Dilip, Incentives and Institutional Reform in Tax Enforcement: An Analysis of Developing Country Experience, Oxford University Press, New Delhi, 1978.

7. Gandhi, V.P., Some Aspects of India’s Tax Structure- An Economic Analysis, Vora & Co. Publishers, Bombay, 1970.

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