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Tax Avoidance vs. Tax Evasion

The debate over „avoidance vs. evasion‟ is quite old and yet, it remains a topic of much interest and discussion. Some experts call tax avoidance as a mechanism to „save‟ tax, which conforms to the letter of law but inconsistent with the spirit of law. Evasion on the other hand is entirely illegal, since it neither conforms to the letter nor spirit of law.

Going by the judicial trends, courts all over the world are rejecting structures put in place to avoid tax, showing that the already-fine line between avoidance and evasion is getting thinner. New legislative rules are being enacted as to bring within their ambit, tax-avoiding mechanisms put in place by the ever-resourceful taxpayers. This is indicative of the fact that it is increasingly necessary to conform to the letter as well as spirit of law, i.e. form as well as substance. In the Indian context, the recent Supreme Court decision in Vodafone has reignited this debate.

In this note, Taxsutra team has attempted to collate key observations in a few landmark rulings across 5 jurisdictions on the issue of tax-avoidance vs. tax evasion, where there is no specific anti-avoidance (GAAR) legislation.

Quotable quotes

Every man is entitled if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be.

Duke of Westminster, 1936, UK It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or combination which may be regarded.

Ramsay vs. IRC,1981, UK

Unacceptable tax avoidance typically involves the creation of complex artificial structures by which, as though by the wave of a magic wand, the taxpayer conjures out of the air a loss, or a gain, or expenditure, or whatever it may be, which otherwise would never have existed.

Lord Goff, Ensign Tankers v. Stokes, 1992, UK

The language of a taxing statute will often have to be given a wide practical meaning … which allows (and indeed requires) the court to have regard to the whole of a series of transactions which were intended to have a commercial unity.

IRC vs. Scottish Provident Institution, 2004, UK

The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham, may sustain or disregard the effect of the fiction as best serves the purpose of the tax statute.

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Reed J, Higgins v. Smith, 1940 USA

From Gregory and Aiken Industries, we glean the following: Transactions involving a foreign corporation are to be disregarded for lack of meaningful economic activity if the corporation is merely transitory, engaging in absolutely no business activity for profit--in other words, it is a ‘mere skeleton.’ Transactions will also be disregarded if the foreign corporation lacks dominion and control over the interest payments it collects.

Bauer J, NIPSCO v. Commissioner, 1997, USA

A strict business purpose test in certain circumstances would run counter to the apparent legislative intent which, in the modern taxing statutes, may have a dual aspect. The statute is a mix of fiscal and economic policy. The economic policy element of the Act sometimes takes the form of an inducement to the taxpayer to undertake or redirect a specific activity.”

Stubart Investments Ltd v. The Queen (1984), Canada

The proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it.

Reddy J, McDowell v. CTO, 1985, India

We are unable to agree with the view that the Duke of Westminster is dead, or that its ghost has been exorcized in England. The House of Lords does not seem to think so, and we agree, with respect. In our view, the principle of Duke of Westminster is very much alive and kicking in the country of its birth.

Srikrishna J, UOI v. Azadi Bachao Andolan, 2003, India

Ramsay did not discard Westminster but read it in the proper context by which ‘device’ which was colourable in nature had to be ignored as fiscal nullity. Thus, Ramsay lays down the principle of statutory interpretation rather than an over-arching anti-avoidance doctrine imposed upon tax laws

Vodafone International Holdings v. UOI, 2012, India

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INDEX

Contents Page Numbers

A. UK

1. IRC v. Fisher‟s Executors (1926) AC 395 ...................................................................... 5 2. IRC vs. Duke of Westminster (1936 AC 1)..................................................................... 5 3. Ransom vs. Higgs [1974] 3 All ER 949 (HL) .................................................................. 5 4. Ramsay vs. IRC (1981) 1 All E.R. 865 ........................................................................... 6 5. IRC vs. Burmah Oil Co. (1982) 54 TC 200 .................................................................... 6 6. Furniss vs. Dawson (1984) 1 All E.R. 530 ..................................................................... 6 7. Craven vs. White (1988) 3 All. E.R. 495 ........................................................................ 7 8. Ensign Tankers (Leasing) Ltd. v. Stokes (1992) 1 AC 655 ............................................ 7 9. IRC vs. MCGUCKIAN (1997) BTC 346 ......................................................................... 7 10. MacNiven v. Westmoreland Investments Ltd. (2003) 1 AC 311 ................................... 8 11. Barclays Mercantile Business Finance Ltd v. Mawson [2005] AC 685 (HL) ................ 8 12. IRC vs. Scottish Provident Institution [2004] 1 WLR 3172 .......................................... 9 13. HMRC vs .Tower MCashback LLP [2011] UKSC 19 ................................................... 9

B. USA

1. Gregory v. Helvering, 293 U.S. 465 (dated 1935) .......................................................... 10 2. Higgins vs. Smith - 308 US 473 (dated 1940) ................................................................ 10 3. Gilbert vs. Commissioner – 248 F 2nd 399 (1957) .......................................................... 10 4. Knetsch v. United States - 364 U.S. 361 (1960) ............................................................ 11 5. Aiken Industries vs. Commissioner 56 T.C. 925 (1971) ................................................. 11 6. NIPSCO vs. Commissioner 115 F.3d 506, 512 (7th Cir. 1997) ...................................... 12

C. Canada

1. Stubart Investments Ltd vs. the Queen (1984) CTC 294 (SCC) ..................................... 13 2. Crown Forest Industries Ltd. v. Canada, [1995] 2 S.C.R. 802........................................ 13 3. Prevost Car Inc vs. The Queen (2008 TCC 231) ........................................................... 14

D. France

1. Bank of Scotland, (2006) 9 ITLR 683............................................................................. 15 2. Schneider Electric (dated 28th June, 2002) .................................................................... 15 3. Bank of Polska (dated 31st January 2001) ..................................................................... 15

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E. India

1. McDowell v. Commercial Tax Officer (1985) 154 ITR 146 (SC) ..................................... 16 2. State of UP vs Renusagar Power & Co (1988) 4 SCC 59 (SC) ...................................... 17 3. Sunil Siddharthbhai vs. CIT (1985) 4 SCC 19 (SC) ....................................................... 17 4. CIT vs. Motors and General Stores (P) Ltd (1967) 66 ITR 692 ...................................... 17 5. Mathuram Agrawal v. State of Madhya Pradesh 3 (1999) 8 SCC 667 ........................... 17 6. CIT vs. A. Raman & Co (1968) 67 ITR 11 (SC) ............................................................. 18 7. CIT vs. B.M. Kharwar (1969) 72 ITR 603 (SC) .............................................................. 18 8. CIT vs. Walfort Share and Stock Brokers Pvt. Ltd 2010 (6) Scale 471 ........................... 18 9. CIT vs. Calcutta Discount Co Ltd (1973) 91 ITR 8 (SC) ................................................. 19 10. UOI v. Azadi Bachao Andolan (2003) 263 ITR 706 (SC) ............................................. 19 11. Vodafone International Holdings vs. UOI (January 20, 2012) ...................................... 20

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UK:

IRC v. Fisher’s Executors (1926) AC 395.

Lord Sumner in this case, observed that “the highest authorities have always recognized that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so within the law, and that he may legitimately claim the advantage of any expressed terms or of any omissions that he can find in his favour in taxing Acts. In doing so, he neither comes under liability nor incurs blame.”

IRC vs. Duke of Westminster 1936 AC 1

The House of Lords laid down that paying a lesser amount of tax than what is otherwise required is not illegal, as long as the payment is in conformity with the

appropriate statute. “Every man is entitled if he can, to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow tax-payers may be of his ingenuity, he cannot be compelled to pay an increased tax. This so-called doctrine of „the substance‟ seems to me to be nothing more than an attempt to make a man pay notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable.” The ruling upheld form over substance.

Ransom vs. Higgs [1974] 3 All ER 949 (HL)

Lord Simon stated that “In some fiscal systems there is a general provision that any transaction the paramount object of which is the avoidance of tax shall be void for that purpose though valid for all other purposes. Our own fiscal system has no such provision, but rather attempts to deal with tax avoidance schemes specifically as they come to notice. The inevitable result of this and of other matters is a fiscal code of such complexity that many ordinary citizens, particularly those engaged in commerce and industry, seek the aid of experts in handling the tax affairs of themselves and the

corporations for which they have responsibility ; and, since the burden of taxation is heavy (in some circumstances punitive), and since there is generally some delay before tax avoidance schemes come to light (during which time a rich windfall may be garnered), there is a strong incentive for such experts to devote their talents to devising tax avoidance schemes for clients, actual or potential, and for such clients

to adopt the schemes devised. That is what appears to have happened in the instant cases.”

He further stated that “It may seem hard that a cunningly advised taxpayer should be able to avoid what appears to be his equitable share of the general fiscal burden and cast it on the shoulders of his fellow citizens. But for the Courts to try to stretch the law to meet hard cases (whether the hardship appears to bear on the individual taxpayer or on the general body of taxpayers as represented by the Inland Revenue) is not merely to make bad law but to run the risk of subverting the rule of law itself. Disagreeable as it may seem that some taxpayers should escape what might appear to be their fair share of the general burden of national expenditure, it would be far more disagreeable to substitute the rule of caprice for that of law.”

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Ramsay vs. IRC (1981) 1 All E.R. 865

The House of Lords ruled that the principle laid down in Duke of Westminster, must not be „overstated or overextended.‟ It was held that “If it can be seen that a document or transaction was intended to have effect as part of a nexus or series of transactions, or as an ingredient of a wider transaction intended as a whole, there is nothing in the doctrine to prevent it being so regarded: to do so is not to prefer form to substance, or substance to form. It is the task of the court to ascertain the legal nature of any transaction to which it is sought to attach a tax or a tax consequence and if that emerges from a series or combination of transactions, intended to operate as such, it is that series or

combination which may be regarded.” Thus, the House of Lords attached more importance to the „intention‟ or „substance‟ of the transaction, rather than its structure.

IRC vs. Burmah Oil Co. (1982) 54 TC 200

This case dealt with a self-cancelling series of transactions, involving reorganization of the share capital of the taxpayer‟s wholly owned subsidiary. Lord Diplock held that “It would be disingenuous to suggest, and dangerous on the part of those who advise on elaborate tax-avoidance schemes to assume, that Ramsay's case did not mark a significant change in the approach adopted by this House in its judicial role to a pre-ordained series of transaction (whether or not they include the achievement of a

legitimate commercial end) into which there are inserted steps that have no commercial purpose apart from the avoidance of a liability to tax which in the absence of those particular steps would have been payable. The difference is in approach. It does not necessitate the over-ruling of any earlier decisions of this House; but it does involve recognising that Lord Tomlin's oft-quoted dictum in IRC v Duke of Westminster 19 TC 490, [1936] AC 1 at 19, 'Every man is entitled if less than it otherwise would be', tells us little or nothing as to what methods of ordering one's affairs will be recognised by the courts as effective to lessen the tax that would attach to them if business transactions were conducted in a straightforward way.”

Furniss vs. Dawson (1984) 1 All E.R. 530

The House of Lords upheld the Ramsay principle. It was held that “When one moves from a single transaction to a series of inter-dependent transactions designed to

produce a given result, it is, in my opinion, perfectly legitimate to draw a distinction between the substance and the form of the composite transaction without in any way suggesting that any of the single transactions which make up the whole are other than genuine.”

Lord Brightman observed that “In a pre-planned tax saving scheme, no distinction is to

be drawn for fiscal purposes, because none exists in reality, between (i) a series of steps which are followed through by virtue of an arrangement which falls short of a binding contract, and (ii) a like series of steps which are followed through because the participants are contractually bound to take each step seriatim.”

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Craven vs. White (1988) 3 All. E.R. 495

It was held that “What broadly constitutes the Ramsay principle is that there is no real disposal, or no real loss (or gain) within the meaning of the statute, if the relevant step has been inserted into a preordained series of transactions or a composite transaction for no commercial purpose other than the avoidance of a liability to tax. A distinction has to be drawn between a composite transaction of that kind, and a series of independent transactions of which the first constitutes a step taken to prepare for the avoidance of tax, such avoidance being achieved by later, independent, steps. It is that latter type of scheme which is usually known as strategic tax planning, which must be

distinguished from unacceptable tax avoidance caught by the Ramsay principle.”

Ensign Tankers (Leasing) Ltd. v. Stokes (1992) 1 AC 655

In this case, a company became a partner of a limited partnership that had acquired the right to produce the film "Escape to Victory". 75% of the cost of making the film was financed by way of a non-recourse loan from the production company, the company claimed the benefit of depreciation allowances based upon the full amount of the production cost. The House of Lords disallowed the claim, but allowed depreciation calculated on 25% of the cost for which the limited partnership was at risk. House of Lords examined the transaction as a whole and concluded that the limited partnership had only 'incurred capital expenditure on the provision of machinery or plant' of 25% and no more.

Lord Goff held that “Unacceptable tax avoidance typically involves the creation of complex artificial structures by which, as though by the wave of a magic wand, the taxpayer conjures out of the air a loss, or a gain, or expenditure, or whatever it may be, which otherwise would never have existed. These structures are designed to achieve an adventitious tax benefit for the taxpayer, and in truth are no more than raids on the public funds at the expense of the general body of taxpayers, and as such are unacceptable.”

IRC vs. MCGUCKIAN (1997) BTC 346

In this case, the intention of the tax avoidance scheme was to convert the income from shares by way of dividend to a capital receipt. Lord Steyn held that “While Lord Tomlin's observations in the Duke of Westminster case [1936] A.C. 1 still point to a material

consideration, namely the general liberty of the citizen to arrange his financial affairs as he thinks fit, they have ceased to be canonical as to the consequence of a tax avoidance scheme.”

He further held that “(the Ramsay principle) was founded on a broad purposive interpretation, giving effect to the intention of Parliament. The principle enunciated in Ramsay was therefore based on an orthodox form of statutory interpretation. And in asserting the power to examine the substance of a composite transaction the House of Lords was simply rejecting formalism in fiscal matters and choosing a more realistic legal analysis. Given the reasoning underlying the new approach it is wrong to regard the decisions of the House of Lords since Ramsay as necessarily marking the limit of the law on tax avoidance schemes.”

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Lord Steyn held that the present case however, was a „classic case‟ for the application of the Ramsay principle. Based on the facts, he held that the impugned transaction was an ineffective tax avoidance scheme.

Lord Browne-Wilkinson rejected the argument that the Ramsay principle only requires the artificial steps inserted for tax purposes to be disregarded if, apart from the Ramsay principle, they would have been effective to achieve a tax advantage. He held that “The approach pioneered in Ramsay and subsequently developed in later decisions is an approach to construction, viz. that in construing tax legislation, the statutory provisions are to be applied to the substance of the transaction, disregarding artificial steps in the composite transaction or series of transactions inserted only for the purpose of seeking to obtain a tax advantage. The question is not what was the effect of the insertion of the artificial steps but what was its purpose. Having identified the artificial steps

inserted with that purpose and disregarded them, then what is left is to apply the statutory language of the taxing Act to the transaction carried through stripped of its artificial steps. It is irrelevant to consider whether or not the disregarded artificial steps would have been effective to achieve the tax saving purpose for which they were designed.”

MacNiven v. Westmoreland Investments Ltd. (2003) 1 AC 311

Lord Hoffman held that “I venture to suggest that some of the difficulty which may have been felt in reconciling the Ramsay case with the Duke of Westminster's case arises out

of an ambiguity in Lord Tomlin's statement that the courts cannot ignore „the legal position‟ and have regard to „the substance of the matter.‟ If „the legal position‟ is that the tax is imposed by reference to a legally defined concept, such as stamp duty payable on a document which constitutes a conveyance on sale, the court cannot tax a transaction which uses no such document on the ground that it achieves the same economic effect. On the other hand, if the legal position is that tax is imposed by reference to a commercial concept, then to have regard to the business ‘substance’ of the matter

is not to ignore the legal position but to give effect to it.”

He further held that “in saying that the transactions in the Ramsay case were not sham

transactions, one is accepting the juristic categorisation of the transactions as individual and discrete and saying that each of them involved no pretence. They were intended to do precisely what they purported to do. They had a legal reality. But in saying that they did not constitute a „real‟ disposal giving rise to a „real‟ loss, one is rejecting the juristic categorisation as not being necessarily determinative for the purposes of the statutory concepts of „disposal‟ and „loss‟ as properly interpreted. The contrast here is with a commercial meaning of these concepts. And in saying that the income tax legislation was intended to operate „in the real world‟, one is again referring to the commercial context which should influence the construction of the concepts used by Parliament.”

Barclays Mercantile Business Finance Ltd v. Mawson [2005] AC 685 (HL)

The House of Lords held that the Ramsay principle did not entail a general disregard of transactions or its elements that had no commercial purpose, for the purpose of

applying any taxing statute. Thus, as long as the transaction fulfilled all the statutory requirements, the appellant was entitled to the tax benefits under the statute. It was held

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that “Cases such as these (Furniss and Burmah) gave rise to a view that, in the application of any taxing statute, transactions or elements of transactions which had no commercial purpose were to be disregarded. But that is going too far. It elides the two steps which are necessary in the application of any statutory provision: first, to decide, on a purposive construction, exactly what transaction will answer to the statutory description and secondly, to decide whether the transaction in question does so.”

It was further held that “The present case, like MacNiven (supra) illustrates the need for

a close analysis of what, on a purposive construction, the statute actually requires. … If the lessee chooses to make arrangements, even as a preordained part of the transaction for the sale and lease back, which result in the bulk of the purchase price being irrevocably committed to paying the rent, that is no concern of the lessor. From his point of view, the transaction is exactly the same.”

IRC vs. Scottish Provident Institution [2004] 1 WLR 3172

The House of Lords held that “the language of a taxing statute will often have to be given a wide practical meaning … which allows (and indeed requires) the court to have

regard to the whole of a series of transactions which were intended to have a commercial unity.” It was held that if the scheme amounted in practice to a single transaction, the court should look at the scheme as a whole.

HMRC vs .Tower MCashback LLP [2011] UKSC 19

In this case, the Ramsay principle was relied upon and it was held that in the context of a complex pre-ordained transaction, the court‟s task was to test the facts, realistically viewed, against the statutory test, purposively construed. At the same time, the Court also noted that the law laid down in Barclays was „good law.‟

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USA

Gregory v. Helvering, 293 U.S. 465 (dated 1935)

In this case, the substance of the transaction was upheld over the form. Sutherland J observed as follows:

“Putting aside the question of motive in respect of taxation altogether … what do we find? Simply an operation having no business or corporate purpose-a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. No doubt, a new and valid corporation was created. But that corporation was nothing more than a contrivance to the end last described. It was brought into existence for no other purpose; it performed, as it was intended from the beginning it should perform, no other function. When that limited function had been exercised, it immediately was put to death.”

Thus, the Court held that “In these circumstances, the facts speak for themselves and are susceptible of but one interpretation. The whole undertaking, though conducted according to (the statute), was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.”

Higgins vs. Smith - 308 US 473 (dated 1940)

In this case Reed J, delivering opinion of the Court, held that “A taxpayer is free to adopt such organization for his tax affairs as he may choose and having elected to do some business as a corporation, he must accept the tax disadvantages. On the other hand, the Government may not be required to acquiesce in the taxpayer‟s election of that form for doing business which is most advantageous to him. The Government may look at actualities and upon determination that the form employed for doing business or carrying out the challenged tax event is unreal or a sham, may sustain or disregard the effect of the fiction as best serves the purpose of the tax statute.”

Gilbert vs. Commissioner – 248 F 2nd 399 (1957)

Elaborating on the „economic substance‟ doctrine, Medina CJ observed that “In many cases in which the Gregory principle [1935 decision, see above] is called into play, the question is whether a tax significant transaction has occurred … The principle is also fully applicable where there is no doubt that a very real transaction has taken place and the question is whether the characterization urged by the taxpayer accords with substance economic reality. In each case, the taxpayer must show that his treatment of the transaction does not conflict with the meaning the Congress had in mind when it formulated the section sub judice. … This principle must be observed in determining

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whether advances are properly treated as loans under the 'interest indebtedness' and 'bad debt' sections on indebtedness' and 'bad debt' sections of the Code.”

Knetsch v. United States - 364 U.S. 361 (1960)

In this case, interest payment on a loan taken by the taxpayer was disallowed, since the transaction entered into was considered sham. The taxpayer purchased several bonds and made simultaneous borrowing against them, generating high amount of interest deductions. Brennan J, delivering the opinion of the Court held that "Plainly, Knetsch's transaction with the insurance company did 'not appreciably affect his beneficial interest except to reduce his tax . . . .' [Gilbert v. Commissioner, 248 F. 2d 399, 411 (dissenting

opinion]. For it is patent that there was nothing of substance to be realized by Knetsch from this transaction beyond a tax deduction. What he was ostensibly 'lent' back was in reality only the rebate of a substantial part of the so-called 'interest' payments. ... There may well be single-premium annuity arrangements with nontax substance which create an 'indebtedness' for the purposes of § 23 (b) of the 1939 Code and § 163 (a) of the 1954 Code. But this one is a sham."

However, Douglas J, while dissenting, opined that "Tax avoidance is a dominating motive behind scores of transactions. It is plainly present here. Will the Service that calls this transaction a 'sham. today not press for collection of taxes arising out of the surrender of the annuity contract? I think it should, for I do not believe any part of the transaction was a 'sham.' To disallow the 'interest' deduction because the annuity device was devoid of commercial substance is to draw a line which will affect a host of situations not now before us and which, with all deference, I do not think we can maintain when other cases reach here. The remedy is legislative. Evils or abuses can be particularized by Congress. We deal only with 'interest' as commonly understood and as used across the board in myriad transactions. Since these transactions were real and legitimate in the insurance world and were consummated within the limits allowed by insurance policies, I would recognize them tax-wise."

Aiken Industries vs. Commissioner 56 T.C. 925 (1971)

In this case, the Tax Court was concerned with taxability of interest payments under Article 9 of the US-Honduras treaty. Upholding substance over form, the Court held as follows:

“In seeking to give substance to the terms of article IX which establish those requirements, we are free under article II, section (2), of the convention, to assign to those terms „not otherwise defined‟ by the convention the meanings which would normally attach to such terms under our laws „unless the context otherwise requires.‟ In so doing, we recognize that the fact that the actions taken by the parties in this case were taken to minimize their tax burden may not by itself be utilized to deny a benefit to which the parties are otherwise entitled under the convention.”

“we find that the interest payments in question were not „received by‟ a corporation of a contracting State (herein a Honduran corporation) within the meaning of article IX of the convention. As utilized in the context of article IX, we interpret the terms „received by‟ to mean interest received by a corporation of either of the contracting States as its own and

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not with the obligation to transmit it to another. The words „received by‟ refer not merely to the obtaining of physical possession on a temporary basis of funds representing interest payments from a corporation of a contracting State, but contemplate complete dominion and control over the funds.

The convention requires more than a mere exchange of paper between related corporations to come within the protection of the exemption from taxation granted by article IX of the convention, and on the record as a whole, the petitioner has failed to demonstrate that a substantive indebtedness existed between a United States corporation and a Honduran corporation.”

“In effect, Industrias, while a valid Honduran corporation, was a collection agent with respect to the interest it received from MPI. Industrias was merely a conduit for the passage of interest payments from MPI to ECL, and it cannot be said to have

received the interest as its own. Industrias had no actual beneficial interest in the interest payments it received, and in substance, MPI was paying the interest to ECL which „received‟ the interest within the meaning of article IX. Consequently, the interest in question must be viewed as having been „received by‟ an entity (ECL) which was not a „corporation or other entity‟ of one of the contracting States involved herein, and we therefore hold that the interest in question was not exempt from taxation by the United States under article IX of the convention.”

NIPSCO vs. Commissioner 115 F.3d 506, 512 (7th Cir. 1997)

In this case, the Court deviated from the decision in Aiken‟s case. Here, the Court was concerned with the taxability of interest payments under the US-Netherlands DTAA. The Court held that the subsidiary of the US company in Netherlands, to whom interest was paid, was not a mere conduit. Bauer J made the following observations:

“it is inappropriate for us to sever a corporation from its transactions in analyzing a case, such as this one, where the corporation was formed with the intent of structuring its economic transactions to take advantage of laws that afford tax savings.”

“From Gregory and Aiken Industries, we glean the following: Transactions involving a foreign corporation are to be disregarded for lack of meaningful economic activity if the corporation is merely transitory, engaging in absolutely no business activity for profit--in other words, it is a „mere skeleton.‟ Transactions will also be disregarded if the foreign corporation lacks dominion and control over the interest payments it collects.”

“In this case, Finance (the Netherlands subsidiary) was set up to obtain capital at the lowest possible interest rates. Accessing the Eurobond market through a Netherlands Antilles subsidiary was not, at the time, an uncommon practice to accomplish this end. The record demonstrates that Finance was managed as a viable concern, and not as simply a lifeless facade. Finance conducted recognizable business activity--concededly minimal activity, but business activity nonetheless. Significantly, Finance derived a profit.”

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Canada

Stubart Investments Ltd vs. the Queen (1984) CTC 294 (SCC)

The Court in this case held that a liberal business purpose test would be more in conformity with the legislative intent, since the taxing statute is a mix of economic and fiscal policies. It is important to note that the Canadian GAAR was enacted after the pronouncement of this decision.

“A court must apply a taxing statute so as to bar the claim of entitlement to an allowance, deduction or other advantage or benefit where the taxpayer created entities or rights and obligations in order to revise the character, under the statute, of the income or earnings already achieved by the taxpayer. The claim would not necessarily be barred, however, where the new alignment of the taxpayer's affairs is adopted only to reduce or avoid taxation of earnings or income thereafter arising independently from the establishment of the arrangements in question.”

“I would reject the proposition that a transaction may be disregarded for tax purposes solely on the basis that it was entered into by a taxpayer without an independent or bona fide business purpose. A strict business purpose test in certain circumstances would run

counter to the apparent legislative intent which, in the modern taxing statutes, may have a dual aspect. Income tax legislation, such as the federal Act in our country, is no longer a simple device to raise revenue to meet the cost of governing the community. Income taxation is also employed by government to attain selected economic policy objectives. Thus, the statute is a mix of fiscal and economic policy. The economic policy element of the Act sometimes takes the form of an inducement to the taxpayer to undertake or redirect a specific activity.”

“Indeed, where Parliament is successful and a taxpayer is induced to act in a certain manner by virtue of incentives prescribed in the legislation, it is at least arguable that the taxpayer was attracted to these incentives for the valid business purpose of reducing his cash outlay for taxes to conserve his resources for other business activities. It seems more appropriate to turn to an interpretation test which would provide a means of applying the Act so as to affect only the conduct of a taxpayer which has the designed effect of defeating the expressed intention of Parliament. In short, the tax statute, by this interpretative technique, is extended to reach conduct of the taxpayer which clearly falls within „the object and spirit‟ of the taxing provisions. Such an approach would promote rather than interfere with the administration of the Income Tax Act, in both its aspects

without interference with the granting and withdrawal, according to the economic climate, of tax incentives. The desired objective is a simple rule which will provide uniformity of application of the Act across the community, and at the same time, reduce the attraction of elaborate and intricate tax avoidance plans, and reduce the rewards to those best able to afford the services of the tax technicians.”

Crown Forest Industries Ltd. v. Canada, [1995] 2 S.C.R. 802

The judgment of the Court was delivered by Iacobucci J, who made the following observations:

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“The goal of the US-Canada DTAA is not to permit companies incorporated in a third party country (the Bahamas) to benefit from a reduced tax liability on source income merely by virtue of dealing with a Canadian company through an office situated in the United States.”

“It seems to me that both Norsk and the respondent are seeking to minimize their tax liability by picking and choosing the international tax regimes most immediately beneficial to them. Although there is nothing improper with such behaviour, I certainly believe that it is not to be encouraged or promoted by judicial interpretation of existing agreements.

Nor do I believe it to have been within the intentions of the drafters of the Convention to permit a corporation (such as Norsk) who is liable for tax on a limited amount that is "sourced" to one of the contracting states -- in this case only on income that is effectively connected to the United States -- to avail itself of the benefits of the Convention even in respect of income which is not so connected and in respect of which the U.S. has no interest.”

“„Treaty shopping‟ … in which enterprises could route their income through particular states in order to avail themselves of benefits that were designed to be given only to residents of the contracting states … would be patently contrary to the basis on which Canada ceded its jurisdiction to tax as the source country, namely that the U.S. as the resident country would tax the income.”

Prevost Car Inc vs. The Queen (2008 TCC 231)

Prévost, a Canadian corporation declared and paid dividends to its shareholder, Prévost Holding B.V. ("PHB.V."), in the Netherlands. Considering the definition of „beneficial owner‟ as given in the Canada-Netherlands DTAA, the revenue contended that the beneficial owner of the dividends was not PH B.V. itself, but its two corporate shareholders, who were resident of the United Kingdom and Sweden. Hence, treaty benefits could not be extended the parties.

The Federal Court of Appeal, Canada, ruled in favor of the taxpayer, holding that PH B.V. was not a conduit for its shareholders. There was no evidence to support that the dividends from Prévost were intended for the shareholders, with PHB.V. as a funnel of flowing dividends from Prévost. The Court held that a holding company is the beneficial owner of dividend paid to it unless there is strong evidence of tax avoidance or treaty abuse.

The Court relied on the definition of „beneficial owner‟ as given in the OECD Model Tax Convention, while elaborating on the concept in detail.

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France:

Bank of Scotland, (2006) 9 ITLR 683

In this case, the French Conseil d‟Etat observed that an American company, which had a French subsidiary, entered into an arrangement with Bank of Scotland (a UK resident), in order to obtain an advantage under Article 9 of the France-UK DTAA. As per this provision, there was a reduced rate of withholding tax on dividend payable by a French entity to a UK entity, which was not available under the France-US DTAA.

The Conseil d-Etat ruled that since the beneficial owner of dividend was actually the American company, the UK resident was not eligible for treaty benefit. It held that the sole purpose of the transaction was to obtain a tax benefit under the France-UK DTAA, which was otherwise not available to the American company.

Schneider Electric (dated 28th June, 2002)

In this case, the Conseil d‟Etat found the French CFC regulations (prior to 2005 amendment) to be incompatible with the France-Switzerland DTAA. A French company (Schneider Electric) had a CFC in Switzerland. The French revenue authorities sought to tax the profits of the CFC. The Conseil ruled that the CFC was a Permanent Establishment as per Article 7 and hence, the profits could be taxed only in the State in which they had arisen i.e. Switzerland.

The French CFC regulations underwent a major change after this decision, in order to make them more compatible with French DTAAs. The result is that now profits of overseas subsidiaries are taxed as „deemed dividend‟ to the parent company in France.

Bank of Polska (dated 31st January 2001)

As per the translation of the judgment, the Conseil d‟Etat held that “…the Administrative Court of Appeal of Paris erred in law in holding that the SA Bank Polska Kasa Opieki (BPKO), which is based in Poland, was in principle liable to the withholding tax on the profits made by the branch established in Paris during the years ended 1982 to 1989”

“Article 7 of the French-Polish DTAA will not apply to income in the nature of deemed profit distributions made by a foreign company, whose intended beneficiaries are partners not domiciled in France … it is established that the only member of the SA Bank Polska Kasa Opieki is a resident of Poland … as a result, deemed distribution of income under Article 115 of the General Code of Taxes, received by the Polish company shall not … be taxed in France.”

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India

McDowell v. Commercial Tax Officer (1985) 154 ITR 146 (SC) / [TS-1-SC-1985]

The appellant was a manufacturer-dealer of liquor. The tax officer claimed that the appellant had failed to include excise duty payable on the liquor, sold to its wholesalers. The appellant claimed that it was paid directly to the excise authorities by the buyers of the liquor. Ruling in favor of the revenue, the Court held that “payment of excise duty is the primary and exclusive obligation of the manufacturer and if payment be made under a contract or arrangement by any other person it would amount to meeting of the obligation of the manufacturer and nothing more.” It was also held that if a transaction is structured in such a way that its sole purpose is to avoid tax, the same would be disregarded for determining tax liability. Justice Ranganath Mishra, particularly held as follows: “Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.” Justice Chinappa Reddy, giving a detailed opinion on tax avoidance, observed as follows: “(while relying on the decision given in Furniss v. Dawson), the ghost of Westminster (in the words of Lord Roskill) has been exercised in England.” “We think that time has come for us to depart from the Westminster principle as emphatically as the British Courts have done and to dissociate ourselves from the observations of Shah, J. and similar observations made elsewhere. The evil consequences of tax avoidance are manifold. First there is substantial loss of much needed public revenue, particularly in a welfare state like ours. Next there is the serious disturbance caused to the economy of the country by the piling up of mountains of black money, directly causing inflation. … Last but not the least is the ethics (to be precise, the lack of it) of transferring the burden of tax liability to the shoulders of the guideless, good citizens from those of the 'artful dodgers'. … We must recognise that there is behind taxation laws as much moral sanction as behind any other welfare legislation and it is a pretence to say that avoidance of taxation is not unethical and that it stands on no less moral plane than honest payment of taxation. In our view, the proper way to construe a taxing statute, while considering a device to avoid tax, is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it.”

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State of UP vs Renusagar Power & Co (1988) 4 SCC 59 (SC) / [TS-2-SC-1988]

This case dealt with lifting of the corporate veil. It was held that “it is high time to reiterate that in the expanding of horizons of modern jurisprudence, the lifting of the corporate veil is permissible. This must however, depend primarily on the realities of the situation.” “The person generating and consuming energy were the same and the corporate veil should be lifted. In the facts of this case Hindalco and Renusagar were inextricably linked up together. Renusagar had in reality no separate and independent existence apart from and independent of Hindalco. … We are, therefore, of the opinion that in the facts of this case the corporate veil must be lifted and Hindalco and Renusagar should be treated as one concern and if that is taken the consumption of energy by Hindalco must be regarded as consumption by Hindalco from its own source of generation.”

Sunil Siddharthbhai vs. CIT (1985) 4 SCC 19 (SC) The Court held that “If the transfer of the personal asset by the assessee to a partnership in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income-tax on a capital gain, it will be open to the income-tax authorities to go behind the transaction and examine whether the transaction of creating the partnership is a genuine or a sham transaction and, even where the partnership is genuine, the transaction of transferring the personal asset to the partnership firm represents a real attempt to contribute to the share capital of the partnership firm for the purpose of carrying on the partnership business or is nothing but a device or ruse to convert the personal asset into money substantially for the benefit of the assessee while evading tax on a capital gain. … other pertinent considerations may be taken into regard when the ITO enters upon a scrutiny of the transaction, for in the task of determining whether a transaction is a sham or illusory transaction or a device or ruse he is entitled to penetrate the veil covering it and ascertain the truth.”

CIT vs. Motors and General Stores (P) Ltd (1967) 66 ITR 692 / [TS-1-SC-1967] In this case, SC held that “in the absence of any suggestion of bad faith or fraud, the true principle is that the taxing statute has to be applied in accordance with the legal rights of the parties to the transaction.” SC held that when the transaction is embodied in a document between parties, the liability to tax depends upon the meaning of the language used in accordance with the ordinary rules of construction.

Mathuram Agrawal v. State of Madhya Pradesh 3 (1999) 8 SCC 667 “The intention of the Legislature in a taxation statute is to be gathered from the language of the provisions particularly where the language is plain and unambiguous. In a taxing Act it is not possible to assume any intention or governing purpose of the statute more than what is stated in the plain language. It is not the economic results sought to be obtained by making the provision which is relevant in interpreting a fiscal statute. Equally impermissible is an interpretation which does not follow from the plain, unambiguous

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language of the statute. Words cannot be added to or substituted so as to give a meaning to the statute which will serve the spirit and intention of the Legislature.”

CIT vs. A. Raman & Co (1968) 67 ITR 11 (SC)

In this case, Shah, J speaking for himself and Sikri and Ramaswami, JJ heavily relied on Westminster‟s case and held as follows: “The plea raised by the Income-tax Officer is that income which could have been earned by the assessees was not earned, and a part of that income was earned by the Hindu undivided families. That according to the Income-tax Officer was brought about by 'a subterfuge or contrivance'. Counsel for the Commissioner contended that if by resorting to a 'device or contrivance', income which would normally have been earned by the assessee is divided between the assessee and another person, the Income-tax Officer would be entitled to bring the entire income to tax as if it had been earned by him. But the law does not oblige a trader to make the maximum profit that he can out of his trading transactions. Income which accrues to a trader is taxable in his hands : income which he could have, but has not earned, is not made taxable as income accrued to him. By adopting a device, if it is made to appear that income which belonged to the assessee had been earned by some other person, that income may be brought to tax in the hands of the assessee, and if the income has escaped tax in a previous assessment a case for commencing a proceeding for reassessment under section 147(b) may be

made out. Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. A taxpayer may resort to a device to divert the income before it accrues or arises to him. Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income-tax Act. Legislative injunction in taxing statutes may not, except on peril of penalty, be violated, but it may lawfully be circumvented.”

CIT vs. B.M. Kharwar (1969) 72 ITR 603 (SC) / [TS-1-SC-1968] The Supreme Court held that “it was now well settled that the taxing authorities are not entitled in determining whether a receipt is liable to be taxed to ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as “the substance of the matter”. The Supreme Court observed that while the authorities are bound to determine the true legal relations resulting from a transaction, yet if the parties have chosen to conceal a legal relationship by a device, it would be open to them to unravel the device and determine the true character of the relationship. However, the Supreme Court noted that “the legal effect of a transaction cannot be displaced by probing into the substance of the transaction”.

CIT vs. Walfort Share and Stock Brokers Pvt. Ltd 2010 (6) Scale 471

While construing the provisions of Section 14A and Section 94(7) of the Income Tax Act 1961 CJI Kapadia, observed as follows: “At the outset, we may state that we have two sets of cases before us. The lead matter covers assessment years before insertion of Section 94(7) vide Finance Act, 2001 w.e.f.

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1.4.2002. With regard to such cases we may state that on facts it is established that there was a „sale‟. The sale price was received by the assessee. That, the assessee did receive dividend. The fact that the dividend received was tax-free is the position recognized under Section 10(33) of the Act. The assessee had made use of the said provision of the Act. That such use cannot be called „abuse of law‟. Even assuming that the transaction was preplanned there is nothing to impeach the genuineness of the transaction. With regard to the ruling in McDowell & Co. Ltd. v. Commercial Tax Officer [154 ITR 148(S)], it may be stated that in the later decision of this Court in Union of India v. Azadi Bachao Andolan [263 ITR 706 (SC)] it has been held that a citizen is free to carry on its business within the four corners of the law. That, mere tax planning, without any motive to evade taxes through colourable devices is not frowned upon even by the judgment of this Court in McDowell & Co. Ltd.‟s case (supra).”

CIT vs. Calcutta Discount Co Ltd (1973) 91 ITR 8 (SC)

Relying on CIT vs. A. Raman‟s case, the Court held that “It is a well accepted principle of law that an assessee can so arrange his affairs as to minimise his tax burden. Hence, if the assessee in this case has arranged its affairs in such a manner as to reduce its tax liability by starting a subsidiary company and transferring its shares to that subsidiary company and thus forgoing part of its own profits and at the same time enabling its subsidiary to earn some profits, such a course is not impermissible under law.”

UOI v. Azadi Bachao Andolan (2003) 263 ITR 706 (SC) / [TS-5-SC-2003] The issue in this case was regarding the validity of CBDT Circular No. 786, providing that a tax residency certificate issued by Mauritian authorities was sufficient proof for an entity to avail benefits under the Indo-Mauritius DTAA. The Supreme Court upheld the validity of the circular. SC further that though the words „sham‟ and „device‟ were loosely used in connection with incorporation under Mauritius Law, these words could not be used to nullify a legal situation. The Tax Residency Certificate issued by the Mauritian authorities was to be taken as a conclusive proof of residency of the entity and of its beneficial ownership for availing benefits of the DTAA. Under the garb of „sham‟ or „device,‟ permission to lift corporate veil could not be sought. Srikrishna J made a significant observation in respect of the views expressed in McDowell‟s case as follows: “With respect, we are unable to agree with the view that the Duke of Westminster is dead, or that its ghost has been exorcized in England. The House of Lords does not seem to think so, and we agree, with respect. In our view, the principle of Duke of Westminster is very much alive and kicking in the country of its birth. And as far as this country is concerned, the observations of Shah J in CIT v. Raman are very much relevant today.”

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Vodafone International Holdings vs. UOI (January 20, 2012) - [TS-23-SC-2012]

Chief Justice Kapadia held that “Ramsay did not discard Westminster but read it in the proper context by which „device‟ which was colourable in nature had to be ignored as fiscal nullity. Thus, Ramsay lays down the principle of statutory interpretation rather than an over-arching anti-avoidance doctrine imposed upon tax laws.” While ruling that Azadi and McDowell are not in conflict with each other, he further held that “The majority judgment in McDowell held that „tax planning may be legitimate provided it is within the framework of law‟ (para 45). In the latter part of para 45, it held that „colourable device cannot be a part of tax planning and it is wrong to encourage the belief that it is honourable to avoid payment of tax by resorting to dubious methods.‟ It is the obligation of every citizen to pay the taxes without resorting to subterfuges. The above observations should be read with para 46 where the majority holds „on this aspect one of us, Chinnappa Reddy, J. has proposed a separate opinion with which we agree.‟ The words „this aspect‟ express the majority‟s agreement with the judgment of Reddy, J. only in relation to tax evasion through the use of colourable devices and by resorting to dubious methods and subterfuges. Thus, it cannot be said that all tax planning is illegal/illegitimate/impermissible. Moreover, Reddy, J. himself says that he agrees with the majority … In our view, although Chinnappa Reddy, J. makes a number of observations regarding the need to depart from the ‘Westminster’ and tax avoidance – these are clearly only in the context of artificial and colourable devices. Reading McDowell, in the manner indicated hereinabove, in cases of treaty shopping and/or tax avoidance, there is no conflict between McDowell and Azadi Bachao or between McDowell and Mathuram Agrawal.” Justice Kapadia, while elaborating on the international aspects of holding structures, observed that “the fact that a parent company exercises shareholder‟s influence on its subsidiaries does not generally imply that the subsidiaries are to be deemed residents of the State in which the parent company resides. … whether a transaction is used principally as a colourable device for the distribution of earnings, profits and gains, is determined by a review of all the facts and circumstances surrounding the transaction.” He further held that “Holding Structures are recognized in corporate as well as tax laws. Special Purpose Vehicles (SPVs) and Holding Companies have a place in legal structures in India, be it in company law, takeover code under SEBI or even under the income tax law. When it comes to taxation of a Holding Structure, at the threshold, the burden is on the Revenue to allege and establish abuse, in the sense of tax avoidance in the creation and/or use of such structure(s). In the application of a judicial anti-avoidance rule, the Revenue may invoke the ‘substance over form’ principle or ‘piercing the corporate veil’ test only after it is able to establish on the basis of the facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidant. … where the Revenue finds that in a Holding Structure an entity which has no commercial/business substance has been interposed only to avoid tax then in such cases applying the test of fiscal nullity it would be open to the Revenue to discard such inter-positioning of that entity. However, this has to be done at the threshold.”

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“In this connection, we may reiterate the ‘look at’ principle enunciated in Ramsay

(supra) in which it was held that the Revenue or the Court must look at a document or a transaction in a context to which it properly belongs to. It is the task of the Revenue/Court to ascertain the legal nature of the transaction and while doing so it has to look at the entire transaction as a whole and not to adopt a dissecting approach. The Revenue cannot start with the question as to whether the impugned transaction is a tax deferment/saving device but that it should apply the „look at‟ test to ascertain its true legal nature [See Craven v. White (supra) which further observed that genuine strategic tax planning has not been abandoned by any decision of the English Courts till date].”

Applying the above tests, Justice Kapadia held that “every strategic foreign direct investment coming to India, as an investment destination, should be seen in a holistic manner. While doing so, the Revenue/Courts should keep in mind the following factors: the concept of participation in investment, the duration of time during which the Holding Structure exists; the period of business operations in India; the generation of taxable revenues in India; the timing of the exit; the continuity of business on such exit. In short, the onus will be on the Revenue to identify the scheme and its dominant purpose.

The corporate business purpose of a transaction is evidence of the fact that the impugned transaction is not undertaken as a colourable or artificial device. The stronger the evidence of a device, the stronger the corporate business purpose must exist to overcome the evidence of a device.” ---