In recent times, the term “GAAR” has been in news a lot, many experts have blamed the recent flight of funds from India by FIIs & FDIs on the same, when the finance minister of India proposed the retrospective applicability of GAAR in his budget speech for the year 2012-13 on March 16, 2012 . GAAR was a part of the proposed Direct Tax Code Bill, but the date of applicability was advanced to April 01, 2012, that too with retrospective effect. The trigger point for the same being the famous Vodafone case.
GAAR stands for General Anti Avoidance Rules, for understanding the meaning of GAAR, first we have to know the meaning of Tax Avoidance. Tax Avoidance is nothing but an attempt to reduce tax liability through legal means, i.e. to regulate your affairs in such a way that you pay the minimum tax imposed by the Act as opposed to the maximum. Anti Avoidance rules can be classified into following:‒
Measures based on general principles in the law
- This refers to principles which are not codified in the legislation (non-statutory)
- They include a range of philosophies and approaches including “substance over form” and
“abuse of law”
General Anti Avoidance rules
- It has same meaning as “anti avoidance rules based on general principles in law” except that it is codified and included in the legislation
Specific Anti Avoidance rules
- These are the specific anti-avoidance rules which applies to the specific situations- CFC, Thin Capitalization rules, Exit Tax etc.
As per the proposed General anti avoidance provisions in India:
The Commissioner of Income tax is empowered to declare an agreement as an impermissible avoidance agreement (IAA) if:
- The whole, a step or a part of the arrangement has been entered with the objective of obtaining tax benefit, and
- The arrangement creates rights and obligations not normally created in arm’s length transactions, or
- Results in direct or indirect misuse or abuse of the provisions of the Direct Tax Code or
- Lacks commercial substance in whole or part, or is not bonafide.
Once an agreement is declared as an impermissible avoidance agreement (IAA):
- the whole or part of the impermissible avoidance agreement can be disregarded.
- The related or connected or accommodating parties can be considered as one and the same person.
- Any accruals, receipts, expense, deductions, rebates etc both revenue and capital can be reallocated amongst the parties.
- Equity can be reclassified as debt or vice versa.
The impact of GAAR in India on different entities can be summed up as follows:
Foreign investors with a holding company in a tax-friendly country are concerned how the Indian tax department will define commercial presence. Normally, if the holding company is doing business in the country of incorporation, has a board of directors that meets in that country and has a predefined threshold turnover, it would satisfy conditions of commercial presence. Mauritius has in recent years become more transparent. It remains to be seen if that is enough to satisfy Indian authorities.
Indian companies expanding overseas too have reasons to be worried. Most set up a holding company outside India and will have many offshoots. A holding company overseas may also enable easier access to cheap overseas borrowings. Subsidiary operating companies may pay dividends to the holding company, which it may not transfer to the Indian parent, as that money could be ploughed into other overseas activities. Under GAAR, tax authorities could rule that the Indian parent did not bring the dividend to India to avoid paying taxes.
GAAR can prove tricky for domestic companies too, and many of their transactions, done in the normal course of business, can be questioned and tax benefit disallowed. Take for instance the merger of a loss-making company into a profit-making one. On merger, losses would offset profits and the lower net profit, if any, would mean substantially lower tax liability for the company.
The merger may have been driven by pure commercial considerations, better integration of operations or to ensure the loss-making company does not shut down, but tax department can claim it was a tactic to avoid taxes.
In another situation, a company can choose between leasing an asset and purchasing the same. On a leased asset, it can claim deduction on lease rental while on an asset that was bought, it can claim depreciation. Disputes can arise on leasing versus buying.
Likewise, a company can be asked why it raised funds through borrowing when it could have issued equity. On borrowings, a company can claim deduction on interest paid. Both decisions depend on what is more beneficial for the company. There could be cases of the large corporate groups creating a service company to manage all its non-core activities. The service company would then charge each company for the services rendered on a cost plus basis. The tax department could dispute the mark-up in the cost of services and claim it was an instance of shifting profit from one company to another.
This is a grey area. Given the tax avoidance rules are general, tax experts say individuals too would be covered. The finance ministry says the government does not intend to go after the salaried. But company leased cars, a perk senior executives enjoy, can be challenged as a tax avoidance measure. This is because the value of the lease would be far higher than the value used for calculating tax.
After a hue and cry was raised against the retrospective applicability of GAAR, the Finance minister deferred the applicability of GAAR to April 01, 2013. In addition to this, he has announced the formation of a panel for implementation of GAAR and to have a relook on the provisions of GAAR. He also announced that the burden of proving tax evasion will lie with the authorities rather than with overseas investors as opposed to earlier stance of burden of proving non evasion of tax lying with the investor.