GAAR accounting and its Scope to combat tax evasion

Ruchi Gandhi

21 Mar, 2022

The provisions for General Anti-Avoidance Rules (‘GAAR’) were added to the Income Tax Act of 1961 (‘Act’) on April 1, 2017, by way of introduction of Chapter-XA. According to the General Anti-Avoidance Rule requirements, a taxpayer’s arrangement may be considered to be an Impermissible Avoidance Arrangement (or ‘IAA’) and the tax consequences in relation to it may be assessed in accordance with the regulations.

GAAR has been viewed as a strategy to combat tax evasion and aggressive tax planning, particularly transactions or business arrangements that are executed with the intent to avoid paying taxes. Because of the implementation of General Anti-Avoidance Rule in India, firms have had to examine and revalidate their transactions in this fast-changing environment.

What is GAAR?

GAAR, as the name implies, is a collection of rules under the Income Tax Act of 1961 that allows revenue authorities to refuse transactions or arrangements of tax benefits that have no business substance or consideration other than obtaining the tax benefits. General Anti-Avoidance Rule is a collection of regulations designed to prevent tax evasion. The provisions of General Anti-Avoidance Rule are included in Chapter X-A of the Income Tax Act, Sections 95 to 102. The processes for using General Anti-Avoidance Rule and the situations under which it does not apply are outlined in Rules 10U to 10UC of the Income-tax Rules, 1962.

Section 102(1) of this chapter defines an arrangement as “any step in, or a portion or whole of, any transaction, activity, scheme, agreement, or understanding, whether enforced or not,” and involves the alienation of any property in that particular transaction, activity, plan, agreement, or understanding.

The enabling provision is found in Section 95 of the Act. The chapter begins with a notwithstanding clause and thereby supersedes all other sections of the Act. According to the requirements of Section 95 of the Act, General Anti-Avoidance Rule shall be applied to the assessee who enters into an agreement or arrangement that is regarded as an Impermissible Avoidance Arrangement under Section 96 of the Act. Furthermore, the tax evaded by engaging in such a transaction may be evaluated in line with the provisions of Chapter X-A of the Act.

Meaning of Impermissible Avoidance Arrangement

An Impermissible Avoidance Arrangement (or “IAA”), as defined in Section 96 of the Income Tax Act^[1], is an arrangement whose primary objective is to secure a tax benefit. In addition, it does the following:

• Creates rights or obligations that are not generally formed between individuals or entities dealing at arm’s length.
• It contributes to the misuse or abuse of the lawful provisions, either directly or indirectly.
• There is a lack of commercial substance partly or wholly.
• The arrangement has been entered into or carried out by methods or in a way that is not typically used for legitimate purposes.

Absence of Commercial Substance

When it is predicted that a business transaction would impact cash flows and it is established whether future cash flows of a firm will alter as a result of the transaction, it is said to have commercial substance. In general, there is always a lack of commercial substance in tax avoidance transactions since they have nothing to do with the entity’s fluctuating cash flows.

Section 97 of the Act addresses the following transactions that may be found to be lacking a commercial substance:

• If the arrangement’s overall content or impact is inconsistent with or different from, the form of its component phases.
• If the transaction involves round trip financing, an accommodating party, aspects that have the impact of offsetting or cancelling each other, or a transaction that is performed through one or more participants and conceals the value, location, origin, ownership, or control of funds that is the subject matter of such transaction, it may be deemed to lack commercial substance.

Round-trip financing refers to a kind of financing in which the money is transmitted among the parties to the agreement and the transfer of such money results in a tax benefit.

In this context, an Accommodating Party is a party to an arrangement whose primary reason for direct or indirect involvement in the arrangement, in whole or in part, is to get a tax advantage, directly or indirectly.

Non-applicability

The GAAR clause does not apply in the following circumstances:

• An agreement in which the total tax advantage accruing to all participants to the arrangement in the relevant assessment year does not exceed Rs. 3 crore (INR 30 million).
• It also does not apply to Foreign Institutional Investors (“FII”) who are the assessees under the Act, have not benefited from Double Tax Avoidance Agreements, and have invested in listed or unlisted stocks.
• A non-resident with respect to an investment in a Foreign Institutional Investor made through offshore derivative instruments or otherwise, directly or indirectly.
• Any income that is accruing or arising to, or is deemed to accrue or arise to, or where it is received or deemed to be received by, any person/entity as a result of a transfer of investments made by such person prior to April 1st, 2017.

Regarding restriction, it is specified that, without prejudice to the above points, the General Anti-Avoidance Rule rules shall apply to any arrangement or agreement, regardless of the date on which it was entered into, in respect of the tax advantage gained from the arrangement on or after 1 April 2017.

Effects of GAAR

When a portion of an arrangement or agreement is judged to be an unlawful avoidance arrangement under the Income Tax Act, the tax consequences are evaluated exclusively with reference to that portion. The following are the implications:

• Rejection of a tax benefit (under treaty or the Act)
• Disregarding or combining or re-characterizing any stage in the arrangement, or a portion of or the entire arrangement
• Treating the agreement as if it had never been made or carried out
• Ignoring any accommodating party or treating any accommodating party and any other party as though they were the same person
• Considering related people to be one and the same
• Reallocating of any income, cost, deduction, relief, and rebate among the arrangement’s parties
• Re-assigning of the asset’s or transaction’s residence/location (to other than what has been given under the arrangement)
• Disregarding the provided corporate structure
• Re-characterization of equity-debt allocation, capital receipt-revenue receipt allocation, and any expenses, deduction, relief, or rebate.
• Other consequences, not limited to the above

Procedures

The detailed methodology for invoking GAAR is as follows:

• If the Assessing Officer (or “AO”), who is usually an officer with the position of Income Tax Officer, Assist. Commissioner of Income Tax, Deputy Commissioner of Income Tax, or Additional Commissioner of Income Tax, believes that it is essential to initiate General Anti-Avoidance Rule at any stage of the assessment or reassessment before him, based on the material and evidence available, he may make a referral to the Commissioner of Income Tax (“CIT”).
• If the CIT believes that the GAAR provisions must be triggered, he must provide a notice to the assessee outlining the reasons and justification for his opinion, as well as a deadline for submitting objections, if any, and providing the assessee with an opportunity to be heard within 60 days.
• If the assessee does not oppose the relevant notice, the CIT shall make such instructions as he thinks appropriate in relation to the declaration of the arrangement to be an IAA.
• If the assessee objects to the planned action and the CIT is satisfied, after hearing the assessee, that the General Anti-Avoidance Rule provisions are not to be enforced, he should convey the same to the Assessing Officer in writing, with a copy to the assessee.
• If, after hearing the assessee, the CIT is not satisfied with the assessee’s explanation, he shall refer the case to the Approving Panel (A Panel comprising of three members, one of whom is or has been a renowned judge of a High Court, one of whom is a member of the Indian Revenue Service not lower than the rank of Chief Comm. of Income Tax, and one member of whom is an academic or scholar holding some specific knowledge of matters such as direct taxes, business taxes, and so on). The reference will be made for the purpose of the declaration of the concerned arrangement as an IAA.
• On receipt of a reference from the CIT, and after providing the assessee and the concerned AO an opportunity to be heard, the Approving Panel will be issuing such directions as it deems fit in relation to the declaration of the arrangement as an IAA, including the detailed specification of the previous year or years to which such declaration of an arrangement as an IAA will be applicable.
• The Approving Panel must offer directives within six months after the end of the month in which the CIT’s reference was received.
• If any tax implications have been decided in the order under the requirements of Chapter X-A, the relevant AO may not make an order of assessment or reassessment without the prior permission of the CIT.
• The assessee, the CIT, and the income-tax officials subordinate to him are bound by the orders provided by the Approving Panel.

It is anticipated that General Anti-Avoidance Rule would provide the tax administration with far too many discretionary powers in the name of combating tax evasion. Because it grants the tax authorities unrestricted authority to investigate any transactions or arrangements, it may lead to a rise in tax litigation. Because the relevant burden of proof is on the assessee to demonstrate that the purpose of engaging in a transaction or arrangement is not to achieve a tax benefit, the assessee must maintain adequate business reasoning and document the evidence to prevent such circumstances.

Conclusion

The General Anti-Avoidance Rule (i.e., GAAR) is a concept that typically authorizes a country’s Revenue Authority to reject tax benefits to transactions or arrangements that have no business substance and the only objective of such a transaction is to get the tax benefit. The necessity for the enactment of General Anti-Avoidance Rule is typically supported by a rising issue that the integrity & correctness of the tax regime has to be reinforced.

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