GENERAL ANTI-AVOIDANCE RULE: INDIA & INTERNATIONAL PERSPECTIVES

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1 GENERAL ANTI-AVOIDANCE RULE: INDIA & INTERNATIONAL PERSPECTIVES **Sumit Lalchandani & Vikram Shah I. Introduction General Anti Avoidance Rule (GAAR) refers to Anti-Tax planning rules. A GAAR typically comprises a set of broad rules based on general principles to counter potential avoidance of the tax in general, in a form which cannot be predicted and provided for at the time when the law is introduced. 1 A country needs GAAR provisions to curb sophisticated tax planning. In other words GAAR may be defined as a concept under which a transaction whose primary purpose is to avoid tax can be invalidated if the concerned authorities are of the opinion that the object and purpose of applicable tax laws would be violated. 2 GAAR will apply in the transactions which are not normally undertaken and give a tax benefit. If GAAR applies, the consequence is that the form of the transactions will be ignored. The intent and substance of the transactions will be considered for tax. Tax benefit will be denied for the form of the transaction. It is the principle of Substance over form. Countries that have anti-avoidance rules broadly similar in form to New Zealand s and Germany s include Canada, 3 South Africa, 4 Hong Kong, 5 and France 6. The rule in Australia was formerly similar, 7 but since 1981 it has been framed in much more detail. 8 1 Removing the Fences: Looking through GAAR, February 2012, PWC. 2 GautamAhuja, Forget Tax Planning-Get Ready for GAAR in Direct Tax Code 2010, ITAT, available at < accessed on August 12, Income Tax Act, R.S.C. 1985, c. 1, s. 245 (Can.). 4 Income Tax Act 58 of (S. Afr.). 5 Inland Revenue Ordinance, (1947) Cap. 112, 61 (H.K.). 6 Code De Procédure Fiscal [C.L.P.F.] art.l64 (Fr.). 7 Income Tax Assessment Act 1936 (Cth) s 260 (Austl.). 8 W.T. Ramsay Ltd. v. Inland Revenue Comm rs, [1982] A.C. 300, (H.L.). 502

2 GAAR: Indian context While introducing the provisions of General Anti Avoidance Rule (GAAR) in the Income-tax Act, it was mentioned in the Explanatory Memorandum to the Finance Bill, 2012 that the question of substance over form has consistently arisen in the implementation of taxation laws. In the Indian context, judicial decisions have varied. While some courts in certain circumstances had held that legal form of transactions can be dispensed with and the real substance of transaction can be considered while applying the taxation laws, others have held that the form is to be given sanctity. There are some specific anti-avoidance provisions, but, prior to introduction of GAAR; general anti-avoidance has been dealt in specific cases only through judicial decisions. In an environment of moderate rates of tax, it is necessary that the correct tax base be subject to tax in the face of aggressive tax planning. Internationally, several countries have codified the substance over form doctrine in the form of General Anti Avoidance Rule (GAAR) and are administering statutory GAAR provisions. The General Anti Avoidance Rule (GAAR) is a codification of the proposition that while interpreting the tax legislation, substance should be preferred over the legal form. Transactions have to be real and are not to be looked at in isolation. The fact that they are legal does not mean that they are acceptable with reference to the meaning in the fiscal statute. Where there is no business purpose, except to obtain a tax benefit, the GAAR provisions would not allow such a tax benefit to be availed through the tax statute. These propositions have otherwise been part of jurisprudence in direct tax laws as reflected in various judicial decisions. The GAAR provisions codify this substance over form rule. Double taxation: Treaty shopping Presently the Income Tax act, under section 90 9 and 91 10, contain a provision for an agreement for avoidance of double taxation. A need for such provision was felt as to protect the individual or a corporate entity against the risk of being taxed twice in cases where the 9 Section 90 of the Income Tax explains that the Indian Government may enter into a treat with a foreign counter part in order to avoid the issue of double tax for the tax payer. 10 Section 91 explains that where a resident proves that he has paid tax in a foreign country with which India does not have an agreement, in such a case the concerned person is eligible for deduction from income tax payable to him. 503

3 same income is taxable in two states. Such a situation arises when a country of residence is different from the country of which the income is generated. To prevent this individual is provided with the option of choosing weather to govern by domestic law or by the tax treaty whichever one is favorable for him. 11 However it was observed in many cases residents of third country were taking advantage of this even though the agreement was meant for resident of the contracting country only. This process has been termed as treaty shopping and though it has been declared as lawful by the courts, the government considers it to be source of losing major public revenue resulting into introduction of GAAR. Tax Evasion v. Tax Avoidance The Courts have over the years drawn out the general parameters and principles in outlining whether a transaction or scheme would be considered as tax avoidance/tax evasion or tax planning under the tax laws. It has been held in a number of cases held that it is the right of a tax payer to do everything he can so as to attract upon himself the least amount of tax. 12 The following judicial decisions conclude that tax avoidance was not treated on the same lines as tax evasion: In IRC v. Duke of Westminister, 13 it was held by the House of Lords that a tax-payer has a legal right to attract upon him the least amount of tax and that tax evasion is different from tax avoidance. Thus, tax avoidance was declared legal. The Hon ble Supreme Court in A. Raman s 14 case observed that the law does not oblige a trader to make the maximum profit that he can get 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. Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. A taxpayer 11 Sub-Section (2) of Section 90 of the Income Tax Act, 1961 lays down where the Central Government has entered into an agreement with the Government of any country outside India under sub-section (1) for granting relief on tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee. 12 James Kessler,Tax Avoidance Purpose and Section 741 of the Taxes Act 1988, 4 BRIT, Tax Review 375, 376 (2004). 13 [1935] All ER 259 (H.L.). 14 CIT v.a Raman and Co, [1968] 67 ITR 11 (SC). 504

4 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 Incometax Act. Legislative injunction in tax statutes may not, except on peril of penalty, be violated, but may lawfully be circumvented. Again in AzadiBachaoAndolan v. Union of India, 15 the court held that even if a transaction has been entered into with the primary motive of avoiding tax, such transaction would not become a colourable device and thus, not result in disqualification. Here, the courts relied on the judgment of the Westminster case which laid down the principle an act which is otherwise valid in law can be treated as non est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interests, as perceived by the respondents. The court in this case has also attempted to make a distinction between tax planning and tax avoidance. However, this distinction has very little relevance in the present era because of the varying and conflicting court views. But the DTC introduced by the Government makes an attempt to eliminate the distinction that exists between tax avoidance and tax evasion. The discussion paper on DTC has justified the inclusion of GAAR on the grounds that tax avoidance just like tax evasion seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, credible and effective manner. Impact on FIIs GAAR is not directed at the FIIswhich should cover holders of participatory notes and offshore derivative investments.or any international investors or against any particular country. GAAR are general anti-avoidance rules which would be attracted with reference to any tax payee who is liable to pay tax in India and for some impermissible arrangement who is seeking to avoid or reduce the tax. So it is applicable equally even to Indian domestic companies. So it should be clear that GAAR is not targeted against FIIs or against any particular country. 15 Union of India v. AzadiBachaoAndolan, [2003] 263 ITR 706 (SC). 505

5 The GAAR Committee has recognized the right of taxpayers to mitigate taxes through arrangements that are not abusive, contrived or artificial. GAAR should therefore be used as a last resort and not a first recourse. As a measure of fairness, it has been proposed that existing investments should be grandfathered. II. GAAR and Finance Bill 2012 The provisions relating to GAAR are mentioned in Chapter X-A: Section 95 to Section 102 of the Finance Bill Introduced as part of the 2012 Finance Bill, the GAAR provision s objective is to insist upon the principal of substance over form, meaning the real intention of the parties involved and the purpose of establishing an arrangement are taken into account for determining the tax consequences, irrespective of the legal structure of the transaction or arrangement. Governments have come out with GAAR, which give them powers to examine whether the transaction involves tax avoidance or not. These are wide spectrum, general provisions targeting all unknown, unexpected methods of tax avoidance measures. GAAR also gives tremendous powers in the hands of Government. These can be misused. Therefore the rules provide for some checks. 16 The Finance Bill, 2012 ( Finance Bill ) proposes to introduce a far-reaching GAAR in the Income-Tax Act, Though largely modeled on GAAR proposed in the Direct Taxes Code Bill, 2010 (DTC), GAAR provisions in the Finance Bill are in some ways wider in scope and application. The GAAR Rule, coupled with its largely subjective nature could make tax planning, implementation and litigation extremely challenging. Virtually all transactions that may give rise to tax benefits will have to be evaluated under GAAR provisions. Analysis of the GAAR provisions in the Finance Bill 2012: Section 95 provides that an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement and consequences in relation to tax of such a declaration can be determined. 16 RashminSanghvi& Associates, An analysis of Finance Bill 2012, available at < accessed on August 17,

6 Section 96 provides the definition and conditions under which an arrangement can be declared to be an impermissible avoidance arrangement. The section also provides for circumstances under which an arrangement shall be presumed to be entered into or carried out for main purpose of obtaining tax benefit. Section 97 provides for circumstances under which an arrangement shall be deemed to lack commercial substance. Section 98 provides for method of determination of consequences in relation to tax of an arrangement after it is declared to be an impermissible avoidance arrangement. It provides for certain illustrative but not exhaustive methods for determination of tax consequences. Section 99 provides that for determining tax benefits for the purposes of the newly inserted Chapter X-A parties who are connected may be treated as one and same person, accommodating party may be disregarded; any accommodating or other party to an arrangement may be treated as one and the same person; and an arrangement may be looked through. Section 100 provides that provisions of newly inserted Chapter X-A can be applied in alternative to or in addition to any other basis of determination of tax liability. Section 101 provides for power to prescribe guidelines for application of provisions of newly inserted Chapter X-A. Section 102 provides definition of certain terms relevant for newly inserted Chapter X-A. Impermissible Avoidance Arrangement GAAR will also apply in the transactions or arrangements which are declared as Impermissible Avoidance Arrangement. Two basic conditions should be satisfied for a transaction to be considered as Impermissible Avoidance Agreement: i) The main purpose is to be obtain tax benefit; and ii) It lacks commercial substance; Both the above mentioned conditions are cumulative. A mere tax benefit does not mean GAAR will apply. Further, the tax benefit has to be coupled with lack of commercial substance for the applicability of GAAR. 507

7 But however, it can be argued that restricting the applicability of GAAR only to arrangements whose main purpose is to obtain a tax benefit would be reasonable. This view is strengthened on account of the following reasons: (i) A separate provision presumes allarrangements resulting in any tax benefitto have been entered in to for the mainpurpose to obtain a tax benefit unless proved otherwise by the tax payer. The onus to prove that an arrangement does not result in to a tax benefit is on the tax payer. (ii) Further, the provisions define a tax benefit as any reduction, avoidance or deferral of tax whether or not it is because of a tax treaty. It also includes any reduction of total income or increase in loss. III. General Anti Avoidance Rules in various countries Different countries often treat a transaction in quite an inconsistent way for tax purposes. This inconsistency can give rise to tax planning and also tax avoidance opportunities. An example is found in the New Zealand Court decision WestpacBanking Corporation v Commissioner of Inland Revenue, where Harrison J, havinganalyzed the international tax consequences of a structured finance transaction,concluded, This process, known as tax arbitrage, is a settled feature of international financing arrangements. 17 The GAAR provision as prevalent in different countries has been summarized below: a. Canada: GAAR was first introduced in Canada in and was aimed at preventing artificial tax avoidance agreements. 19 It was prospective including a grandfathering clause to exempt those statutory provisions which are already involved in the tax avoidance agreements Westpac Banking Corporation v Commissioner of Inland Revenue HC AK CIV , at 5. The process referred to was a cross border differential creating tax asymmetry, where various repo transactions were treated as loans, with deductible interest coupons, by overseas jurisdictions in accordance with economic substance, whilst the New Zealand characterization of a dividend (tax exempt in this situation) was based on legal form. 18 Lynch Paul, GAAR Committee Update-March Canadian Tax Adviser, May 24,2011, available at accessed on July 17,

8 According to the Canadian GAAR, an avoidance transaction is defined as a transaction, or one that is a part of a series of transactions where the single transaction or the series results directly or indirectly in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit. 21 The Federal Court of Canada in the case of OFSC Holdings 22 observed that the words may reasonably be considered to have been undertaken or arranged in sub-section 245(3) of the Income Tax Act indicate that the primary purpose test is an objective one. Therefore the focus will be on the relevant facts and circumstances and not on statements of intention. It is also apparent that the primary purpose is to be determined at the time the transactions in question were undertaken. It is not a hindsight assessment, taking into account facts and circumstances that took place after the transactions were undertaken. It is not a hindsight assessment, taking into account facts and circumstances that took place after the transactions were undertaken. 23 On the other hand, the Information Circular issued by the Canada Revenue Agency (CRA) which provided the guidance with respect to the application of the GAAR in Canada state that the purposes of a transaction are determined not only from the taxpayer s statement of intention but also from all the circumstances of the transaction or transactions. 24 If the primary or principal purpose in undertaking the transaction is other than to obtain a tax benefit, then the transaction is not an avoidance transaction. 25 So, it is clear that the primary purpose test is an objective test and not subjective test. 19 Benjamin Alarie, Retroactivity and the General Anti-Avoidance Rule, November 18, 2005, available at < Avoidance_Rule>, accessed on August 10, GAAR Rethink, The Firm, July 23, 2012, available at < accessed on July 24, Canada s General Anti Avoidance Rule-The Process, GowlingsTaxand, July OSFC Holdings Ltd. v.the Queen, 2001 DTC 5471 (FCA). 23 Understanding GAAR, BDO Canada, available at < >, accessed on August 01, Information Circular No. 88-2, Revenue Canada Taxation, October 21, 1988, available at < accessed on August 03, William Innes, Patrick Boyle, Milner Casgrain and Joel Litikman, The Essential GAAR Manual: Policies, Principles and Procedures, CCH Canadian Limited 2006, pp

9 The Supreme Court of Canada in the case of Canada Trustco 26, at para 43 of the ruling held that a single, unified approach to the textual, contextual and purposive interpretation of the specific provisions of the Income Tax Act that are relied upon by the taxpayer is required in order to determine whether there was abusive tax avoidance. Indian GAAR- elements from Canadian GAAR Indian draft rules on GAAR clearly define an arrangement to include steps in a transaction. From the Canadian perspective, a transaction is singular which is why they have a rule according to which the GAAR applies if a transaction or a transaction is a part of a series results in a tax benefit. So in Indian system, a transaction is only one thing and in Canadian system the way that they have defined arrangement, shows that the transaction can be composite. Indian GAAR is potentially much broader than the Canadian GAAR. 27 Canada has had three aspects to its GAAR and India has followed elements of them, but with some differences. Firstly, the idea of a tax benefit in the Indian GAAR is very similar to the Canadian GAAR. Secondly the requirement of a tax purpose or tax motivated transaction is also similar to the Canadian GAAR. However, the Indian version departs from the Canadian GAAR because Canadian GAAR focuses solely on misuse or abuse and so there is a question of whether Canada violated the spirit of the Act while adhering to the words of the Act. 28 Also, India has the element of commercial substance test which doesn t appear in the Canadian GAAR. 29 One of the great innovations of the Canadian GAAR was to add the misuse and abuse test. 30 The idea of tax avoidance, the hallmark of tax avoidance is contrary to the legislation. GAAR is designed to prevent the tax avoidance which is contrary to what the 26 Canada Trustco Mortgage Co. v. Canada, 2011 SCC 36,[2011] 2 S.C.R GAAR Impact on cross-border structuring, BMR Insights, July 2012, available at < accessed on August 09, GAAR Rethink, The Firm, July 23, 2012, available at < accessed on July 24, The GAAR Guidelines, July 05, 2012, available at < accessed on August 08, GAAR-A Canadian Perspective, Canadian Tax Foundation, February

10 legislation is intending. But GAAR is not a broad brush tool to change all sorts of features of the tax system, instead there should be legislative amendments and if there are treaties that are causing a concern, renegotiate the treaties. 31 These are specific ways of dealing with specific problems and GAAR is a residual rule. Canadian GAAR gave sweeping powers to the Revenue when it was introduced in However, over a period of time, Courts have interpreted the GAAR in a more reasonable and balanced manner. Another notable feature of Canadian GAAR is that it puts the onus of proving that the transaction is intended for tax avoidance, on the Revenue authorities.canadian GAAR also has provision for seeking advance rulings to achieve certainty for taxpayers intending to enter into a transaction. 32 b. USA: GAAR is known as Economic Substance Doctrine (ESD) in the United States. The US enacted the Doctrine of Economic Substance or the ESD as recently in Under it, a transaction has substance if it changes in a meaningful way the taxpayers economic position besides the tax effect and if there is a substantial purpose for entering the transaction. ESD was used as a judicial doctrine for more than 70 years till In 2010, legislation was passed which codified the precondition for taxpayers to escape the ESD and imposition of penalties. However, the legislation did not address the issue of tax avoidance and the decision was left to the courts. ESD was a codification of common law and not a new law; it s spared four types of commonly used transactions such as the choice of capitalizing via debt or equity, making a foreign investment via a domestic or foreign corporation, reorganizations and related party transactions. The US ESD was applied prospectively and does not allow for advance rulings GAAR Rethink, The Firm, July 23, 2012, available at < accessed on July 24, Gautam Chopra, India: Indian GAAR- Need to adopt best practices, Mondaq October 03, 2011, available at < accessed on August 11, India Searches for GAAR best practices, BMR Insights, February 01, 2011, International Tax Review, available at < 0practices%20_Mukesh%20Butani_ITR_01%20Feb pdf>, accessed on August 11,

11 Comparing American ESD & Indian GAAR Indian GAAR is different from the US GAAR i.e., ESD. It is argued that Indian GAAR is a mix of Canadian and South African GAARs. The two key design principles are already enshrined in the Finance Act 2012 i.e., a four part test to determine if a transaction is permissible and a three part commercial substance test. As compared to the four part test in India, US ESD rules simply have a two part test i.e., did the tax payer have a business purpose and did the tax payer have economic substance to undertake the transaction. US has a number of rules i.e., other types of anti-abuse provisions that specifically target certain types of transactions. So, when the US ESD came into play, it focused on transactions which were not necessarily covered under these rules. So, it was more of a residual test and this is a fundamental difference between the Indian GAAR and US ESD. 34 c. Mauritius: Market tycoons and financial experts believe that India s new General Anti-Avoidance Rules will have an immediate impact on the use of Mauritius as a tax haven for investing in India.The reason is the Mauritius-India tax treaty, which allows for tax exemption in capital gains. As a result, much of the Mauritian investment into India is actually round tripping by Indian companies setting up a Mauritian entity to avoid Capital Gains Tax (CGT) in India. The GAAR rules however are being interpreted as suggesting that investors into India using the Mauritius route will now be subject to CGT unless they can demonstrate a substantial commercial presence in Mauritius. 35 Internationally, investments are structured through holding-company jurisdictions, and India has seen the extensive use of Mauritius as the intermediate jurisdiction through 34 GAAR Rethink, The Firm, July 23, 2012, available at < accessed on July 24, GAAR and its implications, CARE Ratings, May 10, 2012, available at s pdf, accessed on August 15,

12 which inbound investments are made. 36 Similarly, outbound investments are also increasingly made through such intermediate jurisdictions, including Mauritius. The India-Mauritius Treaty does provide certain benefits on account of the capital gains tax exemption in India. 37 The Hon ble Supreme Court in the AzadiBachaoAndolan case 38 endorsed tax planning through the use of Mauritius as an investment holding jurisdiction in the absence of express anti-avoidance or Limitation of Benefits provisions under the India-Mauritius Treaty. 39 This position was reaffirmed by the Supreme Court in Vodafone case, provided the corporate structure is genuine. Already, the proposed GAAR seems to have had an effect upon Indian taxation. On March 22, 2012, the Authority for Advance Ruling ("AAR") [1] upheld a tax demand on Otis Elevators in India and denied capital gains tax benefits provided by the India Mauritius tax treaty. 40 Nevertheless, the AAR upheld the Indian Income Tax Department's submission that this structure was designed to avoid tax in India and that the share buyback transaction was a "colorable device." The Otis ruling follows the principle of "substance over form" found in the proposed GAAR, even though it makes no direct reference to it. In any event, Otis gives an insight to the thinking of the AAR and the intentions of the Indian Income Tax Department. It is imperative that the administrative machinery for the implementation of GAAR is objective and the wide powers granted should not be wielded with the sole objective of garnering higher revenue collections. GAAR must necessarily be administered 36 Indian GAAR impacts on Mauritius tax haven use, India Briefing, April 5, 2012, available on accessed on July 27, Direct Tax Newsflash, Khaitan & Co, July 19, 2012, available at Direct%20Tax%20Newsflash%20-%2019%20July% pdf, accessed on August 07, (2004) 1 CompLJ 50 SC, (2003) 184 CTR SC Capital Gains exemption under India-Mauritius Treaty, Taxand, July 23,, available at accessed on August 14, In this case, Otis India bought shares from Otis Mauritius through a share buyback scheme that resulted in capital gains tax for Otis Mauritius. Under the India Mauritius tax treaty, this should not have been taxable in India. 513

13 transparently and with abundant prudence, in order to ensure it does not act as a deterrent to foreign investment. 41 Mauritius versus Singapore versus other jurisdictions Significant investment is made through jurisdiction such as Mauritius, Singapore, Netherlands and Cyprus various tax-related, commercial and strategic reason. A Revenue circular 42 issued in 2000 provides that treaty benefits cannot be denied to Mauritius entities that have received tax residency certificates from the Mauritius Revenue Authority. 43 The Committee has recommended that the circular should continue to be effective till capital gains tax on listed securities is eliminated (which is another recommendation by the Committee). Therefore, in cases where the circular is applicable, GAAR should not be applied to question the residential status of the Mauritian entity. However, it must be noted that the Indian Government is currently in discussions with Mauritius for introducing some form of limitation of benefits ( LoB ) or anti-abuse provisions within the treaty. GAAR should not be invoked if the treaty has a LoB provision limiting treaty entitlement in specific cases. For instance, the tax treaty with Singapore has a LoB clause because of which the capital gains tax exemption on share transfers may not be available to a Singapore entity that is a shell or a conduit company. Certain expenditure or listing requirements may be fulfilled so that the entity is not treated as conduit or a shell company. 44 To the extent the entity satisfies the LoB criteria, GAAR would not apply to it. However, several tax treaties such as those with Netherlands and Cyprus do not have an LoB clause, and hence entities investing from such jurisdictions may be subject to the qualifications imposed under GAAR. Interestingly certain tax treaties such as the treaty with Luxembourg, allows domestic GAAR provisions to override the treaty. 41 Krishna Kumar, Will GAAR rob the sheen off India-Mauritius structures? The Hindu Business Line, April 15, 2012, available at accessed on August 15, CBDT Circular 789 of This circular was upheld by the Supreme Court in Union of India v. AzadiBachaoAndolan, [2003] 263 ITR Under the protocol to the treaty a resident of Singapore should not be treated as a conduit as long as it incurs annual operational expenditure of SGD 200,000 in the two years preceding the sale of shares. 514

14 NEED OF THE GAAR Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner. Sectors that provide a greater opportunity for tax avoidance tend to cause distortions in the allocation of resources. Since the better-off sections are more endowed to resort to such practices, tax avoidance also leads to cross-subsidization of the rich. Therefore, there is a strong general presumption in the literature on tax policy that all tax avoidance, like tax evasion, is economically undesirable and inequitable. 45 On considerations of economic efficiency and fiscal justice, a taxpayer should not be allowed to use legal constructions or transactions to violate horizontal equity. In the past, the response to tax avoidance has been the introduction of legislative amendments to deal with specific instances of tax avoidance. Since the liberalization of the Indian economy, increasingly sophisticated forms of tax avoidance are being adopted by the taxpayers and their advisers. The problem has been further compounded by tax avoidance arrangements spanning across several tax jurisdictions. This has led to severe erosion of the tax base. Further, appellate authorities and courts have been placing a heavy onus on the Revenue when dealing with matters of tax avoidance even though the relevant facts are in the exclusive knowledge of the taxpayer and he chooses not to reveal them. 46 In view of the above, it is necessary and desirable to introduce a general anti-avoidance rule which will serve as a deterrent against such practices. This is also consistent with the international trend. 45 Department of Revenue, Ministry of Finance, Government of India, Direct Taxes Code, August Removing the fences: Looking through GAAR, PWC, February

15 MERITS OF GAAR GAAR provides wide powers to the tax authorities to deal with impermissible avoidance arrangements. It provides that if an arrangement is declared to be an impermissible avoidance arrangement, the consequences in relation to tax of the arrangement, including the denial of a tax benefit or a benefit under a tax treaty, shall be determined in such manner as is deemed appropriate in the circumstances of the case, including by way of but not limited to: a) disregarding, combining or re-characterizing any step in, or a part or whole of, the impermissible avoidance arrangement; b) treating the impermissible avoidance arrangement as if it had not been entered into or carried out; c) disregarding any accommodating party or treating any accommodating party and any other party as one and the same person; d) deeming persons who are connected persons in relation to each other to be one and the same person for the purposes of determining tax treatment of any amount; e) re-allocating amongst the parties the arrangement (i) any accrual, or receipt, of a capital or re venue nature; or (ii) any expenditure, deduction, relief or rebate; f) treating (i) the place of residence of any party to the arrangement; or (ii) the situs of an asset or of a transaction, at a place other than the place of residence, location of the asset or location of the transaction as provided under the arrangement; or g) considering or looking through any arrangement by disregarding any corporate structure. 516

16 CONCLUSION An essential part of being free, then, is knowing exactlyhow free one is. This argument has particular resonance when we look atgeneral anti-avoidance rules. The argument is that general anti-avoidancerules truly objectionable aspect is that no one really knows how far their reachextends. People are prevented from taking action that might be allowed, the argument continues, because they do not want to take the risk of their action being disallowed. The GAAR Committee has recognized the right of taxpayers to mitigate taxes through arrangements that are not abusive, contrived or artificial. GAAR should therefore be used as a last resort and not a first recourse. If people know what the law is in advance, they can choose to put themselves in the position of being subject to it. Subjection to the law is, therefore, a willful act. This argument is particularly relevant togeneral anti-avoidance rules. Since no one knows exactly when general anti avoidance rules will apply, people who are caught by them have not made a conscious decision to be subject to them, and are therefore coerced. The Finance Bill and provision of the GAAR threaten to have serious effects upon companies that have invested in India or have plans to do so. Unfortunately, they have adversely affected the outlook and confidence of foreign investors in India at a time when India is actively seeking increased levels of foreign direct investment. It remains to be seen how the Indian tax authorities will implement these provisions. However, it is clear that the amendments will be challenged in the Indian courts. Recently, Vodafone served notice to the Indian government under the India Netherlands Bilateral Investment Treaty challenging the proposed retroactive tax amendments to the Tax Act. Until these legal issues are resolved, it would be prudent to discuss with your tax and legal advisors any potential impact that the Finance Bill's retroactive amendments or the GAAR may have on any existing or future investments in India. 517