Case Studies on General Anti- Avoidance Rules (GAAR)

Case Studies on General Anti- Avoidance Rules (GAAR) Geeta Jani

Contents 1 Case Studies on General Anti-Avoidance Rules (GAAR)

Case studies Abstinence from subscribing to rights issue Evaluating Rs. 3 Cr. limit of Rule 10U(1)(a) Gift taxation under s.56(2)(x) Buy-back v. Dividend Merger at fair value Choice of capital Equity v. Debt Exit from India; SPV presence; treaty benefit and purchaser s perspective 2 Case Studies on General Anti-Avoidance Rules (GAAR)

Abstinence from subscribing to rights issue 3 Case Studies on General Anti-Avoidance Rules (GAAR)

Facts ICo is presently owned by A and B in the ratio of 90:10 Issue Rights Shares A Pre-Rights ICo B 90 (10) 10 (90) A and B are unrelated ICo offers rights shares at par value (while FMV of ICo shares is significantly higher) B subscribes to rights shares; A abstains from subscribing to rights shares Post rights, A and B hold ICo shares in the ratio of 10:90 Under GAAR, A.O. wants to re-characterize the arrangement as effective transfer of interest from A to B taxable either in the hands of A (as transfer) or B (as receipt of gift) A and B resists GAAR by contending that there is no arrangement particularly, as A s nonsubscription is an unilateral act 4 Case Studies on General Anti-Avoidance Rules (GAAR)

Meaning of arrangement S.102(1): arrangement means any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding. Dictionary meanings of operation and scheme : Operation means an effect brought about in accordance with a definite plan; action Scheme means design or plan formed to accomplish some purpose; a plot 5 Case Studies on General Anti-Avoidance Rules (GAAR)

Examples of unilateral arrangement Shifting POEM from NTFJ to TFJ Changing residential status by an individual when large chunk of overseas income is likely to accrue Converting stock-in-trade into capital asset or vice-a-versa Resignation by a director to avoid trigger of s.2(24)(iv) Conversion of firm/llp into company Action of trustee of a discretionary trust to distribute income and/or refrain from distributing income 6 Case Studies on General Anti-Avoidance Rules (GAAR)

Evaluating Rs. 3 Cr. limit of Rule 10U(1)(a) 7 Case Studies on General Anti-Avoidance Rules (GAAR)

Facts and issue USCo USA 100% MauCo Mauritius India 100% ICo Equity CCD USCo has 100% subsidiary MauCo; that has 100% subsidiary ICo MauCo issues equity to USCo; ICo issues CCDs to MauCo USCo and MauCo hold valid TRC ICo pays interest on CCDs to MauCo at ALP (say - 30 Cr.) ICo has withheld TDS @ 7.5% in terms of revised India- Mauritius treaty Deductibility of interest in hands of ICo is undisputed and is not subject to GAAR; GAAR is invoked by regarding MauCo s involvement as tainted I-M Interest WHT 7.5% I-US Interest WHT Domestic law WHT 15% 40% + SC Issue: How is tax benefit to be reckoned? De-minimis threshold for invoking GAAR is 3 Cr. - Is it met? If treaty benefit is denied fully? If treaty benefit of I-US available? Meaning of relevant assessment year for evaluating threshold limit 8 Case Studies on General Anti-Avoidance Rules (GAAR)

Consequences of IAA USA USCo 100% Equity Consequences Treating IAA as not entered into or carried out [s.98(1)(b)] Disregarding MauCo as an accommodating party [s.98(1)(c)] Tax impact Taxing USCo as if it had directly invested in ICo - WHT @ 15% ----------do---------- MauCo Mauritius India 100% CCD Treat MauCo and USCo as one and same person [s.98(1)(d)] Reallocate interest income from MauCo to USCo [s.98(1)(e)] ----------do---------- ----------do---------- ICo I-M Interest WHT 7.5% I-US Interest WHT 15% Domestic law WHT 40% + SC Treating the place of residence of MauCo to be in USA by concluding that MauCo s location of residence in Mauritius is without any substantial commercial purpose [s.98(1)(f)] Disallowing treaty benefit to MauCo [s.98(1)] Taxing MauCo as if it is a company incorporated in USA and effective denial of treaty benefit in absence of TRC - WHT @ 40% on a net basis (as s.115a does not apply to CCD*) WHT @ 40% on a net basis (as s.115a does not apply to CCD*) *As CCD is unlikely to be regarded as monies borrowed in foreign currency 9 Case Studies on General Anti-Avoidance Rules (GAAR)

Gift taxation under s.56(2)(x) 10 Case Studies on General Anti-Avoidance Rules (GAAR)

Facts A Brother B B s daughterin-law Exempt under proviso (I) to s.56(2)(x) Exempt under proviso (I) to s.56(2)(x) Not exempt under s.56(2)(x) A and B are brothers; A is financially affluent Son of B, recently expired in an accident; the son is survived by his widow and children A, out of concern for B s family and well being, gifts a sum of Rs. 10 Cr. to B B, out of his own volition, gifts sum of Rs. 10 Cr. to his daughter-in-law (i.e. son s widow) Gift by A to B is exempt under proviso (I) to s.56(2)(x) as received from relative (brother) Gift by B to daughter-in-law is exempt under proviso (I) to s.56(2)(x) as received from relative (lineal ascendant of spouse i.e. husband s father) However, gift from A to B s daughter-in-law is not protected under s.56(2)(x) Can GAAR be invoked to tax B s daughter-in-law under s.56(2)(x)? 11 Case Studies on General Anti-Avoidance Rules (GAAR)

S.96(2) and Rule 10UA S.96(2): An arrangement shall be presumed, unless it is proved to the contrary by the assessee, to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit. Rule 10UA: For the purposes of sub-section (1) of section 98, where a part of an arrangement is declared to be an impermissible avoidance arrangement, the consequences in relation to tax shall be determined with reference to such part only. 12 Case Studies on General Anti-Avoidance Rules (GAAR)

Tax Authority s allegations for invoking GAAR Arrangement is effectively gift of money by A to B s daughter-in-law; Main purpose of gift to B being a step - is to avoid taxation under s.56(2)(x) S.96(2) shifts onus on taxpayer to prove that main purpose of such step is other than tax benefit Tainted element test: Abuse of provision which creates carve out for select few relatives [s.96(1)(b)] Substance of the arrangement (i.e. direct gift by A to B s daughter-in-law) is inconsistent with or differs from legal form of individual steps [s.97(1)(a)] Arrangement also involves accommodating party i.e. B whose participation only limited to obtaining of tax benefit by the end recipient of the gift [s.97(3)] Is carried out by inserting a step and hence implemented in a non ordinary manner [s.96(1)(d)] 13 Case Studies on General Anti-Avoidance Rules (GAAR)

Illustrative commercials to support that gift to B by A is independent of B s decision to gift to son s widow B is free to apply the gift in any manner desired and is not obliged to gift to his son s widow B could have kept funds with himself and supported son s family B may have his own independent resources A s gift was due to his relations with brother and may not have been made but for that A may have intended to support B and B s family through B 14 Case Studies on General Anti-Avoidance Rules (GAAR)

Kanga & Palkhivala s Tenth Edition, Volume 1, Page No. 1345 Cross Transfers In CIT v. Kothari* the SC held that cross transfers e.g. a transfer of assets by A for the benefit of B s wife and a transfer of assets of equal or nearly equal value by B for the benefit of A s wife which are so intimately connected as to form parts of a single transaction, are covered by this section, though the two transfers may not be mutual i.e. each transfer may not constitute consideration for the other in the technical sense. But from the mere facts that a transfer is made by A to B and after some time by B to A s wife or minor child and the subject matter of the transfers is the same, inference cannot be drawn that they are parts of the same transaction so as to amount to an indirect transfer by A to his wife or minor child **. The correct test which has to be applied in the case of cross transfers is to find not whether they are interconnected or not, and if they are so interconnected, whether they are parts of the same transaction and were effected in such a way that they can be said to have been adopted as a device to evade the implication of this section. * 49 ITR 1107 (SC) ** CIT v. Wadilal (47 ITR 305); Parwardhan v. CIT (76 ITR 279); Porbunderwatia v. CIT (85 ITR 385). Contrary decision in Venkatachala v. State of Madras (86 ITR 701) is incorrect 15 Case Studies on General Anti-Avoidance Rules (GAAR)

Buy-back v. dividend 16 Case Studies on General Anti-Avoidance Rules (GAAR)

Facts Tranches HoldCo Face Value 100% WOS Premi um Total Tranche 1 10-10 Tranche 2 10 20 30 Tranche 3 10 50 60 WOS is engaged in manufacturing automobile ancillaries Shares issued to HoldCo in three tranches Shares are held in physical form, distinctly identifiable WOS has huge accumulated profits ploughed back in business without dividend pay out Contemplated business expansion given up in recent past due to regulatory restrictions WOS proposes to buyback of shares at FMV (i.e. Rs. 90) HoldCo tenders Tranche 3 shares in buyback offer WOS pays BBT on distributed income of Rs. 30 (Rs. 90 Rs. 60) under s.115qa 17 Case Studies on General Anti-Avoidance Rules (GAAR)

Tax Authority s allegations for invoking GAAR WOS has no track record of dividend distribution despite sufficient profit in past Counter factual: Buyback is in substance distribution of dividend In any case, buyback is at par with capital reduction which also triggers dividend taxation Even if buyback is accepted, main purpose of tendering high cost shares is to reduce BBT The offer ought to have been basis FIFO principle Lacks commercial substance as there is no effect on business risk and cash flow irrespective of which shares are tendered [s.97(1)(d)] 18 Case Studies on General Anti-Avoidance Rules (GAAR)

Taxpayer s defenses against invoking GAAR Object of arrangement is to return funds to shareholders: Main object is not tax benefit Implemented in one-step; in legally compliant and transparent manner CBDT Circular admits taxpayer s right to select or choose method of implementing a transaction Buy-back realigns share capital; which is not possible in case of dividend distribution Re-alignment of share capital reduces compliances under Companies Act, 2013 Capital reduction entails NCLT approval, creditor s approval and cumbersome Buy-back excluded from the definition of dividend in ITA Tax Authority not to re-characterise buy-back as of dividend either fully or partly (CBDT Circular dated 26 February 2016 ) S.97(1)(d) inapplicable as arrangement does impact cash flow position of parties BBT liability calculated in accordance with Rule 40BB which prefers specific identification method 19 Case Studies on General Anti-Avoidance Rules (GAAR)

Merger at fair value 20 Case Studies on General Anti-Avoidance Rules (GAAR)

Facts Merger at fair value HoldCo owns 100% shares of ICo1 and ICo2 ICo1 Land HoldCo UT ICo2 Land Issue shares at FV ICo1 owns land parcel that has appreciated in value ICo1 has ceased to carry on business, while group needs funds for business expansion by monetizing land of ICo1 Merger ICo2 has brought forward capital loss and/or unabsorbed depreciation ICo1 is at an advanced stage of finalizing land deal Sale of land parcel to PQR HoldCo Group has implemented the following: Merge ICo1 with ICo2 ICo2 records assets/ liabilities at FV under AS-14 ICo2 Cash PQR Post appointed date (but before effective date), land is transferred UT Land Sale of land ICo2 claims cost-step up in books and sets off brought forward capital loss and/or depreciation 21 Case Studies on General Anti-Avoidance Rules (GAAR)

Tax Authority s allegations for invoking GAAR Overall arrangement is to monetize land owned by ICo1 and deploy funds in ICo2 s business Substance of the matter is at par with direct sale of land by ICo1 to third party buyer followed by dividend distribution to HoldCo which HoldCo infuses in ICo2 as capital Intermediate step of merger with ICo2 is with the sole purpose of tax benefit both for normal tax as also MAT liability: Brought forward losses are set off; Cost-step up is obtained in books and MAT is mitigated; There is savings of DDT as well 22 Case Studies on General Anti-Avoidance Rules (GAAR)

Tax Authority s allegations for invoking GAAR The arrangement has following tainted elements: Involves accommodating party i.e. ICo2 [s.97(1)(b) r.w.s.97(3)] No significant effect on business risk or net cash flow except saving of MAT/normal tax liability [s.97(1)(d)] Entered into in a manner or by means (insertion of steps) which are not ordinarily employed for bona fide purposes [s.96(1)(d)] S.98(1) casts wide powers on A.O. to re-compute tax (including MAT) Treating the impermissible step as not entered into or carried out Disregarding accommodating party (i.e. ICo2) Re-allocating receipt to ICo1 (and consequentially making ICo2 liable as a successor)` Tax benefit in the hands of ICo1 can be calculated by treating ICo1 and ICo2 to be the same person [s.99] There is no grandfathering benefit - Court approval has no impact on GAAR evaluation 23 Case Studies on General Anti-Avoidance Rules (GAAR)

Taxpayer s defenses against invoking GAAR Main purpose of merger is to monetize land owned by ICo1 and deploy funds in ICo2 s business such commercial object is achieved by merging ICo1 into ICo2 Sale to third party is an independent arrangement - not part of merger If buyers had not offered desired price, ICo2 may not have sold land ICo2 could have mortgaged land and obtained loan from Bank Merger was a permissible and preferred alternative: Liquidation of ICo1 would be more time consuming Merger has beneficial treatment under the Act and taxpayer used such incentive CBDT s clarification on choice principle respects the manner of implementing the transaction; taxpayer is not obliged to make the worst choice 24 Case Studies on General Anti-Avoidance Rules (GAAR)

Taxpayer s defenses against invoking GAAR Tax Authority was heard as a part of court proceedings and hence the court order needs to be respected MAT liability is strictly governed by book profit (subject to specified upward/downward adjustments) S.98(1) does not authorize Tax Authority to re-cast the books of account DDT is an additional tax and not tax: cannot be reckoned in calculation of tax benefit or subjected to s.95 consequences 25 Case Studies on General Anti-Avoidance Rules (GAAR)

Choice of capital Equity v. Debt Variant 1 26 Case Studies on General Anti-Avoidance Rules (GAAR)

Variant 1 - Facts and Issue Bank Loan of 700 FCo (Taxpayer) ICo (owned by FCo) wants to acquire business for horizontal expansion FCo to fund acquisition by internal accruals (300) and external finance from Bank (700) Equity 300 CCD 700 Terms of CCD by FCo to ICo: Fixed coupon (at ALP); 10 years term; 100% No voting rights ICo Used for business acquisition Unsecured; fixed conversion ratio Payable at par on liquidation, senior to all forms of capital Business Ind-AS may characterize CCD as equity Issue: Can CCD be re-characterized as equity under GAAR? 27 Case Studies on General Anti-Avoidance Rules (GAAR)

Choice of capital Equity v. Debt Variant 2 28 Case Studies on General Anti-Avoidance Rules (GAAR)

Variant 2 - Facts and Issue ParentCo 100% FCo Equity 1000 ParentCo holds 100% in FCo which holds 100% in ICo ParentCo infuses Equity in FCo (1000) FCo infuses Equity + CCD in ICo (10+990) (1:99) Interest is paid at ALP and subjected to limitation of s.94b 100% ICo Equity 10 CCD 990 It is likely that FCo may claim participation exemption in respect of CCD interest CCD is fully classified as Equity under Ind-AS Issue: Can CCD be re-characterized as equity under GAAR? 29 Case Studies on General Anti-Avoidance Rules (GAAR)

Variant 2 - Tax Authority s allegations for invoking GAAR Counter factual: FCo could have infused by way of equity - infusion by way of CCD is mainly to secure tax benefit FCo has no obligation to service external debt FCo, being a 100% shareholder, is risk neutral irrespective of debt v. equity FCo interposed as a conduit of ParentCo to convert equity funding into debt GAAR may also trigger since tainted elements are present, such as: Transaction does not create arm s length rights and obligations - Independent investor would not have invested in huge debt without adequate base of equity [s.96(1)(a)] FCo effectively an accommodating party Presence of SAAR (s.94b) does not preclude applicability of GAAR Once the arrangement is IAA, s.98(2) permits A.O. to re-characterize debt into equity 30 Case Studies on General Anti-Avoidance Rules (GAAR)

Variant 2 - Taxpayer s defenses against invoking GAAR CCD is a chosen mode of financing: For flexibility to divest CCD investment without diluting management control For flexibility to exit in favour of buyer group (who prefers external debt) To control compliances under Companies Act, 2013 which may be linked to paid up share capital CCD is a permissible and preferred choice specific example in Shome Committee Report Purpose is to fund ICo s expansion No GAAR if there is compliance with SAAR (s.94b) and TPR (s.92) Equity characterization under Ind-AS in books of ICo does not impact the legal form 31 Case Studies on General Anti-Avoidance Rules (GAAR)

Exit from India; SPV presence; treaty benefit and purchaser s perspective 32 Case Studies on General Anti-Avoidance Rules (GAAR)

Facts USCo SPV ICo US TFJ India ICo is an operating company within fold of US Group since 2005 SPV holds TRC; SPV did not have any activity other than overseeing operations of ICo as a parent Representatives of USCo and ICo are negotiating with a purchaser (BuyerCo) for acquisition of stake in ICo BuyerCo is not desirous of acquiring business of ICo in India for commercial and non India tax reasons BuyerCo is neutral about acquiring shares of SPV from USCo; or acquiring shares of ICo from SPV; USCo is insisting on latter Probable reasons (unknown to BuyerCo) for insistence by USCo could be: US tax law efficiency Plan of reinvesting funds at SPV level for business acquisition in Africa USCo, if it receives funds, may be obliged to deposit proceeds to liquidate its liabilities Desire to avail exemption from tax as per treaty 33 Case Studies on General Anti-Avoidance Rules (GAAR)

Issues USCo SPV ICo US TFJ India Can BuyerCo be considered as a party to GAAR prone arrangement? Is there any tax benefit derived by BuyerCo? Can GAAR be invoked in the hands of the seller group on the ground that option to exit at SPV level involves obtaining of tax benefit? Can GAAR be defended on the ground that the taxpayer has an open option to plan his tax efficiency? Can treaty benefit be denied to SPV? Can BuyerCo be considered as assessee in default or representative assessee of USCo or SPV, upon invocation of GAAR? 34 Case Studies on General Anti-Avoidance Rules (GAAR)

Thank You! This Presentation is intended to provide certain general information existing as at the time of production. This Presentation does not purport to identify all the issues or developments. This presentation should neither be regarded as comprehensive nor sufficient for the purposes of decision-making. The presenter does not take any responsibility for accuracy of contents. The presenter does not undertake any legal liability for any of the contents in this presentation. The information provided is not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of the presenter, this document may not be quoted in whole or in part or otherwise. 35 Case Studies on General Anti-Avoidance Rules (GAAR)