There are several aspects which needs to be considered for investing in India viz norms of foreign direct investment, choice of entities, incentives available with respect to investment, tax treaties, corporate and capital gains tax, maturity of transfer pricing regulations and indirect taxes. The tax legislation in India has always been in the forefront of controversies and is considered as one of the principal apprehensions by foreign investors for doing business in India. One of the reasons for the such an uncertainty in the tax environment had been the introduction in the domestic tax law of General Anti Avoidance Rules (GAAR). CBDT on 27th Jan 2017 has issued clarification via Circular No 7 of 2017 that the provisions of Chapter X-A of the Income Tax Act, 1961 relating to General Anti-Avoidance Rule will come into force from 1st April, 2017.
GAAR stands for General Anti Avoidance Rules. It was first introduced by Pranab Mukherjee as finance minister in the budget of 2012. General Anti Avoidance Rules (GAAR) caused immense insecurity among foreign investors in India, leading the government to defer its implementation till April 2015. When it was finance minister Arun Jaitley’s turn to decide on the fate of GAAR in 2015, he further deferred it to April 2017 to give industry as well as the tax department more time to adjust to this sophisticated tax regime.
GAAR provisions are contained in chapter XA of the Income Tax Act, 1961 section 95 to Section 102. It empowers officials to deny the tax benefits on transactions or arrangements which do not have any commercial substance or consideration other than achieving tax benefit. It contains a provision allowing the government to retroactively tax overseas deals involving local assets.
GAAR contains provisions to stop misuse of treaties that India has with other countries for tax avoidance. These are rules targeted at businesses that are structured solely for avoiding tax in India, such as routing investment into the country through tax havens. Transactions that fail the GAAR test will be subject to tax. Although effective from May 2016 as a step towards avoidance of treaty abuse the treaty between India and Mauritius (being considered as most abused) had been amended.[1]
The Relevant sections from Income Tax Act, 1961 relating to GAAR are reproduced below:
CHAPTER X-A[2]
GENERAL ANTI-AVOIDANCE RULE
- Applicability of General Anti-Avoidance Rule. —Notwithstanding anything contained in the Act, an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement and the consequence in relation to tax arising therefrom may be determined subject to the provisions of this Chapter.
Explanation. —For the removal of doubts, it is hereby declared that the provisions of this Chapter may be applied to any step in, or a part of, the arrangement as they are applicable to the arrangement.
- Impermissible avoidance arrangement. — (1) An impermissible avoidance arrangement means an arrangement, the main purpose of which is to obtain a tax benefit, and it—
| (a) | creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length; | |
| (b) | results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act; | |
| (c) | lacks commercial substance or is deemed to lack commercial substance under section 97, in whole or in part; or | |
| (d) | is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes. |
(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.
- Arrangement to lack commercial substance. — (1) An arrangement shall be deemed to lack commercial substance, if—
| (a) | the substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part; or | |
| (b) | it involves or includes— |
| (i) | round trip financing; | |
| (ii) | an accommodating party; | |
| (iii) | elements that have effect of offsetting or cancelling each other; or | |
| (iv) | a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction; or |
| (c) | it involves the location of an asset or of a transaction or of the place of residence of any party which is without any substantial commercial purpose other than obtaining a tax benefit (but for the provisions of this Chapter) for a party; or | |
| (d) | it does not have a significant effect upon the business risks or net cash flows of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained (but for the provisions of this Chapter). |
(2) For the purposes of sub-section (1), round trip financing includes any arrangement in which, through a series of transactions—
| (a) | funds are transferred among the parties to the arrangement; and | |
| (b) | such transactions do not have any substantial commercial purpose other than obtaining the tax benefit (but for the provisions of this Chapter), | |
| without having any regard to— |
| (A) | whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement; | |
| (B) | the time, or sequence, in which the funds involved in the round trip financing are transferred or received; or | |
| (C) | the means by, or manner in, or mode through, which funds involved in the round trip financing are transferred or received. |
(3) For the purposes of this Chapter, a party to an arrangement shall be an accommodating party, if the main purpose of the direct or indirect participation of that party in the arrangement, in whole or in part, is to obtain, directly or indirectly, a tax benefit (but for the provisions of this Chapter) for the assessee whether or not the party is a connected person in relation to any party to the arrangement.
(4) For the removal of doubts, it is hereby clarified that the following may be relevant but shall not be sufficient for determining whether an arrangement lacks commercial substance or not, namely: —
| (i) | the period or time for which the arrangement (including operations therein) exists; | |
| (ii) | the fact of payment of taxes, directly or indirectly, under the arrangement; | |
| (iii) | the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement. |
- Consequences of impermissible avoidance arrangement. —(1) If an arrangement is declared to be an impermissible avoidance arrangement, then, the consequences, in relation to tax, of the arrangement, including denial of 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 the following, namely:—
| (a) | disregarding, combining or recharacterising 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) | reallocating amongst the parties to the arrangement— |
| (i) | any accrual, or receipt, of a capital nature or revenue 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. |
(2) For the purposes of sub-section (1), —
| (i) | any equity may be treated as debt or vice versa; | |
| (ii) | any accrual, or receipt, of a capital nature may be treated as of revenue nature or vice versa; or | |
| (iii) | any expenditure, deduction, relief or rebate may be re characterised. |
- Treatment of connected person and accommodating party. —For the purposes of this Chapter, in determining whether a tax benefit exists, —
| (i) | the parties who are connected persons in relation to each other may be treated as one and the same person; | |
| (ii) | any accommodating party may be disregarded; | |
| (iii) | the accommodating party and any other party may be treated as one and the same person; | |
| (iv) | the arrangement may be considered or looked through by disregarding any corporate structure. |
- Application of this Chapter. —The provisions of this Chapter shall apply in addition to, or in lieu of, any other basis for determination of tax liability.
- Framing of guidelines. —The provisions of this Chapter shall be applied in accordance with such guidelines and subject to such conditions, as may be prescribed.
- Definitions. —In this Chapter, unless the context otherwise requires, —
| (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; | |
| (2) | “asset” includes property, or right, of any kind; | |
| (3) | “benefit” includes a payment of any kind whether in tangible or intangible form; | |
| (4) | “connected person” means any person who is connected directly or indirectly to another person and includes, — |
| (a) | any relative of the person, if such person is an individual; | |
| (b) | any director of the company or any relative of such director, if the person is a company; | |
| (c) | any partner or member of a firm or association of persons or body of individuals or any relative of such partner or member, if the person is a firm or association of persons or body of individuals; | |
| (d) | any member of the Hindu undivided family or any relative of such member, if the person is a Hindu undivided family; | |
| (e) | any individual who has a substantial interest in the business of the person or any relative of such individual; | |
| (f) | a company, firm or an association of persons or a body of individuals, whether incorporated or not, or a Hindu undivided family having a substantial interest in the business of the person or any director, partner, or member of the company, firm or association of persons or body of individuals or family, or any relative of such director, partner or member; | |
| (g) | a company, firm or association of persons or body of individuals, whether incorporated or not, or a Hindu undivided family, whose director, partner, or member has a substantial interest in the business of the person, or family or any relative of such director, partner or member; | |
| (h) | any other person who carries on a business, if— |
| (i) | the person being an individual, or any relative of such person, has a substantial interest in the business of that other person; or | |
| (ii) | the person being a company, firm, association of persons, body of individuals, whether incorporated or not, or a Hindu undivided family, or any director, partner or member of such company, firm or association of persons or body of individuals or family, or any relative of such director, partner or member, has a substantial interest in the business of that other person; |
| (5) | “fund” includes— |
| (a) | any cash; | |
| (b) | cash equivalents; and | |
| (c) | any right, or obligation, to receive or pay, the cash or cash equivalent; |
| (6) | “party” includes a person or a permanent establishment which participates or takes part in an arrangement; | |
| (7) | “relative” shall have the meaning assigned to it in the Explanation to clause (vi) of sub-section (2) of section 56; | |
| (8) | a person shall be deemed to have a substantial interest in the business, if,— |
| (a) | in a case where the business is carried on by a company, such person is, at any time during the financial year, the beneficial owner of equity shares carrying twenty per cent or more, of the voting power; or | |
| (b) | in any other case, such person is, at any time during the financial year, beneficially entitled to twenty per cent or more, of the profits of such business; |
| (9) | “step” includes a measure or an action, particularly one of a series taken in order to deal with or achieve a particular thing or object in the arrangement; | |
| (10) | “tax benefit” includes, — |
| (a) | a reduction or avoidance or deferral of tax or other amount payable under this Act; or | |
| (b) | an increase in a refund of tax or other amount under this Act; or | |
| (c) | a reduction or avoidance or deferral of tax or other amount that would be payable under this Act, as a result of a tax treaty; or | |
| (d) | an increase in a refund of tax or other amount under this Act as a result of a tax treaty; or | |
| (e) | a reduction in total income; or | |
| (f) | an increase in loss, |
| in the relevant previous year or any other previous year; | ||
| (11) | “tax treaty” means an agreement referred to in sub-section (1) of section 90 or sub-section (1) of section 90A.’. |
Globally, several countries have introduced general anti-avoidance provisions, in different forms and the trend is gaining further momentum.
Vide Notification dated 23.09.2013 issued by the CBDT, Rules 10U to 10UC have been inserted in the Income-tax Rules, 1962 to provide for the entire procedure for monitoring the General Anti Avoidance Rules. Majorly Rules 10U to 10UC of the Income-tax Rules,1962 contains the necessary procedures for application of GAAR and conditions under which it shall not apply.
| Rule | Description |
| Rule 10U | Provisions of Chapter X-A not to apply to certain entities |
| Rule 10UA | Determination of consequences of impermissible avoidance arrangement |
| Rule 10UB | Notice, Forms for reference |
| Rule 10UC | Time limit for the purposes of section 144BA |
| Form no. 3CEG | Form for making the reference to the Commissioner by the Assessing Officer u/s 144BA (1) |
| Form no. 3CEH | Form for returning the reference made under section 144BA |
| Form no. 3CEI | Form for recording the satisfaction by the Commissioner before making a reference to the Approving Panel under sub-section (4) of section 144BA |
Stakeholders and industry associations had requested for clarifications on implementation of GAAR provisions and a Working Group was constituted by CBDT to examine the issues raised.
Accordingly, Central Board of Direct Taxes, Ministry of Finance, Department of Revenue vide circular no.7/2017. (No 500/43/2016-FT & TR -IV) dated 27.01.2017 came out with the clarifications on implementation of GAAR Provisions under the Income Tax Act 1961.
It has been clarified vide circular that if the jurisdiction of FPI is finalized based on non-tax commercial considerations and the main purpose of the arrangement is not to obtain tax benefit, GAAR will not apply. GAAR will not interplay with the right of the taxpayer to select or choose method of implementing a transaction. Further, grandfathering as per IT Rules will be available to compulsorily convertible instruments, bonus issuances or split / consolidation of holdings in respect of investments made prior to 1st April 2017 in the hands of same investor. It has also been clarified that adoption of anti-abuse rules in tax treaties may not be sufficient to address all tax avoidance strategies and the same are required to be tackled through domestic anti-avoidance rules. However, if a case of avoidance is sufficiently addressed by Limitation of Benefits (LoB) provisions in the tax treaty, there shall not be an occasion to invoke GAAR. It has been clarified that if at the time of sanctioning an arrangement, the Court has explicitly and adequately considered the tax implications, GAAR will not apply to such an arrangement. It has also been clarified that GAAR will not apply if an arrangement is held as permissible by the Authority for Advance Rulings. Further, it has been clarified that if an arrangement has been held to be permissible in one year by the PCIT/CIT/Approving Panel and the facts and circumstances remain the same, GAAR will not be invoked for that arrangement in a subsequent year. The proposal to apply GAAR will be vetted first by the Principal Commissioner of Income Tax / Commissioner of Income Tax and at the second stage by an Approving Panel headed by a judge of High Court. The stakeholders have been assured that adequate procedural safeguards are in place to ensure that GAAR is invoked in a uniform, fair and rational manner.
The introduction of GAAR does not bring halt to the tax planning or any thinking on bringing about savings in taxes. However, it certainly calls for a paradigm shift in thinking and in mindset, about what would now be acceptable as tax planning and more importantly as to how that would be demonstrated. Documentation should come as life saver – meticulous maintenance of clear and consistent documentation demonstrating the business purpose and intent will acquire critical significance as never before. More so, with the Guiding Principles for determination of Place of Effective Management (POEM) of a Company being introduced by circular No. 06 of 2017 (F. No. 142/11/2015-TPL) which clearly infers that that for determining POEM emphasis is on substance over form. All these amendments will lead to real substance-based planning, closely aligned with the businesses and operating model.
The present business decisions are largely based on Tax consideration. Infact it can be put that the whole of the business structuring is based on the Tax benefits. With the provisions like GAAR being introduced tax will not be seen to be driving businesses any more and it shall be the commercial consideration of business which shall become important. So, it is not the tax driving business it should be business driving the taxes. Business reasons and commercial rationale will be central to any planning in a new ecosystem created by GAAR.
Robust tax governance procedures should be in place to keep enterprise from being unnecessarily exposed to the application of provisions of GAAR. Government is committed to provide certainty and clarity in tax rules.
As the Budget 2017 unfolds let’s see what government has in its pitara. The world is waiting for tomorrow that is 1 Feb 2017.
Happy Budget to all of us..!!
[1] The Erstwhile double tax agreement between India and Mauritius (the “India-Mauritius treaty”) provided, inter alia, an exemption from tax in India on capital gains earned by a tax resident of Mauritius. Such capital gains are subject to tax based on residency rules, thereby giving taxation right to Mauritius. Tax on capital gains was nearly zero in Mauritius, making it an attractive destination for investors looking to invest in India. Government of India on 10th May 2016, India and Mauritius have signed a protocol amending the India-Mauritius treaty, giving India the right to tax capital gain on the alienation of shares in an Indian company.
[2] inserted with effect from the 1st day of April, 2016
