Introduction: The Union Budget 2012 contained a controversial retrospective amendment proposal and General Anti Avoidance Rule (GAAR). The effective date of GAAR was postponed to 1 April 2013 to the relief of many assessees. In this article the intent of introduction of GAAR and its impact on assesses is discussed taking into account draft guidelines of which have been notified.
Intention of the Government
GAAR was part of Direct Taxes Code Bill 2010 and the main purpose of GAAR is to target tax evaders who use the Mauritius or other tax heaven routes for investments and use double taxation treaties to avoid tax.
Participatory notes angle
It is relevant to know about participatory notes which are used for routing unaccounted wealth of NRIs into the country. Participatory notes are often referred as P-notes. Investments in the stock markets are made through P-Notes route. These P notes are issued overseas and used by foreign investors not registered with capital market regulator SEBI (Securities and Exchange Board of India) for their exposure in Indian stock market.
Draft guidelines regarding implementation GAAR have been notified by the government on 28 June 2012. These guidelines have been framed taking into account the responses from all concerned. Before we get into the details of guidelines of GAAR, it would be useful to understand the terms, avoidance of tax, evasion of tax and Impermissible Avoidance Arrangement.
Tax evasion / tax planning:
When an assessee makes an attempt to reduce his tax liability through legal means and pays minimum tax, such attempt of the assessee is aimed towards avoidance of tax and it is perfectly legal. Similarly when an assessee indulges in illegal means to reduce his tax liabilities, such actions are aimed at evasion of tax. This exercise generally involves booking of fictitious entries for increasing the expenditure or suppressing the income by falsification of books. Evasion of tax is punishable.
To take advantage of fiscal incentive, assessee complies with the conditions of such incentive and such action is termed as tax mitigation. GAAR provisions do not apply to tax mitigation.
Impermissible Avoidance Arrangement
The Section 96 of the Income Tax Act, 1961 states what Impermissible Avoidance Arrangement is. Any arrangement which may look otherwise legal on the face of it but may declared as an impermissible avoidance arrangement (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 directly or indirectly in misuse or abuse of the provisions of the Act or
Lacks commercial substance in whole or part, or deemed to lack commercial substance
Apparently transaction is not bonafide
Focus on Draft guidelines:
Section 101 of the Income Tax Act, provides that “the provisions of this Chapter shall be applied in accordance with such guidelines and subject to such conditions and the manner as may be prescribed”. Thus Guidelines and conditions play a vital role in determining the effectiveness of the provisions of the chapter.
Finance ministry came out with a draft of guidelines which are more clarificatory in nature and are mainly intended to allay the fears of Assesses. There is room for improvement in efforts made.
The Committee had made the following recommendations to be incorporated in the guidelines.
Monetary threshold: GAAR is not applicable to transactions below the thresh hold limit, although threshold limit is not notified. In other words, these provisions will apply only to transactions or arrangements where tax benefit is over a specified threshold. Once the threshold is fixed, the assessee below threshold limit need not worry about implication of GAAR.
Prescribed forms: Committee recommended use of prescribed forms
For the Assessing Officer to make a reference to the Commissioner u/s 144BA(1)
For the Commissioner to make a reference to the Approving Panel u/s 144BA(4) and
For the Commissioner to return the reference to the Assessing Officer u/s 144BA(5)
It is also relevant to note that the provisions of the section also take care of the principles of natural justice i.e., notice and affording an opportunity to hear the assesses stand. The committee believes that these forms will further bring transparency and avoid abuse/misuse of powers by the department.
Time limit: Committee recommended that Commissioner of Income tax(CIT) should make a reference to the Approving Panel within 60 days of the receipt of the objection from the assessee and in case of the CIT accepting the assessee’s objection and being satisfied that provision of chapter X-A are not applicable, the CIT shall communicate his decision to the AO within 60 days of the receipt of the assessee’s objection(refer to section 144BA(4) and 144BA (5)
Set up of approving panel: The approving panel should be situated at Delhi and it should consist of three members, out of which, two members should be of the level of Chief Commissioners of Income Tax and the third member should be an officer of the level of Joint Secretary or above from the Ministry of Law. All the members should be full time members
Recommendation for circular on GAAR: Committee recommended for a incorporation of detailed note in the circular for readers to have more clarity on the subject. Various examples have been given and it is very good to see these examples which enhance the understanding of situations.
Special provision for Foreign institutional investors: FIIS have sought exemption from GAAR provisions and a flat tax on gains without any distinction on transactions. Committee clarified that if FIIS choose to take a treaty benefit, GAAR provisions may be invoked but not in the case of non resident investors of FIIs.
GAAR is retrospective: It has been clarified that GAAR provisions will apply to the income accruing or arising on or after 01.04.2013 and will be used to support Specific Anti Avoidance Rules (SAAR) and Where specific SAAR is applicable GAAR will not be invoked in normal circumstances.
Definition of connected person: Committee felt this definition in Section 102(5) is ambiguous. It clarified that “Connected person” would include the definition of “associated enterprise” given in section 92A, the definition of relative‟ in section 56 and the “persons” covered u/s 40A(2)(b). This will avoid confusion.
Partly Impermissible/impermissible arrangement: Committee clarified that where only a part of the arrangement is impermissible, the tax consequences of “Impermissible Avoidance Arrangement” will be limited to only that part of the arrangement. This may be a contentious issue despite this clarification.
Illustrative cases: At the end of the draft guidelines so many illustrative cases have been given in Annexure-E. These illustrations reveal the mind of the Government although certain clarifications require a fine tuning. For eg: illustration 13, 16 and 18.
Shome Committee’s recommendations
Dr. Manmohan Sigh, Prime Minister of India, constituted an expert committee to be led by Dr. Parthasarathi Shome as Chairman to address key concerns raised by all stakeholders. The committee in its interim report recommended for postponement of implementation of GAAR by another 3 years i.e. till 2016-17.Shom committee felt that immediate implementation of GAAR gives a message of not recognizing the tax treaties and amounts to creating an uncertainty in the minds of foreign institutional investors and it affects foreign capital inflows. It suggested for a five-member approving panel, consisting of industry/professional representation which builds trust and allays fears of assessees. The interim report is a pointer to the Final report is likely to be release shortly.
Conclusion Strict implementation of GAAR may affect the foreign capital inflows and similarly retrospective amendments nullifying the Supreme Court judgment in Vodafone case will open doors for litigation. Both the Prime minister and present Finance Minister made statements which indicate that GAAR provisions will certainly be re-examined to lessen the rigours.
Source: Income Tax Act, 1961 and Draft guidelines on GAAR
The writer is the deputy general manager-legal at OCL India Ltd.