GAAR: The Way Ahead

By: Suhas Sagar

The field of taxation has always been witness to the eternal cat-and-mouse game between taxpayers and tax authorities. Nowhere is this contest more pronounced than in India. As taxpayers keep devising newer ways of mitigating their tax liability, the tax authorities respond with their own weapons – retrospective amendments and high pitched tax assessments displaying a rather adversarial state of mind. The apogee of this tussle was reached in the Vodafone case involving the indirect transfer of Indian assets by offshore enterprises.

However, in the recent past, there is a consensus building amongst the international tax community that the problem of tax base erosion and shifting of profits needs to be addressed in a prompt and direct manner. The fact that the Organisation for Economic Cooperation and Development (OECD) is developing a detailed action plan to tackle ‘Base Erosion and Profit Shifting’ (BEPS) is an unmistakable indicator of this trend.

One of the primary ways of tackling these issues is through the promulgation of General Anti-Avoidance Rules (GAAR) – statutory provisions designed to ensure that taxpayers are not able to avoid taxes. Various jurisdictions have enacted GAAR provisions to address BEPS. The United Progressive Alliance (UPA) – II Government had drafted and placed on the statute books a version of GAAR with supplementary rules notified in the Income Tax Rules, 1962. These provisions were scheduled to become effective from 1 April 2015.

The extant GAAR provisions rely on the notions of ‘commercial substance’ and ‘commercial purpose’ – wide, amorphous concepts without clearly defined objective criteria. The GAAR provisions in their current form prompted many grumblings from the international investor community who claimed that these provisions would give carte blanche to the tax officers to visit adverse tax consequences over even legitimate tax structures.

To allay the fears of the stakeholders, the Government constituted an Expert Committee headed by Dr. Parthasarthi Shome to review the GAAR provisions and suggest improvements. The result was an extensively researched and thought out report which recommended inter alia threshold requirements, an exclusion list and illustrative examples to demonstrate cases of tax avoidance vis-à-vis instances of legitimate tax planning. While the Government did incorporate a few of the recommendations into the law (e.g. the constitution of an Approving Panel), a majority of them remained unimplemented. This was another example of an aggressive and uncertain tax regime which was termed (rather dramatically) as ‘tax terrorism’.

Cue the General Election of 2014 and enter the NDA–II Government. A Government which had ridden to power on the promise, amongst other things, of a stable and certain tax regime. It was no surprise then that in his first full Union Budget, the Hon’ble Finance Minister Shri Arun Jaitley announced a deferral of the GAAR provisions by 2 years – scheduled now to be effective from 1 April 2017. In his Budget Speech, the Finance Minister also promised a grandfathering of transactions entered into before 1 April 2017. This was perceived in certain circles as providing a reprieve, albeit temporary, to investments routed through the African nation of Mauritius – the largest source of FDI in India.

While the motives behind the deferral of GAAR are open to speculation, the ostensible reason for the deferral is to have a relook at the provisions and bring them in line with the recommendations of the OECD’s BEPS Project and international best practices.

Given that some or the other form of GAAR is an inevitability in the international tax landscape, the Government would do well to take into consideration the recommendations of the Shome Committee Report and come out with a new and improved GAAR. One that is suitably general in nature – as all GAAR provisions, in the final analysis, must necessarily be – yet with a definite objective threshold and applicability criteria.

A balancing act is requisite in this scenario – promotion of foreign investment versus the prevention of tax base erosion.

(Suhas Sagar earned his B.A. LL.B (Hons.) degree from National Law School of India University, Bangalore in 2013. He’s currently a Lecturer in Tax at The The Hague University of Applied Sciences.)