General Anti-Avoidance Rules

India and International perspective

www.deloitte.com/in

Contents

Executive summary

Pre GAAR concept

Pre GAAR concept India experience

GAAR concept

10

International experience

11

India Regime

17

Way forward

23

General Anti-Avoidance Rules India and International perspective

Executive summary

Tax avoidance like tax evasion, seriously

undermines the achievements of the public
finance objective of collecting revenues in an
efficient, equitable and effective manner1.
Internationally, tax avoidance has been recognized as an
area of concern and several countries have expressed
concern over tax evasion and avoidance. This is also
evident from the fact that either nations are legislating
the doctrine of General Anti-Avoidance Regulations in
their tax code or strengthening their existing code.

In India, the proposed Direct Tax Code 2010 (DTC
2010 or Code) seeks to address the issues relating
to tax avoidance and evasion by bringing in General
Anti-Avoidance Rules (GAAR) in addition to various
transaction-specific Special Anti-Avoidance provisions.
The Discussion paper issued along with the proposed
new tax code states that tax avoidance arrangements
adopted by taxpayers span across several tax
jurisdictions, and it is desirable to introduce GAAR that
would serve as a deterrent to the use of increasingly
sophisticated forms of tax avoidance by taxpayers.
The paper also states that the appellate authorities
and Courts have cast a heavy onus on the revenue
authorities for dealing with matters of tax avoidance,
especially when the relevant facts are in the exclusive
knowledge of the taxpayer who chooses not to reveal
them.

1 Discussion paper on Direct

Taxes Code 2009

The introduction of GAAR regulation recognizes that it

may not always be feasible for the judiciary to address
the unforeseen implications of transactions carried out
for tax purposes and also the need to provide some
semblance on the matter of tax avoidance. However,
where tax benefit is to be considered as the sole
criterion (as is currently recognized under the proposed
new Code) for determining tax avoidance, such a

provision may undermine the common denominator

in determination of a tax avoidance scheme, i.e., the
principle that though the taxpayer is free to choose the
most tax efficient method, the commercial justification
for the choice taken and tax consideration (benefit) is
not the only reason.
Considering the goals of tax avoidance legislation,
namely, deferral, re-characterization, elimination and
shifting, India would need to address the issue in the
proper perspective so that the provisions and their
implementation do not become a law onto themselves.
In the circumstances, one should be aware of some
issues relating to the promulgation of a General AntiAvoidance Rule, in terms of it being receptive to:
Providing a robust framework based on sound legal
jurisprudence and principles to address the issue
of abusive transactions, which tend to ride on the
shortcomings of the tax system. As indicated by
many international tax theorists and practitioners,
the design of GAAR should be by reference to business-purpose test with emphasis on the different
concepts of the economic substance associated with
the categories of tax avoidance behavior, such as
tax evasion, acceptable tax avoidance and abusive
tax avoidance rather than narrow the scope to the
aspect of a tax benefit test.
Incorporate a substance over form rule where a
transaction or a series of transactions are entered
into to judge the authenticity and purpose of the
transaction rather than teleologically apply the tax
benefit provision, surpassing all other aspects of the
transaction.

 The issue of bilateral tax treaty override by way of

bringing the same under the relevant treaties in
terms of limitation of benefits clause. In the absence
of the same, it may result in violation of international
principles of treaty interpretation.
Striking a balance between wide coverage and
uncertainty it is imperative that the Government
issues detailed guidelines on inherent principles and
on the type of transactions/arrangements they may
consider as avoidable transaction. A mechanism
similar to an advance ruling may be considered to
avoid uncertainty, protracted litigation and disputes.

This paper outlines some of the nuances relating to

General Anti-Avoidance Rule by examining the historical
perspective for tax avoidance generally and in India. The
concept of GAAR, international experience on GAAR
legislation in some jurisdictions, the proposed provisions
under the Direct Tax Code followed by a comparison
with other countries, few instances on the applicability
of the GAAR provisions, and the way forward for both
the authorities and the taxpayers have been covered in
the paper.

General Anti-Avoidance Rules India and International perspective

Pre GAAR concept

Internationally and in India, a constant debate has

been raging over the issue of tax avoidance. Over
the years, the term tax avoidance has come to be
understood as arranging affairs with the main object
or purpose of obtaining tax advantage while prima
facie fully intending to comply with the law in such
respect. Some principles underlying the meaning of
tax avoidance are:
The expression tax avoidance is used to describe
every attempt by legal means to prevent or reduce
tax liability, which would be otherwise incurred,
by taking advantage of some provision or lack of
provision in the law. It pre supposes the existence
of alternatives, one of which would result in less
tax than the other. Moreover, motive would be an
essential element of tax avoidance. A person who
adopts one of the several possible courses to save tax
must be distinguished from a taxpayer who adopts
the same course for business or personal reasons2.
A course of action designed to conflict with or defeat
the evident intention of Parliament3.
Where it reduces the incidence of tax borne by an
individual taxpayer contrary to the intentions of
Parliament4.
Tax planning may be legitimate, provided it is within
the framework of law. Colorable devices cannot be
part of tax planning and it is wrong to encourage or
entertain the belief that it is honorable to avoid the
payment of tax by resorting to dubious methods. It
is the obligation of every citizen to pay their taxes
honestly without resorting to subterfuges5.
Further, Courts in India have broadly indicated
that if some device has been used by a taxpayer to
conceal the true nature of the transaction, it is the
duty of the taxing authority to unravel the device
and determine its true character. However, the legal
effect of the transaction cannot be displaced by
probing into the substance of the transaction.
Considering these continuing difficulties of classifying
transactions as being acceptable within the framework
of law or not, a need is being felt to move towards a
structured approach to address the issue of avoidance
both from a legal and economic point.
Thus, tax avoidance could be said to transact between
substance over form of a transaction, the issue being of
whether it is legal or economic substance.

Legal substance would refer to characterization which

emerges from a close study of the rights and obligations
in a legal relation whereas Economic substance has
different interpretations as propounded by various
jurisdictions:
Real economic substance This is the American
notion under which the Economic substance
is determined by looking at both objective and
subjective factors to see if there is any potential
for profit other than tax savings, or if there is any
meaningful change in the economic position of the
taxpayer. Under this doctrine, a transaction lacking
economic substance will be ignored. In Gregory
vs Helverig (1934) - US, the Court outlined that
it does not follow that Congress meant to cover
such a transaction. The meaning of a sentence
may be more than that of the separate words, as
a melody is more than the notes, and no degree of
particularity can ever obviate recourse to the setting
in which all appear, and which all collectively create.
If what was done here was what was intended by
[the statute], it is of no consequence that it was all
an elaborate scheme to get rid of income tax, as it
certainly was [But] the purpose of the section is
plain enough; men engaged in enterprises might
wish to consolidate, or divide, to add to, or subtract
from, their holdings. Such transactions were not to
be considered as realizing any profit, because the
collective interests still remained in solution.

In other words, the benefit of the objective tax result
would be denied, where the transaction did not
change the economic position, apart from the tax
benefit, nor did it reflect any facet of the business,
which could be considered as lacking economic
substance, and was not the thing which the statute
intended.
Step Transaction plus business purpose This UK
version combines step transactions doctrine and
business purpose doctrine and enables the courts to
overlook the step transactions that serve no business
purpose. This could be evolved from the various
juridical pronouncements made by the UK courts with
regard to transaction considered as entered into with
the objective of tax avoidance.
In Duke of Westminster vs IRC, their Lordships held that
the Act is to receive a strict or literal interpretation and

2 Carter Commission in
Canada
3 Lord Nolan in IRC v.
Willoughby
4 Lord Templeman
5 Simon in Latilla v. I.R.C. (11
ITR Suppl. 78, 79) (HL)

that a transaction is to be judged not by its economic

or commercial substance but by its legal form.
In Ramsay vs IRC, their Lordships watered down
the economic substance theory on the ground
that it could be invoked only when the purposive
interpretation approach is adopted. The principle
outlined herein came to be considered as a general
rule of statutory construction, not a separate judicial
doctrine.
The common denominator which can be found in most
countries is that if a taxpayer has multiple avenues
available to structure his transaction, he is free to
choose the most tax-efficient avenue, provided a level
of commercial justification for the same exists, and tax is
not the only reason.
In respect of international recognition to the concept,
the Vienna Convention provides that international
agreements are to be interpreted in good faith. In case
any international agreement/treaty leads to unintended
consequences like tax evasion or flow of benefits to
unintended person, it is open to the signatory to take
corrective steps to prevent abuse of the treaty. Such
corrective steps are consistent with the obligations
under the Vienna Convention.

Further, the OECD leaves it to the individual countries

to introduce anti-abuse legislation, which they consider
could be applied without interference by the Model
Convention or the bi-lateral tax treaty between the
countries inter-se. However, the OECD Commentary on
Article 1 of the Model Tax Convention also clarifies that
a general anti-abuse provision in the domestic law in
the nature of substance over form rule or economic
substance rule would not be in conflict with the treaty.
In other words, the general anti-abuse rule would
override the provisions of the tax treaty.
Hence, the underlying principle emanating from
international experience in respect of tax avoidance and
where GAAR legislation has not been enacted is the
recognition that the contentious issue of determining/
establishing the doctrine of substance over form would
have to be established through an examination of the
legal substance, the legal form, or the real economic
substance of the transaction. This has also been duly
adapted under Indian jurisprudence as outlined in the
section below.

General Anti-Avoidance Rules India and International perspective

Pre GAAR concept

India experience
6 CIT v. A. Raman and Co,
[1968] 67 ITR 11 (SC)
7 B
 ank of Chettinad Ltd. v.
CIT [1940] 8 ITR 522 (PC)
8 McDowell and Co. Ltd. v.
Commercial Tax Officer,
[1985]154 ITR 148 (SC)
9 Union of India v. Azadi
Bachao Andolan, [2003]
263 ITR 706 (SC)

Indian tax laws, though providing for specific antiavoidance measures, do not have any general antiavoidance rules or regulations. 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, as outlined below, though the
uncertainty continues.
The Honble Supreme Court (SC) in A Ramans case6
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
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 Income-tax Act. Legislative injunction
in tax statutes may not, except on peril of penalty, be
violated, but may lawfully be circumvented....

Westminster, and took the view that tax planning was

legitimate so long as it was strictly within the four corners
of the law and any colorable device or dubious methods
to minimize tax incidence were not legally permissible.
It appears that there is no single approach towards the
issue of substance over form. A clear tendency exists
for Revenue authorities to try and counter any kind of
undesired outcome (in their eyes) of a certain piece of
legislation by applying the substance over form doctrine.
However, while examining a legally valid transaction, the
Revenue authorities should proceed objectively and not
hypothetically attribute motives behind the taxpayers
action.
We have witnessed a contentious journey for
determining whether the affairs planned by the taxpayer
were legitimate to be strictly within the four corners of
the law or was a colorable device or dubious method
entered into with a purpose to minimize tax incidence
leading up to the decision9 wherein the SC reiterated
and continued to enshrine the principles as laid out in
Duke of Westminster as under:

Further, in Bank of Chettinads case7, the Honble Privy

Council (PC) stated that:
...the tax authority is entitled and is indeed bound
to determine the true legal relation resulting from
a transaction. If the parties have chosen to conceal
by a device the legal relation, it is open to the tax
authorities to unravel the device and to determine the
true character of the relationship. But the legal effect of
a transaction cannot be displaced by probing into the
substance of the transaction...

...With respect, therefore, we are unable to agree with

the view that Duke of Westminsters case (1936)
AC 1 (HL); 19 TC 490 is dead, or that its ghost has been
exorcised in England. The House of Lords does not
seem to think so, and we agree, with respect. In our
view, the principle in Duke of Westminsters case (1936)
AC 1 (HL); 19 TC 490 is very much alive and kicking in
the country of its birth. And as far as this country is
concerned, the observations of Shah J. in CIT v. Raman,
(1968) 67 ITR 11 (SC) are very much relevant even
today... and

Another important Indian case8 addressing the substance

over form question reiterated the principles laid down
by the House of Lords in the decision of Duke of

...It thus appears to us that not only is the principle

in Duke of Westminsters case (1936) AC 1 (HL); 19 TC
490 alive and kicking in England, but it also seems to

While examining a legally valid transaction, the

Revenue authorities should proceed objectively and not
hypothetically attribute motives behind the taxpayers
action.
8

have acquired judicial benediction of the Constitutional

Bench in India, notwithstanding the temporary
turbulence created in the wake of McDowells case
(1985) 154 ITR 148 (SC).
Further, the SC in Azadi Bachao Andolans case observed
that:
The contention that the Double Taxation Avoidance
Convention (DTAC) between India and Mauritius
is ultra vires is not acceptable even if the DTAC
is susceptible to treaty shopping on behalf of the
residents of third countries.
A tax treaty or convention must be given a liberal
interpretation. A holistic view has to be taken in this
regard.
An act, which is otherwise valid in law, cannot be
treated as non-est merely on the basis of some
underlying motive (supposedly resulting in some
economic detriment or prejudice to the national
interest, as perceived by the respondents).
However, the Revenue authorities have over the years
challenged various forms of transactions entered into
by taxpayers, specifically with regard to cross-border
transactions. The recent example being in the case
of the purchase of shares by Vodafone International
of a foreign company, which held directly/indirectly

shares in an Indian company. In the matter before

the Bombay High Court, it was observed that the
domestic tax law recognizes the right of a taxpayer to
plan his transactions to reduce the incidence of tax.
In the absence of statutory provisions to the contrary,
instruments and legal structures which are utilized for a
bonafide business purpose do not permit an enquiry by
the authorities into the underlying economic interest.
However, the parties cannot conceal the nature of
their legal relationship by adopting a structure which is
different from the legal character assumed by them.
Considering the background to the ongoing tussle, the
intention of the Government in proposing to legislate
GAAR provisions could be drawn from the principle
for recognizing the continuum of Courts addressing
unforeseen implication of transactions under the tax
provisions and in the circumstances, to provide a vision
to an assumed obscure state of affairs.
However, it needs to be seen how the principles
enshrined through judicial pronouncements (being
principle based or purposive) would continue to be
followed under the proposed GAAR regime as is
proposed under DTC 2010, wherein the distinction
between tax avoidance and tax evasion is being sought
to be obliterated.

General Anti-Avoidance Rules India and International perspective

GAAR concept

A broad spectrum GAAR carries a real risk of

undermining the ability of business and individuals to
carry out sensible and responsible tax planning and that
on the other hand introducing a moderate rule which
does not apply to responsible tax planning, and is
targeted at abusive arrangements would be beneficial.
Legislatures in various countries are moving towards
promulgating General Anti-Avoidance Rules to address
the ongoing debate between illegal evasion and legal
avoidance, or what is termed as acceptable and
unacceptable avoidance of tax.
According to legal experts, the implementation of
GAAR has led to difficulties in various jurisdictions. In
spite of that, none of the jurisdictions have shown signs
of dispensing with the provisions; in fact, they have
revised the concept when judicial pronouncements have
refused to recognize the same.
However, GAARs should not be relied upon to address
foreseeable methods of tax avoidance occasioned
by statutory difference in the tax treatment of similar
transactions or relationships10. In these circumstances,
to the extent that the avoidance is considered
unacceptable, the preferred response for legislature
is to either amend the specific provisions at issue or
introduce a specific anti-avoidance to preclude their use
for unacceptable tax avoidance11.
In dealing with the issue of tax avoidance through a
legislative code or judicial principles, it is imperative to
provide clarity in dealing with the situation. This may be
through a purposive interpretation of legislation so as
not to offend the rule of law where such a general rule
could be considered to be on the boundary of having
no limits.
As stated by Judith Freedman12 in summarizing the
findings in the stated publication, there is a need for

10

better legislation, giving clearer signal to taxpayers,

better tools to the judiciary and an improved basis for
enhanced cooperation between taxpayers and revenue
authorities. Further, the only true solution to avoidance
is to have a more principle based tax system, but this
requires more than mere changes to wording and that
further work is clearly needed on forms of drafting
(rather than just pick and implement), both at the
specific and meta levels.
Further, in the recently released A study to consider
whether a GAAR rule should be introduced into the UK
Tax System, it has been stated:
....that introducing a broad spectrum GAAR would
not be beneficial for the UK tax system. This would
carry a real risk of undermining the ability of business
and individuals to carry out sensible and responsible
tax planning and that on the other hand introducing
a moderate rule which does not apply to responsible
tax planning, and is targeted at abusive arrangements
would be beneficial for the UK Tax system....

10 T Edgar: Designing and

Implementing a Target
Effective General AntiAvoidance Competence
11 David Duff-Relationships,
Boundaries and Corporate
Taxation: Compliance
and Avoidance in Era of
Globalization
12 Editorial Comment: Beyond
Boundaries: Developing
Approaches to Tax
Avoidance and Tax Risk
Management

International experience

Canada
General
A taxpayer is entitled to structure affairs so as to
minimize tax within the confines of the law. However,
tax planning (or tax minimization) must be contrasted
with tax evasion, which may render the taxpayer liable
to fines or imprisonment. Some forms of tax planning
are restricted through the use of specific anti-avoidance
provisions, more generally abusive planning, is checked
through a statutory GAAR.
Background of legislation
Canadian tax laws contain GAAR provisions since 1988.
Explanatory notes issued by the Federal Department of
Finance in 1988 stated that the rule:
....is intended to prevent abusive tax avoidance
transactions or arrangements but at the same time is
not intended to interfere with legitimate commercial and
family transactions. Consequently, the new rule seeks to
distinguish between legitimate tax planning and abusive
tax avoidance and to establish a reasonable balance
between the protection of the tax base and the need for
certainty for taxpayers in planning their affairs....
Trigger event
If a transaction is an avoidance transaction, the Canada
Revenue Agency (CRA) may deny the tax benefit that
would otherwise result. An avoidance transaction
is any transaction that would otherwise result in a
direct or indirect tax benefit, or that is part of a series
of transactions that would otherwise result in a tax
benefit. For GAAR purposes, a transaction includes an
arrangement or event. However, a transaction will not
be considered to be an avoidance transaction if it can
reasonably be considered to have been undertaken or
arranged primarily for bonafide purposes other than to
obtain the tax benefit.
Even if a transaction is an avoidance transaction, GAAR
will apply only if the transaction results in a misuse or
an abuse of the provisions of tax laws. In other words,
GAAR applies only to transactions that lack a bonafide
non-tax purpose and that result in a misuse or abuse of
the tax laws.
The Canadian Supreme Court in the case of Canada
Trustco Mortgage Co. [2005] SCC 54 established the

following principles to guide the interpretation of the

GAAR:
While the economic substance of a transaction
might be relevant at various stages of GAAR analysis,
economic substance has little meaning in isolation
from the proper interpretation of specific provisions
of the Act. Accordingly, any argument that is
based on notions of economic substance must be
considered in light of the specific provisions being
examined.
A finding of misuse or abuse is possible in the
following situations:
the taxpayer uses specific provisions of the tax
laws in order to achieve an outcome that those
specific provisions seek to prevent;
a transaction defeats the underlying rationale of
the provisions that are relied upon; or
an arrangement circumvents the application of
certain provisions, such as specific anti-avoidance
rules, in a manner that frustrates or defeats the
object, spirit or purpose of those provisions.
Abuse is not established if it is reasonable to
conclude that an avoidance transaction was within
the object, spirit or purpose of the provisions that
confer the tax benefit.
Recently, the Canadian Supreme Court had, in the case
of Copthorne Holdings Ltd. v. Canada, 2011 SCC 63,
observed that the general anti-avoidance rule scheme
is set out in the Act and requires that three questions
be decided: (1) was there a tax benefit; (2) was the
transaction giving rise to the tax benefit an avoidance
transaction; and (3) was the avoidance transaction
giving rise to the tax benefit abusive.
The Court further observed that in order to determine
whether a transaction is an abuse or misuse of the Act,
a court must first determine the object, spirit or purpose
of the provisions that are relied on for the tax benefit,
having regard to the scheme of the Act, the relevant
provisions and permissible extrinsic aids.
While an avoidance transaction may operate alone to
produce a tax benefit, it may also operate as part of
a series of transactions that results in the tax benefit.
While the focus must be on the transaction, where it is
part of a series, it must be viewed in the context of the
series to enable the court to determine whether abusive
tax avoidance has occurred. In such a case, whether a

General Anti-Avoidance Rules India and International perspective

11

transaction is abusive will only become apparent when

it is considered in the context of the series of which it is
a part and the overall result that is achieved.
The analysis will lead to a finding of abusive tax
avoidance: (1) where the transaction achieves an
outcome the statutory provision was intended
to prevent; (2) where the transaction defeats the
underlying rationale of the provision; or (3) where the
transaction circumvents the provision in a manner that
frustrates or defeats its object, spirit or purpose. These
considerations are not independent of one another and
may overlap.
Providing further guidelines, the Court emphasized that
the transaction may have a tax purpose, but that does
not necessarily mean that the tax purpose will always be
the primary reason for the transaction.
However, where a transaction takes place primarily for a
non-tax purpose, there will be no avoidance transaction.
In the absence of an avoidance transaction, the fact that
a transaction may have a secondary tax benefit purpose
will not trigger the GAAR. Whether the transactions are
between parties at arms length or not at arms length
should be immaterial (Stubart Investments Ltd. v. The
Queen, [1984] 1 S.C.R. 536).

Further, where corporate reorganization takes place,

the GAAR does not apply unless there is an avoidance
transaction that is found to constitute an abuse. Even
where corporate reorganization takes place for a tax
reason, the GAAR may still not apply. It is only when
a reorganization is primarily for a tax purpose and is
done in a manner found to circumvent a provision of
the Income Tax Act that it may be found to abuse that
provision. And it is only where there is a finding of
abuse that the corporate reorganization may be caught
by the GAAR.
Procedural requirements
In Canada Trustco, the Canadian Supreme Court laid
down the following procedural principles:
The onus is on the taxpayer to refute the following
(on a balance-of-probabilities basis):
the assertion that a tax benefit results from the
transaction. It is not permissible, however, for the
CRA to take the position that more tax would
have been paid if the taxpayer had engaged in
some other transaction or that the amount of tax
paid is less than some notional amount that the
CRA believes should have been paid; and
the assertion that the transaction was an
avoidance transaction. The taxpayer might be able
to refute this assertion by showing a bonafide and
primary non-tax purpose for the transaction.
If there is a tax benefit and an avoidance transaction,
the burden then falls on the CRA to establish that
there is abusive tax avoidance.
Australia
General
Tax avoidance generally involves a series of artificial or
contrived transactions undertaken with the objective of
reducing a taxpayers tax liability without committing
either criminal or taxation offences. Tax avoidance can
take a variety of forms, such as reducing or diverting
assessable income, increasing deductions and offsets,
deferring the payment of tax, manipulating business
structures, or altering the type and nature of transactions.
Background of legislation
Australias GAAR was introduced in 1981 and is
contained in Part IVA of the Income Tax Assessment Act
1936 (ITAA 1936).

12

John Howard, the then Treasurer, described the

objective of GAAR in these terms:
The proposed provisions embodied in a new Part
IVA seek to give effect to a policy that such measures
ought to strike down blatant, artificial or contrived
arrangements but not cast unnecessary inhibitions on
normal commercial transactions by which taxpayers
legitimately take advantage of opportunities available
for the arrangement of their affairs.
In his speech, the then Treasurer reaffirmed the limited
scope of the new legislative solution In order to confine
the scope of the proposed provisions to schemes of
the blatant or artificial variety, the measures in this
Bill are expressed so as to render ineffective a scheme
whereby a tax benefit is obtained and an objective
examination, having regard to the scheme itself and to
its surrounding circumstances and practical results, leads
to the conclusion that the scheme was entered into for
the sole or dominant purpose of obtaining a tax benefit.
The Australian GAAR is a provision of last resort, i.e. it
should not apply unless the taxpayers claim is otherwise
allowable. It, therefore, counters schemes that strictly
satisfy the technical requirements of the tax law,
including the ordinary provisions and SAAPs, but when
objectively viewed, are considered to be conducted
or carried out with the sole or dominant purpose of
obtaining a tax benefit.
If certain conditions are met, the provisions allow the
Commissioner to cancel all or part of any tax benefits
which a taxpayer derives from the scheme.
The three key conditions which must be satisfied for Part
IVA to apply are: (i) there must be a scheme, (ii) there
must be a tax benefit obtained in connection with the
scheme, and (iii) it must be reasonable to conclude that at
least one person entering into the scheme did so for the
sole or dominant purpose of obtaining a tax benefit.
On 18 November 2010, the Australian Government
released for public comment a Discussion Paper that
deals with the review of the existing anti-avoidance
rules. The paper deals with possible improvements to
both the general and specific anti-avoidance provisions
with a view to simplify as well as improve the operation
of these provisions.

Is there a scheme?
A scheme for these purposes is defined broadly as:
a) any agreement, arrangement, understanding,
promise or undertaking, whether express or implied
and whether or not enforceable, or intended to be
enforceable, by legal proceedings; and
b) any scheme, plan, proposal, action, course of action
or course of conduct.
It may comprise many steps or parts and is not
necessarily limited to the step that produced the tax
benefit. Furthermore, for any given scenario, it is
possible that a number of schemes may be identified
within the total steps undertaken.
Is there a benefit?
A tax benefit is obtained in any of the following cases
where the event would not have occurred but for the
scheme:
an amount is not included in assessable income,
including amounts which are converted from
assessable income to capital gains eligible for
discount treatment;
a deduction is allowed;
withholding tax is not payable;
property is disposed off under a dividend stripping
scheme;
a foreign tax offset is allowed; or
a capital loss is incurred.
What is the purpose?
The GAAR will only apply where at least one person
who entered into or carried out the scheme did so for
the sole or dominant purpose of enabling a taxpayer to
obtain a tax benefit. In order to ascertain the purpose
of the scheme the following eight matters should be
considered:
1) the manner in which the scheme was entered into or
carried out;
2) the form and substance of the scheme;
3) the time at which the scheme was entered into and
the length of the period during which the scheme
was carried out;
4) the income tax result that, but for Part IVA, would be
achieved by the scheme;
5) any change in the financial position of the relevant
taxpayer that has resulted, will result, or may
reasonably be expected to result, from the scheme;

General Anti-Avoidance Rules India and International perspective

13

6) any change in the financial position of any person

who has, or has had, any connection (whether of a
business, family or other nature) with the relevant
taxpayer, being a change that has resulted, will result
or may reasonably be expected to result, from the
scheme;
7) any other consequence for the relevant taxpayer,
or for any person referred to in (6), of the scheme
having been entered into or carried out; and
8) the nature of any connection (whether of a business,
family or other nature) between the relevant taxpayer
and any person referred to in (6).
Procedure for applying GAAR
The Commissioner of Taxation has released Practice
Statement13 which provides detailed guidelines for tax
officers on the practical application of Part IVA.
Interaction between the GAAR and other provisions
of the Taxes Acts
The operation of Part IVA of ITAA 1936 is not limited
by any other provisions of ITAA 1936, ITAA 1997, or
the International Tax Agreements Act 1953 (ITAA 53),
wherein all tax treaties are enacted as schedules.
Specific Anti-Avoidance Rules
There are a number of specific rules in the ITAA
1936 and ITAA 1997 targeted at certain schemes
that are regarded as impermissible by the Australian
Government. Examples of these (on a non-exhaustive
basis) are outlined below:
Alienation of income
A right to income arising out of the ownership of
property can be transferred. Where the right to income
is transferred but the property giving rise to the income
is retained by the transferor, the consideration received
for the transfer of the right to income is assessable as
income14.

14

This provision does not apply where the right to

income is transferred for a period of less than 7 years;
the parties to the transfer are associated and the
consideration for the transfer is less than an arms length
consideration; the transfer is then disregarded for tax
purposes and so the transferor remains assessable on
the income15.
Foreign tax credit schemes
Schemes entered into after 13 August 1998 to
acquire or generate foreign tax credits that can be
used to shelter low-taxed foreign-sourced income
from Australian tax. A specific power is provided
to the Commissioner to amend a foreign tax credit
determination.
Dividend stripping
Dividend stripping is not defined in the legislation. The
essence of dividend stripping is that value is taken out
of a company in the form of a dividend, normally an
abnormally large dividend which clears all the current
and accumulated profits out of the company, in order to
achieve a tax benefit.
In case of dividend stripping arrangement, the
Commissioner is allowed to cancel the tax benefits
derived by shareholders who sell their shares before
a dividend is declared. The share-dealing company in
such a situation is also denied a rebate in respect of the
dividend. A rebate is also denied where the purchaser of
the shares is not a share-dealing company but seeks to
claim the loss on the shares as a capital loss16.

13 PS LA 2005/24 Application

of General Anti-avoidance
Rule
14 Section 102CA ITAA 36
15 Section 102B ITAA 36
16 Section 46A and B ITAA 36

Dividend streaming
The scope of Part IVA includes franking credit trading
and dividend streaming schemes where one of the
purposes of the scheme is to obtain a franking credit
benefit17. Franking credit schemes involve the disposition
of shares or an interest in shares where the elements
described in the provision exist.
Where the company and the person receiving the
dividend or distribution are parties to the scheme, the
Commissioner has a choice as to whether:
to post a debit to the companys franking account;
or
to deny the franking credit benefit to the recipient of
the dividend or distribution.
The amount of debit to franking account is the amount
that the Commissioner considers reasonable in the
circumstances, i.e. not being an amount larger than
the debit to the franking account occasioned by the
payment of dividend.

GAAR audits and adjustments must be reported level

by level up to the State Administration of Taxation for
approval.
Specific Anti-Avoidance Rules
Apart from GAAR, China has specific rules concerning:
Transfer pricing
Thin capitalization
Controlled foreign companies
Recognition of a beneficial owner for treaty purposes
Impact on treaty usage
Under Article 58 of the EITL, treaty provisions prevail in
case there is a conflict with the provisions of the EITL.
Accordingly, absent any provision in a particular treaty to
the contrary and depending on the specific application
of the GAAR provision to the particular transaction,
this could be read to mean the provisions of that
treaty will prevail over the GAAR provisions of the EITL.
However, this issue has not yet been tested to date, and
accordingly, whether such a reading of the law will be
accepted remains unclear.

China
Time since in statute
The new EITL18, which came into effect on 1 January
2008, includes a general anti-avoidance provision
(Article 47 of the EITL).
What are the trigger events
Article 47 of the EITL provides: If an enterprise engages
in a business arrangement without bonafide commercial
purposes that results in reducing its taxable revenue or
taxable income, the tax bureau has the right to make
adjustments based on reasonable methods.

However, it may be noted that in many, if not most

cases, it is likely that GAAR would be applied to alter the
facts to which Chinese law would be applied, and as
such a conflict in so far as the treaty is concerned would
not arise.
It should be noted that the more recent treaties
concluded by China include provisions specifically
stating that domestic GAAR would operate to counter
transactions without justified commercial purpose but to
take advantage of the treaty benefits.
South Africa

The tax authorities may initiate a GAAR audit of

enterprises that enter into the following arrangements:
abuse of tax incentives;
abuse of treaties;
abuse of the corporate structure;
use of tax havens for the avoidance of taxes; and
other business arrangements without bonafide
commercial purposes.

17 Section 177EA ITAA 36

18 Enterprise Income Tax Law

Procedure for applying GAAR

Tax authorities identify potential cases for investigation
based on the information submitted by taxpayers or
gathered through their own channels.

General
GAAR operates as one of the measures to counter tax
avoidance, and is generally considered as a residual
measure, which may apply in addition to or as an
alternative to any other or specific anti-avoidance
provision.
Background of legislation
During 2006, the Income Tax Act 50 of 1962 was
amended to enable the South African Revenue Service
(SARS) to more effectively combat tax avoidance in
South Africa. Section 103(1), the general anti-avoidance

General Anti-Avoidance Rules India and International perspective

15

provision, was repealed and the GAAR was introduced.

The GAAR is contained in Part IIA of Chapter III of the
Income Tax Act and specifically applies to impermissible
avoidance arrangements as defined.
A provision against tax avoidance applies where:
an impermissible avoidance agreement has been
entered into with its sole or main purpose being to
obtain a tax benefit; and
in the context of business:
it was entered into or carried out in a manner
that would not normally be employed for
bonafide business purposes other than for
obtaining a tax benefit; or
it lacks commercial substance;
in the context other than business, it was entered
into or carried out by means or in a manner not
normally employed for a bonafide purpose, other
than obtaining a tax benefit; or
it has created rights or obligations which would not
normally be created between persons dealing at
arms length, or it would result directly or indirectly
in the misuse or abuse of the provisions of the
Income Tax Act.
Tax consequences
If the above requirements are met, South African
revenue authorities may:
disregard, combine or re-characterize the
arrangement or any step thereof;
disregard any accommodating or tax-indifferent
party or treat this party and any other party as one
and the same person;
deem the parties who are connected persons in
respect of each other as one and the same person;
re-allocate any income, receipt or accrual of a capital
nature or expenditure;
re-characterize any income of a capital nature as
income of a revenue nature;
treat the transaction as if it has not been carried out,
or in any other manner that in revenue authorities
view is adequate for the prevention or diminution of
the tax benefit.
Trigger event
The presence of certain criteria is considered as
indicative of tax avoidance. These include:
the legal substance of the arrangement as a whole
is inconsistent with, or differs significantly from, the
legal form of its individual steps;
16

the presence of round trip financing;

the presence of an accommodating or tax-indifferent
party (described as a party for whom the amounts
received from the arrangement are not subject to
normal tax, or the tax liability is significantly offset by
an expenditure incurred by that party in terms of the
arrangement);
the presence of elements which have the effect of
offsetting or cancelling each other.
Further developments
The SARS have recently released a Draft Comprehensive
Guide to the General AntiAvoidance Rule which
provides for guidance to revenue authorities on
interpretation and application of GAAR.
Broadly, in interpreting the provisions relating to GAAR,
the guideline provides that a tax benefit may be denied
under the GAAR if such tax benefit would misuse or
abuse the object, spirit or purpose of the provisions
of the Income Tax Act that are relied upon for the
tax benefit. It would require a purposive approach
to interpret the provisions of the Income Tax Act,
which is already the accepted approach to legislative
interpretation in South Africa. The introduction of the
misuse or abuse test is specifically directed at ensuring
that the remedy provided by the section is advanced and
that the mischief against which the section is directed is
suppressed. As a result, a mere literal interpretation of
the provisions will no longer safeguard a taxpayer who
applies the provisions in the Income Tax Act in a context
or manner which is not intended by the Income Tax Act.
Although it is accepted that where the substantive tax
provision is clearly articulated and free from ambiguity,
a departure from the ordinary meaning of the language
used is not required. The misuse or abuse requirement
in the GAAR nevertheless requires that the intention of
the legislator is considered in determining whether the
provisions of the Income Tax Act are applied in a manner
which is intended.
Further, the purpose test under the GAAR is a more
objective test, wherein the sole or main purpose of the
arrangement itself is the relevant purpose and no longer
the subjective purpose of the taxpayer.

India Regime

Proposed GAAR DTC 2010

Under the Code, GAAR will be invoked if the following
conditions are satisfied:
a) The taxpayer should have entered into an
arrangement.
b) The main purpose of the arrangement should be to
obtain a tax benefit and the arrangement:
i) has been entered into, or carried out, in a manner
not normally employed for bonafide business
purposes;
ii) has created rights and obligations which would
not normally be created between persons dealing
at arms length;
iii) results, directly or indirectly, in the misuse or
abuse of the provisions of this Code; or
iv) lacks commercial substance, in whole or in part.
Meaning of arrangement
An arrangement will mean any transaction, conduit,
event, trust, grant, operation, scheme, covenant,
disposition, agreement or understanding, including all
steps therein or parts thereof, whether enforceable or
not. Therefore, if the motive behind individual steps is
to obtain a tax benefit, but the overall scheme is not so,
the individual steps will nevertheless be treated as an
arrangement and the GAAR may be invoked.
An arrangement will also include any interposition of an
entity or transaction where the substance of such entity
or transaction differs from the form given to it.
Lack of commercial substance
The lack of commercial substance, in the context of an
arrangement, shall be determined, but not limited to, by
the following indicators:
i) The arrangement results in a significant tax benefit
for a party but does not have a significant effect
upon either the business risks or the net cash flows
of that party other than the effect attributable to the
tax benefit.
ii) The substance or effect of the arrangement as a
whole differs from the legal form of its individual
steps.
iii) The arrangement includes or involves:
a) round trip financing;
b) an accommodating party, as defined;
c) elements that have the effect of offsetting or
cancelling each other;

d) a transaction which is conducted through one or

more persons and disguises the nature, location,
source, ownership or control of funds; or
e) an expectation of pre-tax profit which is
insignificant in comparison to the amount of the
expected tax benefit.

The concepts of round trip financing and

accommodating party will be defined in the Code.
Tax consequences of impermissible avoidance
arrangements
If the conditions specified above are satisfied,
the Commissioner will be empowered to declare
the arrangement as an impermissible avoidance
arrangement and determine the tax consequences
of the taxpayer as if the arrangement had not been
entered into. For this purpose, he may:
i) disregard, combine, or re-characterize any steps
in, or parts of, the impermissible avoidance
arrangement;
ii) disregard any accommodating party or treat any
accommodating party and any other party as one
and the same person;
iii) deem persons who are connected persons in relation
to each other to be one and the same person for
purposes of determining the tax treatment of any
amount;
iv) re-allocate any gross income, receipt or accrual of a
capital nature, expenditure or rebate amongst the
parties;
v) re-characterize any gross income, receipt or accrual
of a capital nature or expenditure;
vi) re-characterize any multi-party financing transaction,
whether in the nature of debt or equity, as a
transaction directly among two or more such parties;
vii) re-characterize any debt financing transaction as an
equity financing transaction or any equity financing
transaction as a debt financing transaction;
viii) treat the impermissible avoidance arrangement
as if it had not been entered into or carried out
or in such other manner as the Commissioner in
the circumstances may deem appropriate for the
prevention or diminution of the relevant tax benefit;
or
ix) disregard the provisions of any agreement entered
into by India with any other country under section
265.

General Anti-Avoidance Rules India and International perspective

17

An arrangement declared as an impermissible avoidance

arrangement shall be presumed to have been entered
into or carried out for the main purpose of obtaining
a tax benefit unless the party obtaining the tax benefit
proves that obtaining a tax benefit was not the main
purpose of the avoidance arrangement.
Procedure for applying GAAR
The power to invoke GAAR is bestowed only upon the
Commissioner of Income Tax (CIT). For this purpose, the
Code empowers him to call for such information as may
be necessary. He is also required to follow the principles
of natural justice before declaring an arrangement as an
impermissible avoidance arrangement. He will determine
the tax consequences of such impermissible avoidance
arrangement and issue necessary directions to the
Assessing Officer for making appropriate adjustments.
The directions issued by him will be binding on the
Assessing Officer.
Key issues
The key issues / implications under the proposed GAAR
are:
Tax avoidance has been widely defined with the
objective to encompass a number of circumstances
and instances of tax avoidance, leading to
uncertainty and extensive litigation.
GAAR can be invoked where obtaining a tax benefit
is the main purpose, and it is not clear as to what is
meant by main purpose; the courts would be left to
decide whether in the given facts the main purpose
of the transaction/arrangement was to obtain tax
benefit.
Where an adjustment is made (invoking GAAR), it is
not clear whether the full effect of the same would
be given to ensure that there is no double taxation.
The onus of proving that an arrangement has not been
carried out for the main purpose of obtaining a tax
benefit is with the taxpayer, while the tax authorities
may not have any evidence of tax avoidance.
There is no cut-off date for applicability of GAAR
provisions to any arrangement and, therefore, where
the impact of past arrangements continues in Direct
Tax Code regime; the same may still be covered by
GAAR irrespective of the fact that the arrangement
has been approved by the tax officer or subjected to
judicial review.
19 Article 27

18

GAAR Tax Treaty

It has been provided that the GAAR provisions would
apply to a taxpayer notwithstanding that the treaty
provisions are more beneficial. Considering the
approaches as outlined before (under the Vienna
Convention and the OECD wherein the underlying
principle would be that GAAR could override the provisions of a treaty), it is important to note that OECD
Commentary on Article 1 of the Model Tax Convention
also clarifies that a general anti-abuse provision in the
domestic law in the nature of substance over form rule
or economic substance rule would not be in conflict
with the treaty.
However, as enshrined in the Vienna Convention19,
every treaty in force is binding upon the parties to it
and must be performed by them in good faith, Pacta
sunt servanda is based on good faith. This entitles states
to respect obligations. This good faith basis of treaties
implies that a party cannot invoke provisions of its
domestic law as a justification for a failure to perform.
Thus, if a legislature unilaterally enacts new domestic tax
laws which are contrary to an existing treaty, without
the treaty having been amended or terminated, such
action is violation of international law and also violates
the principles of pacta sunt servanda. This type of
treaty violation is known as treaty override.
Further, according to rules of legislative interpretation, specific legislation overrides general legislation.
Therefore, changes of a domestic law generally, which
could be the case with GAAR, may not affect the treaty.
Considering the same, in the absence of an anti-avoidance provision under the treaty, it remains to be seen
whether the provisions would be able to override the
treaty.
Specific anti-abuse rules
In addition to the GAAR provisions, the Code provides
for specific anti-avoidance rules to deal with some of
the following circumstances. These are similar to the
provisions under the Income-tax Act, 1961:
i) Certain payments deemed to be dividend [Clause
314(4) r.w 314(81)];
ii) Clubbing of income arising to other person by virtue
of a transfer without transfer of the asset [Clause
8(1)];
iii) Denying tax benefits to a business formed by

splitting up, or the reconstruction or a business

already in existence [Schedule 11, 12 & 13];
iv) Denying tax benefits to a business formed by
transfer to a new business of machinery or plant
previously used for any purpose [Schedule 11, 12,
13];
v) Expenditure incurred in relation to income not
includible in total income [Clause 18];
vi) Payment to associated persons in respect of expenditure [Clause 115];
vii) Transfer of shares to a firm or closely held company
without or for inadequate consideration [Clause
58(2)(j)];
viii) Carry forward and set off of losses in the case of
certain companies [Clause 66];
ix) International transactions not at arms length
[Clause 116];
x) Transactions resulting in transfer of income to nonresidents [Clause 119];
xi) Avoidance of tax in certain transactions in securities
[Clause 120].
Comparison of the proposals with legislation in
other jurisdictions
A comparison of the proposed Indian GAAR provisions

vis--vis other countries (discussed in the preceding

sections) indicates that the provisions are broadly on
the lines incorporated by South Africa. However, the
South African draft guidance indicates that in essence,
a tax benefit may be denied under the GAAR if such
tax benefit would misuse or abuse the object, spirit or
purpose of the provisions of the Income Tax Act that
are relied upon for the tax benefit. This clearly requires
a purposive approach to interpreting the provisions
of the Income Tax Act, which is already the accepted
approach to legislative interpretation in South Africa.
Further, as indicated under South Africa GAAR, the
purpose test is a more objective test, wherein the sole
or main purpose of the arrangement itself is the relevant
purpose and no longer the subjective purpose of the
taxpayer.
Thus, in implementation, one would need to adapt the
principle that the tax benefit would misuse or abuse the
object, spirit or purpose of the provisions of the Income
Tax Act. However, under the proposed law in India, even
where the main purpose of a step in the transaction, or
the part of a transaction is to obtain a tax benefit, the
arrangement would be presumed to be carried out with

General Anti-Avoidance Rules India and International perspective

19

the main purpose of obtaining a tax benefit. Though the

provisions indicate the establishment of main purpose, it
is unclear as to the methodology of determining the main
purpose. Further, the absence of simultaneous business
purpose or a bonafide purpose test and the mere
presence of a tax benefit give rise to the presumption that
the avoidance arrangement was designed and entered
into solely or mainly to obtain a tax benefit. This may also
lead to greater onus on the taxpayer to establish that
the main purpose was not the tax benefit. Hence, it is
imperative that the criterion of tax benefit should not
be made the sole purpose and object of invoking GAAR
provisions.
As such, it may be appropriate to adopt the approach
adapted under the Canadian provisions wherein it
is stated that an avoidance transaction means any
transaction
a) that, but for this section, would result, directly or
indirectly, in a tax benefit, unless the transaction
may reasonably be considered to have been
undertaken or arranged primarily for bonafide
purposes other than to obtain the tax benefit; or
b) that is part of a series of transactions, which
series, but for this section, would result, directly or
indirectly, in a tax benefit, unless the transaction
may reasonably be considered to have been
undertaken or arranged primarily for bonafide
purposes other than to obtain the tax benefit.
It is further provided that the provisions would be
applicable to a transaction only if it may reasonably be
considered that the transaction would result directly or
indirectly in a misuse of the provisions of any one or
more of the Act, treaty etc., or would result directly or
indirectly in an abuse having regard to those provisions.
Thus, under Canadian law and as even interpreted by
their Courts, the misuse or abuse test would involve a

two-part inquiry.
The first is to interpret the provisions giving rise to
the tax benefit to determine their object, spirit and
purpose which would be the question of law.
The second is to examine the factual context of a
case in order to determine whether the avoidance
arrangement defeated the object, spirit or purpose
of the provisions under consideration. This would
generally be a question both of law and fact, in
which the onus will be upon the Commissioner to
assess the factual element of the case.
Further, it may also be relevant to consider the recent
report on introduction of GAAR in the UK for some of the
methodologies and rules being suggested in this respect.
Hence, considering the intent of introducing GAAR,
there is a likelihood in implementing the provision
by underplaying the object, spirit and purpose of the
provisions and the arrangement based on the facts
of the case. In the circumstances, it may be advisable
to appreciate and adapt the two part inquiry in terms
of the provisions and the arrangement rather than
restrict it to determining whether the main purpose of
the arrangement was a tax benefit. Further, a single
objective test may undermine the importance of looking
into the objective and purpose of the legislation, which
may not be the intention of the legislation itself.
Case study in respect of applicability of the
proposed provisions
(Cases considered from the Canadian authorities
circular)
Case 1
A corporation transfers property used in its business
to a related corporation to permit the deduction of
non-capital losses of the related corporation. All of
the shares of the two corporations have been owned

It may be advisable to appreciate and adapt the two part

inquiry in terms of the provisions and the arrangement
rather than restrict it to determining the whether main
purpose of the arrangement was a tax benefit.
20

by the same taxpayer during the period in which the

losses were incurred.
Where the transaction could be considered as consistent
with the scheme of the Act, it may be argued that the
GAAR provisions would not be infringed. However, if a
transfer of a property or other transaction is undertaken
to avoid a specific rule, such as a rule designed to
preclude the deduction of losses after the acquisition of
control of a corporation by an arms length person, such
a transfer would be a misuse of the provisions of the
Act and be subject to provisions of the Act.
Thus, genuine corporate reorganization should not
be affected.
Case 2
A company has property with an unrealized capital
gain that it wishes to sell to a third party. A related
corporation, a wholly owned subsidiary has a net
capital loss. Instead of selling the property directly to
the third party and realizing a capital gain, the person
transfers the property to the related corporation. The
related corporation sells the property to the third
party and reduces the resulting taxable capital gain
by the amount of its net capital loss.
Where the provisions of the Act provide that the sale
to a related corporation should be at arms length,
it could be argued that the transaction may not
infringe the provisions as in determining the cost in
the hands of the related corporation, the cost to the
company would be considered.
Thus, the transfer of property by holding company
to subsidiary company or vice versa under Indian
regulations should not be impacted.

Case 3
An individual provides services to a corporation with
which he or she does not deal at arms length. The
company does not pay salary to the individual because
payment of salary would increase the amount of loss
that the company will incur in the year.
There may be a provision in the Act requiring salary to
be paid in these or any circumstances; the failure to pay
salary is, therefore, not contrary to the scheme of the
Act read as a whole.
In the circumstances, in the Indian context, the taxpayer
may choose to determine the terms of transactions
which are not expressly prohibited under the terms of
the Act.

Case 4
A taxable company has agreed to purchase all of
the shares of an operating company, which is also a
taxable Indian company The purchaser incorporates
a holding company which borrows the purchase
price and pays the vendor for the shares. The holding
company and the operating corporation amalgamate
so that the interest payable on the monies borrowed
to acquire the shares can be deducted in computing
the income from the business of the amalgamated
corporation.
Generally, leverage of debt by Indian companies and
subsequent amalgamation should not be considered
as abusive under GAAR. However, the implication
of provisions of Section 14A could be considered to
bring the same under a tax benefit and hence under
GAAR provisions.
Case 5
A taxable Indian company merges with another
taxable Indian company that is a shell company.
Upon merger, the shareholders who controlled the
predecessor receive common shares of the merged
company and the minority shareholders of the
predecessor receive redeemable preferred shares
that are immediately redeemed. The sole reason
that the minority shareholders receive shares instead
of cash is to cause the merger to comply with the
requirements of the Act.
Structuring of company reorganization through
redeemable preference shares should not be covered
by GAAR.
Case 6
A taxable Indian company has a subsidiary that is
sustaining losses and needs capital to carry on its
business. The subsidiary would not be able to obtain
any tax savings in the year. The holding company
borrows the money from a bank and subscribes to
the shares of the subsidiary and claims a deduction
for the interest.
Generally, based on judicial precedents, the interest
would be deductible for the holding company.
However, the implication of provisions of Section
14A could be considered to bring the same under a
tax benefit and hence under GAAR provisions.

General Anti-Avoidance Rules India and International perspective

21

Case 7
A non-resident company has an Indian subsidiary.
The subsidiary has substantial reserves and the
non-resident company desires to cash out by selling
to an unrelated party. The gains on sale would be
substantial and subject to higher rate of tax. The
subsidiary distributes the reserves as dividend,
which reduces the valuation of the company. The
non-resident then sells the subsidiary.
The payment of the dividend and the consequent
DDT on such dividend should not be construed as
covered under GAAR.
Case 8
A non-resident company has an Indian subsidiary.
The subsidiary has been capitalized by nominal
capital only and it has taken substantial borrowings
from group companies and/or third parties
(non-residents/residents) such that the debt is several
times the equity for the Indian subsidiary. A question
may arise on the deductibility of interest paid by
the Indian subsidiary for the reason that it is thinly
capitalized.
Under the current income tax law, there are no
specific provisions for disallowance of interest on the
basis that the taxpayer is thinly capitalized, However,
under the proposed GAAR provisions (where tax
benefit is the purpose) coupled with the transfer
pricing provisions (arms length principle), the tax
authorities may consider disallowance of interest
provided the conditions are satisfied. However, it
is relevant to note that countries have adopted
thin capitalization rules based on the principle of
either the fixed ratio approach or the arms length
approach or the safe harbor approach.

22

Case 9
A non-resident company has an Indian subsidiary.
The subsidiary has substantial reserves and the Indian
subsidiary desires to repatriate surplus cash through
buy back of its shares and no tax is paid in India on
the profits repatriated for the reason that the capital
gain on buy back of shares is exempt in India under
the applicable treaty of the non-resident.
The shares may be bought back by the Indian
subsidiary for a number of reasons, namely, to
increase holding of resident shareholders, increase
the earnings per share or to pay surplus cash not
required by business, etc. Further, the provisions
of the proposed Code also specifically provide that
distribution of profits through a scheme of buy back
of shares under the applicable provisions of the
Companies Act shall not be deemed as dividend.
Accordingly, the buyback of shares should not be
subject to GAAR provisions merely because no Indian
tax has been paid in the transaction.

Way forward

The GAAR provisions are like a double-edged sword

and would need to be judicially invoked by the revenue
authorities.
As discussed earlier, the Courts in India have examined
the issue of tax avoidance and laid down the principles
as to what constitutes tax avoidance. In light of the
various judicial precedents, the tax authorities in India
tend to raise the issue of tax avoidance and deny relief
to the taxpayer. Given the uncertainties involved in such
application, it is imperative for the proposed GAAR to
be successful; it should not impact genuine business
transactions or promote uncertainty. One of the key
objectives for introducing the Direct Tax Code is to
simplify the language to enable better comprehension
and remove ambiguity to foster voluntary compliance,
thus reducing litigation. However, the scope of GAAR
provisions in the present draft could cause massive
uncertainty and lead to extensive litigation as potential
legitimate tax planning could also become the target of
GAAR.
In this connection, it would be imperative that the
guidance note to be formulated should be sensitive to
the issue of addressing avoidance from the prospect
of upholding the rule of law, the object and purpose
of the legislation, rather than be construed as law in
itself and giving a free rein to administrative or judicial
discretion. Some suggestions on reframing/modeling the
provisions on the basis of international experience may
be adopted:
Legislation
Our model could be based on the Canada model the principles laid down by Canada Supreme Court
to be adhered.
The tax benefit on the transaction should not be
the only criterion. If the transaction is done where
tax benefit and commercial benefit are present, the
transaction should not be covered by GAAR.
The provisions could be made applicable in respect
of transaction where entering into the transaction
and the cause and effect of the transaction occur
after the date of implementation.

Detailed guidelines to be provided on the lines of the

Canadian law with relevant examples illustrating the
reasons and analogy in applying GAAR provisions.
GAAR should not be judged on the basis of a single
transaction, but on a series of transactions. Further,
where no tax benefit arises under the whole series
of transactions, the same should not be subject to
GAAR evaluation, even though a part of the series
may result in tax benefit.
Corresponding adjustments to be provided in the
hands of the parties to the transaction.
Procedural
If CIT finds a transaction, which comes under the
purview of GAAR, the same may be referred to an
independent quasi-judicial body.
The CIT and taxpayer can make submissions and the
ruling by the quasi-judicial body can be final.
Threshold limit should be around Rs 150 million on
the lines of transfer pricing assessment.
Provision of Advance Ruling facility - existing
definition under the Code to be widened to include
GAAR.
Treaty and other provisions
Treaty override could be implemented through
protocol with the respective countries providing
for limitation of benefits and beneficial ownership
principles therein.
It may be more appropriate to provide for thin
capitalization rules which could also be covered
under transfer pricing provisions than allowing the
same to be covered under GAAR.
In this context, we may refer to what Chris Evans, has
written in his Article Containing Tax Avoidance: AntiAvoidance Strategies (2008)
It may be too cynical to assume the existence of tax
avoidance as a constant and perpetual motivation
for every taxpayer20, but there is no doubt that tax
avoidance is widespread and that it presents a major
problem for those concerned with public finance
issues. There is some evidence that the aggressive retail

20 C.H. Gustafson, The

Politics and Practicalities of
Checking Tax Avoidance
in the United States in G.
S. Cooper, Tax Avoidance
and the Rule of Law,
(Amsterdam: IBFD, 1997),
at p 376.

General Anti-Avoidance Rules India and International perspective

23

marketing of tax avoidance products and schemes may

have been constrained in recent years, but avoidance
activity is by its nature opportunistic and ad hoc. Simply
raising the price of avoidance (through successful
containment, increased regulation and constrained
supply) will not choke off demand.
Indeed, no single response or approach whether
administrative, legislative or judicial can adequately
or effectively contain avoidance activity. Such
containment only begins to occur where strategies
drawn from all three spheres complement each other
by operating in combination. As Sir Ivor Richardson
astutely pointed out some years ago, current
requirements for a comprehensive and integrated
approach go beyond a more traditional analysis where
the legislature exerts control of tax avoidance
through special and general anti-avoidance provisions;
the revenue administration contributes in administering
those provisions and exercising discretions; and the
judiciary is expected to strike the right balance between
acceptable and unacceptable tax planning through its
interpretation and application of tax legislation21.
Ultimately, however, corporate and personal taxpayers
themselves have to take responsibility for the level
of avoidance and the degree of acceptance of such
behaviour that exists at any time in any society. The
revenue authority, the legislature and the judiciary
can play a role in shaping the demand for, and supply
of, tax avoidance activity, but such issues belong, in
the final analysis, in the realms of moral and ethical
behaviour of the taxpayers themselves. Corporate and

24

personal social responsibility and the reputational

damage that excessive and egregious avoidance
activity can attract remains the ultimate deterrent,
notwithstanding the impressive arsenal that can be
available to those who seek to counter avoidance.
Beyond that we should also perhaps be mindful
that two of the traditional goals of public finance
simplicity and equity have critical roles to play in
determining social responses to avoidance activity.
In recent years, these two goals may have been less
prominent in tax reform than the efficiency goal that
lends itself to easier economic measurement and
evaluation.
It is paradoxical that the more complex that the
tax regime becomes (often in attempts to contain
avoidance activity), the more likely it will be that
opportunities for avoidance will arise. Avoidance
activity thrives in complexity and uncertainty. And
where that complexity exacerbates the natural
interaction (sometimes mediated by intermediaries)
between the taxpayer and the revenue authority such
that it becomes frictional rather than cooperative,
there will almost inevitably be a higher probability of
avoidance activity.
It may be relevant for taxpayers to examine the
transactions/arrangements entered into, so that
the same do not fall within the boundary of being
considered as impermissible avoidable transactions
entered into with the object of obtaining a tax benefit.

21 I. Richardson, Reducing

Tax Avoidance by Changing
Structures, Process and
Drafting in G. S. Cooper,
Tax Avoidance and the Rule
of Law, (Amsterdam: IBFD,
1997), at p 327.

Notes

General Anti-Avoidance Rules India and International perspective

25

Contacts

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26

General Anti-Avoidance Rules India and International perspective

27

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