GAAR - General Anti Avoidance Rule

Posted on : 04 January, 2022 11:23

General anti-avoidance rule (GAAR)

We all are aware of the fact that the government generates most of its revenue from taxes which they collect from individuals or organizations. A number of individuals and organizations sometimes adopted such practices through which they maximize their profit by avoiding the tax. A number of mature economies like Canada, Austria, Germany, and France have adopted general anti-avoidance rules (GAAR) to make their tax system more transparent and to avoid tax leaks.

What is GAAR?

GAAR Meaning:- GAAR (General anti-avoidance rule) is the rule which is made to empower the revenue authority in a country to deny tax benefit of transactions or arrangements which do not have any commercial substance and transaction is done with the sole purpose of achieving the tax benefit. It generally brings to strengthens the integrity of the tax system.

Background

Article 265 of the constitution of India empowers the government to levy or collect tax from the people of India. In any case when a person escaping from paying tax generally would be liable for tax evasion under Indian laws.

There is an urgent need that was found by the government in 2007 after the Vodafone case, the biggest sensation of Indian taxation history under which the Indian government claimed for us$2milion lost in taxes. In India, the discussion on GAAR came to light with the release of the draft Direct tax code bill on 12 August 2009. Later its revised paper was tabled in parliament on 30 august 2010. The Parthasarthy shome panel was set up in 2012 to draw the final guidelines on GAAR. This committee recommends deferring the GAAR by three years. It also recommends some investor-friendly measures such as

It also suggested that the income from the sale of listed securities should be exempted from the taxpaying
More certainty on entitlement to tax treaty benefits should be there for investors from Mauritius and Singapore.
GAAR should be used as a last resort not as the first case.

Ultimately GAAR, framed by the Department of Revenue under the Finance Ministry came into effect from April 2017. Its provision comes under the Income-tax act 1961. It is effective from the assessment year 2018-19, applied to the transactions which are prima facie legal but result in tax reduction.

Broadly tax reduction can be classified into the following three categories;

Tax mitigation- Tax mitigation is a positive term and is permitted under the act. It is the term for a situation where the taxpayer takes advantage of a fiscal incentive provided to them by tax legislation by complying with its condition. This tax reduction is acceptable by the government.
Tax evasion- It is an illegal activity in which a person or entity deliberately avoids the taxpayers. Willful tax erosion is a federal offense under the Internal revenue service tax code. This is not covered by GAAR as the existing jurisprudence is sufficient to cover tax evasion.
Tax avoidance -It refers to the minimization of the tax amount owed by an individual or a business by using legal methods or by taking advantage of loopholes. The tax credit, deductions, income exclusion, and loopholes are forms of tax avoidance. Millions of individuals and businesses use some form of tax avoidance to cut down their tax payments.

GAAR is specifically brought for such transactions whose sole intention is to avoid tax or which have the implication of avoiding tax.

Key features of the GAAR

The GAAR provisions being enacted in India are largely modeled on South African GAAR, which seeks to incorporate the substance over form doctrine in Indian tax laws.
It will be applicable to arrangements regarded as Impermissible avoidance agreements(IAA) and can enable tax authorities to re-characterize such arrangements and deny tax benefits or treaty benefits so as to curb any means of tax avoidance.

As per section 96 of the IT act, Impermissible agreements are arrangements whose main purpose is to obtain a tax benefit in addition to the satisfaction of at least one of the four tainted element tests as,

Creates rights or obligations which are not ordinarily created between persons dealing at arm’s length.
This results in the misuse or abuse of the provision of the act.
Lacks commercial substance
Carried out in a manner which is not ordinarily employed for the bonafide purpose.

Procedure for Invoking

The arrangement for an IAA was first examined by the tax officer.
Later it shall be referred to the Principal Commissioner or Commissioner of income tax to declare an arrangement as IAA if the tax officer finds the need of GAAR to be invoked.
If the CIT satisfied GAAR to be invoked then a notice would be sent to the taxpayer.
The taxpayer has to furnish his objection within 60 days.
When it is satisfied that the arrangement is IAA then it shall refer to the approving panel.
When the approving panel is satisfied that the arrangement is IAA, it shall issue directions declaring the arrangement as IAA.
The declaration is to be passed within six months from the date on which reference was received.
The decision of the approving panel is binding on CIT and no appeal is permitted against its order.
The taxpayer can either appeal to the Income-tax appellate tribunal or can file a writ in the High court if he finds that the decision of the panel violates the principle of natural justice or there is any misapplication of the law.
GAAR provisions also provide for setting up Advance Ruling authority, where there would be a mechanism on obtaining an advance ruling on whether the arrangement is permissible or not.

Impact analysis

Although the GAAR has a strong implication in strengthening the taxation system and halting the tax avoidance strategy which generally adopted by the individual or organization in their business, it also faces a number of criticism as

Regulations are difficult to implement as it is hard to differentiate between different types of avoidance practices..
It is considered to be too harsh in nature which may torture the general honest taxpayer too.
It has given a wide discretionary power in the hands of tax authorities which apprehends to be misused and abused.
GAAR does not provide for any separate appeal mechanism.

The government needs to come up with more clarification and better guidelines, to maintain a balance between investor interest in the Indian economy and at the same time fight with the anti-abusive provisions. The tax authorities and the taxpayers evolve gradually to get accustomed to the provision of the GAAR. There should be clarity on the ambiguities in GAAR provisions and must adopt the global best practices in its implementation.

How is GAAR differentiated from SAAR?

GAAR is the general anti-avoidance rule as we discussed above whereas SAAR is the special rule targeted at individuals on case-by-case-specific provisions.