GAAR- Generally Anti Avoidance Rules

This was presented by the then Union Finance Minister Mr Pranab Mukherji in the budget 2012-13.This is tool that can restrict the tax evasion done regularly from the tax heavens like Mauritius, Luxemburg, Switzerland.

However it was given an extension to implement till April 2015 due to the uncertainty over its implementations.
In the Budget 2014 by FM, this issue was again taken for discussion and markets gave a fierce reaction again!
Most of the Indian companies which operate in the international space or the HNIs or FIIs have taken undue advantage of low tax business regime which was intended to strengthen the business ties with the specific regions.

In more precise words the Mauritius route can be described as a channel used by individuals and Multi National Companies to evade paying taxes in India. The tax evasion in India through this route is estimated to be in tune with 55 billion dollar, mostly attributed to the loopholes in a bilateral agreement on double taxation.
The basic criticism of a statutory GAAR which is raised worldwide is that it provides a wide discretion and authority to the tax administration which can cast an excessive tax and compliance burden on the taxpayer without commensurate remedies.

One of the methods by which this can be addressed is to provide guidance on what the provisions entail and how they would be administered. These guidelines are meant to provide explanations and clarity regarding the GAAR provisions.
Following are a few prominent cases of GAAR provisions decisions.
They are only few but commonly occurred while and referred from the official document explaining the invocation conditions.

Case:
A business sets up an undertaking in an under developed area by putting in substantial investment of capital, carries out manufacturing activities therein and claims a tax deduction on sale of such production/manufacturing. Is GAAR applicable in such a case ?
Interpretation:
There is an arrangement and one of the main purposes is a tax benefit. However, this is a case of tax mitigation where the tax payer is taking advantage of a fiscal incentive offered to him by submitting to the conditions and economic consequences of the provisions in the legislation e.g., setting up the business only in the under developed area. Revenue would not invoke GAAR as regards this arrangement.

Case:
A business sets up a factory for manufacturing in an under developed tax exempt area. It then diverts its production from other connected manufacturing units and shows the same as manufactured in the tax exempt unit (while doing only process of packaging there). Is GAAR applicable in such a case ?
Interpretation:
There is an arrangement and there is a tax benefit, the main purpose or one of the main purposes of this arrangement is to obtain a tax benefit. The transaction lacks commercial substance and there is misuse of the tax provisions. Revenue would invoke GAAR as regards this arrangement.

Case
`A` company borrowed money from a company `B` and used that to buy shares in three 100% subsidiary companies of `A`. Though the fair market value of the shares was Rs. Y, `A` paid Rs. 6Y for each share. The amount received by the said subsidiary companies was transferred back to another company connected to `B`. The said shares were sold by A for Rs. Y/5 each and a short-term capital loss was claimed and this was set-off against other long-term capital gains.
Interpretation:
By the above arrangement, the tax payer has obtained a tax benefit and created rights or obligations which are not ordinarily created between persons dealing at arms length. Revenue would invoke GAAR with regard to this arrangement.

Case:
An employee of a private limited company A is to receive a bonus or salary. The employee subscribes for preferential shares of the employer. The preferential shares are purchased by a connected company of A, or are redeemable at a premium that reflects a portion of the employees annual salary or bonus, after a period of one year. In this manner, the employee receives the income as capital gain.
Interpretation:
The acquisition of the preferential shares is part of an arrangement designed to avoid the tax that would have been required to be paid on salary. By this arrangement, there is a tax benefit and there is a misuse of the tax provisions. The Revenue would invoke GAAR with regard to this arrangement.

Case:
A company A in country X invests in a company B situated in country R . Country R has a provision of residence based taxation of capital gains in its tax treaty with India. B further invests the funds in equities in India and earns capital gains. B does not have substantive commercial substance in country R .
Interpretation:
If A invests directly in India, it does not get benefit of treaty and has to pay capital gains tax in India. By routing the funds through B in country R, the payment of capital gains tax in India has been avoided. This is an impermissible avoidance arrangement and revenue would invoke GAAR with regard to this arrangement.

Case:
A company sets off losses in the stock market against gains which is aimed at balancing the portfolio.
Interpretation:
Sale/purchase through stock market transactions where the buyer and seller are anonymous to each other would not come under GAAR provisions. GAAR provisions could be invoked based on specific facts where transactions are not anonymous i.e. parties are related to each other or a transaction has been entered into through a pre-arrangement between unrelated parties who have been brought together by an intermediary like a broker in order to adjust profit and losses between themselves.

Case:
Company A , is incorporated in country ABC as a wholly owned subsidiary of company B which is not a resident of ABC or of India. The India-ABC tax treaty provides for non-taxation of capital gains in the source country and country ABC charges a minimal capital gains tax in its domestic law. Some shares of an Indian Company C were acquired by A. The entire funding for investment by A in C was done by B. A has not made any other transaction. These shares were subsequently disposed of by A, thus resulting in capital gains which A claims as not being taxable in India by virtue of the India- ABC tax treaty.
Interpretation:
The beneficial ownership vests with the connected company B which had played a crucial role in the transaction conducted by A. Though the legal ownership ostensibly resides with the A, the real and beneficial owner of the capital gains is the B Company which controls the connected company A . This is an arrangement which has been created with the main purpose of avoiding capital gains tax in India through misuse or abuse of tax provisions. Hence it is impermissible arrangement. Revenue would invoke GAAR as regards this arrangement.

Case:
A foreign bank Fs branch in India arranges loan for Indian borrower from F banks branch located in a third country. The loan is later assigned to F banks branch in XYZ country to take benefit of withholding provisions of India-XYZ treaty (India-XYZ Treaty provides no source based withholding tax on interest to a bank carrying out bona-fide business.)
Interpretation
Since there is no withholding provision on interest earned by XYZ residents under the India-XYZ treaty, the above arrangement of finalizing the loan from one country and assigning it to another country has been made to avoid withholding provisions. This is a misuse of tax treaty and thus will be treated as an impermissible avoidance arrangement. Revenue would invoke GAAR with regard to this arrangement.

Case:
An Indian company is in the business of import and export of certain goods. It purchases goods from Country A and sells the same in country B. It sets up a subsidiary in Country X - a zero/ low tax jurisdiction. The director of the Indian company finalizes the contracts in India but shows the documentation of the purchase and sale in Country X. The day to day management operations are carried out in India. The goods move from A directly to B. The transactions are recorded in the books of subsidiary in country X, where the profits are tax exempt.
Interpretation:
A company is camouflaging the sale and purchase transactions as X country based transactions. By this arrangement, the Indian company has obtained a tax benefit. The substance or effect of the arrangement as a whole is inconsistent with, or differs significantly from, the forms of its individual steps and hence, lacks commercial substance. Revenue would invoke GAAR with regard to this arrangement.

Conclusion
GAAR has become a headache for investors as many of the FII and domestic companies have every now and then used the loopholes to the fullest extent. Any action against this arrangement would trigger selling by the large institutions and FIIs. Uncertainty also hovers around the idea that GAAR can also be misused by the authorities. But it is a fact that if implemented in the right manner GAAR can function to recover Billions of dollars revenue from the tax evaders