GAAR probe begins on companies suspected of tax avoidance

Recently, the revenue department has launched investigations under the General Anti-avoidance Rule (GAAR) into companies and entities that may have used creative methods to avoid paying taxes.

• A Hyderabad-based company, Ekge Retail, has received a notice in which the department has applied Section 96(1)(d) of the Income-tax Act, which deals with impermissible agreements undertaken to avoid taxation.
• The company has now approached the high court for state of Telangana at Hyderabad challenging the applicability of the section for some transactions undertaken by it in 2018 and 2019.

About General Anti-avoidance Rule (GAAR)

• It was first introduced in 2012.
• The provisions of GAAR are contained in Chapter X-A of the Income Tax Act, 1961.
• The GAAR provisions are effective from assessment year 2018-19 onwards, i.e. financial year 2017-18 onwards.
• The GAAR provides that certain transactions would be "impermissible avoidance arrangement" (IAA) if
  • The main purpose is to obtain tax benefit
  • It has one of the following characteristics:
    • It creates rights and obligations, which are not normally created between parties dealing at arm's length
    • It results in misuse or abuse of the provisions of the tax law
    • It lacks commercial substance and
    • It is carried out by means or in a manner which is normally not employed for an authentic (bona fide) purpose.

Procedure

• The government has now specified a procedure in which GAAR notices can be issued.
• It was decided that before issuing a notice, a tax officer must escalate the matter to a tax commissioner.
• If the commissioner is convinced, then it will be forwarded to a panel, which will have to give its approval before any action is taken.

Constitution of the panel.

• GAAR has existed in its current form in the regulations since 2017-18, but its effective implementation started this year only after the constitution of the panel.
• The main objective of this panel is to ensure that it is invoked fairly and to avoid subjectivity at the level of officers to pick up cases.
• GAAR would go into effect if the tax department thinks that some transactions or structures in or outside of India were set up or done just to avoid paying income tax.
• Any decision by a company to set up an office in another country or undertake a merger or acquisition merely as part of tax planning could attract GAAR.

Global Scenario

• In the meanwhile, several advanced economies have implemented the GAAR, prominent among them are- the US, the UK, France, Germany, the Netherlands, Canada, New Zealand, China, Poland and Australia.

Why GAAR?

• Tax avoidance is legal; but now, large scale revenue loss is occurring due to aggressive tax planning by corporations using avoidance opportunities.
• Governments in many countries are introducing anti- avoidance rules to check this revenue loss from excessive avoidance.
• It aims to address tax avoidance and ensure that those in different tax brackets are taxed the correct amount.
• It empowers the revenue authorities to deny tax benefits transactions or arrangements which do not have any commercial substance or consideration other than achieving the tax benefit.

Issues with GAAR

• A common criticism of GAAR is that it provides discretion and authority to the tax administration which can be misused.
• There are fears that GAAR will discourage foreign investment in India.
• It was considered controversial and there was a demand that the government put in proper checks and balances
• Unreliable and inadequate data is also a major constraint.

Conclusion

• To prevent misuse of GAAR provisions by the tax department, adequate safeguards have also been put in place.
• The government has clarified that GAAR will not be invoked in cases where investments are routed through tax treaties that have a sufficient limitation of benefit (LOB) clause to address tax avoidance.
• An LOB clause in tax treaties generally requires investors to meet certain spending and employment criteria to avail the benefits of the treaty, to ensure that only genuine resident companies benefit from the pact.
• The government has specified that all transactions or arrangements that have been approved by courts and quasi-judicial authorities like the authority for advance ruling and that specifically address the issue of tax avoidance will not be subject to the GAAR test

Exam Track

Prelims Take Away

• GAAR
• LOB Clause