A distinct welcome feature in the guidelines is the recognition that GAAR provisions are a codification of substance over form rule and that the transactions should not be looked at in isolation. As assured by the erstwhile finance minister, the guidelines clearly specify that the onus of proof of an arrangement being impermissible would be on the revenue, who needs to act on the principles of natural justice. The proposals to have a monetary threshold as a relief to the small taxpayers and statutory forms for transparency in procedures are steps in the right direction.
Another positive feature is the assurance given by the guidelines that in normal circumstances, GAAR will not be invoked in cases where SAAR is applicable, though exceptional abusive behaviour could invite the invocation of GAAR.
However, what is disappointing is that the guidelines fall short of clarifying the very constituents of tax avoidance. Also, they provide little conceptual discussion on fundamental and serious issues such as treaty shopping, thin capitalisation, arbitrage transactions and circumstances that could motivate the piercing of the corporate veil.
It is not enough for the guidelines to state that GAAR will not impact tax mitigation exercise supported by a fiscal incentive. It must be clarified that when a taxpayer, for reasons of tax efficiency, opts for one of the two permissible methods or ways of completing a transaction, regardless of whether taxpayer is or is not concerned with a specific fiscal incentive in the law, it would not constitute tax avoidance. Such specific clarification would be an extension of the illustration which acknowledges that a taxpayer can opt to lease an asset instead of buying an asset. Most importantly, it must be clearly brought out that invocation of GAAR would be restricted to cases where there is largely an artifice or make believe or mere paper work unaccompanied by commercial purpose or commercial consequences.
In some international jurisdictions, the tax authority invoking GAAR is expected to provide comparable counter-factuals of the arrangement and suggest how the arrangement should have been accomplished reasonably, but without compromising on all commercial and business advantages of the taxpayer arrangement. This is an important ingredient which deters the tax authority from ignoring commercial realities. The guidelines are silent on this point.
The very starting point of what constitutes main purpose of obtaining tax benefit continues to be elusive. It must be clarified, in context and spirit, that only the arrangement with an eye on tax benefit as its predominant driver without there being a real commercial purpose would be targeted. Further, the presence of tax benefit should be judged by combining all connected parties to an arrangement.
The denial of exemption for capital market transactions from GAAR ambit has come as a let-down for the FII community and could have an adverse impact on the investments flowing into India. Though some comfort is sought to be provided through safe harbour rules to the FIIs subject to payment of domestic taxes, it would be desirable to provide a straightforward carve-out from GAAR for all portfolio investments, whether the investors are FIIs or P-Note holders.
The examples illustrated in the document carry merit. The revenue department ought to intervene where there is an exemption claimed for a packaging or labelling unit; or, in clear instances of circular trading, unconscionable and artificial loss claim and a paper company which does nothing except producing invoices etc. However, most of these cases are too simplistic. It is the complex transactions which are more likely to attract GAAR.
More illustrations from stakeholders would help make the guidelines more comprehensive and helpful. For instance, the illustrations could include acceptance by the department that compliance with Limitation of Benefits (LOB) test of DTAA will be respected unless there are compelling heavy reasons and that a structure established prior to GAAR will not be questioned unless it was conceived as part of an indivisible scheme or design which is implemented after March 31, 2013. After all, Indian tax law has generated enormous litigation and it would be a public service if there are no additions thereto. Illustrations may also be given for group transactions such as grant of interest free loan by a parent company to a subsidiary in business interest that would be excluded from GAAR.
A fundamental maxim is that justice should not only be done, but should appear to be done. Towards this end, the approving panel should comprise of minimum two independent persons. A bureaucratic panel cannot inspire confidence on an ongoing basis.
As per section 101 of the Finance Act 2012, GAAR provisions are to be interpreted in accordance with the guidelines. Therefore, care should be taken to publish illustrations by way of a separate circular to ensure that the illustrations do not form part of law under the above section.
All in all, this is a welcome effort to give further clarity on the application of GAAR to commercial situations. It will be desirable to provide conceptual clarity on the lines indicated above if the avowed objective of avoiding protracted litigation and greater certainty is to be met.
The author is national tax leader, Ernst & Young. These are his personal views