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transcript
Case studies on General Anti-Avoidance Rules (GAAR)
1 May 2020
CA Pinakin Desai
Case Studies on General Anti-Avoidance Rules (GAAR) May 20202
Introduction to GAAR
Case Studies on General Anti-Avoidance Rules (GAAR) May 20203
► Tax planning is legitimate provided it is within the framework of law
► A tax-saving motive does not justify the taxing authorities or the courts to nullify or
disregard otherwise proper, valid and bona fide transaction
► However, law does not protect transactions that are a colourable device or sham
► Vodafone Holdings BV [2012] 341 ITR 1 (SC):
“DTAA and Circular No. 789 dated 13.4.2000, in our view, would not preclude
the Income Tax Department from denying the tax treaty benefits, if it is
established, on facts, that the Mauritius company has been interposed as
the owner of the shares in India, at the time of disposal of the shares to a
third party, solely with a view to avoid tax without any commercial
substance.”
Judicial GAAR (JAAR) – Precursor to GAAR
Case Studies on General Anti-Avoidance Rules (GAAR) May 20204
► Azadi Bachao Andolan [2003] 132 Taxman 373 (SC):
“The situation in the United State is reflected in the following passage from
American Jurisprudence:
“…If a taxpayer at assessment time converts taxable property into non-
taxable property for the purpose of avoiding taxation, without intending
a permanent change, and shortly after the time for assessment has passed,
reconverts the property to its original form, it is a discreditable evasion of the
taxing laws, a fraud, and will not be sustained…”
….
If the Court finds that notwithstanding a series of legal steps taken by an
assessee, the intended legal result has not been achieved, the Court might be
justified in overlooking the intermediate steps, but it would not be permissible
for the Court to treat the intervening legal steps as non-est based upon
some hypothetical assessment of the 'real motive' of the assessee. In our
view, the court must deal with what is tangible in an objective manner and
cannot afford to chase a will-o'-the-wisp.”
Judicial GAAR (JAAR) – Precursor to GAAR
Case Studies on General Anti-Avoidance Rules (GAAR) May 20205
Overview of GAAR
► An arrangement is an impermissible avoidance arrangement (IAA) if:
OR
OR
OR
Primary condition Tainted element presence
Main purpose
is to obtain tax
benefit
Creates rights, or obligations, which are not ordinarily
created between persons dealing at arm’s length
Results, directly or indirectly, in the misuse, or abuse, of
the provisions of this Act
Lacks commercial substance or is deemed to lack
commercial substance under s.97, in whole or in part
Is entered into, or carried out, by means, or in a manner,
which are not ordinarily employed for bona fide purposes
Arrangement
Case Studies on General Anti-Avoidance Rules (GAAR) May 20206
► “Look at” approach no longer survives
► Explain “why” have you done “what” you have done!
► Obtaining tax benefit cannot constitute legitimate reason
► “Purpose” lies in the mind of the progenitor
► Evaluate alternative counterfactuals in light of commercial objects
► Think from armchair of a businessman
► Purpose should be supported by adequate “substance”
Shift from “look-at” approach
Case Studies on General Anti-Avoidance Rules (GAAR) May 20207
► Finance Minister’s Speech in introducing Finance Bill, 2012:
“I propose to introduce a General Anti Avoidance Rule (GAAR) in order to
counter aggressive tax avoidance schemes, while ensuring that it is used
only in appropriate cases, by enabling a review by a GAAR panel.”
► Explanatory Memorandum to Finance Bill, 2012:
“…keeping in view the aggressive tax planning with the use of
sophisticated structures, there is a need for statutory provisions so as to
codify the doctrine of “substance over form…”
GAAR counters ‘aggressive tax avoidance schemes’
Case Studies on General Anti-Avoidance Rules (GAAR) May 20208
► Extract from Shome Committee Report on GAAR
“In a regime of moderate rates of tax, it is necessary that the correct tax base be
subjected to tax and that aggressive tax planning be countered…”
…an avoidance arrangement should be first distinguished from tax mitigation and
second, if it is avoidance, whether it may, nevertheless, be permissible. Thus, every
case of tax avoidance should not be considered under GAAR unless it is an
abusive, artificial and contrived arrangement.”
► FAQ 10 of CBDT Circular No. 7 of 2017
“Q. How will it be ensured that GAAR will be invoked in rare cases to deal with
highly aggressive and artificially pre-ordained schemes and based on cogent
evidence and not on the basis of interpretation difference?
A. The proposal to declare an arrangement as an IAA under GAAR will be vetted first by
the Principal Commissioner/Commissioner and at the second stage by an Approving
Panel, headed by judge of a High Court. Thus, adequate safeguards are in place to
ensure that GAAR is invoked only in deserving cases.”
GAAR counters ‘aggressive tax avoidance schemes’
Case Studies on General Anti-Avoidance Rules (GAAR) May 20209
► TP covers international transactions between associated enterprises
► TP covers specified domestic transactions
► GAAR is pre-cursor to PPT (Principal Purpose Test) of MLI
► PPT applies if one of the principal purposes of arrangement or transaction is
treaty benefit (unless meeting object and purpose of relevant treaty provisions)
► Tax benefit to connected persons also covered in GAAR
GAAR broader than transfer pricing and BEPS
Case Studies on General Anti-Avoidance Rules (GAAR) May 202010
► S.102(1):
“arrangement” means any step in, or a part or whole of,
any transaction, operation, scheme, agreement or understanding,
whether enforceable or not,
and includes the alienation of any property in such transaction, operation, scheme,
agreement or understanding.”
► Dictionary meanings of “operation” and “scheme”:
Operation means “an effect brought about in accordance with a definite plan; action”
Scheme means “design or plan formed to accomplish some purpose; a plot”
Definition of “arrangement”
► Shifting residence to Dubai for rendering services
► Forming SPV in TFJ for routing investments into India
► Resignation by a director to avoid trigger of s.2(24)(iv)
Case Studies on General Anti-Avoidance Rules (GAAR) May 202011
► S.102(10) defines “tax benefit” as:
“tax benefit” includes,—
a) a reduction or avoidance or deferral of tax or other amount payable under this
Act; or
b) an increase in a refund of tax or other amount under this Act; or
c) a reduction or avoidance or deferral of tax or other amount that would be payable
under this Act, as a result of a tax treaty; or
d) increase in a refund of tax or other amount under this Act as a result of a tax
treaty; or
e) a reduction in total income; or
f) an increase in loss,
in the relevant previous year or any other previous year
Scope of “tax benefit”
Case Studies on General Anti-Avoidance Rules (GAAR) May 202012
► Rule 10U(1)(a) prescribes de-minimis threshold:
“The provisions of Chapter X-A shall not apply to an arrangement where the tax
benefit in the relevant assessment year arising, in aggregate, to all the parties to
the arrangement does not exceed a sum of rupees three crore;”
► “Tax benefit” as defined in Rule 10U(3):
“For the purposes of this rule, "tax benefit" as defined in clause (10) of section 102
and computed in accordance with Chapter X-A shall be with reference to—
(a) sub-clauses (a) to (e) of the said clause, the amount of tax; and
(b) sub-clause (f) of the said clause, the tax that would have been chargeable had
the increase in loss referred to therein been the total income.” (refer earlier slide)
Scope of “tax benefit”
Case Studies on General Anti-Avoidance Rules (GAAR) May 202013
► Mr. X, a high-net worth investor, subscribes to redeemable
debentures of A Co
► Features are as under:
► Tenure: 3 years
► Issue price: INR 100
► Redemption: INR 130
► No interest payable during tenure of debenture, premium is
back-ended
► A Co claims redemption premium of INR 30 (130-100) as interest
expenditure equally over 3 years as per AS-29 [Madras Industrial
Investment Corporation Ltd. v. CIT (1997) 225 ITR 802 (SC)]
► Mr. X offers entire INR 30 as interest income in year 3 upon
redemption of debentures
► ICDS is not applicable to Mr. X
► Issue: Can GAAR be invoked to treat feature of back-ended
interest as IAA?
Example on “tax deferral”
Mr. X
A Co
InterestSubscription
to
debentures
Case Studies on General Anti-Avoidance Rules (GAAR) May 202014
Decoding GAAR application through case studies
• Setting up unit in SEZ notified area
• Slump sale to SPV at less than FMV
• Equity infusion followed by transfer of loss-making subsidiary
• Routing investment through SPV
Arrangements having
commercial purpose
• Choice of 22% CTR
• Change of residence
Legitimate statute driven tax
benefit
• Buy-back v. dividend
• Choice of entity to avail 15% CTR
• Foreign funds investing through an AIFChoice principle
• Inbound investment
• Reverse merger
• Demerger instead of merger
Artificial arrangement
Case Studies on General Anti-Avoidance Rules (GAAR) May 202015
Arrangements having commercial purpose
Case Studies on General Anti-Avoidance Rules (GAAR) May 202016
Setting up unit in SEZ notified area
► I Co manufactures goods for ABC, being a major customer
of I Co
► ABC has a condition that its supplier should be in the
vicinity of 2 km radius from ABC’s facility
► I Co already has a manufacturing facility at Location A,
were one of ABC’s facility is located
► ABC has set up additional unit in Location B and has
offered that I Co can be a supplier provided that I Co also
sets up an additional unit in Location B
► Location B is an industrially backward and SEZ notified
area
► Primary driver to choose Location B was preventing loss
of business from major customer; tax incentive is
incidental
► Issue: Is choice of I Co to set up manufacturing facility in
SEZ impacted by GAAR?
I Co
SEZ
Case Studies on General Anti-Avoidance Rules (GAAR) May 202017
Slump sale to SPV at less than FMV
Step 1: Sale of Business to SPV
P, Q and R
ICo
UT2 UT1
SPV
UT1
BV = 1,000
FV = 10,000
100% ① Transfer UT1
business at book
value of 1,000 Cr.
Step 2: Participation by Investor in SPV
P, Q and R
ICo
UT2
SPV
UT1
Investor
80% 20% ② Capital
Infusion at FV
of 2,000 Cr.
Case Studies on General Anti-Avoidance Rules (GAAR) May 202018
Slump sale to SPV at less than FMV
► I Co is carrying on two businesses UT1 and UT2, that are separately managed by different
set of promoter/s
► I Co is desirous of expanding business of both UT1 and UT2
► I Co desires to hold on to UT2 while expanding UT1 by finding Co-Investor for UT1
► Hence, I Co desires to sell part stake in UT1 to such Co-Investor
► I Co is informed by merchant banker and investment analysts that it will be easier to find
Co-Investor if UT1 is housed in a separate entity
► In anticipation of investment, I Co separates UT1 by selling to SPV at book value of INR
1,000 Cr. while FMV of UT1 is higher (INR 10,000 Cr.)
► After about 1 year, Co-Investor infuses funds in SPV for 20% stake in UT1 (INR 2,000 Cr.)
► SPV uses funds provided by Co-Investor to partly discharge consideration payable to I Co
and partly for its own business
► I Co uses proceeds from SPV to expand UT 2 and holds 80% stake in SPV having UT 1
► Issue: Under GAAR, can Tax Authority tax slump sale at fair value in hands of I Co?
Case Studies on General Anti-Avoidance Rules (GAAR) May 202019
Equity infusion followed by transfer of loss-making subsidiary
► List Co currently holds investment in loss-making
WOS
► WOS has incurred genuine business losses
► Due to slack in business, WOS has defaulted in
repaying loans from banks and private parties
► An aggressive and notorious creditor of WOS is
pressurizing WOS for payment – threatens to
invoke guarantees against List Co
► List Co infuses additional equity in WOS to fund
the loan repayments
► In next year, List Co transfers shares of WOS to
third party at substantial capital loss
► List Co also regularly bids for acquiring
companies under IBC
► Issue: Can capital loss be disallowed in hands of
List Co under GAAR?
WOS
(loss-making)
List Co
Infuses
additional
equity100%
WOS
(loss-making)
List CoThird Party
Buyer
Transfer
shares100%
Case Studies on General Anti-Avoidance Rules (GAAR) May 202020
Routing investment through SPV
► In 2017, NL Group acquired 10% stake in I Co, an
operating company through NL Co 1
► NL Co 1 has no activity other than overseeing investment in
I Co - NL Co 1 was established for following reasons:
► Group has policy of making foreign investments through
separate SPV instead of directly through principal
company (NL Co)
► NL Co has active business operations; active
infrastructure and employees in NL
► NL Co 1 has competent BOD to manage investment in I
Co and take administrative support (where necessary)
from NL Co
► Can borrow by pledging shares of either NL Co 1 or I
Co (pledging I Co shares may have regulatory hurdles)
► Borrowing at NL Co 1 level helps to maintain desired
debt-equity mix - comparable to industry norms
► Can invite foreign investment in future – either at
Netherlands (in NL Co 1) or at India (in I Co)
NL
India
NL Co
NL Co 1
I Co
100%
10%
Equity
Case Studies on General Anti-Avoidance Rules (GAAR) May 202021
Routing investment through SPV
► Both NL Cos are treaty residents holding valid
TRC/COR certificate
► NL Co 1 sells shares of I Co in April 2020
► As per taxpayer, main purpose of routing investment
through NL Co 1 cannot be tax benefit - as NL Co is
an “equivalent beneficiary”
► “Equivalent beneficiary” means any person who
would be entitled to an equivalent or more
favourable benefit with respect to an item of
income
► Issue: Can treaty benefit be denied to NL Co 1
under GAAR?
NL
India
NL Co
NL Co 1
I Co
100%
10%
Equity
Case Studies on General Anti-Avoidance Rules (GAAR) May 202022
Legitimate statute driven tax benefit
Case Studies on General Anti-Avoidance Rules (GAAR) May 202023
Choice of 22% CTR - Facts
► In 2001, I Co had invested in shares of List Co
► In 2020, I Co transferred such shares on RSE and
earned LTCG
► Under normal provisions, no LTCG arises because of
cost step up u/s. 55(2)(ac) linked to FMV as on 31
January 2018
► Under MAT, gains taxable @ 15%
► I Co opts for 22% CTR u/s. 115BAA and mitigates MAT
liability
► Under s.115BAA, MAT provisions are not applicable
to I Co
► Issues:
► Can choice of opting in for 22% CTR be challenged
under GAAR?
► Can GAAR be triggered considering s.115BAA is a
non-obstante provision?
I Co
List Co
Holds equity
shares as long
term capital asset
Case Studies on General Anti-Avoidance Rules (GAAR) May 202024
Tax Authority’s arguments
► Exercising choice to opt-in for 22% CTR is a unilateral decision - which constitutes an
“arrangement”
► Main purpose of exercising choice is to avoid tax
► There are no other commercial consequences
► The company does not enjoy any meaningful incentive which is required to be given up
Taxpayer’s arguments
► The taxpayer has been given an option by the statute itself
► The taxpayer commits himself to sacrifice of a number of possible incentives and
exemptions in order to avail the lower rate of tax @ 22%
► There are no conditions attached to the exercise of option
► The choice principle should be respected
► Even assuming that the choice is driven by tax benefit, none of the tainted elements will get
attracted
Choice of 22% CTR - Analysis
Case Studies on General Anti-Avoidance Rules (GAAR) May 202025
Change of residence
Facts:
► Mr. A has received an offer for employment with UAE
company
► Mr. A has been given an option to work from home by
staying in India
► Mr. A negotiates with employer to work by staying at UAE
► The counter offer of Mr. A was inspired by higher take-
home salary on a net of tax basis
► Mr. A travels to UAE for employment and stays there for
two years
► Mr. A becomes a non-resident of India for 2 years
► Family of Mr. A continued to be in India
► Mr. A permanently returns to India after 2 years
► Issue: Whether GAAR can be invoked?
Mr. A Mr. A
(India) (UAE)
Case Studies on General Anti-Avoidance Rules (GAAR) May 202026
Choice principle
Case Studies on General Anti-Avoidance Rules (GAAR) May 202027
Buy-back v. dividend
Promoter
ICo
100%
► I Co (a private limited company) is engaged in
manufacturing business
► I Co has huge accumulated profits ploughed back in
business without dividend pay out
► Contemplated business expansion given up in recent
past due to regulatory restrictions
► Promoters are in highest tax bracket
► I Co proposes to buyback shares at FMV
► I Co pays BBT on distributed income under s.115QA
@ 23.30%
► Issue: Can buy-back be re-characterized as dividend
under GAAR?
Case Studies on General Anti-Avoidance Rules (GAAR) May 202028
Choice of entity to avail 15% CTR
Promoter
ICo
100%
WOS
100%
► I Co is engaged in manufacturing automobiles
► Promoters intend to expand I Co’s business by setting
up new manufacturing facility
► By September 2019, I Co has already passed BOD
resolution; finalized investors/financiers; prepared
blue-print; placed orders for new plant/machinery
► S.115BAB is introduced which provides 15% CTR for
new manufacturing company
► I Co currently enjoys tax holiday and has accumulated
MAT credit
► Decision is taken to house new manufacturing facility in
separate WOS of I Co – WOS to opt-in for s.115BAB
► Issue: Can formation of WOS to avail s.115BAB benefit
be questioned under GAAR?
New
Facility
Case Studies on General Anti-Avoidance Rules (GAAR) May 202029
Tax Authority’s allegations for invoking GAAR
► WOS mainly formed to obtain tax benefit of 15% CTR – no commercial
justification for WOS when decision already taken to expand business within fold
of I Co
► Tainted element test:
► Lacks commercial substance as there is no effect on business risk and cash
flow irrespective of which entity houses business [s.97(1)(d)]
Case Studies on General Anti-Avoidance Rules (GAAR) May 202030
Taxpayer’s defenses against invoking GAAR
► Object of ‘arrangement’ is to expand the business
► New law expects taxpayer to carry out future expansions through new company
► S.115BAB linked to date of commencement of manufacturing; cannot discriminate
between ongoing and future business expansion
► Constructive use of an incentive is different from unintended abuse of provision
► Decision to opt-in has commercial consequences, such as:
► Impacts business valuation, rights and obligations of investors/financiers
► Imposes condition of new plant/machinery
► Compliance of SAAR in a truthful and non-abusive manner negates GAAR
► GAAR does not foreclose “choice principle”
Even if the main purpose is to obtain tax benefit, none of the other tainted
ingredients will be attracted
Case Studies on General Anti-Avoidance Rules (GAAR) May 202031
Foreign funds investing through an AIF
► F Co, a foreign pension fund, wants to invest in
infrastructural projects in India
► F Co is notified as a “specified person” u/s. 10(23FE)
► F Co invests in a Cat II AIF to the extent of 75%
► AIF invests in I Co through combination of 80 debt and
20 equity
► Interest income earned by AIF subject to pass through
taxation and taxable directly in hands of F Co [s.115UB(1)]
► Interest income exempt in hands of F Co due to
s.10(23FE)
► I Co claims interest deduction u/s. 36(1)(iii)
► S.94B does not apply for I Co since debt is issued by AIF,
which is a tax resident
► Issues arising under GAAR:
► Choice of entity i.e. AIF instead of direct investment?
► Choice of funding i.e. debt instead of equity?
► S.94B restrictions applicable on I Co?
Foreign Pension
Fund (F Co)
AIF
I Co (Infrastructure
Facility)
Outside India
India
75%
100% Equity
Debt – 80
Equity - 20
25%Indian
Manager
(Sponsor)
Case Studies on General Anti-Avoidance Rules (GAAR) May 202032
Artificial arrangement
Case Studies on General Anti-Avoidance Rules (GAAR) May 202033
Inbound investment
► In 2010, UK Co set up 100% subsidiary in Mauritius to
invest in India
► Mau Co is pure investment holding company; no other
business operations apart from overseeing I Co; no office
or employees in Mauritius; BOD of Mau Co manages 500
other companies; minutes of meeting ill maintained
► Mau Co is treaty resident holding valid TRC
► In May 2017, additional capital is infused in I Co for
business expansion
► Mau Co issues equity to UK Co; I Co issues equity to
Mau Co
► In March 2019, Mau Co intends to transfer all shares of I
Co
► Issue:
► Whether treaty benefit under Art. 13(4) can be denied
on shares acquired prior to 1 April 2017?
► Whether treaty benefit under Art. 13(3B) can be
denied on shares acquired post 1 April 2017?
UK
Mauritius
India
UK Co
Mau Co
I Co
100%
100%
Equity
EquityTransfer
Case Studies on General Anti-Avoidance Rules (GAAR) August 201734
Reverse merger
Mr. P
Merger
ACo
(loss-making)
BCo
(giant and
profit-making)
Issue single shareMrs. P
► A Co and B Co are privately owned by Mr. P and Mrs.
P respectively (i.e. P Group)
► B Co is highly profitable company in a mature
business which consistently generates cash surplus
► A Co has substantial trading losses
► No business synergy between A Co and B Co
► S.72A conditions unlikely to be fulfilled should there
be conventional (forward) merger
► B Co is merged with A Co; Mrs. P receives single
share of A Co
► As part of merger, A Co renamed as B Co and object
clause of A Co is changed
► Accumulated losses of A Co are fully set off in the
year of merger
Alternative fact pattern: A Co has discontinued
business but holds an important and non-transferable
tenancy right – no compensation payable if tenancy
right is surrendered or cancelled
Case Studies on General Anti-Avoidance Rules (GAAR) August 201735
Demerger instead of merger
Demerger
D Co
(loss-making)
Issue
shares
R Co
(profit-making)
(power
generation)Trading
business
► D Co – a closely held company, was engaged in trading
business
► D Co suffered losses and discontinued business operations
► R Co is into power generation business and making profits
► No business synergy between D Co and R Co
► R Co intends to acquire D Co’s business
► S.72A conditions unlikely to be fulfilled if there is merger of
D Co into R Co
► D Co’s business is de-merged into R Co; and R Co issues
shares to existing Promoters as consideration
► Demerger is s.2(19AA) compliant
► Accumulated losses of D Co fully set off against profits of R
Co in year of demerger
Alternative fact pattern:
► D Co manufactures electricity charged batteries
► R Co is unsure of D Co’s legacy and ongoing litigations
► Demerger ensures that ongoing litigation is not
transitioned to R Co
Case Studies on General Anti-Avoidance Rules (GAAR) May 202036
Consequences of GAAR
Section Consequences
98(1)(a) Disregarding any step or part or whole
98(1)(a) Combining or re-characterising any step or part or whole
98(1)(b) Treat as if IAA not entered into
98(1)(c) Disregard / treat any accommodating party and another as one
and same
98(1)(d) Deeming connected persons to be one and the same
98(1)(e) Reallocate income/ expense/ relief
98(1)(f) Treat place of residence, situs of asset or transaction at different
place
98(1)(g) Disregard/ look through any corporate structure
Consequences are inclusive; and are determined in such manner as is “deemed
appropriate”
Case Studies on General Anti-Avoidance Rules (GAAR) May 202037
GAAR mitigation
Case Studies on General Anti-Avoidance Rules (GAAR) May 202038
► SC ruling in Vodafone International Holdings B.V. (2012) (341 ITR 1)
“S.H. Kapadia, CJ - 68. … In short, the onus will be on the Revenue to identify the scheme
and its dominant purpose. The corporate business purpose of a transaction is evidence of
the fact that the impugned transaction is not undertaken as a colourable or artificial device.
The stronger the evidence of a device, the stronger the corporate business purpose must
exist to overcome the evidence of a device.
K.S. Radhakrishnan, J. - 46. Revenue/Courts can always examine whether those corporate
structures are genuine and set up legally for a sound and veritable commercial purpose. Burden is
entirely on the Revenue to show that the incorporation, consolidation, restructuring etc. has
been effected to achieve a fraudulent, dishonest purpose, so as to defeat the law.”
► FM’s speech in Parliament while enacting GAAR provisions in Finance Act, 2012 (7 May 2012):
“After examining the recommendations of the Standing Committee on GAAR provisions in the DTC
Bill, 2010, I propose to amend the GAAR provisions as follows:
(i) Remove the onus of proof entirely from the taxpayer to the Revenue Department before
any action can be initiated under GAAR.”
► Pursuant to recommendations in Shome Committee’s Report, Rule 10UB requires AO to issue a show
cause notice to the taxpayer indicating basis of initiating GAAR; before making a reference to
Commissioner
Onus of proof
Case Studies on General Anti-Avoidance Rules (GAAR) May 202039
► Procedural
► GAAR provisions can be triggered after two stage approval – Commissioner and
Approving Panel
► GAAR shall not apply if the arrangement is held permissible by Authority for Advance
Ruling (AAR) – CBDT Circular 7 of 2017 dated 27 January 2017
► Exemptions provided in Rules
► Rule 10U(1)(d) - GAAR not to apply to income arising from transfer of investments made
prior to 1 April 2017
► Rule 10U(1)(a) - “The provisions of Chapter X-A shall not apply to an arrangement
where the tax benefit in the relevant assessment year arising, in aggregate, to all the
parties to the arrangement does not exceed a sum of rupees three crore;”
Safeguards from trigger of GAAR
Case Studies on General Anti-Avoidance Rules (GAAR) May 202040
Impact of grandfathering under Rule 10U(1)(d)
Shareholder
ICo
100% PaymentCapital reduction
► Shareholder had invested in I Co shares before 1 April 2017
► I Co implements scheme of capital reduction (assumed at FV)
► SC ruling in case of CIT v. G. Narasimhan [1999] 236 ITR 327 -
sale consideration upon capital reduction is split into dividend
(to the extenta of accumulated profits) and capital gains income
► In DDT regime, I Co liable to DDT to the extent of accumulated
profits – DDT liability may not be grandfathered as I Co does
not have any income arising from transfer of investment
► Post abolishment of DDT, shareholder liable to tax on dividend
income to the extent of accumulated profits
► Issue: Is dividend income arising on transfer of investment also
grandfathered?
“The provisions of Chapter X-A shall not apply to any income
accruing or arising to, or deemed to accrue or arise to, or
received or deemed to be received by, any person from transfer
of investments made before the 1st day of April, 2017 by such
person”
Case Studies on General Anti-Avoidance Rules (GAAR) August 201741
Impact of grandfathering under Rule 10U(1)(d)
► Tax Authority’s arguments:
► Grandfathering restricted only to income stream that arises from transfer of
investment - dividend does not arise only on transfer
► No distinction may be drawn between normal distribution of dividend or a form of
distribution which is co-terminus with event of capital reduction
► Taxpayer’s arguments:
► Rule 10U does not define the term ‘income’ – hence, the term ‘income’ shall
partake the meaning assigned in ITL
► In Rule 10U(1)(d), the term ‘income’ is qualified by ‘any’ i.e. income of whatever
kind arising from transfer of investment
► Consideration arises only from transfer of investment and not otherwise
► Consideration otherwise assessable as capital gains u/s. 46(2) is fictionally treated
as dividend only for purposes of tax computation
Case Studies on General Anti-Avoidance Rules (GAAR) May 202042
► Tax Court of Canada – D.G.H. Bowman, Jabs Construction Ltd. v. The Queen,
June 25, 1999
“GAAR is an extreme sanction. It should not be used routinely every time the
Minister gets upset just because a taxpayer structures a transaction in a tax
effective way, or does not structure it in a manner that maximizes the tax”
► S. E. Dastur
“GAAR will lead to prolific litigation - I daresay in the future, a substantial part of
the litigation will centre around Chapter XA of the Income-tax Act (concerning
General Anti-Avoidance Rule) bearing in mind the very wide, if not wild, provisions
which have been enacted.”
Concluding thoughts
Case Studies on General Anti-Avoidance Rules (GAAR) May 202043
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