General Anti-Avoidance Rule (GAAR)

vs. Transfer Pricing

Yash V. Rajpurohit

October 13, 2018

 Tax Planning vs. Avoidance vs. Evasion

 Tax Planning:-
The tax planning is described as the arrangement of financial activities in a way
that the assessee can avail maximum tax benefit by making best possible use
of all the legal benefits, i.e., deductions, exemptions etc.

 Tax Avoidance:-
The tax avoidance is a technique of refraining from tax liability, through just and
fair means, but intends to defeat the fundamental motive of the
legislature. The dividing line amidst the two concepts is thin and blur.

 Tax Evasion:-
The term Tax Evasion is usually used to mean any illegal arrangement where
tax liability is hidden or ignores, i.e., the tax payer knowingly pays less tax
than what he is legally obligated to pay, either by hiding income or information
from tax authorities.
 Tax Planning vs. Avoidance vs. Evasion
Risk

High Tax Evasion

Tax Avoidance
Medium

Low Tax Planning

Tax
Low Medium High Benefits
 Timeline: Substance vs. Form

Permissible
Vodafone
UOI vs. Azadi
Duke of Westminster vs. International
Bachao Andolan (263
IRC (19 TC 490) (HC) Holdings B.V. vs.
ITR 706)(SC)
UOI (341 ITR 1)

1935 1982 1985

GAAR
1936 2003 2012

Gregory v/s. Helvery McDowell & Co. Ltd.

(US Supreme Court) vs. CTO (154 ITR 148)

Ramsay vs. IRC

(54 TC 101) (HL)

Impermissible
 GAAR in India - Introduction

 Budget Speech by Finance Minister on 16 March 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.

 GAAR provisions were first introduced in the Finance Act, 2012 with
effective from AY 2014-15

 Finance Act, 2013 amended the GAAR provisions on the basis of

recommendations of Expert Committee Report and deferred the
application to AY 2016-17
 Introduction (Contd…)

 Finance Act, 2015 further deferred the applicability of GAAR

provisions by two years

 GAAR provisions are now applicable from the FY 2017-18 onwards,

i.e. AY 2018-19

 The provisions of GAAR are contained in Chapter X-A of the Income-

tax Act, 1961 (i.e. Sections 95 to 102 and Section 144BA)

 The procedures for application of GAAR and conditions under which it

shall not apply are framed in Income-tax Rules, 1962 (i.e. Rule 10U to
Rule 10UC)
 Framework of GAAR Provisions
Section/Rules Overview
95 Applicability of GAAR
96 Impermissible Avoidance Arrangement (“IAA”)
97 Arrangement of lack commercial substance
98 Consequences of IAA
99 Treatment of connected person and accommodating party
100 Application of Chapter X-A
Chapter X-A to be applied in accordance with guidelines to be
101
framed
102 Definitions
144BA Administration of GAAR
Rule 10U Exclusions from applicability of Chapter X-A
Rule 10UA Determination of consequences of IAA
Rule 10UB Notices and forms
Rule 10UC Time Limits
Circular No. 7 of 2017 FAQs on GAAR
 GAAR Enabling Provisions

 Section 95: Applicability of General Anti-Avoidance Rule.

“(1) Notwithstanding anything contained in the Act, an arrangement

entered into by an assessee may be declared to be an impermissible
avoidance arrangement and the consequence in relation to tax
arising therefrom may be determined subject to the provisions of this
Chapter…..
Explanation.—For the removal of doubts, it is hereby declared that the
provisions of this Chapter may be applied to any step in, or a part of, the
arrangement as they are applicable to the arrangement”

 Section 96: Impermissible avoidance arrangement.

(1) An impermissible avoidance arrangement means an arrangement, the

main purpose of which is to obtain a tax benefit, and it-
….. (a) to (d).
 Anti-Avoidance Tests

 Thus, an arrangement shall be an impermissible avoidance arrangement, if:

i. the main purpose of the arrangement is to obtain a tax benefit and
ii. such arrangement falls within the ambit of any of the clauses from (a) to
(d) of section 96(1) of the Act (i.e. the anti-avoidance test).

 The anti-avoidance tests as referred above are as follows:

a) creates rights, or obligations, which are not ordinarily created
between persons dealing at arm's length;
b) results, directly or indirectly, in the misuse, or abuse, of the provisions
of this Act;
c) lacks commercial substance or is deemed to lack commercial
substance under section 97, in whole or in part; or
d) is entered into, or carried out, by means, or in a manner, which are not
ordinarily employed for bona fide purposes
 GAAR Provisions – A Snapshot

Is there an arrangement
No
Yes
Main purpose of the whole/step No
in/part of the arrangement is to GAAR is
obtain tax benefit Not Applicable

Yes
No
Does the arrangement fall in any of
the above four Anti-avoidance test

Yes
The arrangement may be an
Impermissible Avoidance GAAR is Applicable
Arrangement (IAA)
 Illustration No. I
 ABC Ltd. is engaged in the business
ABC Ltd of manufacturing agricultural tools
and equipments, through its non-
SEZ unit.

Non-SEZ Sale of  The SEZ unit merely carries out

SEZ Unit
Unit invoicing and carries out the
Finished Goods
purchase and sale of the finished
at FMV goods.
Export
 However, due to the export market
XYZ Ltd fetching a better price, the SEZ unit
(Non-AE) makes a good profit.

 Thus, it is able to show higher profits

Can GAAR be invoked to deny
in the SEZ unit than in the non-SEZ
the tax benefit?
unit, and consequently claims a
higher deduction in the computation
of income.
 GAAR vs. SAAR

 SAAR is tailor-made to a particular situation or particular instance, such

as Transfer Pricing, Clubbing provisions, Limitation of interest, etc.

 Scope of SAAR is restricted to the instances enumerated in the legislation.

 SAAR cannot be used to rope-in all types of transactions, which are not
founded in economic substance and may results in erosion of the tax base
of the country

Whether AO can invoke GAAR provisions, when SAAR is already

applicable?
 Arm’s Length condition in GAAR
 An impermissible avoidance arrangement means an arrangement, the main
purpose of which is to obtain a tax benefit, and it-
(a) creates rights, or obligations, which are not ordinarily created
between persons dealing at arm's length; …...

 Thus, one would need to examine the principles of arm’s length price/
market value, to demonstrate that the transactions are at arm’s length, and
thus, do not fall in the mischief of clause (a)

 If the arrangement is at arm’s length then GAAR cannot be invoked under

clause (a) of section 96(1) of the Act

 However, one may still have to analyse the other conditions as mentioned
in section 96 of the Act [i.e. clause (b) to (d)]
 Arm’s Length condition (Contd…)

 The term arm’s length is not defined in Chapter X-A of the Act

 Section 92F (a):

“arm's length price” means a price which is applied or proposed to be
applied in a transaction between persons other than associated
enterprises, in uncontrolled conditions;

Whether Chapter X provisions can be used to benchmark the

arrangement between non-associated enterprises?

 Thus, even in cases where Chapter X does not apply, one can still take the
aid of the arm’s length principles, to demonstrate that the arrangements
are at arm’s length as per clause (a) of section 96(1) of the Act
 Illustration No. II

 Kangaroo Ltd enters into an agreement

(composite contract) with Kingfisher Ltd,
for setting up a turnkey automobile
Kangaroo
Ltd
assembling plant in India, for an agreed
price of INR 500 crores.
O/s India
India
Subsidiary  The breakup of the agreements is given
below:
Composite
Tiger Ltd a. INR 100 crores for the offshore design
Contract
and technical know-how
b. INR 350 crores for offshore supplies of
equipment, etc. (Not taxable in India
under the Act, no import duty was
leviable)
c. INR 50 crores for local supplies and
installation charges.
 Illustration No. II (Contd…)

 During the assessment, the AO/ TPO accepted the ALP of the composite
contract, by application of Other Method (using bid documents).

 Subsequently, AO found that the arrangement with Kangaroo Ltd., was arranged
in a manner as to reduce the tax impact in India, without causing any detriment
to Tiger Ltd.

 It was noticed by the AO that an offshore design services would suffer

withholding tax in India, and its price was depressed, as compared to the fair
market value of offshore design which was around INR 200 crores.

 The arrangement resulted in a significant tax benefit to the taxpayer.

Can GAAR be invoked in such case?

 Illustration III
 High Tax Ltd., an Indian company,
No Tax Ltd incorporated a No Tax Ltd. in a tax haven with
an equity infusion of USD 1 million.

O/s India  No Tax Ltd. gives a loan of USD 1 million to

India another subsidiary of High Tax Ltd.,
Equity Loan incorporated in India. No Tax Ltd. conducts no
High Tax
other business operations.
Y Tax Ltd
Ltd
 Y Tax Ltd. pay an interest rate @ 10% p.a. and
claims a deduction.

Can GAAR still be invoked,  The TPO evaluates the transaction between Y
even if the transaction was Tax Ltd. and No Tax Ltd. at arm’s length, as the
found to be at arm’s length? interest rate of 10% has been benchmarked by
application of the CUP method.

(Note: as per the tax treaty, interest income of non-

resident would be subject to tax @ 10% instead)
 Generalia Specialibus Non Derogant
 In the Essar judgment, the Supreme Court held that the provisions
provided in the Electricity Act are special and hence will override the
general provision of the Limitation Act 1993 (later 1996), applying the very
same principle that special law prevails over general law.

 The Hon’ble Supreme Court in the case of CIT vs. Shahzada Nand and
Sons (60 ITR 392) with respect to above Latin maxim observed as under:
“Another rule of construction which is relevant to the present enquiry is
expressed in the maxim, generalia specialibus non derogant, which means
that when there is a conflict between a general and a special provision, the
latter shall prevail…..
…..But this rule of construction is not of universal application. It is subject
to the condition that there is nothing in the general provision, expressed or
implied, indicating an intention to the contrary…”
 Generalia Specialibus Non Derogant
 Section 100: Application of this Chapter.
The provisions of this Chapter shall apply in addition to, or in lieu
of, any other basis for determination of tax liability.

 The Central Board of Direct Taxes (CBDT) vide its Circular No. 7 of 2017
dated 27-01-2017 clarifies that SAAR may be inadequate to address all
situations of tax abuse, an invocation to GAAR provisions may be resorted
to even in cases where SAAR provisions exist.

 Therefore, it would be worthwhile to see whether the courts may hold

GAAR and SAAR (such as Transfer Pricing or Limitation on Interest
Deduction, etc.) to be mutually exclusive or what would be the interplay
between the two; and whether fulfilment of conditions as legislated under
SAAR, would protect the taxpayer from the wider and general provisions of
GAAR.
 Administration of GAAR
If necessary,
make a PCIT / CIT
AO at assessment / reference
reassessment stage Issue a notice and
File objections within
provide opportunity
Issue a notice Taxpayer maximum 60 days
of being heard
to seek files
objections objections If satisfied with the PCIT / CIT
Taxpayer
objections filed shall issue direction
Taxpayer
If no as GAAR
objections not
If not satisfied filed applicable
with objections filed PCIT / CIT shall Provisions of
If GAAR not
issue such normal proceedings
PCIT / CIT direction applicable to apply
shall make reference
If GAAR
applicable

Issue direction, AO to pass final

Approving Panel to
as it deems fit, order, with
provide opportunity Within Taxpayer can
approval of PCIT/
for hearing to within 6 months 60 days appeal before ITAT
CIT of tax
taxpayer and AO
consequences
THANK YOU

Yash Rajpurohit
Chartered Accountant