Gearing up for General Anti-Avoidance RulesIndia is among a number of countries introducing General Anti-Avoidance Rules (GAAR) as part of a global tax crackdown. How should companies prepare for GAAR?
With increasing economic globalisation and free movement of funds between countries, governments around the world are increasingly taking action to address the issues of tax evasion and tax avoidance.
To clarify, tax evasion refers to illegal arrangements where the tax liability is hidden or ignored, while tax avoidance is when the tax liability is reduced intentionally – albeit within the parameters of the law. Tax planning, on the other hand, involves the arrangement of a person’s business and/or private affairs, in order to minimise tax liability. There is a thin line between tax planning and tax avoidance.
Countries have enacted various methods to tackle the issues of tax evasion and avoidance including applying anti-avoidance principles emerging from judicial decisions, introducing specific and targeted anti-avoidance rules or introducing a General Anti-Avoidance Rule (GAAR).
GAAR enables the revenue authorities to deny the tax benefits of a transaction or arrangement leading to tax evasion or avoidance. It is already used in various countries, such as Australia, Canada, China, Ireland, New Zealand and South Africa.
GAAR was introduced in India in the 2012 Finance Act, but implementation has been delayed by two years until the financial year 2015-16. This provides taxpayers with a small window of opportunity to review their existing structures and get their tax affairs in order.
The Indian approach
GAAR may be applied where any step or part of a transaction is considered an impermissible avoidance arrangement. For an arrangement to be declared impermissible avoidance, it will need to be proved that:
- the main purpose of the arrangement was to obtain a tax benefit; and
- the arrangement fulfils at least one of the following criteria:
- it creates rights or obligations between people dealing at arm’s length which would not ordinarily be the case
- it directly or indirectly results in the misuse or abuse of the provisions of Indian tax laws
- it lacks commercial substance
- it is entered into or carried out in a way that is not ordinarily employed for bona fide purposes.
In light of the above, it is clearly important for anyone doing business in India
to have a detailed understanding of the terms “tax benefit”
and “commercial substance”,
as they apply in Indian tax laws.
Once an arrangement is determined to be impermissible avoidance, the Indian tax authorities may take various actions, the consequence of which are essentially to deny the tax benefit under Indian tax laws or tax treaties to the taxpayer.
In the Indian context, a key issue is that while a taxpayer has the option to apply tax treaties or Indian tax laws, whichever may be beneficial, the doctrine of GAAR would prevail irrespective of whether the rates specified in the tax treaty are beneficial or not. This is a highly contentious issue which foreign investors are bound to oppose.
Another key question requiring deliberation is whether GAAR would be invoked for an arrangement, part of which is entered into before implementation of GAAR in the 2015/16 tax year, and where the benefits continue to flow to the taxpayer after 1 April 2015.
In India, as in any country where GAAR is in place or is being considered, companies are advised to undertake a ‘GAAR health check’ on some of the key aspects of their business. Some of the questions they should be asking themselves include:
- Is there a need to restructure group operations and, if so, could future income streams arising from the reorganisation be challenged under GAAR?
- Are inter-company arrangements and tax-efficient supply chain management agreements commercially justifiable?
- Are investments and other business transactions of commercial substance?
- Is robust documentation in place to substantiate the rationale behind commercial transactions and the business operations of the entities involved?
- Under an umbrella contract, has a value been attributed to each independent component of the contract, to ensure it is commercially justifiable?
- Has the limitation of benefit clause – contained within certain tax treaties – been complied with?
- Does the mode of financing, including the financing of assets, require review?
- Does the mode of repatriating profits to entities in and outside the country require review?
- Is it possible to improve on the sequence and timing of arrangements?
- Is the income received earned by beneficial owners?
- Are complicated structures being unwound in the most tax-efficient way?
- Is there a procedure for approaching the tax authorities in advance to determine whether GAAR could be invoked?
There are still a number of ambiguities surrounding the growing prevalence of GAAR and the provisions will be tested over time. In the meantime, businesses, their investors and tax professionals should determine whether there is a route to tax efficiency that can exist alongside GAAR. If not, they will need to consider appropriate and adequate modifications.
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