General Anti-Avoidance Rule (“GAAR”) has been the most talked about and debated feature of Finance Bill, 2012. GAAR is a recognized principle of taxation in different jurisdictions across the world. But its reach and sweep in India, as envisaged in the Finance Bill, are being felt by many to be a little too wide.

The provisions of GAAR introduced as chapter X-A of the Income Tax Act, 1961 gives revenue authorities sweeping power to declare any business arrangement or a transaction “impermissible avoidance arrangement” if they are of the view that such business arrangement or a transaction has been primarily entered into to avoid taxes. Section 96 defines an impermissible avoidance arrangement as any arrangement the ‘main purpose’ or one of the main purposes of which is to obtain a tax benefit and it (inter alia) —

• 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;

In the absence of any elucidating guidelines/rules the terms “ main purpose”“ordinarily created”, “misuse or abuse” are amenable to widest interpretation by revenue authorities which in turn may spawn multitude of litigation and thereby heckle the very spirit and purpose of GAAR. It cannot be denied that ordinarily persons dealing at arm’s length will, between two business propositions, opt for the one that is gainful /profitable from a wide array of considerations including favorable incidental tax implications. In such circumstances will such business propositions be questioned just because tax implication is also one of the criteria of acceptance? It is pertinent to mention that the apex court in AzadiBachaoAndolan case has upheld an individual’s right to “plan” his transaction to mitigate tax liability and that tax planning cannot be questioned merely because it is “tax advantageous”, provided “economic substance” is demonstrated.

Section 98 provides when a transaction is declared “impermissible avoidance arrangement” the consequences may include “denial of tax benefit or a benefit under a tax treaty”. Treaty shopping is an international concern. Ordinarily, the best way to stem treaty shopping is to includea Limitation of Benefit (LOB) clause in DTAA and not to have anti abusive provisions that override treaty provisions. DTAAs are entered into to encourage international trade by providing for relief from double taxation. However, as have been held by courts of few countries, notably Israel and Netherlands, treaty benefits could indeed be denied if the transactions are sham or colourable.

As a principle of taxation, GAAR is a sound proposition. By discouraging sham and fraudulent transactions, it aims to ensure that the laws facilitating cross border business relations and spread are being utilized by bona fide business entities to give globalization a positive shoot in the arm. Needless to say, provisions of GAAR should be manifestly unambiguous, should be able to mirror the legislative intent. It is, however, noted that the broad set of GAAR provisions in Finance Bill, 2012 leave considerable room for subjective interpretation by revenue authorities and consequently for their abuse and misuse. The definition of “tax benefit” is so exceptionally wide and encompassing that even a needless tax avoidance can be brought within the ambit of GAAR.

It is necessary that the GAAR provisions are laced with certain checks and safeguards. Rules and guidelines (Section 101 provides for guidelines and prescribed conditions) ought to be framed in consultation with all stakeholders prescribing the kind of structure or transactions that will attract GAAR as also the threshold (quantitative) and limitation period for invoking GAAR. In addition, the expression “impermissible avoidance agreement” needs to be redefined to make it objective and reflective of its intended purpose.

The aforesaid changes in GAAR would in all likelihood bring about an atmosphere of clarity and certainty essential for attracting both foreign and domestic investments and enabling rational economic decision making on the part of business entities. It is heartening to note that the government has initiated certain positive steps to remove the confusion about the scope and applicability of GAAR provisions in Finance Bill, 2012. The implementation and administration of GAAR would also be critical in determining its success. A recent study in Australia has revealed that the tax payers are more proactively compliant when they feel that they have been treated well and fairly by tax officers.

At the end of the day, for the business entities who believe in weaving intricate and sophisticated web of transaction primarily to avoid tax, GAAR would come as a wakeup call. The deferral of GAAR is merely a brief interlude before it becomes a reality on April 1, 2013. One hopes, however, that there is less of subjectivity and discretion, and more of objectivity and precision both in the wordings as well as implementation of the anti avoidance rules.