Volume 5, Issue 14

4th July, 2012

Tax Alert
Draft Guidelines on Implementation of General Anti Avoidance Regulations (GAAR)

Background of GAAR Provisions

The Indian tax laws got their first whiff of introduction of General Anti Avoidance Rules (‘GAAR’) in the proposed Direct Tax Code Bill released by the Government of India (‘GoI’).  Subsequently, since the introduction of Direct Tax Code 2010 (‘DTC’) has been postponed, the GoI had proposed the introduction of GAAR provisions in the Finance Bill 2012.  The manner and shape in which the GAAR provisions were proposed to be introduced in the Finance Bill 2012 met with widespread concerns.  The same were partially mitigated by the GoI by deferring the applicability of GAAR provisions by one year and rationalizing certain onerous provisions.

Introduction of Draft Guidelines regarding implementation of GAAR

A Committee was earlier constituted to give recommendations for formulating guidelines for proper implementation of GAAR provisions under the DTC. With the subsequent introduction of GAAR in the Finance Act 2012, the Committee has now provided its recommendations regarding guidelines / circulars for implementation of GAAR provisions in light of the Finance Act 2012.  The recommendations of the Committee would be codified by way of Circulars and Rules once the same are accepted by the GoI.

The proposed recommendations have been released in public domain with a view to garner participation from all concerned stakeholders.  The Prime Minister’s Office has also issued a clarification that the recommendations of the Committee are open for consultation and feedback from stakeholders. 

Explanation of GAAR

  • The note for GAAR Guidelines provides that GAAR provisions seek to codify the doctrine of ‘substance over form’ in interpreting tax legislation. 
  • The GAAR provisions are not proposed to be applied in cases of tax evasion since the latter is even otherwise prohibited under the Indian Income Tax Act, 1961 (‘Act’).
  • The GAAR provisions will also not be applied in cases where a taxpayer adopts genuine tax mitigation strategy by availing fiscal incentives afforded by the tax legislation.  For example availment of tax holidays by setting up new units in SEZs should not result in invocation of GAAR.
  • The Notes clearly state that the onus of proving an impermissible avoidance arrangement lies on the Revenue authorities.  Such onus would involve proving:
    • there is an arrangement;
    • which leads to a tax benefit;
    • the main purpose or one of the main purposes of the arrangement was to obtain the tax benefit; and
    • the arrangement exhibits one of the prescribed characteristics. 

Key recommendations of the Committee

  • Monetary threshold – The Committee recommends that the GAAR provisions should not apply to arrangements where the tax benefit does not exceed a prescribed monetary limit.  The actual monetary limit has not been specified and it remains to be seen whether this recommendation would benefit ‘small taxpayers’ or ‘very small taxpayers’.
  • Partial relief for Foreign Institutional Investors (‘FII’)  – The Committee recommends that GAAR should not be invoked against FIIs (or its non-resident investors) if such FIIs pay taxes under the Act.  As a corollary, GAAR could be invoked against FIIs which opt to claim tax treaty benefits.  However, even in such cases, GAAR would not be invoked against the non-resident investors of such FIIs. 
  • Operation of GAAR provisions – The Committee recommends that it should be clarified outright that the GAAR provisions will apply to income accruing or arising on or after 1 April 2013.  This suggests that arrangements entered into before 1 April 2013 which could result in accrual of income after 1 April 2013 could also be within the ambit of GAAR. 
  • Specific Anti Avoidance Rules (‘SAAR’) to take precedence– The Committee recommends that where specific SAAAR is applicable, GAAR need not be invoked unless exceptional cases of arrangements nullifying the impact of SAAR are adopted by a taxpayer. 
  • Definition of connected person – The Committee recommends that the broad and ambiguous term ‘connected person’ be clarified by bringing (i) associated enterprises as per Indian Transfer pricing regulations’ (ii) relatives as per section 56 of the Act; and (iii) person covered under section 40A(2)(b) of the Act within its ambit. 
  • Proportionate tax exposure – The Committee recommends that the tax consequences of an impermissible avoidance arrangement should not be on an overall basis but should rather be limited to such part of the total arrangement as is impermissible.  Thus, in cases where an arrangement is only partially deemed to be impermissible, tax consequences relating to only such portion would follow. 

Several examples have been given by the committee to illustrate when GAAR can be invoked and when it cannot be. Some of the important examples are highlighted below:

Illustrative aspects of non applicability of GAAR as per examples provided

Illustrative aspects of applicability of GAAR as per examples provided

Availing tax holiday by setting up of undertaking in an underdeveloped area by substantial new investment

Availing tax holiday by splitting up / reconstruction of business activities by shifting production from an existing unit to an undertaking set up in an underdeveloped area

Investments in India through holding company situated in low tax jurisdiction where substantive commercial substance is reflected in the holding company

Tax treaty benefits claimed by a Group by interposing a company in a low tax jurisdiction where such company is not the beneficial owner / controller of its investments

Non declaration of dividends to Indian shareholders by foreign subsidiaries where such decision is driven by business / commercial factors

Adoption of cash repatriation by way of buyback   rather than dividend payouts

Merger of loss making entities with profit making entities since the same would be subject to SAAR

Assignment of loan by a foreign bank to its branch located in a low tax jurisdiction in order to ensure lower withholding taxes on such interest income by invoking tax treaty

Raising of borrowed funds rather than equity from unrelated parties in the absence of thin capitalization norms

Availment of tax treaty benefits by compliance of the Limitation of Benefit provisions where such compliance is primarily possible on account of related party transactions

Transactions governed by Indian transfer Pricing regulations such as interest payments to associated enterprises, availment of non core services from a group entity, etc


Claiming of capital loss on transactions involving sale of securities to unknown buyers


Key procedural aspects recommended by the Committee

  • Prescription of time limits – The Committee has recommended time limits ranging between 60 days to six months for disposition of various references with a view to ensuring that the possibility of invocation of GAAR attains finality within a reasonable period of time. 
  •  Prescription of statutory forms – With the intent of ensuring transparency and natural justice, the Committee has prescribed statutory forms which need to be filled by the Assessing Officer and the Commissioner of Income Tax for inter alia making a reference to the Commissioner of Income Tax or Approving Panel respectively.   Interestingly, the proformas of the prescribed forms require the tax authorities to identify and provide detailed reasons on account of which they seek to invoke the GAAR provisions. 
  • Constitution of Approving Panel – It isrecommended that the Approving panel should comprise three members out of which 2 members should be of the level of Chief Commissioner of Income Tax and the third member should be an officer of the level of Joint Secretary or above from the Ministry of Law. 

SKP’s Comments

The draft guidelines are a welcome clarification which seems to suggest, on paper, that the GAAR provisions will not be applied indiscriminately.

  • Further the placing of time limits for invocation of the GAAR provisions and the prescribed forms could also act as a buffer preventing widespread application of the GAAR provisions.
  • The clear view on permissibility of tax mitigation by availing benefits prescribed under tax laws and non applicability of GAAR provisions to non resident investors of FIIs are some of the other heartening aspects.
  • However, the discrimination between FIIs paying taxes under the Act vis a vis FIIs enjoying treaty benefits may not fully assuage the fears of the FIIs.
  • Furthermore, it needs to be clarified that the doctrine of substance over form cannot be applied to all cases such that legitimate tax planning opportunities are construed as tax avoidance schemes.  A point of debate (tax planning versus tax avoidance) may only become more pronounced after introduction of the GAAR provisions.