OBJECTIVES

The objectives of this project are to:

Get a detailed insight into the concept of GAAR General Anti-Avoidance Rules; its
meaning and importance.

Analyze the global applicability of GAAR.

Evaluate and understand the provisions applicable to GAAR under the Income Tax Act.

Critically evaluate the concept of GAAR and consider the recommendations as per the
Second Draft Report on General Anti-Avoidance Rules submitted by Dr.
Parthasarathi Shome Committee (Report)

Analyze its impact of India.

RESEARCH METHODOLOGY
This research is doctrinal in nature. Secondary and Electronic resources have been largely used
to gather information and data about the topic.
Books and other reference as guided by Faculty of the Corporate Taxation, have been primarily
helpful in giving this project a firm structure. Websites, dictionaries and articles have also been
referred.

INTRODUCTION
Countries impose taxes of various types with the objective of raising revenue for Government
spending. Taxpayers may be expected to minimize their tax liabilities by arranging their affairs in
a manner that is termed tax efficient i.e. through tax mitigation. This does not include tax
evasion. It has been universally accepted that tax evasion through falsification of records or
suppression of facts is illegal. Tax reduction through legal means, on the other hand, is
increasingly considered a matter of right by taxpayers. The courts also tend not to frown upon
this emergent approach of tax payers. This could perhaps be considered a paradigm shift in the
approach towards taxability, and has given rise to the grey area of tax avoidance which is
perceived by tax authorities as strictly legal in form but perhaps not in substance i.e. a business
arrangement to avoid tax may not reflect its embedded legislative intent.
The rise of the Indian economy in past two decades has been one of the most impacting events to
occur in the country post its independence from its colonial rulers. One of the most significant
markers of this growth has been the resilience of the economy to external pressures and troughs.
The Indian economy has been relatively unscathed in the aftermath of the global financial
meltdown of 2008. The country has seen a massive rise in gross domestic production (GDP)
and consequently per capita incomes have also risen across the board.
The Indian economy no longer functions as a singular isolated entity, in the globalized era that
exists today cross border trade and transactions are the norm rather than the exception. In such a
circumstance organizations are more than likely to move operations to countries where suitable
conditions exist for such businesses to flourish.
Such movement of business and consequently profits outside India is not looked in a good vein
by the government. Various authorities, have, therefore, felt that tax reduction through unethical
means should not be allowed, particularly when headline rates of tax have been significantly
reduced. It is therefore, in the interest of safeguarding the interests of revenue that the General
Anti Avoidance Rules (GAAR) were proposed by the Honourable erstwhile finance minister
3

Mr Pranab Mukherjee along with the Finance Act, 2012.

THE CONCEPT OF GAAR

The most obvious issues in taxation today arise over the geographical boundaries which, under
our current tax law, determine the allocation of revenue between different jurisdictions. But there
is another set of boundaries that is of major significance in any discussion of taxation: this
consists of the boundary between illegal evasion and legal avoidance and the boundary between
what is sometimes termed acceptable and unacceptable avoidance.1
There is a broad consensus among legislators around the world towards the need for cohesive
anti avoidance structures which differentiate between legitimate tax mitigation and tax
avoidance. The introduction of GAAR, ideally, seeks to place curbs on tax avoidance without
impinging on the right of the business to effectively mitigate the tax impact on its business
within acceptable legal boundaries.
This point to a need for better legislation, giving clearer signals to taxpayers, better tools to the
judiciary and an improved basis for enhanced cooperation between taxpayers, their advisers, and
the tax authorities. Further work is clearly needed on forms of drafting, both at the specific and at
the Meta levels. Such work should try to move beyond boundaries and towards tackling the
underlying issues.2
The implementation of GAAR around the world has not been without its fair share of challenges;
countries such as Canada, Australia, and South Africa have had previous experience dealing with
a set of anti avoidance rules. Their experience suggests that GAAR does not provide an easy
solution. However, most importantly, none of the jurisdictions have backed down despite
setbacks but have rather come back with newer and stronger versions of the guidelines wherever
the originals plans have been defeated.3
1 http://www.claonline.in/DisplayArticle.aspx?ID=MzQzNQ==&FileName=MjAxMl8xNDIuaHRt
2 Beyond Boundaries : Developing Approached to Tax Avoidance and Tax Risk Management, Oxford University
CBT
3 John Prebble, An American GAAR, TaxProf Blog, 2010 available at: http://ssrn.com/abstract=1658233

The only true solution to avoidance is to have a much more principle-based tax system which
allows tax payers to operate with a level of certainty that is required for businesses to function
and grow.
For a long time Revenue has fought tooth and nail to prevent and suppress the ill of tax
avoidance but has failed to stop it despite having specific avoidance measures in its hand. But
with introduction of the Direct Taxes Code Bill, 2010 Legislature has proposed various genuine
measures in the domestic tax laws to tackle the problem of tax avoidance. One of the many
measures proposed is General Anti-Avoidance Rule (GAAR) under which a transaction can be
nullified by the concerned authorities if they are of the opinion that the central motive of
the transaction is to obtain tax benefit and allowing the transaction will violate object and
purpose of applicable tax laws.

Pre-Requisites for GAAR Implementation4

The justifications behind GAAR as noted above are no doubt noble and so are its long term
benefits. Nevertheless, even before contemplating the implementation of GAAR, the following
shortcomings in the system will have to be rectified as pre-cautionary measures i.

To ensure that the guidelines to be notified would be better understood by both the
taxpayers and the income-tax department.

ii.

Ambiguities in the existing laws may be removed by way of amendments.

iii.

The tax administration is to be better equipped in terms of man power, knowledge of

concepts and infrastructure so that the system is mature enough for the implementation of
such an advanced law.

iv.

The economic scenario in the country is conducive for such implementation.

4 Arkay & Arkay, Chartered Accountants, GAAR: Past, Present & Future, available at
http://www.moneycontrol.com/news_html_files/news_attachment/2013/GAAR_Web.pdf
5

GAAR IN VARIOUS COUNTRIES5

AUSTRALIA:
Australias GAAR legislation has seen much change since its inception nearly a century ago.
The 1981 GAAR (known as Part IVA) is currently viewed by many stakeholders as oneof the
most mature and comprehensive in the world. The current GAAR was originally designed to
replace what had been perceived as ineffective anti-avoidance laws. Australias then-Treasurer
John Howard stated that the 1981 rules were designed to strike down transactions believed to be
blatant, artificial and contrived. Over the years, the Australian courts have expanded the
GAARs scope and reach to apply to what many view as normal, commercial transactions.
But more recently, this landscape has changed with the Australian Government in March 2012
announcing plans to amend the GAAR (Part IVA). The Australian Taxation Office (ATO) has lost
seven out of nine Part IVA cases in the last three years, resulting in a call for an overhaul of the
provisions.
CANADA:
Canada was one of the first countries to explore the concept by means of explanatory notes
issued in 1988 which laid down the rules governing abusive tax avoidance transactions. The
guidelines stated that their intention was not to interfere with legitimate commercial and family
transactions but rather to curb avoidance transactions which were defined as transactions which
would result in a direct or indirect tax benefit or form part of a series of transactions which
would result in tax benefits. However, transactions which serve legitimate business purposes are
not considered avoidance transactions

5 Ernst & Young, GAAR Rising: Mapping Tax Enforcements

www.ey.com/Publication/.../GAA.../GAAR_rising_1%20Feb_2013.pdf

Evolution

available

at

SOUTH AFRICA AND CHINA:

South Africa, and China have enacted counter tax avoidance proposals which seek to curb upon
the aggressive use of tax havens for the explicit avoidance of taxes, and transactions whose sole
purpose is to avoid taxes. Among other transactions, Round tripping, accommodating parties and
difference between legal substance of arrangement and legal substance is individual steps have
been identified as events indicative of tax avoidance.
UNITED KINGDOM:
In June 2012, the United Kingdom launched a formal consultation on a new GAAR. This
followed the Budget 2012 announcement that such a rule will be introduced in Finance Act 2013
(with a commencement date of 1 April 2013), which in turn followed the publication of a report
by an independent study group led by Graham Aaronson QC. 6 The stated aim of the proposed
GAAR is in line with the Aaronson reports recommendation to introduce a rule that targeted
only artificial and abusive arrangements and not the centre ground oftax planning.
The UK GAAR as originally proposed requires taxpayers (and potentially a court) to consider
whether there are arrangements where: (i) having regard to all the circumstances, it would be
reasonable to conclude that the obtaining of a tax advantage was the main purpose, or one of the
main purposes, of the arrangements, and (ii) the entry into the arrangements cannot reasonably
be regarded as a reasonable course of action, having regard to all the circumstances. Concerns
had been expressed, however, that this formulation did not provide sufficient certainty that the
key operative provisions will apply only to their intended target and not to a broader range of
circumstances. Similar concerns had been expressed that the draft legislation set out in the UK
Consultation Document itself does not contain sufficient safeguards to prevent possible mission
creep the use ofthe GAAR in circumstances not intended at the outset. The legislations
stated overall intention is to apply only to artificial and abusive tax schemes, bolstering the UK
Governments message that Britain is open for business and has a competitive tax system.

6 Graham Aaronson QC, GAAR study: a study to consider whether a general anti-avoidance rule should be
introduced
into
the
UK
tax
system,
11
November
2011,
http://www.hmtreasury.gov.uk/d/gaar_final_report_111111.pdf

UNITED STATES OF AMERICA:

The United States does not have a GAAR, but it does have a very long history, dating back to the
1930s, of addressing potentially abusive arrangements througha series of disclosure rules,
penalties, and targeted anti-avoidance statutes and regulations in addition toa number of
judicially developed doctrines. Also, the United States in 2010 adopted a general statutory
provision, codifying the economic substance doctrine, that could be viewed as somewhat
comparable to a GAAR provision.
The economic substance statutory provision, which carries a strict liability penalty of up to 40%,
did not replace the countrys long common law history. TheUS common law includes a number
of other substance- focused doctrines in addition to the common law economic substance test.
That voluminous history of court decisions remains in place and presumably will continue to
evolve along with interpretations of the new statutory provision.
JAPAN:
In this jurisdiction there are two types of codified anti-avoidance to be applied in altogether
different situations. One is applicable to closely held corporations that have a long history and
another is applicable to the reorganisation of a tax regime which was enacted in 2001. An
analysis of international practices indicates that unlike modern anti-avoidance legislations where
the structure of transaction is more often an important condition for invoking GAAR, some
older statutory rules are more general in nature and do not provide guidance as to determining
factors which are more decisive in applying GAAR to a particular transaction or series of
transactions. While in certain countries mere existence of an arrangement undertaken for the
purpose of tax avoidance is sufficient to invoke GAAR, in some other countries motive of tax
advantage defeating the purpose of the legislation is pre-condition for invoking it.

GAAR AND INDIA

The GAAR is a broad set of provisions which grants powers to authorities to invalidate any
arrangement, for tax purposes, if it is entered into by the assesse with the main purpose of
obtaining a tax benefit.
A tax benefit would include a benefit relating to Income-tax, Wealth Tax, Dividend Distribution
Tax and Branch Profit Tax Apart from the tax benefit test, the arrangement also has to satisfy at
least one out of four additional tests discussed in the ensuing paragraphs.
The principal condition for invalidating an arrangement under the GAAR provisions is that the
arrangement (or any step thereof) must have been entered into with the main purpose of
obtaining tax benefit. This condition in most cases, is likely to get satisfied automatically at the
assessment stage itself.7 Given that, under the proposed law, specific presumption is to that
effect, GAAR provisions will be attracted automatically unless the taxpayer is able to prove
otherwise. This would cast an onerous burden on the taxpayer in such cases which will have to
be discharged with appropriate positive evidence.
Once the test of the main purpose of tax benefit is satisfied, the taxpayer is required to undergo
further scrutiny to pass various other critical tests to avoid the application of the GAAR
provisions and prevent the possible action of invalidating the arrangement. These critical tests,
include whether:
(a) the arrangement is not carried out in a manner normally not employed for bonafide purposes;
or
(b) it is not at arms length; or
(c) it results in direct or indirect misuse/abuse of the provisions of the Code; or
(d) it lacks commercial substance.
7 Supra note 5
9

Further, in accordance with the enlarged definition of the test of lack of commercial substance,
it would also be necessary for the taxpayer to pass certain further tests such as: whether there is a
significant effect upon the business risks or net cash flow of the concerned parties, the test of
substance over form, whether the arrangement involves round trip financing or any
accommodating or tax indifferent party or any element having effect of offsetting each other and
so on.
Such an arrangement would be regarded as Impermissible Avoidance Arrangement, and the
CIT would have the power to invalidate the arrangement and determine the consequences thereof
under the Code with exceptionallywide powers.

Procedure followed in India:8

The task of invoking and administering GAAR provisions is entrusted to theCIT. It needs to be
recognized that in the Indian tax administration scenario, the CIT is the head of the tax
administrative jurisdiction, which consists of several AOs working under him. He is also largely
responsible for achieving the targets of tax collections given to him by the Government. The
possibility of conflict of interest in implementation of GAAR provisions in a fair and just
manner, though unintended, cannot be ruled out.
The CIT is required to issue notice to the taxpayer requiring him to produce evidence,
particulars, etc. on which the taxpayer relies in support of his claim that the arrangement in
question is not an Impermissible Avoidance Agreement. For this purpose, it is mandatory for
the CIT to give the opportunity of hearing to the assesse. During the proceedings before the CIT,
it is expected that the principles of natural justice will be followed.
Thereafter, the CIT is required to pass an order (within 12 months) if it is held that the
arrangement is impermissible as contemplated in the GAAR. Then, he is required to give
appropriate direction to the AO in his order. Interestingly, no specific time limit is provided for
issuing such a notice. It seems that the notice should be issued before the time barring date for
completing the relevant assessment. Based on these directions, the AO is required to pass a draft
8 Price Waterhouse Coopers, Removing the Fences: Looking Through GAAR, February 2012 available at
http://www.pwc.in/assets/pdfs/publications-2012/pwc-white-paper-on-gaar.pdf
10

order. The remedy available to the taxpayer is to file objections before the DRP consisting of
three CITs. The DRP, after following the appropriate procedure, is required to decide the matter
within a period of nine months and give appropriate directions to the AO who, in turn, is required
to pass the final assessment order based on these directions. The taxpayer can file an appeal
before the Income Tax Appellate Tribunal (ITAT) against the order. Considering past experience,
the DRP should be made independent and should operate on the lines of ITAT to provide a real
and effective remedy to the taxpayer. This will instill confidence amongst the tax payers,
domestically as well as globally. Such a mechanism will also help in keeping India as a
competitive destination for attracting foreign investments.
Once the CIT passes an order under the GAAR provisions, he is also required to send a copy to
the CIT having jurisdiction over the other party involved in the arrangement. The other CIT will
then proceed against the other party underthe GAAR provisions. The other CIT may again
independently examine the same arrangement. In a given situation, the other CIT may come to a
different conclusion in relation to that other party.

Consequences of such application:

Once the provisions of the GAAR are invoked in respect of any arrangement, the CIT has been
given wide powers to counteract the consequent tax advantages and to determine the tax
consequences either by ignoring the arrangement in question or in any other manner as the CIT
may deem appropriate, for the prevention or diminution of the relevant tax benefit.9 The CIT may
negate, disregard, set aside or re-characterise any arrangement or he may derecognize one or
more parties to the arrangement etc. The provision virtually empowers the CIT to lift the
corporate veil to reallocate income/expenses/ deductions/ relief, negate transactions and even
treat several entities as one for tax purposes. In certain cases, the findings and decision of the
CIT may have even non-tax consequences under other laws. Effectively, the CIT would have
enormous discretionary powers (which, of course, is expected to be judicially exercised) for
prevention or diminution of the relevant tax benefit and determine the consequences of the
arrangement in question under the Code. For example, in a given case, the CIT may treat a loan
as capital and deny the deduction of interest. Upon such treatment, corresponding consequences
9 Supra note 4
11

may follow under the Code. Similarly business profit can be recharacterised as royalty or fees for
technical services and taxed in India in the hands of a non-resident even in the absence of a
Permanent Establishment (PE). Unless judiciously exercised, these actions can create issues in
the home country of a non-resident taxpayer especially regarding characterisation of a genuine
income transaction, especially where India has entered into a tax treaty with the other country.
The Code also provides for overriding of tax treaty provisions where the GAAR is applied under
the Code.

12

ANALYSIS

OF

PROVISIONS SECTIONS 95

SECTION 144-BA

OF THE INCOME

TO

102

AND

TAX ACT

The general tendency witnessed in matters where there is any paradigm shift in the fiscal policy
of a country is that unless the move is aimed to directly benefit tax payers, irrespective of the
long term results sought, it is always viewed with skepticism - the insertion of GAAR into the
statute books serves as no exception to this rule. Therefore, the primary aim of the administration
at this juncture must first be to clarify the intent and purpose of such a move and take the subject
into confidence, else counter-productive results will be a certainty. It is the objective of this
section of the paper to weigh the intricate objectives of GAAR against the provisions as they
stand incorporated to critically assess the feasibility of implementing this fiscal instrument.

Tax policy of the Indian Government10

As a matter of priority, before an effective analysis of the provisions on GAAR can be
undertaken, the stand of the Indian government with regard to tax planning, avoidance and
evasion must be discussed. The policy of the government on the subject indicates that while tax
planning and mitigation are tolerated and permissible, avoidance and evasion are discouraged.
While evasion is per say illegal, not everything that is legal is desirable or permissible' Second
Draft Report on General Anti-Avoidance Rules submitted by Dr. Parthasarathi Shome
Committee (Report), available at and thus avoidance though legal, is still discouraged. This is
also the undertone of the entire Chapter dealing with GAAR. However, there is some respite in
the fact that the government still views GAAR as a deterrence mechanism and not a revenue
generating tool.
Chapter X A was introduced into the Income Tax Act, 1961 through the Finance Act, 2012 under
which sections beginning from 95 up to 102, and section 144BA deal with GAAR Finance Act,
2012 (Act No. 23 of 2012) enacted on 28-5-2012. However, the application of these sections,
10 Supra note 8
13

owing to stakeholder pressure, was delayed by another year, i.e. applicable from assessment year
2014-2015, through a circular issued by the Finance Ministry.11

Applicability of the General Anti- Avoidance Rules

The applicability of the General Anti- Avoidance Rules as has been laid down under section 95
extends to such impermissible avoidance agreements that the assessee might enter and may be
declared so by the competent authority. The explanation to the section also states that the
provisions of the chapter may be applied to any step in, or a part of, the arrangement as they are
applicable to the arrangement. However, the expert committee has strongly suggested that where
only a part of the arrangement is declared impermissible, the provisions under the chapter must
only be used to counter that relevant part, while leaving the rest of the transaction unaffected.

Treaty Override- Whether justified?

International law, particularly commercial law, is presumed to be built upon a foundation of
international cooperation and understanding, which includes several mutually agreed rights and
obligations, created by consenting contracting parties. Taxation treaties are also subject to the
same standards, if not higher norms of compliance and disregarding or unilaterally altering such
promises made can be viewed seriously with adverse international consequences.12
Against this background, it may be pertinent to note that section 95 begins with a non-obstante
clause to exclude the applicability of anything else contained within the Act. This must be read
along with the amendment made to section 90 by the Finance Act which now provides for subsection 2A which reads "Notwithstanding anything contained in sub-section (2), the provisions
of Chapter X-A of the Act shall apply to the assessee, even if such provisions are not beneficial
to him." When both these sections are couched in such terms, the implications are many and far
reaching.
11 Circular No. 3/2012, Dated 12-6-2012, Supplementary Memorandum Explaining the Official
Amendments Moved in the Finance Bill, 2012 as Reflected in the Finance Act, 2012.
12 www.finmin.nic.in/the.../dept.../Draft_GAAR_GuidelineITAct1961.pdf

14

The old debate as to where the Act' includes even Double Taxation Avoidance Agreements
(DTAAs) that the government enters into with other countries in its executive capacity would
have to be reopened and depending on the answer to that question, whether or not DTAA would
be subject to the overriding powers of GAAR would have to be decided in the light of section 90
of the Income Tax Act. It has been consistently held that, 13 DTAA become part of the municipal
law once enacted and that such Agreements, when in conflict with the domestic law, must
generally be given effect to, overriding the disadvantage to the assessee as contained in the
statute.14 If the contrary view is taken, it would not be a correct reflection of the intention behind
concluding such Agreements.15
With these observations having been made, the scope and legitimacy of unilaterally disallowing
the benefits conferred by a Treaty provision by one of the Contracting States may be deliberated
upon. There is some justification to such application to be found within the Commentaries to the
OECD Model Convention, as has also been practiced by some countries. Based on purposive
interpretation of the treaty provisions, certain countries disallow treaty benefits under the plea of
treaty abuse, calling them unintended benefits'. This argument is also sought to be sustained as a
logical interpretation resulting from the construction of Conventions in good faith.16
However, this method of interpretation is not without opposition and hence, as an intermediary
measure, the report of the expert committee has recommended a view that where the treaty itself
has anti-avoidance provisions, such provisions should not be substituted by GAAR provisions
but where such anti-abuse provisions are absent, GAAR may be invoked.
Additionally, with specific reference to India's treaties with Mauritius and Singapore, particularly
Mauritius, the Committee's report suggests that until the capital gains tax has been done away
with, the Revenue must honour Circular 789 and the Residence Certificate issued by the
Government of Mauritius must be accepted as evidence on the point of genuineness of the
13 Azadi Bachao Andolan v Union of India, - (2003-TII-02-SC-INTL).
14 Commissioner of Income Tax v Visakhapatnam Port Trust, - (2003-TII-14-HC-AP-INTL).
15 Commissioner of Income Tax v Davy Ash more India Ltd., -(2003-TII-26-HC-KOL-INTL); Leonhard Andhra
And Partner, Gmbh v Commissioner of Income Tax, -(2003-TII-94-HC-KOL-INTL)

16 Article 31 of the Vienna Convention on the Law of Treaties.

15

residence status of an entity. In the humble view of the authors, this may run contrary to the
intentions of introducing GAAR in the first place and will work against the principle of equity in
taxation. Such a move if accepted will imply that a TRC is enough to override GAAR provisions
and would abruptly end one of the most laudable objectives of the rules as envisaged in the
Budget that of plugging a loophole which foreign institutional investors exploited to avoid
paying capital gains tax in India.17

Impermissible Avoidance Arrangements' Meaning and Ambit

The definition of an impermissible avoidance arrangements under Section 96 of the Act covers
within its scope any arrangement whose main purpose or one of the main purpose' is to obtain a
tax benefit and it results in:
(a) rights or obligations not ordinarily created between parties dealing at arm's length;
(b) direct or indirect misuse or abuse of the Act;
(c) lacks commercial purpose or deems to lack the same under Section 97; or
(d) is entered into or carried out by means not ordinarily employed for bona fide purposes.
Such a definition has been criticized on several grounds which include

One, it may be pointed out that the original version of GAAR as it appeared in the Direct Tax
Code of 2009 and in 2010, the purpose test required that the main purpose of the arrangement
was to obtain tax benefit. However, the present provision has enlarged the scope of the
definition to include any arrangement where the main purpose or one of the main purposes is
to obtain tax benefit, thereby diluting the purpose test and leaving room for uncertainty.

Two, sub-sections 1(b) and (c) suggest ample room for discretion on the part of the tax
official in determining what constitute misuse or abuse' under the Act and what may be
termed as lack of commercial purpose', considering the fact that the section empowers the

17 Supra note 12
16

authority to even question a transaction where the sole purpose might not be a tax benefit but
still may be an incidental consequence.

Three, as there are specific transfer pricing regulations applicable to international

transactions and certain specified domestic transactions, the tainted element in such cases, it
is submitted, is to be examined only in the event of such transactions not being covered by
the regulations and where the main purpose of the arrangement is to obtain tax benefit. As
suggested by the committee report, a mechanism needs to be provided for the Assessing
Officer (AO) to ascertain whether rights, or obligations, created in an arrangement are the
same as ordinarily created between persons dealing at arm's length and expert guidance must
be made available to such an officer.

Fourthly and finally, subsections 1(b) to (d), as pointed out previously, refer to uncertain
concepts and hence judicial tests evolved to check abuse may be used as a referral point.
Particularly, established principles developed under tests such the Business Purpose Rule', 18
Sham transaction Rule',19 and the Doctrine of wrong characterization'.20

Decoding Lack of Commercial Purpose' and the Consequences of an

impermissible Arrangement'
The phrase arrangement to lack commercial substance' has not been defined under Section 97 of
the Act but an enumerative list of the same is provided. It is noted here that earlier version of
GAAR in the DTC Bills of 2009 and 2010 defined the commercial substance as an
arrangement shall be deemed to be lacking commercial substance if it does not have a
significant effect upon the business risks, or net cash flows, of any party to the arrangement
apart from any effect attributable to the tax benefit that would be obtained but for the provisions
of section . This generic definition must be reinstituted into section 97 to further clarity.
18 Gregory v Helvering, 293 US 465 (1935) (US) (Helvering) and IRC v Brebner , (1967) 2 AC 182
(UK)
19 IRC v Challenge Corporation Ltd ., (1987) 2 WLR 24 (NZ)
20 Ridge Securities v IRC, 44 TC 373 (UK), Council of India v Scobie,4 TC 618 (UK) and Vestley v
IRC, 40 TC 112 (UK)
17

Section 97 as it stands presently incorporated under the Act, reflects with approval the substance
over form doctrine under subsection 1(a). This power of the authority to declare impermissible
the substance or effect of the arrangement as a whole when it is inconsistent or significantly
differs with its individual steps or form, read along with the powers vested under section 98 1
(a), which may be invoke to disregard, recharacterise or combine any step(s) under an
impermissible agreement, is consistent with the practice in certain countries like Canada, Japan,
USA and the UK.21
The other criteria laid down for categorizing an arrangement as impermissible are:
Section 97 (1) (b) if it involves:
(i)

round tripping- the scope of which is clarified under Section 97 (2),

(ii)

an accommodating party as discussed in Section 97 (3),

(iii)

elements that have the effect of cancelling or offsetting each other

(iv)

a transaction which is conducted through one or more persons and disguises the
value, location, source, ownership or control of funds which is the subject matter of
such transaction; or

(v)

Section 97 (1) (c) when it involves the location of an asset or of a transaction or of the
place of residence of any party which is without any substantial commercial purpose
other than obtaining a tax benefit for a party.

Finally, Section 97 (4) specifies that the period of the transaction, the taxes that may be paid
under it directly or indirectly and the existence of an exit route created are not to be treated as
relevant factors while determining if an arrangement lacks commercial purpose or not. As
recommended by the committee, it must necessarily be clarified through legislative amendment
that factors (i) to (iii) in Section 97(4) of the Act are, instead of being irrelevant, not sufficient
21 Roy Rohatgi, Basic International Taxation, Vol.2, 2 nd Ed., Taxmann at 149. and as adopted in cases such
as Gregory v Helvering (Helvering) and IRC v Ramsay (Ramsay).

18

for an arrangement to be excluded from the commercial substance test but may be relevant in the
consideration of other aspects of GAAR. If the contrary view is taken, a dangerous scenario
would arise where even bona fide transactions might be unnecessarily hit by the Act.
Critically appraising the methods that may be employed to arrive at an impermissible
arrangement and the consequences of such a declaration as contained in Section 98 and the
treatment of an accommodating and connected party under Section 99 reveal two short comings.
One, concepts such as the ones contained in Sections 98 and 99 are very specific and involve
multiple dimensions, both on the domestic and international fronts. Therefore, the officials must
receive in depth training and practical exposure in such type of transactions before being allowed
to judge them. Two, against these requirements and an honest analysis of the present tax system
which is not equipped with the adequate infrastructure, man power or transparency, it is doubted
whether the Indian tax administration is equipped to handle such complex issues at this stage.
Lastly, Section 100 states that chapter shall apply in addition to, or in lieu of, any other basis for
determination of tax liability. Section 101 mandates that the provisions of the chapter must be
applied in accordance with any guidelines issued from time to time by the Government on the
matter. Section 102 lays down the definitions for various terms used within the chapter. As the
expert committee has urged, the term associated persons' as defined under Section 103(3)(a)
must be put in line with the already existing definitions Section 92A of the Act to avoid
multiplicity of interpretations.

19

AVOIDANCE

OR

EVASION? A TIMELINE

OF

JUDICIAL

PRONOUNCEMENTS
Overview
A close perusal of international taxation jurisprudence will reveal that there has been
considerable judicial debate on the aspects of tax planning, mitigation, avoidance and evasion.
While a series of decisions across the world asserted the right of the subject to so dispose of his
capital and income as to attract upon himself the least amount of tax, there were certain other
intermediate ones which pointed otherwise.22 That avoidance of tax is not evasion and it carries
no ignominy with it, for it is sound law, not bad morality, for anybody to so arrange his affairs as
to reduce the brunt of taxation to a minimum' was perhaps most emphatically stated by the
English courts and was also one of the most predominant views followed by other national
courts.23 In the context of payment of tax, evasion' necessarily meant to try illegally to avoid
paying tax'; therefore, tax planning' was not evasion 24 and the subject cannot be changed
ignoring the legal position and regarding the substance of the transaction', the courts in England
reiterated.25 However, this position was soon to change with the advancement of InterGovernmental Tax Treaties with Limitation of Benefit [LOB] clauses and new mechanisms like
Specific Anti Avoidance Rules [SAAR] and General Anti- Avoidance Rules [GAAR] being
incorporated into domestic laws. Therefore, any discussion of such later tools like GAAR,
contemplated and designed to preserve tax bases, will be incomplete without an analysis of the
judicial opinion prior to or contemporaneous with their enactment. This section attempts to trace
the time line of such judicial thought, simultaneously providing for critical analysis of selected
cases.
22 Duke of Westminister v IR, 19 TC 490, 511, 520 (HL) [Duke]; CIT v Abhayananda Rath [Rath] 255
ITR 436.
23Per Jagadisan J, Aruna v State of Madras , 55 ITR 642, 648. Viscount Simon LC in Latilla v IR, 11
ITR Suppl 78, 79 (HL), and Greene MR in Howard v IR, 25 TC 121, 134, 10 ITR Suppl 90 (CA).
24 Supra 1
25 IR v Wesleyan Society , 16 ITR Suppl 101(HL); Provident Inv v CIT, 24 ITR 33, affirmed in 32 ITR
190 (SC)
20

The Indian Experience

The general trend with judicial pronouncements in India on the point of tax avoidance may be
said to generally mirror the English experience as and when cases of the like nature came up for
consideration. The ratio in the Duke of Westminster case26 having settled the position on
avoidance and evasion went undisturbed and promptly followed in India and the supposed
doctrine that in revenue cases the substance of the matter' may be regarded as distinguished
from the form or the strict legal position, was reiterated by the Privy Council in Bank
of Chettinad Ltd. v CIT27 and by the Supreme Court in CIT v Keshav Lal Patel28.
This trend however became unsettled with the rather intriguing judgment in Mcdowell v CTO29,
where the Supreme Court seemed to suggest that the legal position in cases of tax avoidance
should be taken as altered in the light of the three decisions of the House of Lords30. Thus in the
scheme of events so far, the off shot judgment in the Mcdowell case demands further analysis.

A Change in Fiscal Jurisprudence so far: Mcdowell V. CTO

The factual matrix of Mcdowell was very simple. McDowell was a licensed manufacturer of
liquor in Hyderabad. The company had failed to disclose the excise duty paid on liquor sold by it
to wholesalers. The taxing authority, through a notice, called upon the company to show cause
why assessments made should not be reopened. The company challenged the validity of this
notice and argued that the excise duty paid by the buyer did not become a part of the company's
turnover.

26 (19 TC 420)
27 Bank of Chettinad Ltd. v CIT (8 ITR 522, 526, followed in Chockalingam v CIT, 9 ITR 278.)
28 CIT v Keshav Lal Patel (55 ITR 637, 642.), CIT v Motors and General Stores Ltd. - (2002-TIOL-820-SC-ITLB) and in CIT v Kharwar - (2002-TIOL-703-SC-IT).

29 Mcdowell v CTO - (2002-TIOL-40-SC-CT) followed in Workmen v Associated Rubber Ltd., 157 ITR
77 (SC), Neroth v CIT, 166 ITR 418 and CIT v Minal, 167 ITR 507.)
30 Ramsay v IR (54 TC 101) and IR v Burma Oil (54 TC 200. ) and Furniss v Dwason (55 TC 324. ).
21

Justice Ranganath Mishra, speaking for the majority, stated that tax planning may be legitimate
as long as it is within the contours of law. Colourable devices cannot be part of tax planning and
it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax
by resorting to dubious methods. However, Justice Chinnappa Reddy went one step further and
held that the Westminster principle was dead in England and that its ghost had to be done away
with. This observation was soon defeated when the English appellate courts reiterated the
Westminster principle in several subsequent cases.31
Justice Chinnappa Reddy's decision is on two grounds 32 that it one, diminishes considerably the
thin line that separates tax avoidance from evasion and two, that it was not consistent with the
correct interpretation of the English law on the subject as it existed then. Soon after the 1985
judgment, the opposition to Chinnappa Reddy J's solitary extreme view was seen in the form of a
lethal retort by Justice Sabyasachi Muhkarji's 33 when he emphatically stated that no amount of
moral sermons would change people's attitude to tax avoidance and when the court observed
that one should avoid subverting the rule of law. 34 As a matter of law, the Supreme Court
reiterated in these later cases that where the true effect of a transaction is clear, the appeal to
discourage tax avoidance was not a relevant consideration.

Aftermath
The correct legal position with regard to tax mitigation post Mcdowell 's were attempted to be
clarified in several decisions of the Madras High Court35 and of the Gujarat High Court36,where
it was held that the 1985 decision does not hit tax planning but only looks down at colourable
devices.
31 Mac Niven (Inspector of Taxes) v Westmorland Investments Ltd [(2001) 1 All ER 865]
32 Kanga, Palkhivala and Vyas, The Laws and Practice of Income Tax, Vol.1, 9th Ed., Lexis Nexis
Butterworths.
33 CWT v Narottam, 173 ITR 479
34 Union of India v Playwood Electronics, 184 ITR 308, 318
35 Valliappan v. ITO 170 ITR 238, 280-286
36 Banyan and Berry v. CIT 222 ITR 831, 850
22

Reiterating the Westminster Principle: Azadi Bachao Andoan v Union of India37

In 2003, a division Bench of the Supreme Court upheld the government's appeal against the
Delhi High Court judgment quashing Circular No.789,38 which provided that the Mauritius Tax
Residency Certificate issued by the Mauritius Tax Office was sufficient evidence on the point of
residence and beneficial ownership for applying the Convention on the Avoidance of Double
Taxation between India and Mauritius.39
In fact, upholding the decision in McDowell as an exception to the well settled rule, the judges
upheld the right of the tax payer to legitimately plans his affairs and avail the benefits of
mitigation. It must be equally emphasized at this juncture that the decisions in McDowell40
and Azadi41 are not contradictory since they dwell on different issues. However, the Calcutta
High Court42 has thought it relevant to answer this apparent conflict and has held that since the
decision of a division bench of the Supreme Court in Azadi's case has correctly interpreted the
decision of a five bench decision in McDowell, the former will be binding on lower courts.

The Final Word: Vodafone International's Case43

The dispute in Vodafone revolved around the interpretation and scope of a deeming fiction under
Section 9 of the Income Tax Act, 1961 and the underlying aspects of situs of the capital asset and
the revenue's powers to tax non-resident transactions. In this case, Vodafone International
Holdings BV, a Dutch based Vodafone entity, acquired a controlling stake in Hutchison Essar
Ltd., an Indian company, from Cayman Islands based Hutchison Telecommunications
37 Azadi Bachao Andolan v Union of India - (2003-TII-02-SC-INTL).
38 Supra note 4
39 Supra note 7
40 Supra 29
41 2003-TII-02-SC-INTL
42 Oberoi Hotels Pvt. Ltd. ITA No. 13 of 2001 - (2011-TIOL-178-HC-KOL-IT).
43 Vodafone International Holdings B.V. v. Union of India Appeal No. 733 of 2012.

23

International Limited by acquiring shares of CGP Investment, a Cayman Islands company in

February 2007. CGP held various Mauritian companies, which in turn held a majority stake in
HEL. In September 2007, the Revenue Authorities issued a show-cause notice to Vodafone for
failure to withhold tax on the amount paid for acquiring the said stake, as the Revenue
Authorities believed that Hutchinson was liable for capital gains it earned from the transfer of
shares of CGP, as CGP indirectly held stake in HEL.
After the Revenue succeeded at the Bombay High Court, the Hon'ble Supreme Court in the
appeal by Vodafone reversed the decision and observed that the entire transaction has been
carried out outside India and in relation to property which is situated outside India and since it
involves transaction between two non-residents in respect of shares of a company incorporated
outside India, the Indian Tax Authorities had no territorial tax jurisdiction over the said
transaction.

CONCLUSION
24

India - The country whose growth story has been and will continue to be the focal-point of the
21st century, along with a couple of other nations. With the increasing globalization, upsurge in
cross-border transactions and profound capital inflow, India is all set to occupy the center-stage
in a decade or so as one of the ideal locations for large investment. However, with a view to
address the growing concerns of Revenue Authorities (RA) over the use of sham structures to
make investments in India solely to obtain tax benefits/avoid tax and to codify the judicial
doctrines which partly-prohibited the foregoing tax evading scheme, the Finance Act of 2012
introduced GAAR vide the inclusion of Chapter XA to the IT Act, 1961.
On an overall impression of GAAR, it seems to be a mixed bag with its fair share of positives
and negatives. Although one cannot mainly argue against the merits of GAAR and the intent with
which it is enacted, there needs to be unmistakable direction and clarity in its implementation. In
order to ensure the same, the government appointed an expert committee headed by
Parthasarathy Shome. A draft report of the recommendations made by Parthasarathy Dr. Shome
Committee was released recently.
Thus, GAAR is a dynamic concept which comes under the ambit of corporate tac=xation and is
applicable in the Indian situation.

REFERENCES

25

BOOKS AND ARTICLES

http://www.claonline.in/DisplayArticle.aspx?
ID=MzQzNQ==&FileName=MjAxMl8xNDIuaHRt

Beyond Boundaries : Developing Approached to Tax Avoidance and Tax Risk

Management, Oxford University CBT

John Prebble, An American GAAR, TaxProf Blog, 2010 available at:

http://ssrn.com/abstract=1658233
Arkay & Arkay, Chartered Accountants, GAAR: Past, Present & Future, available at
http://www.moneycontrol.com/news_html_files/news_attachment/2013/GAAR_Web.pdf
Ernst & Young, GAAR Rising: Mapping Tax Enforcements Evolution available at
www.ey.com/Publication/.../GAA.../GAAR_rising_1%20Feb_2013.pdf
Roy Rohatgi, Basic International Taxation, Vol.2, 2 nd Ed., Taxmann

Kanga, Palkhivala and Vyas, The Laws and Practice of Income Tax, Vol.1, 9th Ed., Lexis
Nexis Butterworths.
Graham Aaronson QC, GAAR study: a study to consider whether a general antiavoidance rule should be introduced into the UK tax system, 11 November 2011,
http://www.hm-treasury.gov.uk/d/gaar_final_report_111111.pdf

Price Waterhouse Coopers, Removing the Fences: Looking Through GAAR, February
2012 available at http://www.pwc.in/assets/pdfs/publications-2012/pwc-white-paper-ongaar.pdf

www.finmin.nic.in/the.../dept.../Draft_GAAR_GuidelineITAct1961.pdf

CASE LAWS

Azadi Bachao Andolan v Union of India

Commissioner of Income Tax v Visakhapatnam Port Trust

Commissioner of Income Tax v Davy Ash more India Ltd. 2003-TII-26-HC-KOL-INTL

Leonhard Andhra And Partner v Commissioner of Income Tax 2003-TII-94-HC-KOL-

2003-TII-02-SC-INTL

INTL

Gregory v Helvering 293 US 465 (1935) (US)

IRC v Brebner (1967) 2 AC 182 (UK)

IRC v Challenge Corporation Ltd. (1987) 2 WLR 24 (NZ)

Ridge Securities v IRC 44 TC 373 (UK)

26

2003-TII-14-HC-AP-INTL

Council of India v Scobie 4 TC 618 (UK)

Vestley v IRC 40 TC 112 (UK)

Duke of Westminister v IR 19 TC 490, 511, 520

CIT v Abhayananda Rath 255 ITR 436.

Per Jagadisan J, Aruna v State of Madras 55 ITR 642, 648

Viscount Simon LC in Latilla v IR 11 ITR Suppl 78, 79 (HL)

Greene MR in Howard v IR 25 TC 121, 134, 10 ITR

IR v Wesleyan Society 16 ITR Suppl 101(HL)

Provident Inv v CIT 24 ITR 33, affirmed in 32 ITR

Bank of Chettinad Ltd. v CIT 8 ITR 522, 526

CIT v Keshav Lal Patel 55 ITR 637, 642

Mcdowell v CTO 2002-TIOL-40-SC-CT

Ramsay v IR 54 TC 101

IR v Burma Oil 54 TC 200

Furniss v Dwason 55 TC 324

Mac Niven (Inspector of Taxes) v Westmorland Investments Ltd

CWT v Narottam 173 ITR 479

Oberoi Hotels Pvt. Ltd. ITA No. 13 of 2001 2011-TIOL-178-HC-KOL-IT

Vodafone International Holdings B.V. v. Union of India Appeal No. 733 of 2012.

27

(2001) 1 All ER 865