GAAR ambiguity clouds corporate revamp


By SR Patnaik & Bipluv Jhingan


Tax avoidance has been recognised as an area of concern for long. This is evident from the fact that countries have been amending their tax regimes to include antitax avoidance provisions. India sought to strengthen its position through the General Anti-Avoidance Rules (GAAR) effective April 1, 2017. GAAR could be invoked if the main purpose of an arrangement is to obtain tax benefit and tax consequences could include denial of treaty benefit and re-characterisation of the transaction.

However, due to their subjective nature, there is a lack of certainty and this has dampened the spirit of foreign investors and India Inc alike. It especially impacts corporate restructuring, where GAAR provisions could, while putting into practice the ‘theory of substance over form’, may make or break legally acceptable corporate transactions.

To address such concerns, the tax department has issued frequently asked questions (FAQs) and clarifications. However, ambiguity looms large over the transactions by way of GAAR. For example, when a lossmaking company is merged into a profit-making company, the accumulated losses of the former may be allowed to be carried forward and set off by the latter, subject to conditions. However, if a profit-making company is merged with a loss-making company, there are no conditions. Will this transaction be covered within the ambit of GAAR? The FAQs only add to the subjectivity of the provisions since they mention that GAAR could be applied along with any specific anti-avoidance provisions, as may be necessary, in facts and circumstances of the case.

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A similar issue may also arise in a case relating to the right of a taxpayer to choose the manner of implementing a transaction. The CBDT has clarified that the GAAR will not interplay with the right of a taxpayer to choose the mode of implementation of a transaction.

However, the risk that the tax department could question the transaction under GAAR, to ascertain whether a particular mode of doing a transaction could be construed to be an artificial device and a dispensable non-commercial step to evade tax, cannot be ruled out.

If a taxpayer chooses to transfer its business pursuant to a slump exchange (that is, where the consideration is paid in the form of securities), which is not taxable as per judicial precedents as compared to a slump sale, it is not known whether the tax department can question the commercial basis of the transaction.

Here’s another example: a taxpayer may choose to raise money through compulsorily convertible bonds instead of equity instruments; a taxpayer choosing to carry his business operations through a limited liability partnership instead of a private limited company and such like. The taxpayers would be claiming deductions on the interest paid on bonds or saving the dividend distribution tax (payable in case of a private limited company). There is a risk that the tax department may scrutinise such transactions under GAAR and the taxpayer will have to establish the genuineness of the case.

Further, another question on restructuring transactions is whether savings under any law other than the Income Tax Act will be a sufficient commercial rationale for arguing that GAAR should not be invoked. For example, a private company has a piece of land which it proposes to sell and it can sell the land directly or the shareholders could sell the shares of the company. If the land is sold directly, the company would be liable to pay capital gains tax as well as DDT before the money reaches the shareholders. It would also be required to pay stamp duty on land sale. However, if it is decided to sell the shares of a company holding the land, the shareholders would be required to pay tax on capital gains on the sale of their shares and a relatively small amount of stamp duty. While the tax department could contend that the share sale option was adopted to avoid DDT payment, it is also a fact that the option also results in a lower stamp duty liability. However, there is no clarity whether saving stamp duty could be regarded as a sufficient commercial rationale to prevent invocation of GAAR.

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All these scenarios are illustrative and we are pretty sure that the readers may come up with thousands of such cases. Taking into account the fact that GAAR was introduced to curb tax avoidance arrangements without creating undue hardship for genuine and honest taxpayers, India would need to address this issue and remove uncertainty that seems to impact business sentiment. While taxpayers hope Budget 2020 will lend more certainty to GAAR, considering the purpose for which it was introduced, we understand that government would be very keen to maintain the elements of subjectivity. In today’s slowing economy, if the government is able to clarify its position and intent, it may work wonders for market sentiment. The taxpayers shall also be well advised to ensure that every step in their proposed restructuring exercise is backed by proper commercial rationale.


(SR Patnaik is partner and head – Taxation, and Bipluv Jhingan is associate at Cyril Amarchand Mangaldas. The views expressed are personal and not of the law firm Cyril Amarchand Mangaldas)





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