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Grrrr Grrrrr GAAR!

Published on Fri, Mar 23,2012 | 22:40, Updated at Mon, Mar 26 at 12:24Source : CNBC-TV18 |   Watch Video :

For decades now tax payers and tax collectors in this country and world over have been consumed by the avoidance versus evasion debate - avoidance acceptable, evasion illegal. But that is about to end, at least here in India because Budget 2012 has advanced the introduction of general-anti-avoidance rules. 8 other countries have implemented GAAR – which has become revenue’s most potent weapon against the increasingly complex world of corporate structures- which in itself is not so bad if it were to be applied with clarity, maturity and a respect for commercial viability.

But then GAAR everywhere has proved to be a litigation minefield. In India too, GAAR will put the onus of establishing substance over form on the company. So what can India Inc do to avoid the avoidance allegations and yet be able to organize its affairs in a tax-efficient manner?

Payaswini Upadhyay goes searching for that unattainable tax nirvana!

Industry suggestions on safeguards
Parliamentary Standing Committee recommendations
Supreme Court substance parameters

----none of these found way in Chapter X-A of the Finance Bill 2012 that proposes to introduce general anti avoidance rules to counter transactions carried out solely to obtain a tax benefit.

Thomas Britt 
Partner, Debevoise & Plimpton
“To be honest, I thought that the proposal gives a very significant amount of discretion to potentially investigate a wide series of corporate transactions happening in India. It’s empowered that discretionary authority with a panel of representatives of the tax department as opposed to, for eg, a member of the judiciary. An interesting component of that is that it seems to create a presumption that if a transaction has been structured in a tax efficient manner – that the primary purpose of structuring it that way was to achieve the tax efficiencies irrespective of what other commercial purposes that particular transaction might have.”

But the biggest burden for taxpayers is that the burden of proof of commercial substance lies on them. Compare that to the South African GAAR where the onus to prove lack of commercial substance is on revenue authorities; in Canada the onus is divided between revenue and taxpayers.

As India takes its place with 13 countries that have gone GAAR, its enterprises, non resident tax payers, private equity and foreign investors will have to avoid avoiding tax.

Because GAAR will characterize a transaction as an impermissible avoidance arrangement if its main purpose is tax benefit and if it meets any of these 4 conditions. That is

- If the transaction creates rights or obligations not created ordinarily between parties dealing at arm’s length
- If the transaction results in misuse of the Income Tax Act
- If the transaction lacks commercial substance in part or as a whole
- And lastly if it is entered into or carried out in a manner which is not genuine

Pranay Sayta,
Partner, E&Y
“When we look at these conditions - the first one that the main purpose is to obtain a tax benefit and second - one of the 4 criteria being met, it can virtually apply to any and every case. There could be a case where there is an interest paid on the debt, there could be an example where a treaty benefit has been claimed by a company which is abroad, there could be a case where there is a merger in India or there could be a case where there is a buyback of shares- it could apply to pretty much any or every case.”

Pinky Mehta
President & Head- Corporate Management Service Division
Aditya Birla Group
“Once the GAAR comes into force, then the transactions like shareholders loan – why the equity has not been infused and the loan has been given; secondly a buy and a lease transactions; then purchase vs lease of an asset- why asset is taken on lease and not purchased; then writing off bad debts vs the provisioning; then merger of the loss making company to the profit making company – things will be questioned by the assessing officer and the assessee has to prove the economic substance of the transactions.”

And that would need companies to document the purpose of every layer and special purpose vehicle used in a transaction.

The commercial substance test would fail if a transaction as a whole or in parts involves
- Round trip financing
- elements that have effect of offsetting or canceling each other or
- a transaction that disguises location, source ownership etc  or if it involves
- An  accommodating party

Thomas Britt  III
Partner, Debevoise & Plimpton
“It may very well be the case that an international investor routes its investments, on a global basis, and not just India through a limited number of jurisdictions around the world and it could be efficient for them for a cost and management perspective. Finally utilizing an offshore SPV for making an investment in India could be the consequence of the government of that jurisdiction creating incentives for the international fund manager to do exactly that – so there are a host of legitimate commercial reasons for utilizing SPVs in other jurisdictions aside from just a tax advantage that I think would be important for an international investor to establish in case GAAR proceeding is brought against them.”

Pranay Sayta,
Partner, E&Y
“If I were to issue whole host of convertible debentures and the interest on that debenture is sought to be allowed and claimed as interest, I would be cautious to ensure that there is sufficient documentation to show that there is a commercial purpose and that it was not another form of equity. The fact, therefore, would be that the convertible debenture has a certain attraction from investor standpoint, from a company's standpoint that it doesn't immediately dilute equity - all of which would have to be at the forefront and adequately documented.”

And yet if the tax department is not convinced with the taxpayers reasons for using a particular structure, part or whole of the transaction can be disregarded, combined or re-characterized. 

Pinky Mehta
President & Head- Corporate Management Service Division
Aditya Birla Group
“Re-characterization means that the tax authorities may treat the accrual and receipt of any capital nature as a revenue nature; they may treat any debt as equity or vice versa; they may reallocate any of the asset; they may ignore the place of residence and they can deny the tax benefits taken by the taxpayer.”

Pranay Sayta,
Partner, E&Y
“For all we know, it could result in a particular transaction being characterized as a dividend payment instead of a buyback, there could be a particular interest expense being characterized as not really an interest expense and therefore being disallowed, there could be a situation where a particular case of conversion might not be accepted of a company into an LLP if it is motivated purely by tax reasons, it could probably amount to a re-characterization of a transaction where sale is carried out by a company from a Treaty friendly jurisdiction and the residents of that particular treaty jurisdiction may be regarded as something different if it is managed and controlled elsewhere or it can be looked through altogether and the parent of that entity may be regarded as the true owner.”

Talking of treaties, India’s GAAR provides a treaty override. Not only could an assesee be denied treaty benefits, it may also face double taxation

Thomas Britt
Partner, Debevoise & Plimpton

“Mauritius doesn’t have a capital gains tax on sale of shares by Mauritius entities of Indian companies but they do have a normal tax on income and operations there. There could be a circumstance where Mauritius taxes levy as well as Indian capital gains tax, which I said, would be unfortunate because that’s clearly one of the primary objective of the double tax treaty.”
 
GAAR was going to come to India soon. Revenue everywhere is going after tax avoidance and not just evasion. In fact Osborne said aggressive avoidance is morally repugnant

So India going GAAR is neither unexpected nor objectionable. What is disappointing though is that the finance ministry has ignored every safeguard or parameter suggested by industry, the parliamentary standing committee and even supreme court.

For instance industry had suggested that the approval panel looking at GAAR appeals be of judicial nature- it is not in GAAR 2012.

Parliamentary Standing Committee had recommended grandfathering transactions already entered into - that has been ignored by GAAR 2012.
And the Supreme Court had laid down 6 substance parameters in the Vodafone judgment- GAAR 2012 has pointedly denied them as proving substance.

But there is hope… maybe the CBDT guidelines that follow will introduce de-minimus thresholds and statutorily acknowledge legitimate tax planning.

Either way, experts say transactions that are currently midway may need to re-look their structures to check if they have been created solely for tax benefits – a course correction is suggested or the parties should prepare themselves for the wrath of GAAR.

 
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