GAAR Rules Will Level Playing Field?
The good news is that GAAR will now apply only to income earned April 1st, 2013 onwards. The bad news is that many other aspects of the GAAR architecture or shall I call them ‘Key Design Elements’ stay the same. Yes the burden of proof has now moved to the tax officer. Yes a proposed transaction can seek an advance ruling. And yes, having a Law Ministry member on the GAAR panel is better than a panel of tax officials but it doesn’t do much to balance the scales. That said, the main GAAR architecture – that is the 4 conditions that determine the permissibility or impermissibility, The Commercial Substance test and the Treaty Override Clause remain unchanged. Many have thought these key design elements to be onerous and unfair to the taxpayer. And hence the question, Can the yet to be announced GAAR rules level the playing field? To answer this I have with me Rupak Saha of GE & Sudhir Kapadia of EY.
Doshi: Mr. Saha, there is a Revenue Officials Committee that is currently deliberating on GAAR Rules or provisions and a report is expected at the end of this month – my question to you is, is there anything those rules can do, address or incorporate that might make the broad architectural design elements of GAAR seem less harsh?
Saha: I think there are broadly three aspects; one is detailed listing of those four tests, to the extent they can be exhaustive the better it is. Second is if they want to carve out, what is legitimate tax planning. I was looking at some comparative GAAR in certain other countries including the proposed GAAR in UK and everyone really talks about legitimate tax planning should be carved out. In that respect, I must also tell you that the revived discussion paper on DTC even for that matter the original discussion paper on the DTC, also the tax talks about mitigation exercises should be left out the purview of GAAR, so that is two.
Third, interestingly I saw on the proposed legislation for UK GAAR as to what kind of evidence which can be admitted to attack tribunals for example which demonstrates that the tax payer acted in a bonafide manner. So for example if there is government material, not tax material but other government pronouncements which says a certain practice is acceptable or the Revenue’s own conduct with respect to other transactions. Some kind of illustrative list of what kind of evidence should one rely upon to establish if the tax payer is bonafide that kind of guidance would also be very helpful. These are the three things which come at the top of my head.
Doshi: Let me go back to the first point you made because the other two I understood clearly, but the first point you said the detailed listing of the four tests, does that mean that you want a book of case law or examples that describe what kinds of transaction should be considered permissible or impermissible, is that what you are looking for? Illustrations?
Saha: Absolutely. Like commercial substance test we can write a book on it but at least there have to be some kind of guidance as to what is commercial substance except by saying this would be deemed to lack commercial substance. We need a little bit more material on that.
Kapadia: To supplement on what Mr Saha said about the first point, when you think about case laws or case specific illustrations, to take one group of illustrations when we talk about a tax payer availing of legitimate tax benefits provided in the statute; you want to expand, you have the possibility of expanding in a backward area that is legitimate tax planning. You want to expand in export zone, you go to an SEZ that is legitimate tax planning.
Doshi: That would also feed into Mr Saha’s second point… distinguish between tax planning and tax avoidance?
Kapadia: That is true, that is one but in principle just to supplement that further if you can illustrate and say look laws which provide certain benefits to a tax payer; if I as a tax payer use that benefit…GAAR should not be a mechanism to demonstrate as a tax payer that I have paid maximum possible tax I could have paid, that is the fear. If I have avenues to legitimately plan or save taxes, I should be able to avail of.
Taking a second example – when we talk about capital structure, the whole world knows if I have equity, I pay dividends that is not tax deductible, if I borrow I pay interest that is tax deductible. Leave related party transactions aside. If as a business, in my capital structure I have a debt and I have an equity that cannot be a second guess from the Revenue to say, “Why did you borrow so much, you are claiming an interest deduction” so this is very critical.
One other point I would like to make is that when the Revenue was trying to say that you should have done this and not that, that ‘this’ part which Revenue says must also have a commercial rational to it.
Doshi: So the re-characterisation or the repurposing of the transaction cannot be totally rational, it cannot be designed only from the point of view of tax, and it has to fit into the commercial purpose of the transaction.
Doshi: It seems to me the most important thing that both of you want is being able to draw a line between planning and avoidance and especially abusive avoidance because that should be what GAAR goes after abusive avoidance.
Saha: Abusive tax avoidance is what you are saying. I was reading the law very closely, the law unlike many other laws; do not harp upon abusive tax avoidance. For example one of the four conditions or the four tests talks of misuse of that abuse of tax. ‘Misuse’ is the key word, it is incremental to abuse. That is what makes us nervous.
The other point about these four tests are to a certain extent for example the first tests which says two parties should not deal in a non-arm’s length manner. The fourth tests talks about two parties not dealing in a bonafide manner. I am not too sure if I understand the distinction between the two in all circumstances. So also these examples would help to contrast between let us say the first and the fourth tests.
Doshi: That is fair. I want to bring in out here one point the neither of you have raised but several people that I spoke to raised is that the first thing that they wanted in a safeguard which is a de minimis or a threshold of some sort saying that transactions of so and so size and below will not come under the purview of GAAR?
Saha : No I think I did mention that. My second condition, the second point which I said that there should be a list of tax mitigation exercises to meet that is de minimis. I do not want to suggest any quantitative de minimis because our quantitative test is different for different people. For an individual a quantitative test cannot have any bearing if you use the same quantitative threshold for a corporation for example. I think those should be much more qualitative.
Doshi: How important is it for the GAAR panel to be a majority of independent members - non revenue, because right now we have revenue and one law officer and that is not going to help in any fashion because they are all government.
Kapadia: That is a good point. I would put it this way. If you think about a GAAR in many ways like transfer pricing there are lot of elements to it which requires some kind of experience in the real world of business. A) To understand what has happened and B) to take into account the overall commercial sort of background or reality. So I would only say that any independent view or importer panel from people who have actually been into transactions, into business can give that holistic perspective both from a revenue point of view as well as from an assessee’s point of view, I think that is very critical.
Doshi: I can’t imagine that you will disagree with. I will bring another point to you and this comes from the UK GAAR report. Of course GAAR is not yet implemented in the UK but that report says and many other GAARs in the world also believe that when there is reasonable doubt is to which side of the line an arrangement falls, whether it is permissible or whether it is impermissible that doubt should be resolved in favour of the taxpayer so that GAAR would not apply. That is again another safeguard that we need to put in India.
Saha: Yes, absolutely. There is no two questions, there is no two ways about it, absolutely.
Doshi: I have one more question on this finally. I think Italy if I understand correctly applies GAAR only to certain listed transactions- for instance mergers or contribution of capital to companies etc – should we also include that in the de minimis list of sorts. Should we say that these kinds of transactions are transactions that will invoke GAAR and these kinds of transactions we will not look at- would that come in the second point that Rupak made.
Kapadia: In my view if you have a limited list of transactions which you want to make GAAR compliant it is always better because then you do not worry about the rest of the universe right and you focus on these and say okay I have to ensure as a tax payer, that if I fall into these listed transactions what I would call the positive list of the GAAR that is always better.
Saha: One argument against that and again I would be extremely happy if that happens but I guess one argument against that is someone to say that would essentially defeat GAAR then you are leaning towards more specific anti-avoidance or these are the 3-4-5-6 areas where there should be specific anti-avoidance, that is an argument which one has to then deal with. But I am not a fan of GAAR to start with so if Sudhir gets his way, more power to him.
Doshi: SAAR and not GAAR that’s what that would amount to
Kapadia: exactly, we are converting GAAR into a SAAR.
Doshi: Can anything that they do – suppose they adhere to everything that both of you have suggested and many of the safeguards that have internationally being applied then would you think that the GAAR that we are implementing in India is a fair version of GAAR or do you think that that no matter what they do in the rules because the four test that you eluded to which are in the act or will be in the act, the substance test is in the act and treaty override is in the act no matter how gentle the rules are GAAR is going to be a harsh GAAR.
Saha: I would say that it is already pretty harsh and once the substantive law is as harsh as it is the ability of secondary legislation to dilute that beyond a point is suspect. It would unfortunately remain a harsh GAAR.
Doshi: Mr. Kapadia, No matter what these rules have, they cannot level the playing field?
Kapadia: It is, I agree. GAAR is by its very nature, harsh.
Doshi: Our GAAR is harsher because of treaty override in many of the descriptions.
Kapadia: Particularly, Treaty override. They have taken into account the 3-4 other transactions.
Doshi: You have misuse and abuse of tax- the wording in those…
Kapadia: I would put it this way. My experience is that it all ultimately boils down to implementation. If you have a mature tax administration and with this kind of panel with independent panelist which looks at the totality of it and says yes, let us be sensible about it and let us not attack the sector ground of legitimate tax planning and go about questioning each and every transaction. You can’t quarrel against a GAAR per se. The greater concern in my view which tax payers have is quite frankly the experience in dealing with the tax administration on contentious issues, it is very-very revenue focused and therefore the concern that we will be questioned on almost any transaction even if there is a legitimate tax planning angle in it. I think that is a larger concern.
Doshi: If wishes were Horses, Tax Payers would fly! Gentlemen thank you for joining me.