New India GAAR circular aims for clarity but remains unsatisfactory

by Sriram Govind

With the 2017 budget in the horizon, India’s Central Board of Direct Taxes on January 27 released a circular to clarify how the India general anti-avoidance rules (GAAR) will be implemented.

The most important takeaway from the release is that the government means business as regards implementation of the India GAAR as of April 1 and that a further deferral should not be expected in this year’s budget.

While a few carefully worded clarifications provided by the circular should be welcomed by the investor community, unfortunately, other statements are bound to increase confusion around the GAAR, particularly regarding how it will be applied to transactions involving tax treaties.

The circular also fails to address several aspects of the India GAAR which remain unclear, making it likely that, unless changes are made in this week’s budget, India will soon experience a new wave of tax litigation.

For background, the India GAAR was introduced in the Income Tax Act, 1961 as Chapter X-A in the 2012 budget, providing the revenue broad powers to recharacterize or rework arrangements that have the main purpose of obtaining a tax benefit, on fulfilment of certain other conditions.

However, owing to mixed investor sentiments, the implementation of the GAAR was deferred until April 1, 2017, through subsequent budgets. To allay concerns, rules for implementation and several clarifications have been released as well.

As a final communication to the taxpayer prior to implementation, the government has now released a set of clarifications on several issues raised by investors and businesses.

India GAAR, tax treaties

Overall, the government’s discussion of the application of GAAR to tax treaties should be unsatisfactory to investors as the clarifications are vaguely worded, leaving interpretation open the tax authorities.

The circular makes it clear that the government will not take a specific position on whether the GAAR would apply where a specific anti-avoidance rule (SAAR) is already applicable. However, it also acknowledges that the GAAR is required only because SAARs do not cover all situations and it is thus arguable, on this basis, that if a transaction is granted approval under a SAAR then the same issue cannot be raised under the GAAR.

The circular further states that if a tax treaty limitation on benefits (LOB) provision ‘sufficiently addresses’ an abusive transaction, the GAAR should not be invoked.

Unfortunately, though, the vague wording in this statement may lead to opposite conclusions. On the one hand, the expression ‘sufficiently addressed’ may mean that the GAAR should not apply to a transaction that is tested under the LOB provision, but is cleared. This would be in line with the view expressed in the final report in Action 6 of the OECD/G20 base erosion profit shifting (BEPS) project.

On the other hand, though, the wording may also allow revenue to argue that in a case that is not found abusive under the LOB provision, the abuse has not been ‘sufficiently addressed.’

Further, some of India’s tax treaties, such as those with the UK, Luxembourg, and UAE, already contain a ‘principal purpose test’ (termed generally as a ‘limitation on benefits’ test) and India may introduce such provision in more treaties going forward through the multilateral instrument. It is unclear whether the position adopted in this circular on LOB provisions should extend to a principal purpose test, as well.

If this is the case, ideally, the Indian revenue would restrict itself to a bilaterally accepted interpretation of ‘main purpose’ as under the treaty for treaty abuse cases, and would also make the mutual agreement procedure (MAP) available to taxpayers under the tax treaty.

Separately, Action 14 of the BEPS project requires as a ‘minimum standard’ access to MAP where domestic GAARs are applied in conflict with tax treaties. As a G20 member that was active in the project, India is expected to implement this, but no clarification has been provided by the government as yet.

Choice of structure or jurisdiction

While the question of the taxpayer’s right to adopt the most favourable structure or the famed Westminster principle is referred to in the circular, the guidance also provides that there is no interplay between the GAAR and this right.

This clarification is strange since, in the Supreme Court of India decision in Azadi Bachao Andolan, the Westminster principle was used to justify a treaty shopping arrangement in the absence of an LOB clause in the treaty, the sort of arrangement that would probably be covered by the GAAR once it comes into force.

Crucially, the circular clarifies that the choice of jurisdiction itself would not lead to application of the GAAR and that if non-tax considerations are part of the main purpose of the transaction GAAR would not be applicable.

This would allow commercial considerations, such as need for pooling of investments in a convenient jurisdiction, presence of a bilateral investment treaty, etc., to be looked at prior to application of the GAAR.

Limitations on scope

The circular also clarifies that instruments created post April 1, by way of conversion of one instrument to another, as well as from splitting of existing shares or issue of bonus shares would be grandfathered, allowing some room for tax efficient restructuring along those lines.

It has also been clarified that an arrangement declared as permissible by India’s authority for advance rulings or approved by a court as part of scheme of amalgamation where the tax implications have been considered, would not be questioned under GAAR, providing clarity on these open issues.

It is also worth mentioning that it has been clarified that if an arrangement has already been accepted by the principal commissioner or the approving panel on reference by a tax officer, then the same arrangement would not be questioned again in subsequent years.

GAAR taxing rights, corresponding adjustments

Significantly, the circular does not prohibit tax authorities from going beyond the current law when fashioning remedies under the India GAAR.

This is a matter of real concern since Indian tax authorities may claim discretionary taxing rights based on this clarification. It is safe to assume that courts would need step in to place limits on the tax authorities going forward to prevent overreach.

Further, the circular clarifies that the limit for application of GAAR, namely, transactions above INR 30 million in value, should be calculated per the arrangement or part of arrangement in question in total and not in respect of each taxpayer.

It has also been clarified that, to deter tax avoidance, corresponding adjustments would not be provided to a related party on account of adjustments made to a taxpayer under the GAAR. The circular also denies any limitation to GAAR based on longevity of arrangement or on imposition of penalties.

On the issue of application of GAAR to claiming benefits under a tax treaty in one year and domestic law in the following year and on other issues raised, the circular does not take any concrete views and fails to provide any real guidance.

Final thoughts

It is important to point out that the government could still go a step further during budget announcements this week and reduce the scope of the GAAR, which is the need of the hour prior to implementation.

It is widely accepted that the provisions of the India GAAR give too much discretion to tax authorities as regards consequences and that it goes above and beyond similar provisions implemented in countries such as Canada, South Africa, or most recently, the United Kingdom.

Since the investor community has already claimed that the proposed GAAR does not provide fairness, certainty, or predictability to taxpayers, in a culture that embraces tax litigation as much as India, a spate of litigation will most certainly follow.

In light of this, some rationalizing measures from the government, along the lines of those proposed by the Shome Committee, would provide much-needed relief to the investor community and the already overburdened courts in India.

The views expressed by the author in this piece are purely personal and do not reflect or represent the views of any affiliated institution.