What is the General Anti Avoidance Rule (GAAR)?

Tax evasion has haunted the Income Tax Department for years. This creates an environment where honest taxpayers have to carry the heavier burden of taxes whereas larger corporations are able to jump through the loopholes to evade tax completely.

This issue reached its peak during the Vodafone Case. The government saw a need for rigorous tax laws against tax evasion when it lost USD 2 billion in taxes. This resulted in the creation of the General Anti-Avoidance Rule (GAAR) in 2017 to eliminate tax evasion and minimise tax leakage. The GAAR provisions are established under the Income Tax Act, of 1961.

What is GAAR?

Initially, the General Anti-Avoidance Rule (GAAR) was proposed in 2009 in the Direct Tax Code. It was later introduced into the Indian Budget Session of Parliament in 2012. The proposals were reviewed by a committee set up for the purpose under the leadership of Parthasarathy Shome.

On 1st April 2017, it was established under the Income Tax Act of 1961. Since the full-scale implementation required the establishment of administrative machinery and official training, the GAAR  became applicable from the assessment year 2018-19.

This provision enables detecting aggressive tax planning, especially the transactions recorded solely to dodge tax. GAAR has been implemented with a motive to strengthen the integrity of the Indian tax system by making sure that no illegal methods are used to evade tax.

Let us now understand the case that led to the implementation of GAAR for the tax system:

Story Behind Origin of GAAR

In 2007, Vodafone bought a 52% stake in Hutchison Essar, an Indian mobile phone company, through an offshore transaction in the Cayman Islands. Following this event, the Indian tax authorities demanded Vodafone pay over ₹20,000 crore, arguing that profits made from such transactions are taxable in India.

Vodafone contradicted this allegation and sought legal relief under the India-Netherlands Bilateral Investment Protection Agreement (BIPA) in 2012. The Supreme Court of India supported Vodafone, stating the company followed the law. The arbitration under BIPA (Bilateral Investment Promotion and Protection Agreement) allowed Vodafone to claim that the tax claim by the Indian government violated the fair treatment principles guaranteed by the treaty.

Despite the Supreme Court’s decision, the tax dispute continued. In 2017, the Delhi High Court stepped in during another arbitration attempt by Vodafone under the India-UK BIPA. The court restricted the arbitration and allowed the inclusion of a presiding arbitrator. The Indian government challenged this decision, maintaining the dispute.

Finally, to prevent such tax evasion in the case of taxable arbitrations, GAAR was introduced.

Tax Evasion vs Tax Avoidance

GAAR has been constituted to curb tax evasion and not tax avoidance. It is important to understand the difference between the two to know the applicability of GAAR.

Know More About Filing Income Tax Returns

How does GAAR work?

GAAR is designed to address the transaction arrangements recorded by the taxpayers that might be considered Impermissible Avoidance Agreements under the Income Tax Act. This inclusion allows the GAAR to be applied broadly.

The objective of GAAR is to detect the actual intent and purpose of the parties and the arrangement over its legal form (substance over form) when assessing tax consequences. Thus, GAAR targets Impermissible Avoidance Arrangements (IAA), which need to satisfy two main criteria:

1. The arrangement’s primary objective is to obtain a tax benefit.

2. The arrangement either:

• Establishes rights or obligations between parties that do not deal with each other at arm’s length, or
• Leads to the misuse or abuse of the provisions of the Income Tax Act, 1961, either directly or indirectly, or
• Lacks commercial substance, either wholly or partially, or
• Is conducted in a manner not typically employed for bona fide purposes.

If the above conditions are satisfied, GAAR can be invoked to validate the transactions recorded and whether they result in tax evasion or not. Subsequently, legal actions are taken if any illegal tax evasion strategies are detected.

Limitations of GAAR

• GAAR can be difficult to implement as the line to differentiate objectionable transactions from permissible transactions is very thin.
• These provisions can be applied subjectively which opens the possibility of abuse by the tax authorities.
• It can discourage tax planning as it is too strict and can have a chilling effect on the taxpayers.

Conclusion

The General Anti-Avoidance Rule (GAAR) significantly strengthens the Indian tax system’s integrity. It is important to record the transactions for income tax returns that are backed by legitimate documents to navigate through the scrutiny process. Don’t let the GAAR discourage your tax planning process.

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