Navigating the Complex World of Tax Strategies Amidst General Anti-Avoidance Rules (GAAR)

In this rapidly changing business landscape, corporates frequently undergo substantial restructuring and reorganisation to stay agile and responsive to evolving circumstances. These structures often originate as a result of various external factors, such as macro-economic conditions or growth objectives.

While tax structuring has become a crucial approach for corporates to strengthen their business objectives, which may also culminate in optimising their taxes; it is important to recognise the emergence of a regulatory tool aimed at addressing tax avoidance – the General Anti-Avoidance Rule (GAAR).

The GAAR is a legislative provision that essentially aims to counteract tax avoidance arrangements that exploit loopholes, contravene the spirit of the law, or artificially reduce tax liabilities. Its purpose is to ensure that taxpayers do not undermine the fundamental principles of tax legislation through aggressive tax planning strategies. Distinguishing between tax avoidance and tax
planning is a critical consideration. Tax planning involves legitimate optimising of taxes using fiscal incentives, while tax avoidance means dodging to pay taxes without contravening the tax laws. Since virtually all business decisions have tax implications in today’s world, it follows that GAAR will radically affect the decision-making process across levels in organizations.

Certainly, it is imperative to comprehend the intricacies of the extant provisions of GAAR that are meticulously designed to serve as an instrument against taxpayers resorting to artificial or contrived arrangements to reduce their tax liability, essentially, it is to cover the transactions under its ambit that are inherently at odds with the spirit of tax laws.

Under GAAR, authorities have the power to determine certain transactions as impermissible avoidance arrangements, allowing them to impose the appropriate taxes and deny claimed benefits. GAAR incorporates several pivotal elements aimed at curbing the abuse of tax laws. By enforcing these tax avoidance rules, tax authorities ensure that businesses operate within the spirit of the law, promoting fairness, equity, and transparency in the taxation system.

Primarily, under these provisions, an arrangement can be considered ‘impermissible avoidance arrangement’ if the main purpose of the arrangement is to obtain tax benefit and it has one of these four elements:

  1. It creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length.
  2. It results, directly or indirectly, in the misuse or abuse, of the provisions of income tax law.
  3. It lacks commercial substance.
  4. It is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

In a nutshell, the provisions pertaining to GAAR enunciates that if the affairs of the business are arranged in commercial wisdom with bona fide intent, then the consequential tax benefits for the parties in an arrangement should not be the determinative factor to invoke GAAR. Therefore, businesses are required to demonstrate that the proposed transactions have strong commercial
substance and are not primarily driven by an objective to reduce taxes.

At our recent KReW Tech Talk at MCA Consulting, we examined specific case studies in the realm of business structuring that’s aligned with GAAR. Our analysis was centred on comprehending how GAAR can impact a transaction and can shape a corporates’ tax and financial landscape. We discussed that in the context of amalgamations and demergers, schemes of arrangements, placed before National Company Law Tribunal (NCLT) often face opposition from the Income-tax Department, who argue that these schemes are primarily designed to obtain tax benefits. Even though the Income-tax Act provides tax-neutrality and related benefits for qualifying amalgamations and demergers, there is ambiguity regarding the weight given to the objections raised by the Income Tax Department during the sanctioning of these schemes under the Companies Act.

For instance, in case 1 involving Gabs Investment Private Limited (“Gabs”) and Ajanta Pharma Limited (“Ajanta”), Gabs is the group holding company and primarily holds shares in transferee company that is Ajanta, which is a speciality pharmaceutical company engaged in development, production and marketing of branded and generic formulations. The philosophy for the subject scheme as canvassed by Gabs is that, the merger will result in direct holding of promoter shares in the transferee company instead of through Gabs. This will lead not only to simplification of the shareholding structure and reduction of shareholding tiers but also demonstrate the promoter’s group direct commitment to and engagement with the transferee company. The promoters would continue to hold the same percentage of shares in the transferee company, pre and post-merger and there would also be no change in financial position of the transferee company. Gabs stated that the scheme was approved by 99.99% shareholders of transferee company and unanimously consented by all its shareholders.

The Income-tax Department argued that the proposed scheme of arrangement was a round-trip financing tactic which includes transfer of funds among the parties to the arrangements through the series of transactions. The scheme of amalgamation is a deliberate measure to avoid tax burden by using the medium of NCLT and the rationale presented by Gabs is without any justification. By this scheme Gabs/shareholders of Gabs are avoiding full tax liability which is strenuously objected by the ITD.

The NCLT affirmed the objections raised by the Income-tax Department, stating that the rationale behind Gabs’ scheme lacked justification.

In the other case 2 of Panasonic India Private Limited and Panasonic Life Solutions India Private Limited, the Income-tax Department objected to the scheme of amalgamation, claiming that it was a ploy to take advantage of accumulated losses eligible for set off in the future.

The Tribunal after considering the arguments distinguished this matter is different from the facts of Gabs (supra) and stated that the objective of the scheme under Gabs, was for simplification of shareholding structure, however, in this case, the petitioner companies has clearly made out of a case of operational synergy between the amalgamating companies.

Further, the NCLT emphasized that the provisions of the Income Tax Act, which govern the treatment of accumulated losses and unabsorbed depreciation allowance in amalgamation or demerger cases, adequately protect the interests of the Income-tax Department. Therefore, the NCLT held that there was no merit in the objections raised by the Income-tax Department and approved the scheme of amalgamation.

With these cases in picture, during our talk, we delved into the topic of how NCLT perceives the implications of the GAAR in compromise and arrangement cases. We discussed that the scheme can only be rejected by the NCLT if the Income Tax Department can prove that its sole purpose is tax evasion and if the department fails to provide such evidence, the NCLT is required to sanction the scheme. Given the wide scope of GAAR provisions and consequences of a transaction being declared as an IAA, it is imperative for businesses to evaluate existing as well as proposed arrangements and structures on the touchstone of GAAR. Despite GAAR being introduced in 2017, it might take at least a couple of years more to gauge how and when the tax authorities invoke GAAR and how far- reaching the implications would be.

It was a valuable discussion, as we sought to better understand the NCLT’s perspective and how it affects our clients and how we can help our clients achieve their business objectives while ensuring compliance with the GAAR.

Needless to mention, with the implementation of GAAR taxpayers should prioritize the genuine commercial purpose of their corporate structures, beyond merely obtaining tax benefits. The business decision-makers’ first and most important course of action following GAAR will be to review their tax positions since such positions will be evaluated for compliance with GAAR and will thus need to be changed on the corporate level.

The applicability of these provisions is very wide as it is intended to cover not only domestic transactions but cross border transactions too. Also, with active participation of G20 countries in the BEPS project, countries are adopting concentrated and systematic efforts towards establishing tax policies which will protect its tax base. Various anti-tax avoidance measures have been incorporated in the domestic tax laws of countries as well as in treaties.

To navigate this evolving landscape in cross border transactions, corporates are increasingly conducting in-depth assessments to determine their eligibility for treaty benefits. This involves closely examining specific conditions, such as the “limitation of benefits” clause, to ascertain whether they qualify for reduced withholding tax rates and other advantages under the treaty. Concurrently, companies are proactively engaging in transfer pricing risk assessments to identify and mitigate potential issues before they escalate. In doing so, they take into account the potential impact of BEPS-related measures on their transfer pricing arrangements. Thus, with the global attention corporate tax governance and tax risk management is receiving, now is a good time for corporates to reflect on their tax governance frameworks and tax controls and consider whether their current framework is robust enough in the current climate.

Further, it is well recognised that as the business landscape evolves, organizations adopt innovative corporate structures and adhere to best governance practices to thrive in a constantly changing environment. Human ingenuity being the driver of innovative corporate structuring plays a crucial
role in recognizing the need for change and innovation in corporate structures. Implementing best corporate governance practices helps organizations strike a balance between compliance and innovation. Best governance practices provide a framework within which human ingenuity can drive innovative solutions while ensuring ethical and legal conduct.

The interplay between human ingenuity, corporate structuring, and best governance practices is essential for organizational growth and success. By embracing human ingenuity and following best governance practices, companies can adapt to a changing business landscape, navigate complex regulations, achieve optimal tax outcomes, and foster an environment that promotes innovation.

Thus, the corporates should review whether their existing tax frameworks embrace the principles of transparency, substantiation, and economic substance and continue to be in line with and are integrated with broader business strategies. This will help organizations navigate the complexities of anti-avoidance regulations and achieve optimal tax outcomes. It is not uncommon for businesses to be missing opportunities or creating risks by inadvertently excluding tax considerations from their business strategy and decision-making processes. Thus, to steer this complex landscape of anti- avoidance regulations, comprehensive understanding, transparency, and a commitment to legitimate tax planning is essential and seeking professional guidance from the experts in the matter would be helpful. By adhering to this, corporates can responsibly optimise their tax liability within the confines of the law, ensuring both compliance and fiscal prudence.

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