LIMITATION OF BENEFIT OF GAAR

GAAR

• GAAR is a statutory anti-avoidance rule.

• GAAR is a tool for checking aggressive tax planning especially for transaction or business arrangement which
is/are entered into with the objective of avoiding tax. It is specifically aimed at cutting revenue losses that happen
to the government due to aggressive tax avoidance measures practiced by companies.
• In March 2012, the then Finance Minister of India announced India’s intent to implement GAAR
• Chapter XA of the Income Tax Act: GENERAL ANTI-AVOIDANCE RULE was added to the Income-tax Act,
1961 via Finance Act, 2012 (Section 95-102)
• It came into force from 1 April 2017, Assessment Year 2018-19.
SECTION 95 OF INCOME-TAX ACT, 1961 VIS-À-VIS GAAR

Section 95 of the Income Tax Act, 1961:

• Non-obstante clause i.e., overrides all other provisions of the Income-tax Act, 1961
• GAAR can be used to override specific anti-avoidance rules e.g., transfer pricing which is specifically enacted to
prevent tax avoidance in related party transactions.
• GAAR, in simple words, confers the tax authorities with powers to deny any tax benefits which are given to a
party by way of any arrangement, including tax treaties, if such arrangement is held to be an Impermissible
Avoidance Arrangement (IAA).
SECTION 96 OF INCOME-TAX ACT, 1961 VIS-À-VIS GAAR

Section 96 of the Income Tax Act, 1961:

GAAR provisions are applicable to ‘Impermissible Avoidance Arrangement’ (IAA) for which following two conditions have to be
satisfied:
1. The main purpose of entering into such arrangement is to obtain tax benefit, and
2. If the arrangement:
• creates rights or obligations, which are not ordinarily created between persons dealing at Arm’s Length Price (or)
• results, directly or indirectly, in the misuse or abuse of the provisions of the Income-tax Act (or)
• lacks or deemed to lack commercial substance in the whole or in part (or)
• is entered or carried out by means or in a manner which is not ordinarily employed for bona fide purpose.
 Onus is on the Revenue to declare that an arrangement being carried on is IAA. On the basis on this, the assessee would be
given an opportunity of being heard. - This implies that no suo moto application of GAAR can be carried out.
 96(2) when interpreted would mean that the presumption against the assessee under GAAR would arise as soon as it was
shown that a treaty was selected to avail a tax benefit. It is immaterial if the main purpose was genuinely to do business and
not to avail a tax benefit. It is also immaterial if the transaction or arrangement is not an instance of abuse as per the treaty.
INTRODUCTION TO LIMITATION OF BENEFIT CLAUSES

• Limitation of Benefits (LoB) clauses are anti-avoidance provisions in tax treaties to restrict treaty benefits only to
genuine residents of the other contracting state.
• LoB clauses contain subjective tests such as examining the main purpose or bona fide nature of arrangements, as
well as objective tests like minimum investment requirements.
• India has introduced LoB clauses in its new and renegotiated tax treaties with countries like Mauritius, UK, USA
and Singapore.
• Prior to this, most Indian tax treaties focused on source-based taxation rather than residence-based taxation, so
preventing treaty shopping was not a major policy goal.
 INTERPLAY BETWEEN LOB CLAUSE AND GAAR
• The Shome Committee recommended that LoB clauses, being a specific anti-avoidance rule, should take precedence over
GAAR based on lex specialis derogat legi generali principle – meaning more specific rules will prevail over more general
rules.
• However, Section 90(2A) of the Income Tax Act contains a non-obstante clause, giving overriding effect to GAAR
provisions over tax treaties.
• This creates lack of clarity on whether GAAR will apply to arrangements covered by LoB clauses in tax treaties.
• The Shome Committee acknowledged this ambiguity and recommended clarification through an amendment or subordinate
legislation.
 Issue:
• GAAR has a broader scope compared to LoB clauses in tax treaties
• An arrangement may satisfy the LoB clause tests but still be deemed impermissible under GAAR
• This leads to uncertainty and potential re-opening of past tax liabilities for investors
• Consequences under GAAR (disregard, re-characterization, re-allocation) are more severe
• Example: Re-opening of the Vodafone case with tax liability of Rs. 12,000 crores after years of the business.
ADDRESSING CONFLICT BETWEEN LOB CLAUSES AND GAAR

1. Disadvantages of Applying GAAR despite LoB Compliance:

• Defeats the purpose of LoB clauses in providing tax certainty to investors
• Disincentivizes foreign investment due to risk of revisiting closed assessments
• Long-winded GAAR procedure leads to high transaction costs for taxpayers
• Loss of investor confidence in Indian tax regime and tax treaties
2. Potential Remedies:
• Amend Section 90(2A) to clarify that GAAR shall not override LoB clauses
• Issue notification/subordinate legislation specifying treaties exempt from GAAR
• Strengthen LoB clauses if base erosion persists, instead of applying GAAR
 ARGUMENTS AGAINST APPLYING GAAR FOR LOB CLAUSES

1. Principle of Lex Specialis Derogat Legi Generali: The LoB clause is a specific anti-avoidance provision in tax treaties, while
GAAR is a general anti-avoidance rule. According to the principle of lex specialis derogat legi generali (specific law overrides
general law), the specific LoB clause should take precedence over the general GAAR provisions.
2. Potential Treaty Override and Investor Confidence: Subjecting LoB-compliant cases to GAAR can be seen as an override of the
tax treaty provisions, which may erode investor confidence in the Indian tax regime and the sanctity of its international tax
agreements.
3. Lack of Abuse or Tax Avoidance: If an arrangement satisfies the LoB clause conditions, it implies that there is no abuse or tax
avoidance motive as per the treaty provisions. Applying GAAR in such cases would be tantamount to disregarding the treaty's anti-
avoidance safeguards.
4. Procedural Fairness and Certainty: Investors obtain Tax Residency Certificates (TRCs) based on their compliance with LoB
clauses. Subjecting them to GAAR afterwards undermines procedural fairness and the certainty they should have after obtaining a
TRC.
5. Potential for Excessive Taxation: GAAR consequences like disregarding, re-characterizing, or re-allocating expenses/revenues can
lead to excessive taxation, even in cases where the taxpayer has genuinely complied with the LoB clause provisions.
ARGUMENTS FOR APPLYING GAAR FOR LOB CLAUSES

1. Broader Anti-Avoidance Coverage: Despite satisfying the specific LoB tests, the tax authorities may argue that GAAR provides a
broader anti-avoidance coverage to scrutinize arrangements more comprehensively for any abusive tax planning or treaty shopping
attempts, or for transactions lacking commercial substance beyond what the LoB clause captures. Ex: Azadi Bachao Andolan for
the Indo-Mauritus Treaty controversy.
2. Evolving Nature of Tax Avoidance Schemes: Tax avoidance schemes and treaty shopping strategies are constantly evolving.
GAAR, being a general anti-avoidance provision, can address new and innovative forms of treaty abuse that may not be covered by
the relatively narrow scope of LoB clauses.
3. Overarching Policy Against Tax Avoidance: The government may argue that its overarching policy stance against tax avoidance
and base erosion should take precedence. Applying GAAR alongside LoB clauses reinforces this policy objective and ensures a
more stringent scrutiny of arrangements.
4. Additional Revenue Protection: From a revenue protection perspective, the tax authorities may contend that applying GAAR in
addition to LoB clauses provides an extra layer of safeguard against potential revenue leakages due to aggressive tax planning
strategies.
5. Interpretation of Non-Obstante Clause: The non-obstante clause in Section 90(2A) of the Income Tax Act can be interpreted as
giving overriding effect to GAAR provisions over tax treaties. This legal interpretation could be used to justify the application of
GAAR even in LoB-compliant cases.
CONCLUSION

The implementation of GAAR, when aligned with the principles of LOB clauses and supported by judicious judicial
interpretation, offers a balanced and effective strategy against tax avoidance. It ensures that India's tax laws are
respected and that foreign investments are made with legitimate intentions. Therefore, while recognizing the value of
LOB clauses in protecting treaty benefits, the nuanced application of GAAR is essential for maintaining the integrity
of India's tax system and its attractiveness as an investment destination.
The recommendation by Shome Committee for tax treaties to include bilaterally negotiated anti-abuse provisions,
rather than relying solely on GAAR, suggests a collaborative approach to tax avoidance. This supports the stance that
GAAR should not be a unilateral tool but part of a broader, treaty-based strategy to address tax evasion.