In this article, Shivayana Balodia discusses GAAR’s Impact on Foreign Investors.
Introduction
International tax avoidance has been well established area of concern across the globe. A host of nations have conveyed their apprehensions about tax evasion and avoidance for a long time now. The doctrine of General Anti-Avoidance Rules (“GAAR”) has steadily found footing in many of the tax codes of such nations. Considering this International practice, India too has aimed to implement GAAR provisions in addition to existing Special Anti-Avoidance provisions. The GAAR poses multiple challenges for a developing nation such as India. Its introduction recognizes that the burden of deciding upon unforeseen circumstances does not solely rest on the Judiciary, and that such transactions need to be scrutinised by the regulatory authority as well. Much of the issue lies with subjective nature of the GAAR. If these provisions are not effectively implemented, it would have serious negative impact on foreign investment for the nation. The goal of any taxation system, specifically one dealing with anti-avoidance, is to focus on such avoidance arrangements without putting an undue burden on the taxpayers.
This paper shall aim to discuss these provisions and what impact they have had on investment decisions of foreign investors. We shall briefly discuss GAAR’s substance over form approach and move on to analysing the case of Vodafone International Holdings v. Union of India[1]. The impact of the Vodafone case in the run up to GAAR will give us some context into the aims of the regime. Finally, the discussion will move on to a juxtaposition of the GAAR regime with the existing DTAA’s, especially with Mauritius and Singapore. Whether the GAAR would still be relevant after the changes in the DTAAs. The paper will try and supplement this discussion with certain data concerning investment patterns since the announcement of GAAR in 2012.
Substance over form: Vodafone case
Prior to the GAAR, the stance taken by taxation laws in India was that identifying tax avoidance was heavily dependant on the intentions of the parties and the burden to identify and unravel the nature of the transaction would fall upon the tax authorities. This ambiguous standard needed a change. The classification of such transactions needed to be made in a more structured manner. This long-standing dilemma was dealt with periodically through various cases. The holding of the Bank of Chettinad Ltd. V. CIT[2], which was later affirmed by the McDowell and Co. Ltd. v. Commercial Tax Officer[3], was that tax planning was permitted if it strictly fell within the four corners of the law. Also, the issue of substance over form was held in favour of the Revenue Department, but it needed a more specific clarification in the future cases. The Supreme Court decision in Azadi Bacho Andolan case, was instrumental in holding that investors would be allowed to take wise decision in terms of ‘treaty shopping’. Tax treaties were to be given a liberal interpretation and hence this led to the landmark judgment in 2012.
The Vodafone decision of the Supreme Court raised a conflict between the McDowell case and Azadi Bachao Andolan case. The revenue department urged that the Azadi Bachao holding is not good in law, on the basis that tax planning cannot be said to be impermissible although tax evasion through the use of colourable devices surely not permissible.[4] The Revenue needed to prove that the transaction entered into in the case was a sham before they could apply the ‘substance over form’ or the ‘piercing of the corporate veil’ doctrines. The case hinged on whether the holding company was merely created to avoid tax or whether it had any commercial or business substance. The court discussed the cornerstone of taxation law with the canons of a good tax system to point out that a tax payer shall be permitted to arrange their affairs in such a manner so as to reduce the tax liability.[5] The mere motive to avoid tax should not invalidate the transaction. Although the court clearly held that it is essential that the transaction must have some economic or commercial substance. The judgment of the Vodafone case clearly recognizes a difference between tax evasion and avoidance.
A very pertinent critique of this judgment lies in assessing whether the Supreme Court focussed on the nature of the tax haven holding company. The court was a bit narrow minded in merely looking at the share transfer of this holding company, without considering other relevant facts. The conduct of the transacting parties and the terms of the Share Purchase Agreement were overlooked by the Hon’ble Court. The Courts analysis of the SPA reveals that it has applied the “look at test”, without really invoking a more dissecting approach.[6] The court has erred in only considering the title document and not the nature of the transaction.[7] Hence from this decision it was quite apparent that the judiciary was merely looking at the form over the substance. It fails to recognize that the form that was represented did not reflect accurate facts, so one must inspect the substance. In conclusion, the were a lot of misapplied principles and overlooked submissions that plagued this judgment.
Consequences of the Vodafone Decision
Taxation law over multiple decades has slowly developed to become more complex and cumbersome. The department, working in tandem with the legislating bodies has constantly updated the law to ensure that plug the various loopholes that are recognized. Examples of such loopholes being; clubbing of income of the taxpayer with that of their spouse and minor children, tax planning activities of trusts, AOP, HUF etc. and most recently aggressive tax planning along with the use of tax havens to avoid taxation. The action taken by the authorities to bring forth a new regulation to enforce a strict taxation regime. The need for GAAR came about through the practice of the judiciary to hold in favour of aggressive tax planning.[8]
Aggressive tax planning has become the bane of honest tax payers. The GAAR regime is harsh provision that has immensely widened the authority of the Revenue department. In doing so, the GAAR provisions risk becoming an impractical law with the passage of time. The Foreign Exchange Regulation Act (FERA) is an example of such legislation, as it failed to curb smuggling of foreign exchange. The Jain Hawala case[9] is a striking example of the same. More recently the introduction of Transfer Pricing has imposed undue burden on small and medium enterprises, while the Multinational Corporations are availing the benefit of tax havens to circumvent tax liability. In general, we notice a trend that the burden of harsh tax provisions and regulations falls onto the honest taxpayers as a result of cunning tax planning activities conducted by a small number of rich and powerful corporations and individuals.
The decision in the Vodafone case has also had a huge impact on Foreign Direct Investment. It can be argued that the judgment was a decision in favour of foreign investors as the SC considered the impact of such taxation laws on incentives to foreign investors. Foreign investors are looking for clear and certain tax laws to make investments. Clarity and certainty are one of the canons of a good taxation system. It is quite unfortunate that the judgment discussed above was able to take a policy decision regarding ease of foreign investment in India. This was one of the issues that plagued anti-avoidance provisions in the pre-GAAR era in India, i.e. judicial decisions determining rules for anti-avoidance. Hence all these interactions paved the way for the Government to enact legislation imposing a general obligation of anti-avoidance.
GAAR Provisions and Foreign Investors: Juxtaposition of GAAR with Double Tax Avoidance Agreements
The main aim of the GAAR provisions is to inspect impermissible avoidance arrangements, those whose main purpose is to obtain tax benefit without any really commercial substance.[10] Here we need to recognize that foreign investors are heavily influenced by a nations taxation system, especially the incentives and concessions that they offer in order to make a sound investment. Their sole motive is maximising profits and hence the burden to incentivize their investment rests upon the legal regime in the nation. The GAAR provisions were a huge scare when they were announced post the decision in Vodafone. They were seen as a response from the Revenue department for having lost out on a huge tax amount. More importantly, it was a dangerous precedent that would allow circumventing of tax liability by any and all investors.
Foreign investment has been actively governed by Double Taxation Avoidance Agreements between states. It is general international practice conducted by states to ensure a more certain and clear taxation system exists for taxpayers that operate across jurisdictions. In discussing the same the question that arises is with the advent of GAAR provisions applying to all transactions, do such treaties get overridden by a domestic regulation imposed by one of the parties to this treaty? The simple answer for the same is yes, the Indian GAAR shall override tax treaties. Such overriding authority is provided for by the OECD recommendation regarding Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Sharing (“MLI”).[11] In accordance with the OECD commentary such tax treaties have seen alterations to ensure that they stay relevant post the notification of GAAR. They have been amended to include an override provision. Additionally, anti-abuse rules have been inserted into the India-Mauritius and India-Singapore tax treaties. In response to this it becomes quite interesting to assess the applicability of GAAR post these treaty amendments. The formulation and language of the GAAR are quite unambiguous in its reach and application. The non-obstante clause,[12] is quite strict in its application to all transaction irrespective of any individual agreements between parties.
The clarification made by the Central Board of Direct Taxes (“CBDT”),[13] provides some clarity on the implementation of the GAAR. The clarification regarding tax efficient jurisdiction, application of limitation on benefit clauses and the grandfathering of existing investments are most notable. These clarifications provided a much-needed sigh of relief for foreign investors. With respect to DTAAs, the CBDT clarified the situations where the GAAR could and could not override these tax treaties. It said that treaties that include a Limitation of Benefit (LoB) clause such as Mauritius and Singapore would not be overridden by GAAR, whereas the contrary would be true for pacts with Cyprus and Netherlands. There is still a need for a supplementary clarification to solidify the stance that if LoB clause are met, then GAAR would not apply.[14]
The Mauritius tax treat was recently amended to make capital gains chargeable at source. In doing so the treaty has tried to individually eliminate tax avoidance issues. The question that arises is that when the tax treaties have taken measures to eliminate these issues, is there really a need for GAAR. As we have seen, the GAAR provisions are very rigid and provide wide ranging powers to the authorities to take action against potential avoidance arrangements. The CBDT is trying to be proactive in plugging the loopholes that arise out of aggressive tax planning arrangements. A critique to GAAR still remains that, why should a company not be allowed to setup a holding company in a tax efficient jurisdiction and avail of its benefits as a form of commercial business? Is it not a business decision of any company to try and ensure minimal tax liability? The motive of the revenue department is clear, i.e. increase tax base and try and establish a norm regarding earnings out of India shall be taxed in India.
There is need for a settled position of what amounts to avoidance and evasion of tax liability, i.e. what are legitimate methods to reduce tax liability. The ability of the Revenue authorities to constantly indirectly change the meaning of illegitimate tax planning activities is very detrimental to providing certainty to the taxpayers. Reverting to the above discussion, we must understand that this power of the Revenue Dept. is merely to keep up with changing times and emergence of new forms of business and commerce. Hence, we can see why a general regulation is required to create an obligation of anti-avoidance. SAAR may not be able to address all situations of abuse, it is not feasible to expect the authorities to promptly identify and notify individual abusive tax avoidance situations.
Comparing GAAR provisions with those of other jurisdiction we notice that the Indian GAAR regime is on similar lines of that in South Africa but there exists a difference in terms of the main purpose test to determine whether the nature of transaction is to obtain a tax benefit. In Indian GAAR, even if a step in the transaction or a part of the transaction was carried out in a manner so as to obtain tax benefit, the whole transaction is considered to be undertaken to obtain such benefit. Such is not true in other jurisdictions such as South Africa, Canada and the United Kingdom.[15] The argument to be made is that, it should be imperative that criterion of “tax benefit” not be made the sole purpose of invoking GAAR. There is a need to categorize this criterion, as has been done under the Canadian GAAR regime. First, being that such transactions that amount to tax benefit, but were undertaken with the primary bona fide commercial purpose other than obtaining tax benefit. Secondly, where a part of the transaction, of a series of transactions, was undertaken with the sole benefit of tax benefit but the overall transaction was undertaken with a bona fide commercial purpose other than to obtain a tax benefit. Although the CBDT has tried to clarify certain issues through the notification discussed above, it has not provided relevant illustrations and examples which would allow potential taxpayers to get more clarity on their tax liability. The Shome Committee included illustrations on the applicability of GAAR, and this practice has not been carried forward by the Finance Ministry to provide a more precise and clearer GAAR regime.[16]
Conclusion
In discussing the Impact of GAAR on foreign investors we have critically analysed the landmark Vodafone case, to understand the context of imposition of these rules. Foreign investment from tax efficient jurisdictions especially Mauritius and Singapore have seen a shift in investment flow over the past couple of years.[17] This would be caused by an uncertainty that looms over the taxation policy in India in conjunction with the relevant International Tax Treaties. Most companies that have acquired benefit of investment through the Mauritius-Singapore route now seem to be hastily re-examining their investment structures. There is an urgent need to consult experts to re-organize their investment patterns. Due to the prevailing uncertainty, Foreign institutional investors have tried shown a growing trend to route their business through other jurisdictions such as Luxembourg. This flows from the lack of clarity on the interplay with International tax treaties and domestic GAAR regime. This paper has looked at this interplay to comment on the applicability of GAAR in situations involving DTAAs, furthermore commenting on the need for certain changes that need to be adopted from other jurisdictions that have refined GAAR system.
The GAAR regime is in its nascent stages in India, there is bound to be a large number of litigation surrounding the same, in a fashion similar to the litigation brought about by the Transfer Pricing rules. The Investors need to take additional measures to categorize their investments under the meaning of “bona fide commercial purpose” aim to stay relevant in this ever-evolving tax regime in India. In this situation, it is essential that the Revenue Department bring forth clarifications regarding the proper purpose test for “tax benefit” and illustrations to ensure ease in compliance. The Revenue Department along with the Government needs to ensure more clarity in the GAAR regime so that India can maintain pace with the global market for investment opportunities.
[1] (2012) 6 SCC 613
[2] (1940) 8 ITR 522 (PC)
[3] (1985) 154 ITR 148 (SC)
[4] Deloitte, ‘General Anti-Avoidance Rules (GAAR): India And International Experience’ <https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/in-tax-gaar-india-and-international-experience-noexp.pdf> accessed 22 October 2018.
[5] Supra n. 1
[6] Supra n. 1
[7] Supra n. 1
[8] Rashmin Associates and others, ‘Vodafone Case: Its Consequences’ (Rashminsanghvi.com, 2018) <http://www.rashminsanghvi.com/articles/taxation/vodafone/vodafone-case-its-consequences.html#AOTC> accessed 22 October 2018.
[9] CBI v. V.C. Shukla (1998) 3 SCC 410
[10] Chapter XA, Income Tax Act 1961
[11] Supra n. 4; The MLI was essentially BEPS Action Plan No. 6
[12] Section 95, Income Tax Act 1961
[13] CBDT – Circular No. 7 of 2017- Clarifications on the implementation of GAAR provisions under the Income Tax Act, 1961
[14] Business Standard, Interview with Vikas Vasal (2017).
[15] Supra n. 4
[16] Shome Committee, Final Report on General Anti Avoidance Rules (GAAR) in Income-Tax Act, 1961. (2012)
[17] SK Lokeshwarri and K Gurumurthy, ‘A Double Whammy For Fpis From April’ (@businessline, 2018) <https://www.thehindubusinessline.com/economy/a-double-whammy-for-fpis-from-april/article9496344.ece> accessed 23 October 2018.
