ONE of the major changes in the Income Tax Act, 1961 proposed by the Finance Bill 2012 relates to introduction of General Anti-Avoidance Rules (GAAR). Since these rules were part of the Direct Taxes Code (DTC) Bill 2010 the expectation was that these will come into force on enactment of the DTC. The Government appears to be keen to bring these in immediately even as the DTC is getting delayed.

The Finance Bill 2012 proposes to add an entire new chapter X-A titled “General Anti Avoidance Rules” comprising of new Sections 95 to 102 to the Income Tax Act with effect from 1 st April 2013. The procedure for implementation of GAAR is being laid out in the new Section 144BA and time limit in the new clause (ix) being inserted in Section 153.

Reasons for introducing GAAR

The Memorandum explaining the provisions of Finance Bill 2012 states that question of “substance over form” keeps arising in taxation laws but there is no judicial unanimity about the circumstances in which the legal form of transactions can be dispensed with and their real substance can be considered for tax purposes. It goes on to say that in an environment of moderate tax rates there is an obvious need to protect the correct tax base from aggressive tax planning and use of sophisticated structures. Therefore, there is a need to codify the doctrine of “substance over form” so that the real intention of the parties and the effect of transaction are taken into account for determining its tax consequences, irrespective of the legal structure superimposed to camouflage the real intent and purpose.

Impermissible avoidance arrangements

The new Sections 95 and 96 provide that an arrangement can be declared as an “impermissible avoidance arrangement” if even one of its main purposes is to obtain a tax benefit, and it -

•  creates rights and obligations, which are normally not created between parties dealing at arm's length, or

•  results in misuse or abuse of provisions of tax laws, or

•  lacks commercial substance or is deemed to lack commercial substance, or

•  is carried out in a manner normally not employed for bonafide purpose.

Besides, an arrangement will be deemed to lack commercial substance if its substance as a whole differs significantly from the form of its individual steps; or it involves -

•  round trip financing;

•  an accommodating party ;

•  elements that have effect of offsetting or cancelling each other; or

•  a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of fund which is subject matter of such transaction; or

•  location of an asset or a transaction or place of residence of any party which would not have been so located for any commercial purpose other than obtaining tax benefit.

Burden of proof

The burden of proving the negative, namely, that obtaining tax benefit is not the main purpose of an arrangement, has been placed on the taxpayer.

Treaty override

Sections 90 and 90A are also proposed to be amended to provide that GAAR will over-ride provisions of tax treaties.

Consequences of declaring an arrangement as “impermissible”

Once an arrangement is declared as an “impermissible avoidance arrangement” then the tax authorities will have the power to determine its consequences including denial of tax benefit or a benefit under a tax Treaty. Section 98 provides following illustrative examples of these tax consequences -

•  disregarding or combining any step of the arrangement.

•  ignoring the arrangement for the purpose of taxation law.

•  disregarding or combining any party to the arrangement.

•  reallocating expenses and income between the parties to the arrangement.

•  relocating place of residence of a party, or location of a transaction or situs of an asset to a place other than provided in the arrangement.

•  considering or looking through the arrangement by disregarding any corporate structure.

•  re-characterizing equity into debt, capital into revenue etc.

Procedure for declaring an arrangement as “impermissible”

The Finance Bill proposes to provide a few safeguards against their misuse through the procedural provision in the new Section 144BA. The procedure for invoking GAAR is proposed as under:-

•  The process for invoking GAAR can be initiated only by the Assessing Officer on the basis of material available before him at any stage of the assessment or reassessment proceedings. For this he has to first make a reference to the Commissioner to declare the arrangement as an “impermissible avoidance arrangement” and to determine the consequence of such an arrangement within the meaning of Chapter X-A,

•  On receipt of the reference the Commissioner has to issue a notice to the assessee, giving the reasons and basis for invoking GAAR and requiring him to submit objections, and providing him an opportunity of being heard.

•  If the Commissioner is not satisfied with the reply of the taxpayer he will have to refer the matter to an Approving Panel of three Commissioners or Chief Commissioners “for the purpose of declaration of the arrangement as an impermissible avoidance arrangement”.

•  The Approving Panel will provide an opportunity of hearing to the assessee and the Assessing Officer, make such further inquiry as may be necessary through any other Income-Tax authority, and pass an order “in respect of the declaration of the arrangement as an impermissible avoidance arrangement”.

•  The Approving Panel has to pass the order within six months of receipt of the reference from Commissioner either declaring the arrangement as impermissible or declaring it not to be so and specifying the years to which such declaration shall apply.

•  The directions issued by the Panel will be binding on the Assessing Officer and he would complete the assessment proceedings in accordance with the same and the provisions of Chapter X-A. For doing so, the Assessing Officer will determine consequences of declaration of an arrangement as impermissible avoidance arrangement, and pass the final order after obtaining approval of the Commissioner.

•  The time taken in the proceedings before the Commissioner and the Approving Panel shall be excluded from limitation period for completion of assessment.

•  The first appeal against an assessment order based on the order passed with the approval of the Commissioner shall lie to the Appellate Tribunal.

Exclusion of DRP procedure in cases where GAAR is invoked

A new clause (14A) being inserted in Section144C provides that where any assessment order is passed with the approval of the Commissioner under section 144BA the procedure laid out in Section 144C relating to reference of draft order to Dispute Resolution Panel (DRP) will not apply.

Analysis of Section 144BA

i. A plain reading of Section 144BA shows that only the Assessing Officer (AO) can initiate the process for invoking GAAR. He can do so at any stage of the assessment proceedings but for this he must have material and evidence before him to do so. This will involve two issues, namely, declaring an arrangement as an “impermissible avoidance arrangement”; and to determine the consequence of such an arrangement within the meaning of Chapter X-A.

ii. Although the power of initiating action under Section 144BA is with the AO he has to comply with the procedure requiring, first, a reference to the jurisdictional Commissioner; and then to the Approving Panel.

iii. The reference to the Commissioner contemplated under Section 144BA (2) is itself a quasi- judicial proceeding in that the Commissioner has to issue a formal notice to the assessee setting out the reasons and basis for invoking GAAR and providing an opportunity to it for submitting objections.

iv. If the Commissioner is not satisfied with the reply of the assessee he has to make a reference to the Approving Panel “for the purpose of declaration of the arrangement as an impermissible avoidance arrangement”. Interestingly, while Section 144BA(1) talks of two elements, namely, declaring an arrangement as an “impermissible avoidance arrangement”; and determining tax consequences thereof, the reference to the Approving Panel is to be only for declaring the arrangement as an “impermissible avoidance arrangement”. In other words, the tax consequences of declaring an arrangement as an “impermissible avoidance arrangement” will not come within the purview of the Approving Panel, and will, presumably be decided by the AO in his wisdom (with the approval of the Commissioner) once the Approving Panel declares the arrangement to be impermissible. Therefore, the safeguard of the Approving Panel procedure will extend only up to the point of declaring an arrangement as impermissible.

v. Section 144BA(12) provides that where tax consequences of an ‘impermissible avoidance arrangement' are required to be determined by the AO in an assessment order he will do so only with the prior approval of the Commissioner. However, unlike Section 144BA(2) this sub section does not prescribe any procedure requiring the Commissioner to grant an opportunity of hearing to the assessee.

vi. Section 144BA is being inserted in Chapter-XIV of the Act relating to assessment procedure. Therefore, the Approving Panels will be part of the assessment machinery and proceedings before these will be part of assessment proceedings as distinct from appellate proceedings. These proceedings will therefore be governed by jurisprudence applicable to the assessing authorities – including Instructions of the Board. The normal practice in the Department is that in case of doubt the assessing authorities err on the side of Revenue, i.e. where two views are possible they take the view in favour of Revenue. It also follows that these Panels constituted by serving departmental officers will be subject to internal audit, revenue audit and vigilance controls etc. Therefore, by their very nature the functioning of these Panels will be greatly circumscribed.

vii. The jurisdiction of the Approving Panels will commence from the time a reference under section 144BA is received from the Commissioner and will continue till directions are issued by the Panel. The proceedings before these Panels will be quasi-judicial and therefore, principles of natural justice will apply. The Panels will have to consider the reference and the objections of the assessee as a collegium, examine the rival evidence placed before them, conduct further enquiries that may be necessary, give opportunity of hearing to both parties, apply its mind to the issues before it, and pass a reasoned order. The responsibility on these Panels will therefore, be onerous indeed as the matters in cases where GAAR will be invoked will obviously be complicated and involve large revenues. However, these Panels will be manned by different part-time Commissioners (or Chief Commissioners) assigned by the Board more or less in the same manner as is being done for Dispute Resolution Panels (DRP). The experience of functioning of the DRPs constituted of three Commissioners posted in different cities has been singularly disappointing. Most Commissioners are burdened with numerous statutory and administrative matters in their regular charges. Therefore, it will be impractical to expect that functioning of the Approving Panels comprising of such part time members will be any better.

viii. If an arrangement is declared as an “impermissible avoidance arrangement” by invoking the GAAR in cases of international transactions (Cases of foreign companies and Transfer Pricing cases under Section 92CA(3)) then the safeguard of Section 144C relating to reference to DRPs will not be available. The only safeguard in these cases will be the requirement of prior approval by the Commissioner under Section 144BA (12).

ix. The Approving Panels will be required to issue directions within six months from the end of the month in which the reference under sub-section (4) was received by the Approving Panel. The time taken by the Approving Panels will be excluded from the limitation period. In cases involving determination of Transfer Pricing by TPOs the limitation period will be three years from the end of the relevant assessment year instead of two years.

x. Taking an overall look at the course of assessment proceedings in a case where GAAR are to be invoked one finds that the assessment proceedings will first require preliminary hearing by the AO and gathering of material on the basis of which he may form an initial opinion for invoking GAAR; reference by the AO to the jurisdictional Commissioner; hearing before the Commissioner; reference by the Commissioner to the Approving Panel; hearings before the Panel; order by the Panel; further hearings before the AO for determining the tax consequences; reference of draft assessment order to the Commissioner for approval; passing of final assessment order by the AO. And, if the case also involves Transfer Pricing issues, as most of these cases are likely to involve, then in between a full round of proceedings before the Transfer Pricing Officer and the AO will also ensue. Indeed, a more cumbersome assessment procedure is difficult to conceive.

xi. Even this tortuous assessment procedure is unlikely to bring matters to any closure as virtually all assessments involving GAAR will lead to appeals. Here again the first appeal against assessment orders completed under Section 144BA will lie to the Tribunal and not the Commissioner (Appeals). Tribunal is the final fact finding body. Its findings on facts cannot be disturbed even by the High Court - except on limited grounds of perversity etc. Therefore, these assessees will have to be content with only one level of appeal on dispute of facts instead of two levels available to others.

xii. Section 254(2A) of the Income Tax Act expects that the Tribunal will decide appeals within four years from the end of the year in which these are filed, that too wherever possible. Therefore, it is unlikely that excluding Commissioner (Appeals) from the Appellate hierarchy and moving the first appeals in these cases to Tribunal (in addition to the cases going to the DRPs) will result in quick resolution of disputes. The more likely outcome of such adhoc tinkering with long established procedures will be that the Tribunal will increasingly get reduced to the level of first appellate authority and will get choked with large number of first appeals in high revenue cases. An obvious off-shoot of this will be exponential increase in disputed tax demands and delayed recoveries.