Brian Arnold, the noted tax treaty expert and commentator wrote in the context of  the introduction of the Canadian General Anti Avoidance Rule as follows: “ … When the rule was initially proposed in 1987 white paper on tax reform, tax practitioners made claims that the rule would bring commercial activity to a standstill; that taxpayers would not be able to carry out even simple straight forward transactions without advance rulings; and that tax lawyers would be unable to give unqualified legal opinions on simple, straightforward transactions….” ** Nothing of that sort happened. After a year of consultation, Canada introduced GAAR from 1988. In 2005, through a retrospective amendment, it was made applicable to treaties as well, and the Canadian Supreme Court, in the treaty context, twice thwarted the attempts of Revenue Canada to ignore certain arrangements.

Somewhat similar reactions as mentioned by Brian Arnold are being voiced in India also by the tax practitioners ever since the DTC has proposed the introduction of a GAAR in India. In fact, it is one of the eight or nine problem areas identified by the Ministry of Finance, if news reports are to be believed. The question that needs to be asked therefore is whether India needs a General Anti Avoidance Rule. A subsequent and important question will then be what form it should take to make it effective while at the same time ensuring that the law abiding taxpayers are not inconvenienced. It may be mentioned that the tax administration has been trying for quite sometime now for having a general anti avoidance rule but without any success.

A GAAR will apply both in the domestic as well as the treaty context. However, for now, restricting our discussion to the treaty context, it may be noted that the Working Group on Non-resident Taxation which comprised representatives of the private sector as also tax practitioners had, way back in 2003 observed as follows: “There is a growing practice amongst certain entities who are non-residents of either of the two Contracting States, of trying to access the beneficial provisions of the DTAAs and indulge in what is popularly known as treaty shopping. The benefit of the Treaty should be accorded only to persons who are residents of either or both of the Contracting States. It is clear that in relation to taxation, necessity of anti-abuse provisions in tax administration cannot be undermined…….”. The group, therefore, recommended  incorporation of  suitable provisions in a chapter on interpretation of DTAAs to deal with treaty shopping, conduit companies etc in addition to recommending incorporation of anti-abuse / limitation of benefit clauses in the treaties themselves.

In fact, the Supreme Court of India in the famous Azadi Bachao case (2003-TII-02-SC-INTL) considered this report, found the suggestions weighty but nevertheless gave benediction to treaty shopping on the ground that the Court is to interpret what the law is and not what the law ought to be. “The maxim "Judicis est jus dicere, non dare" pithily expounds the duty of the Court. It is to decide that the law is, and apply it; not to make it.”(Para 121 of the judgement)

The general complaint voiced against the proposal to introduce a GAAR so far is that it is contrary to the rule of law, that it will increase uncertainty, that it comes in the way of business, that there are specific anti-abuse provisions any way and that the judiciary has upheld substance over form rule in suitable cases.  None of these objections is valid. The judiciary being conscious of its role does not want to interpret treaties and laws in a way that would amount to legislation. This is obvious from the judgement of the Supreme Court in Azadi case (supra). In fact, in one the oft-quoted and controversial part of the judgement, it was observed: ”Many developed countries tolerate or encourage treaty shopping, even if it is unintended, improper or unjustified, for other non-tax reasons, unless it leads to a significant loss of tax revenues ...

Dealing with the need for a General Anti Avoidance Rule, for once, the DTC discussion paper, quite lucidly mentions as follows:

“24.1 Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner. Sectors that provide a greater opportunity for tax avoidance tend to cause distortions in the allocation of resources. Since the better-off sections are more endowed to resort to such practices, tax avoidance also leads to cross-subsidization of the rich. Therefore, there is a strong general presumption in the literature on tax policy that all tax avoidance, like tax evasion, is economically undesirable and inequitable. On considerations of economic efficiency and fiscal justice, a taxpayer should not be allowed to use legal constructions or transactions to violate horizontal equity.

24.2 In the past, the response to tax avoidance has been the introduction of legislative amendments to deal with specific instances of tax avoidance. Since the liberalization of the Indian economy, increasingly sophisticated forms of tax avoidance are being adopted by the taxpayers and their advisers. The problem has been further compounded by tax avoidance arrangements spanning across several tax jurisdictions. This has led to severe erosion of the tax base. Further, appellate authorities and courts have been placing a heavy onus on the Revenue when dealing with matters of tax avoidance even though the relevant facts are in the exclusive knowledge of the taxpayer and he chooses not to reveal them.

24.3 In view of the above, it is necessary and desirable to introduce a general anti avoidance rule which will serve as a deterrent against such practices. This is also consistent with the international trend.”

In the absence of such a rule, the Revenue has been unsuccessfully knocking at the doors of the Judiciary to uphold the substance over form rule. One example may be found in the recent case of E-trade Mauritius (2010-TII-20-ARA-INTL) which has been grabbing media attention for some time now. Here, it was clearly an American company which took advantage of the Indo-Mauritius tax treaty. This was a case of capital gains on the sale of substantial shareholding of an Indian Company. A subsidiary of the American company was set up in Mauritius for this purpose. All the funds for the acquisition of shares came from the American parent and the sale proceeds also went to the same company by way of reduction of share capital and distribution of dividends. On behalf of the Revenue, it was argued that despite the Supreme Court decision in Azadi Bachao case, it was possible to question the conduit arrangement, that it was the American Company which had earned the Capital Gains and that the Indo-USA tax treaty rather than the Indo-Mauritius treaty should be applicable. The AAR, however, expressed its helplessness in the following words:

“…….. It would have been a different matter if the Supreme Court had disapproved the treaty shopping and the tax avoidance measures. In the present state of law i.e. the treaty provision, the Circular of CBDT, the law laid down in Azadi Bachao Andolan and the legal incidents of corporate personality, the attempted distinction between legal and beneficial ownership cannot be sustained on any reasonable basis.” (Emphasis supplied) And further, more tellingly:

“14. Though it looks odd that the Indian tax authorities are not in a position to levy the capital gains tax on the transfer of shares in an Indian company, this is an inevitable effect of the peculiar provision in India-Mauritius DTAA, the Circular issued by CBDT and the law laid down by Supreme Court in Azadi Bachao case. Whether the policy considerations underlying the crucial Treaty provisions and the spirit of the Circular issued by the CBDT would still be relevant and expedient in the present day fiscal scenario is a debatable point and it is not for us to express any view in this behalf.”

Recent shenanigans exposed by Income tax investigations in the IPL scam indicate how brazenly the tax havens and the treaty networks are being exploited by the high and mighty. It is therefore, high time to have an adequate response to deal with the menace in the form of a General Anti Avoidance Rule. Of course, once the essential decision is made, it will be necessary to have intense discussion and put in place proper safeguards so that the shortcut to McDowell at the drop of a hat that was once witnessed amongst the Income tax officers is not repeated again. If the dispute resolution panel put in place recently works satisfactorily, one possibility could be that it may be stipulated that all cases where GAAR needs to be invoked should be authorised by the said panel. These are of course, matters of details that the Revenue can work out. At any event, there are quite a number of models available to the Revenue to Choose from - the Australian model, the New Zealand model and the Canadian model. The Chinese, late entrants to the world of Income taxation itself, has undertaken serious reforms in 2007 and has put in place a GAAR along with CFC and Thin Cap rules. In this era of a global move towards transparency, therefore, India should not lag behind.

** [Article of Brian Arnold in Tax Avoidance and the Rule of Law]