Impact of General Anti-Avoidance Rule in India

 

Dr. Sanjiv Mittal, Dr. Sunil Kumar, Dr. Pradeep Agarwal, Dr. Mohinder Kumar

Introduction

General Anti-Avoidance Rule, most popularly known as GAAR Rules were introduced in India by Mr. Pranab Mukherjee – the then Finance Minister – in March 2012. This rule was introduced to stop the tax evaders or rather to reduce the transactions whose core motive is to evade taxes. The rule targeted, primarily, all the companies that were set up in Mauritius as Shell Companies. These companies had no motive of doing business in Mauritius. The core motive was to route investments into India, utilizing the tax friendly treaty signed between the two nations. Many domestic and foreign firms were doing so. According to data from various trusted sources, between April 2000 and April 2011, total FDI equity inflows from Mauritius to our country were 42 percent of total FDI equity flows.

After introduction of GAAR rules, most of the investors – domestic and foreign – started criticizing it. Investors’ perception started taking a down turn. This decision was looked at as if the government is trying to demote FDI inflows and is not interested in foreign investments.

Summary

Due to all the criticism received by GAAR on its first proposal in The Direct Tax Code DTC, it was announced in the Finance Bill 2012 that it will be reintroduced with some changes which are required and will be in effect from 1st April 2014. An expert committee was set up to recommend the changes in the existing rules. According to the paper, GAAR was adopted from the South African Tax Laws. It was copied without paying much attention towards meaning. So, some words had different context in South Africa and different in India which resulted in misuse of the law at different stages.

Main issues under the proposed anti-avoidance rules are as follows:

  • Rules of tax avoidance are defined in a manner that they contain as many circumstances and instances of tax avoidance as possible. This leads to ambiguity and increased number of litigations.
  • Anti-avoidance rules come in picture when the main purpose of a transaction is to get tax benefit. The meaning of main purpose is not defined and it is left in the hands of the court to decide the main purpose of ant transaction.
  • Suppose the anti-avoidance rules are triggered while making a transaction. In such case, it is not certain as to the complete effect of the transaction will be given or not. Whether the double taxation would be completely avoided or not.
  • Even in a case when the tax authorities do not have any proof against tax payer, it is his responsibility to prove to them that the main purpose of the transaction was not to avoid paying taxes.
  • In case of any transaction, the provisions of this act are applicable at all times without there being any cut-off date. Due to which, past transactions create an impact in the regime of Direct Tax Code. So, it does not matter whether the tax officer authorises the transaction or not.

After the announcement made by the Finance Minister in March 2012, there has been a significant decline in the investments made by foreign entities. There has been uncertainty over the impact of regulations on the foreign institutional investors. Indian equity markets showed higher deviations and instability after the announcement as the investors have become cautious in making their investments. In initial 3 months, markets showed good figures in terms of investment interest but not so well after the announcement as shown by the figures in the table below:

MONTH

GROSS PURCHASE (CR)

GROSS SALE (CR)

NET INVESTMENT (CR)

CUMULATIVE INVESTMENT ($MN)

January 2012

50,467.40

40,109.90

10,357.70

2,037.22

February 2012

79,898.60

54,686.60

25,212.10

5,127.67

March 2012

63,795.10

55,413.80

8,381.10

1,684.82

April 2012

41,091.90

42,200.50

-1,109.10

-205.53

May 2012

6,716.50

5,840.40

876.10

166.21

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Source: http://www.indiainfoline.com

In secondary market, most of the shares of the Indian companies are held by the Foreign Institutional Investors. Market pressures have increased in last few months and as a result these companies are struggling in their performance. Markets are expected to show volatility in the upcoming months also.

Case Laws

Case Law 1 (Vodafone Tax Case):

In 2007, CGP investment based at Cayman Island was an intermediary company of Hutchinson of Hong Kong. This CGP company’s investments had 67% shares of Hutch Essar India. Now when Vodafone bought CGP, they indirectly brought and became owner of Hutch Essar as well. The tax department was of the view that this transaction had the effect of indirect transfer of assets situated in India and thus tax liability arises for Vodafone.

Bombay High Court ruled in favour of the Indian government but on further appeal by Vodafone to the Supreme Court, the decision turned in favour of Vodafone. Supreme Court concluded that the transfer of the share in CGP did not result in the transfer of a capital asset situated in India, and gains from such transfer could not be subject to Income tax.

Finance Minister clarified in IT act 2012 that CGT will be payable outside India if it’s value is derived from Indian assets. Thus, GAAR was introduced in 2012 budget to stop all such tax avoiding instances. It had a retrospective clause which caused almost all corporates to oppose it.

Case Law 2:

A company transfers its property used in business to another related corporation for the purpose of deduction of non-capital losses of the related company. All of the shares of the two corporations have been owned by the same taxpayer during the period in which the losses were incurred. If transaction is with the law, then it is well and good. But, if it is done with the purpose of avoiding some tax laws then that is considered a misuse of the provisions of the Act and be subject to provisions of the Act. Thus, genuine corporate reorganization should not be affected.

Case Law 3:

A firm with a property which has an unrealized capital gain that it wishes to sell to a third party. A related corporation, a wholly owned subsidiary has a net capital loss. Instead of selling the property directly to the third party and realizing a capital gain, the company transfers the property by first selling it to a related corporation to reduce the net taxable capital gain by the amount of its net capital loss. The provisions of the act would not be triggered if cost to the company is considered in determining the cost to the related corporation. Thus, the transfer of property by parent company to its subsidiary company or vice versa under Indian regulations should not be impacted.

Case Law 4:

A taxable company has agreed to purchase all of the shares of an operating company, which is also a taxable Indian company. The purchaser forms a parent company which completes the transaction by borrowing money. Now both the parent company and subsidiary gets merged so that the interest on the borrowed capital could be deducted in computing the income from the business of the merged company. Under Section 14A, this can be considered as tax benefit and under the GAAR provisions.

Applicability to Managerial Decisions and Company’s Taxation

GAAR will be applicable in India from April 2017, as per the latest announcement made by the government. This decision has its impact on the managerial decision making. As the companies will now have to be cautious and recheck before investing through foreign shell companies like from Mauritius. Due to the changes, the income earned through investments from FII and FDI will now be taxed. This increases companies total tax liabilities and they will have to revisit their investment plans.

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Government – through this decision – has provided lot of power to the tax authorities. They can take the tax benefit out of any transaction if they feel that its sole purpose is avoiding taxes. This may lead to harassment of honest investors. This thought has already led to some litigations on the government for taking this action without proper study.

There will be a lot of expectations from the judiciary to maintain the perfect balance between the fair and unfair measures used in tax planning. However, managers who do a company’s tax planning will have to take responsibility on themselves as to what is the acceptable measure and what is not. Because, at last it is the morals and ethics of a tax payer that guides the final decision.

Owen L. Clarke

Introduction

In this paper, Owen L. Clarke talks about the taxation of corporate income and its effects with respect to the United States of America. It talks about local revenues and state revenues and how are they affected due to taxation. In U.S., corporates can be taxed by states only on the amount of transactions that they undertook within the boundaries of the state. Due to this, they are not able to get good amount of revenues from the economic corporate sector for carrying out the public services. Therefore, there is a probability of loss in revenues in the states.

Reforms in taxation were again on top of the list of the U.S. federal government. As tax reforms may have different implication on as many people, here the paper talks about that part of reform which goes with distribution of profits to the corporate shareholders in both, the actual and the economic, sense of the word. It also talks about the consequences it leads to, in terms of taxes.

Summary

Taxes are an important part of the state revenue in U.S. Still, there is no focus on the current scenario of the states and also the costs incurred to the authorities while providing public services at a state and a local level. This would be the scenario if the recent proposals were brought to practice. The economic policy of the country suggests that the shareholder income and the corporate income should be integrated. So, interests of both the parties may not be in harmony. Many car manufacturers, who have global operations, compete with manufacturers from other nations and thus have to reduce effect of national. This concept of integration is not only complex but also not proper and not fair.

State tax authorities looked like answering to general public demand i.e. to combine their corporate and personal tax regulations with the Internal Revenue Code. And many states adopted this, some partially and some completely. Later on, it had to be rechecked and changes had to be made in area of personal tax laws but not in the corporate tax laws. This may be because of the nature of the corporate tax.

Massachusetts corporation tax laws were brought in because there was no integration in the corporate and personal taxes on income. This was because of pressure to meet with the payments of public services. Some may think that this integration is a new concept but that is not the case. Massachusetts has integrated both for over a hundred years in 18th and 19th century. Tax was charged in the hands of the shareholders of the company. But, even that was not able to collect enough amount from corporates for the purpose of providing public services. So, in 1863, they replaced it with the system where tax was charged in the hands of the corporates and they were supposed to pay the tax directly to the state authorities.

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There should be some differences in the logic in which the integration takes place at different levels i.e. at federal and at state level. The things which the state and local administrators provides the corporates and is not provided by the federal administrators. This should be looked upon because they are the only things on which state can demand tax from the corporates. All the tax authorities at the state level try their best to attract different industries in their purview. It should be noted that they provide most of the services directly to the corporates only and not to the shareholders. Therefore, companies should be the one who should pay taxes to the state.

Therefore, if the federal administrators decide to enact some integration plans, then that would further increase the losses in revenues of the states – which is already a problem. Federal government should look at the effects on the revenue of states and local authorities before accepting any proposal of integration. Because if some acts are changed at the state level then it would cause problems from the taxpayers to comply.

The paper concludes that priority and importance should be given to the growth in the national economy rather than the state economy. Many things – like capital generation, corporate financing, transfer of investments, etc. – should be the focus of the federal authorities rather than different ways of collecting revenues. Author suggests that state tax authorities could deal with these problems of revenues without creating serious disturbances. This could happen if the congress, gives opportunity to the state authorities to draft and present an integration plan which satisfies the motives of both the state and the federal governments.

Case Laws

United States have many manufacturers and corporates having their operations throughout the world. In the international market, the companies have to compete with manufacturers and corporates from different countries where tax laws are different and thus the costs of the firm may be less. Now to stay competitive in the international markets and keep generating revenues from all over the world, the corporates should be charged less with the income taxes and such taxes should be charged in the hands of the shareholders for dividends that they receive.

Applicability to Managerial Decisions and Company’s Taxation

If the federal government decides to collect income taxes not from the corporates but from the hands of the shareholders for the dividends that they earn from the corporate, then the managerial decision making will get changed in a certain way. Corporates will have to pay less taxes and the profits will increase with increase in revenues from the international markets. They will have more funds available to invest and as a result growth rate will improve. Also, it will reduce the costs incurred on planning to reduce that tax. However, it will increase a little burden on the individuals i.e. shareholders. This may not be good for revenue losses but it will be good for the country in long run.

On the other hand, if the state starts collecting taxes directly from the corporates then firms will face though competition in the international markets. But the revenue problems of the states should get resolved.

So, an integration plan should be proposed and enacted that resolves the issues of both the federal government and the state governments.

  • MITTAL, S., KUMAR, S., AGARWAL, P., & KUMAR, M. (2013). IMPACT OF GAAR ON INDIAN EQUITY MARKET: AN EMPIRICAL STUDY. CLEAR International Journal of Research in Commerce & Management, 4(10), 17-21.
  • Clarke, O. L. (1975). THE TAXATION OF INCOME FROM CORPORATE SHAREHOLDING: STATE AND LOCAL VIEW. National Tax Journal, 28(3), 373-376.
  • http://economictimes.indiatimes.com/news/economy/policy/anti-avoidance-tax-rule-gaar-to-kick-in-from-april-2017/articleshow/56403421.cms
  • http://www.thehindubusinessline.com/opinion/all-you-wanted-to-know-about-the-vodafone-tax-case/article5699526.ece
  • https://www.usa.gov/taxes
  • http://www.ase.tufts.edu/gdae/education_materials/modules/Taxes_in_the_United_States.pdf
  • http://www.immihelp.com/newcomer/united-states-taxes.html

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