Decoding Finance Bill 2012

Sunil Kapadia - Partner, Ernst & Young
Are GAAR provisions unconstitutional?

GAAR is introduced in Finance Bill 2012 to address aggressive tax planning and codify the doctrine of “substance over the form”. However, such introduction when a Report of the Standing Committee has provided significant comments thereon (which Report is being discussed in the Finance Ministry) is certainly not the best thing. As per legal circles, the provisions of GAAR can perhaps be challenged as violative of the constitutional right to practice any profession, or to carry on any occupation, trade or business. This will also nullify an established position that a tax payer is legally entitled to arrange his affairs so as to pay minimal tax and is not expected to choose a way which entails payment of maximum tax.
Surprisingly, in the present form of GAAR the burden is on the assessee to prove that there is no “tax benefit” and the transaction is not an “avoidance transaction”. Even under criminal law, the Constitution provides that no person accused of any offence shall be compelled to be a witness against himself. The provisions of GAAR by casting a presumption of tax avoidance where any tax benefit results from an arrangement or even part thereof (unless the assessee proves otherwise) amounts to casting an onerous burden on a tax payer.
In Canada, the burden is on the revenue to prove that there is “abusive” tax avoidance and GAAR is applied only if transaction results in misuse or abuse of the provisions of the Act/ Regulations/Rules/Tax Treaties.
A perusal of the finance bill provides following situations for invoking GAAR:
  • Creates  rights / obligations that are not normal between arms’ length parties;
  • Results directly or indirectly in misuse or abuse of the provisions of the Act;
  • Lacks commercial substance;
  • Means or manner employed not ordinary for bona fide purposes.

Current provisions are inspired from the GAAR provisions in the South Africa. Being non-obstinate provisions, GAAR overrides all the other provisions of the Act. Further, the terms used and defined in the GAAR provisions are wide enough to include even legitimate transactions for which a deduction/ benefit is within the GAAR net. Treaty override provisions leave no recourse to assessee to whom GAAR provisions are made applicable.
In Australia, the treaties override the rest of the domestic income tax legislation except GAAR. This position prevails since 1981. However, in respect of treaties signed prior to 1981, the treaties will override even the GAAR. Will this be true for Indian DTAA signed prior to Finance Act 2012?  This is the least that needs to be provided.  Also a public debate/consultation is needed to test the GAAR proposals against commercial transactions to ensure that they would not get unnecessarily caught as UK is contemplating to do. The provisions can in the present form undermine tax certainty and can perhaps lead to making India less attractive in Global Business world.
In UK, a report on feasibility of GAAR was submitted to the UK Government. This report had concluded that GAAR would not be beneficial for the UK tax System as it would carry “a real risk of undermining the ability of the business to carry out sensible and responsible tax planning”. However, it was suggested to introduce a moderate rule which does not apply to reasonable tax planning, and instead target only abusive arrangements as that would be better from a country perspective. Further, even this should not be done without public consultation. We need to have this kind of approach to be incorporated in our legislation.
Certain tests which are to be considered before implementation of GAAR in UK are:
-       whether it simplifies the overall tax code,
-       whether it will promote growth in UK,
-       whether it will improve the UK’s competitive position and increase the perception of fairness in tax system, etc.
Similar considerations and tests should be considered by India before embarking on this journey.
Also it’s not clear as to whether GAAR is applicable in cases where the Legislature itself has provided a “tax benefit”? For example - Investment in bonds approved under section 54EC, Setting up of units in backward areas under section 80IC, Amalgamation of loss making companies into profit making companies, utilization of losses in compliance with Section 72A, etc. Even if the provisions stand the test of constitutional validity, the provisions of the proposed GAAR would have to be read down to exclude such “tax benefits” provided under the statute to ensure that these benefits already forming part of current tax statute are not diluted/denied.