[By Vibhor Maloo & Shubhanshu Dubey]
The authors are students of HNLU, Raipur.
Introduction
As tax evasion tactics become more sophisticated, India’s legal framework is changing significantly. The recent Telangana High Court (HC) ruling has initiated a debate on whether General Anti-Avoidance Rules’ (GAAR) pervasive powers, which empower tax authorities to scrutinize and invalidate transactions primarily aimed at avoiding taxes, even if they comply with the letter of the law which preempt the more targeted approach of Specific Anti-Avoidance Rules (SAAR). SAAR targets particular types of transactions known to lead to tax evasion, such as bonus stripping of shares or dividend stripping. The interaction between GAAR and SAAR is crucial as it balances broad authority with specific rules. GAAR’s broader scope can override SAAR’s targeted approach, as seen in the Telangana High Court ruling, impacting how tax authorities enforce anti-avoidance measures and how taxpayers structure transactions. While SAAR has been amended to include bonus stripping of shares, this judgment underscores GAAR’s precedence and raises questions about its broader implications. Prior to the introduction of GAAR in Chapter XA of the Income Tax Act, 1961, tax evasion in India was mainly addressed through judicial decisions, often referred to as Judicial Anti-Avoidance Rules (JAAR). Simultaneously, the presence of SAAR in Chapter X of the IT Act aided in regulating certain specific transactions that led to tax evasion.
While the SAAR has been amended to encompass bonus stripping of shares, the judgment affirms GAAR’s broader application and precedence. However, it also highlights concerns about the lack of objectivity in GAAR provisions, the discrepancy with specific provisions under SAAR, and the risk of deterring legitimate transactions due to GAAR’s broad interpretation. In the post-assessment year 2018-19, GAAR was introduced to regulate complex tax avoidance outside SAAR’s scope. Over the years, strife has arisen between SAAR and GAAR, though the CBIT has clarified that both can co-exist.
Unraveling Tax Complexity: Role and Evolution of Anti-Avoidance Jurisprudence
The Indian legislative landscape aims to negate Impermissible Avoidance Arrangements (IAA) under Section 96 of the IT Act, targeting arrangements designed to avoid taxes rather than serve a legitimate business purpose. These arrangements are primarily aimed at avoiding taxes rather than serving a legitimate business purpose and are based on the ‘purpose test’. The test involves analyzing the commercial intent behind the arrangement to determine its legitimacy under GAAR where it considers the business intent, the element which prompts detailed analysis of the arrangement, and the abuse of tax provisions. GAAR and SAAR, help to avoid these transactions that aim at preventing tax payments through illegitimate complex processes.
The Vodafone Case demonstrated flaws in the system of transactions outside the scope of SAAR. This case highlighted the limits of SAAR, which deals only with specific tax avoidance practices. Since the transaction did not fall under predefined categories, SAAR could not be applied. The case demonstrated the need for broader rules like GAAR to tackle complex tax avoidance schemes that go beyond the scope of SAAR. This eventually led to the introduction of GAAR in the Indian tax system. In the Common Law Jurisprudence, the case of WT Ramsay v. Inland Revenue Commissioners, the purposive interpretation approach was considered, and it was held that the evaluation should be based on the impact in the entirety of the complete series of transactions, rather than the tax implications of each step. This concept applies only when the relevant legislation requires it, and each step severally does not have to be considered artificial for the principle to apply. This highlights the necessity of assessing transactions on their aggregate economic content rather than individual stages.
In Craven v. White explained the limitations of the Ramsay Principle which is a statutory interpretation principle to counter tax mitigation. The Ramsay principle seeks to contest tax avoidance strategies by scrutinizing pre-ordained transactions, which are are pre-planned steps solely aimed at achieving tax benefits, lacking genuine economic or business purpose, that lack actual economic substance and are not justified by moral grounds, the same will lead to destructive commercial effects. In UK v. Duke of Westminster, it was held that every individual has the right to legally organise their affairs to reduce the tax burden, and if they succeed, they cannot be forced to pay more. The verdict reflects that a laissez-faire economy has to be considered where every person has the right to manage his tax affairs.
In contrast, the Duke of Westminster case emphasises the distinction between lawful tax avoidance and evasion, directing both GAAR and SAAR in India to ensure transactions are genuine rather than just tax-driven. In Mc Dowell & Company Limited v Commercial Tax Officer, it was clearly stated that controversial methods should not be used in tax planning, as they could lead to significant economic harm. Therefore, the consideration of IAA flows from a detailed jurisprudential debate considering primarily the business intent and the commercial substance; however the same has been disputed to date considering the complexity of the transactions involved.
Labyrinth of Anti-Avoidance: Interpreting Telangana HC’s Verdict
Mr Ayodhya Rami was investigated by the Income Tax Authorities (ITA) for discrepancies in the taxable income assessment, including issues of bonus stripping with shares of REFL, a limited company. Bonus Stripping of shares involves buying shares before a bonus issue, selling them at a loss after the bonus issue, and using the loss to offset capital gains. He disclosed the capital loss from the sale of REFL shares, subsequently, the ITA initiated proceedings against him. Mr Ayodhya argued that SAAR should apply instead of GAAR, claiming GAAR shouldn’t apply to transactions covered by SAAR. The court found Ayodhya’s argument contradictory and noted that SAAR’s interpretation did not cover bonus stripping.
The issue was whether the transactions including the issuing and transferring bonus shares were legitimate commercial transactions or merely a tax avoidance strategy. The Court determined that the transactions concerning the bonus shares and their sale lacked genuine business substance and were fundamentally deemed artificial arrangements intended to avoid tax requirements. Additionally, the Court held that under Section 144AB of the IT Act, Mr Ayodhya attempted to circumvent a thorough investigation of these transactions, formulating their appeal to the court prematurely. Section 100 states that the provisions of the chapter can be used in addition to any other provision. The Court analyzed that Chapter X-A of the IT Act, relating to the GAAR provisions, can still be applied, irrespective of whether it was introduced before or after the SAAR provisions. Moreover, the court stated
The court referred to various judicial precedents to analyse the issue. The case of Union of India v. Shiv Dayal Soin & Sons was referred to explain the importance of not applying tax laws retroactively, a principle that is crucial when considering the interplay between GAAR and SAAR. Another case of R.S. Raghunath v State of Karnataka was analysed to refer to the concept that any categorisation under tax laws must be founded on reasonable and just grounds, which ensures the protection of the constitutional right to equality, ensuring that the law is not applied discriminatory. This decision not only clarifies the hierarchy between GAAR and SAAR but also raises important questions about their future applications.
From Icarus to Stability: Refining Anti-Avoidance Rules in India
Although the South African Revenue Guidance didn’t implement it, pertinent observations were accrued that there shall be criteria for determination of the arrangement and the view that one must assess whether the taxpayer would have incurred a tax liability if the transaction had not taken place was endorsed. Such layering is required to curb any arbitrary nature of the income tax proceedings in determining the bona fide of the Arrangements considering that the GAAR and SAAR are criticized for the same.
The recent case of Canada v. Alta Energy Luxembourg SARL case illustrates issues with anti-avoidance rules pertinent to India. GAAR in India, like in Canada, generates confusion due to its subjective character and possible overlap with existing legislation, as seen in the current case, which can lead to uneven implementation. SAARs frequently lack flexibility and fail to address developing tax evasion methods, resulting in gaps, as in the example of bonus stripping. Furthermore, the development of SAARs adds complexity without explaining the legislative purpose. Balancing GAAR as a last resort with updated, clearly described SAARs to handle specific avoidance strategies while promoting stability and preventing uncertainty, which hinders the ease of doing business.
To enhance the effectiveness of GAAR, India can also benefit from the focused and specific approach of GAAR rules in China. For instance, adopting a centralized monitoring body similar to China’s State Administration of Taxation (SAT) could enhance the consistency and transparency of GAAR enforcement in India. Moreover, India could refine its GAAR rules by using the ‘purpose test’, through the incorporation of more specific guidelines, which would ensure clearer interpretation and less uncertainty. This would essentially help in combating tax avoidance while also ensuring a decent investment environment for the stakeholders. While these international approaches provide valuable insights, India’s unique economic and legal context requires a tailored solution that balances robust enforcement with business-friendly policies.
The Gauntlet of Tax Regulation: Critical Analysis of GAAR’s Precedence Over SAAR
The Telangana HC judgment overstates GAAR’s precedence over SAAR without clear guidelines, which may lead to unpredictable tax enforcement. This could lead to scrutiny of complex transactions as tax avoidance. Additionally, the ruling lacks engagement with international practices and misses opportunities to refine GAAR’s application. Additionally, it does not address GAAR’s subjective nature, risking inconsistent application. There is an absence of specific criteria for when GAAR should override SAAR, creating ambiguity. Considering particularly the meaning of generalia specialibus non-derogant, which means means that a general law does not override a specific law. In tax law, this ensures that specific rules (like SAAR) take precedence over general rules (like GAAR) when both apply, it demonstrates the judiciary’s stance on the boundaries of legal tax evasion which may be used in circumstances where SAAR does not completely address the tax evasion scheme and establishes a precedent for cases involving complicated tax arrangements. Moreover, giving GAAR precedence over SAAR could lead to uncertainty in tax planning, potentially deterring legitimate business activities, in the long run.
Considering the case of the State of M.P. v. Kedia Leather and Liquor., the court must consider delineating the limitation of both GAAR and SAAR acknowledging the overlap of the legislative frameworks; however, the doctrine of implied repeal is inapplicable given the legislature’s knowledge. There is an overextension given to the clause that allows GAAR to override other conflicting provisions of the tax law, in consideration of the reliance placed by the SC in Nawal Singh v. State of U.P. and Jik Industries Limited v. Amarlal Jumani, it is erroneous to conclude that the non-obstante clause in Section 95(1) excludes the entirety of the Act and operates independently. The court’s reasoning focused on the substance of the transactions rather than the taxpayer’s purpose, which is an important factor in tax jurisprudence. By omitting to evaluate the motivation behind the transactions, this method may set an unjust precedent for expanding the definition of ‘business revenue’.
Conclusion and way ahead
To improve tax enforcement efficacy and fairness, clear standards for deciding when GAAR takes precedence over SAAR should be established. This includes adopting a rigorous ‘purpose test’ to assess taxpayer motives. Additionally, using international best practices, such as a centralized monitoring agency similar to China’s SAT, could enhance GAAR implementation uniformity. The Telangana HC decision highlights GAAR’s primacy over SAAR and the need for clear standards to ensure fair enforcement. Lawmakers and courts need to reconcile effective enforcement with predictability, using clear criteria and international best practices. Clear criteria for GAAR’s precedence over SAAR and international best practices will be crucial in refining India’s anti-avoidance framework, ensuring fairness and effectiveness. As India refines its tax laws, balancing GAAR and SAAR will be key in future legal conflicts, shaping taxpayer and tax authority strategies.