Critical Analysis of GAAR in Light of the Constitution of India and DTAA

Introduction

The General Anti-Avoidance Rules¹ (GAAR) was introduced in 2012 in Parliament but came into effect only in 2017. It was made applicable for the assessment of the Financial Year 2018-2019. It was enacted to prevent an internationally recognised area of concern: tax avoidance. The Organisation for Economic Cooperation and Development (OECD) defines tax avoidance as “a term used to describe an arrangement of a taxpayer’s affairs that is intended to reduce his liability and that although the arrangement could be strictly legal it is usually in contradiction with the intent of the law it purports to follow”.² Whereas Cambridge Dictionary defines tax avoidance as “reduction of taxes by legal methods which a taxpayer or company is liable to pay”.³

What are GAAR provisions in India?

The General Anti-Avoidance Rules are contained in Chapter X-A of the Income Tax Act, 1961, and range from Sections 95 to 102 of the Act⁴. Section 95 of the said Act talks about the applicability of the provision and states,

Notwithstanding anything contained in the Act, an arrangement entered into by an assessee may be declared to be an impermissible avoidance arrangement and the consequence in relation to tax arising therefrom may be determined subject to the provisions of this chapter.⁵

The Explanation to Section 95 also makes it very clear that the provisions will apply to the whole arrangement or any step or part of the arrangement.⁶ Further Section 96 of the Act defines impermissible avoidance arrangement (IAA) as an arrangement that is made to obtain a tax benefit and it had created rights and obligations which are not ordinarily created between the person dealing at arm’s length or it has resulted in the misuse of the provisions of the said Act whether be it directly or indirectly or if the arrangement lacks or deemed to lack commercial substance in whole or a part of if the arrangement was made by such a means or manner which is usually not employed for the bona fide purpose.⁷ Section 96 also made a presumption that an arrangement has been entered or carried out for the main purpose of obtaining a tax benefit even if a step in, or a part of, that arrangement is to obtain a tax benefit which means that even if one part of the arrangement is to obtain tax benefit the whole arrangement will be considered to be made for the same purpose but this presumption is rebuttable in nature so prove can be given to rebut this presumption.⁸ The term “lack commercial substance” is defined under Section 97 of the Act as,

an arrangement made in conditions in which forms appear more important than substance,⁹ or which include or involves certain actions i.e. round-trip financing, an accommodating party, elements that have the effect of offsetting or cancelling each other, a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject-matter of such transaction, the location of an asset or a transaction or of the place of residence of any party which is without any substantial commercial purpose other than obtaining a tax benefit, it does not have a significant effect upon the business risks or net cash flows of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained.¹⁰

Analysis

Tax avoidance is the legal utilisation of the tax regime to one’s advantage, for the reduction of the amount of tax that is payable by means that are within the law; and involves the exploitation of loopholes and gaps in tax and other legislation in ways not anticipated by the law.¹¹ The GAAR will not apply to the transactions when the taxpayer has one or more bona fide ways of doing a transaction and he selects the manner he wants.¹² The provisions are based on the doctrine of “substance over form” which means that the legal form of an arrangement will be ignored by the taxing authorities, and they will look into its actual substance to prevent artificial structures from being used for tax avoidance purposes. This doctrine is highly subjective and uncertain. The Bombay High Court in Provident Investment Co. Ltd. v. CIT¹³ has observed that:

to look to the substance of the matter and ignore the legal position is to substitute the “uncertain and crooked cord of discretion” for the “golden and straight mete wand of the law”.

The provisions are inherently unpredictable and uncertain in their application because it has a chilling effect on the positions taken by taxpayers which is legal but minimises the tax liability in a manner viewed as undesirable by the tax administration. The provisions grant vast power to the tax authority to invoke GAAR arbitrarily because it failed to differentiate between legitimate tax minimisation and abusive tax avoidance. There were also no legislative and administrative safeguards for genuine taxpayers against the abusive use of GAAR by the Tax Authority. A bare reading of the provisions makes it clear that it gives arbitrary power to the Tax taxing Authorities to implement it and the definition of IAA lacks objectivity both of these give rise to arbitrariness which is violative of Article 14¹⁴ of the Constitution of India as observed by the Supreme Court in Maneka Gandhi v. Union of India¹⁵, “Article 14 strikes at arbitrariness in State action and ensures fairness and equality of treatment.” The provisions also seem to violate the “doctrine of the rule of law”.

F.A. Hayek defines the doctrine of the rule of law as,

“The Government in all its actions is bound by rules fixed and announced beforehand-rules which make it possible to foresee with fair certainty how the authority will use its powers in given circumstances and plan one's individual affairs based on this knowledge.”¹⁶

In S.G. Jaisinghani v. Union of India¹⁷, the Court has emphasised that:

14. … the absence of arbitrary power is the first essential of the rule of law upon which our whole constitutional system is based. In a system governed by rule of law, discretion, when conferred upon executive authorities, must be confined within clearly defined limits. The rule of law from this point of view means that decisions should be made by the application of known principles and rules and, in general, such decisions should be predictable and the citizen should know where he is. If a decision is taken without any principle or without any rule it is unpredictable and such a decision is the antithesis of a decision taken in accordance with the rule of law.¹⁸

A fundamental tenet of the rule of law is that laws must be definite and free of arbitrary decision-making in order to be predictable for individuals to plan their long-term behaviour. The concept that taxpayers should be able to forecast in advance, or at the very least, identify in retrospect and with a sufficient degree of clarity, the tax repercussions of their activities according to regulations enacted via the parliamentary procedures expresses this principle, particularly in a tax context. So, to the extent that GAAR gives or appears to provide the Government unrestricted authority to recast a transaction for tax purposes or to change the applicable tax consequences, the provision can be seen as permitting a type of taxation by administrative decree or analogy or, worse still, the imposition of what may amount to an incontestable tax. A law or rule that is ambiguous, confusing, obtuse, or imprecise is likely to mislead or confuse those who are supposed to be governed by it, and frequent revisions would make it nearly impossible for the populace to make long-term plans and judgments.¹⁹ Certainty and predictability are undeniably important in the tax arena. Whereas the provisions empower the authorities to look beyond the legality of the transaction and give discretionary power to decide the subject of the transaction or the arrangement.

In I.R. Coelho v. State of T.N.²⁰, it was held that “The rule of law is part of the basic structure of the Constitution of India²¹.” Since GAAR provisions are unpredictable, uncertain, and arbitrary in nature so it is violative of the rule of law which is part of the basic structure of the Constitution of India and must be struck down for the violation of the rule of law on the ground of being unpredictable, uncertain, and arbitrary.

GAAR provisions are often advertised as a cure-all for perceived “abuses” of the treaty. In other words, they are applied to change the result that would have been obtained if the treaty had been applied by its stated terms. The double taxation avoidance agreement (DTAA) is a bilateral agreement between two countries entered with the objective to promote and foster economic trade and investment between two countries by avoiding double taxation.²² It is a well-established law that, as stated in Section 90(2) of the Income Tax Act²³ and upheld by the most recent landmark decision of the Supreme Court in Engg. Analysis Centre of Excellence (P) Ltd. v. CIT²⁴, the more advantageous provisions or articles of the DTAAs will prevail over the inconsistent provisions contained in the Income Tax Act.²⁵ To overcome Section 90(2)²⁶ the legislature has inserted another sub-section (2-A) in the said section which states, “Notwithstanding anything contained in sub-section (2), the provisions of Chapter X-A of the Act shall apply to the assessee even if such provisions are not beneficial to him.”²⁷

The Delhi High Court in DIT v. New Skies Satellite BV²⁸, has held, “no amendment, whether retrospective or prospective, could be read in a manner that modifies the operation of the terms of an international treaty.” Domestic law remains static for the purposes of a DTAA. The Court had expressed, despite its supremacy, Parliament “simply did not have the right to, by domestic legislation, modify the conditions of a treaty”. In this ruling, the Delhi High Court also noted that the Vienna Convention on the Law of Treaties, 1969²⁹ (VCLT) provisions were widely acknowledged as a component of customary international law. A treaty may only be amended by agreement between the parties, according to Article 39 of the VCLT.³⁰ The Delhi High Court held that this was a norm that was deeply ingrained in customary international law and that it could not be violated. This idea was supported by Article 51(c) of our Constitution³¹, and as a result, the legislative authority of Parliament was constrained.³² Article 253³³ of the Constitution of India, “gives power to Parliament to make any law for the whole or any part of the territory of India for implementing any treaty, agreement, or convention with any other country or countries or any decision made at any international conference, association, or other body”, Section 90(2) of the said Act is the example of this power to implement DTAAs. Section 90(2-A)³⁴ of the Act is an instance of the exercise of powers under Article 246³⁵ along with Entry 97³⁶, presumably, of the Union List. Article 253 contains the phrase, “Notwithstanding anything in the foregoing provisions of this chapter.”³⁷ The non obstante clause could mean that Article 253 prevails over Articles 245³⁸ and 246.

The High Court of Andhra Pradesh, in Sanofi Pasteur Holding SA v. Deptt. of Revenue³⁹, followed the decision of the Canadian Supreme Court in R. v. Melford Developments lnc.⁴⁰, and held:

“Once a law has been enacted under Article 253, every other law is subject to that law and a law made under Article 253 cannot be amended by a subsequent statute, which has been ordinarily made under the powers conferred under Article 246.”

The Court also noted, “this was necessary to maintain the sanctity of international obligations because otherwise, domestic law would routinely alter the country's international obligations.”⁴¹ Therefore, a law made under Article 253 cannot be amended by a subsequent statute, which has been ordinarily made under the powers conferred under Article 246. Any amendment to a treaty may only be brought about by an agreement between the parties concerned so the purpose and object of the treaty cannot be defeated by bringing in some unilateral domestic legislation.

Conclusion

Undoubtedly, the possibilities for evasion and the difficulties of administration have always shaped tax systems. But the GAAR provisions, unless watered, will only cause uncertainty and ambiguity in the minds of taxpayers. The provisions are like a double edge sword in the hand of taxing authorities to invoke arbitrarily any transaction which may harass the genuine bona fide transactions in absence of safeguards provided to them by the provisions. Despite the clarification from the Central Board for Direct Taxes, the provisions remain uncertain in many aspects. Adequate safeguards must be put in place to ensure the implementation of GAAR provisions. The other alternative method like the “limitation of benefits”⁴² clause which is a special Anti-Avoidance Rule can be preferred. It is upon the Court to interpret the provisions and test them on constitutional parameters but till then adequate safeguards and guidelines must be provided by the Government and authorities.