Law Street - Economic Times (Nov 2010) -GAAR

Dear Readers,
How do I describe GAAR? My greatest fear is that commercial business transactions backed by proper substance, may also fall foul of the GAAR provisions owing to ambiguity and wide sweeping powers. For views from Zenobia Aunty read further. Please click here.
As always the column is also cut and pasted below. Have a nice weekend.
Best regards,
Lubna


The sting in the GAAR tale

• Specific anti avoidance rules are preferable
• If GAAR is a must, grandfathering clause is vital
• Times limits must be imposed for invoking GAAR

When was the last time you received a hand-written letter? Recently, the post man knocked at our door and handed Zenobia Aunty a hand-written letter. Zenobia Aunty hastened to open the envelope. But, it was no gushing fan-mail. Instead, it was a letter from an eminent advocate and her reader, criticizing her for calling attention only to the Controlled Foreign Corporation Rules in the Direct Tax Code (DTC), 2010, and not the “draconian” General Anti-Avoidance Rules (GAAR).

Well, touched by this advocate’s zeal to spare some time and pen a letter, a long spell of research and dictation to her long suffering niece (yes, this columnist) began. The advocated lamented how scams had taken over our country. Scams he explained often arise because of wide discretionary powers and their intended or unintended misuse. Finally, he came back to tax laws, stating that wide discretionary powers even in tax land can resulted in unwanted scenarios.

If the powers given are wide and there are no specific guidelines in place, often even a hardworking honest tax official also finds himself standing at the cross roads, not knowing which way to turn. He stands at the cross roads knowing any action will lead him into the non enviable situation of: Damned if you do, and damned if you don’t!”

The letter was referring to the GAAR proposals. GAAR as contained in the DTC gives wide discretionary powers to a Tax Commissioner to invoke these provisions and to declare any transaction as an “impermissible tax avoidance arrangement”. It is possible that tax authorities could look not at the transaction in its entirety but only at certain aspects of the entire transaction and scream: Foul! As things stand at present, even transactions or arrangements approved by the Courts can be subjected to the wide sweeping powers of the Commissioner.

Zenobia Aunty is all in favour of plugging tax abuse. But at the same time, she does not favour a climate of uncertainty. Specific anti-avoidance rules, such as thin-capitalisation rules, which kick in to prevent misuse of related party debt, are a better option as they deter tax abuse without creating a climate of uncertainty, she explains.

At present, the DTC provides for only the following safeguards in invoking GAAR: (i) The Central Board of Direct Taxes (CBDT) will issue guidelines to govern when GAAR should/could be invoked (ii) A safe harbor, possibly a monetary one, may be included only beyond which the GAAR provisions would be invoked and (iii) Tax payers can approach the Dispute Resolution Panel, if GAAR provisions are sought to be applied to the tax payer.

Are these safeguards adequate? Zenobia Aunty could not help but chanting this ditty (with due apologies to William Shakespeare) under her breath as she went about doing more research on this subject: For a charm of powerful trouble; like a hell broth boil and bubble, GAAR doth bring toil and trouble, Fire burn and DTC caldron bubble.
True certain safeguards have been mentioned. However, it is essential that the proposed guidelines providing for the circumstances in which GAAR could be invoked are objective and remove all traces of uncertainty. The GAAR provisions should not interfere with legitimate and commercial transactions. Further, a monetary threshold for invoking GAAR should be set and this must be reasonable.

It would be ideal if GAAR is dropped and specific anti-avoidance measures are introduced. However, if the powers that be, wish to continue on the path of GAAR certain additional provisions must be built in.

While the DTC prescribes that tax payers can approach the Dispute Resolution Panel if GAAR is sought to be applied, prevention is better than cure. Thus creation of an authority which would give a clean chit to a proposed transaction – on the lines of the Authority for Advance Rulings would create a sense of comfort among the investors, especially the foreign investors. The only fair way to administer a GAAR mechanism would be to introduce a clearing service where the tax authorities would review a proposed transaction or a transaction and give their opinion on the tax position.

The DTC should provide grandfathering provisions under GAAR and ensure transactions entered into only during after the DTC has come into effect can be subject to GAAR. Further, there should be a time limit within which tax authorities can invoke GAAR in respect of any transaction. The Damocles sword cannot hang over the heads of the tax payers in perpetuity. The onus of proof that there has been tax avoidance should lie on the revenue and not the tax payer.

Such additional precautions are necessary to ensure that GAAR does not become a weapon to meet tax revenue targets. Zenobia Aunty hopes that the eminent advocate and indeed her other readers are satisfied that she had done some justice to the complex proposed GAAR mechanism.