Implications Of Telangana High Court's Ruling On General Anti Avoidance Rules
GAAR was implemented in 2017 to identify tax structures and arrangements that lack commercial basis and are designed for the sole purpose of seeking tax concessions.
Taxpayers will have to be extra cautious in the manner in which they plan their tax structure and any attempts at evading taxes under the garb of tax planning will be under the Income Tax Department’s radar.
Colourable devices or misleading transactions cannot be a part of tax planning, and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods, the Telangana High Court has recently held.
In doing so, a high court, for the first time, has interpreted the General Anti-Avoidance Rules, or GAAR, since its implementation in 2017. Prior to this ruling, these provisions were addressed only through administrative circulars.
Under GAAR, the tax department can reject tax benefits to taxpayers in situations where the sole purpose of the taxpayer is to hide behind technicalities and aggressive tax structures in order to avoid paying taxes.
This ruling highlights the importance of advance tax planning, as a GAAR case can result in stringent outcomes. Therefore, for businesses that are very tax-aggressive, it will now make more sense to make disclosures to the department or get an advance ruling in their favour, Tarun Jain, a Supreme Court advocate and tax controversy expert, told NDTV Profit.
The court remarked that before GAAR was codified, the judiciary had already established its own set of rules known as the Judicial Anti-Avoidance Rules, or JAAR. ‘Substance over form’ was the guiding idea of JAAR, which sought to expose misleading structures or transactional arrangements with no actual commercial substance.
GAAR is therefore an offshoot of these judicial regulations, the court said.
Which One Is Applicable — GAAR Or SAAR?
Alla Ayodhya Rami Reddy, the taxpayer in this case, held shares of Ramky Estate and Farms Ltd. REFL issued bonus shares to its shareholders in the ratio of 5:1 and owing to the issuance of bonus shares, the face value of each share of REFL got reduced to 1/6th of its value. Subsequently, these shares were sold to another firm at reduced prices, resulting in a short-term capital loss for Reddy.
This capital loss was used to set off capital gains arising from another set of transactions, thereby reducing the tax liability on the capital gains. The department invoked GAAR on the premise that the capital loss was artificial and that this should be ignored while determining capital gains tax liability.
It was Reddy’s contention that since the transaction under question was specifically excluded from the provisions of Specific Anti-Avoidance Rules, or SAAR, the transaction cannot be indirectly curbed by applying GAAR.
Section 94(8) under SAAR speaks about tax avoidance in cases concerning units of mutual funds and not stocks. Since stocks are specifically excluded from this provision, it was contended that a GAAR case essentially expands the scope of a specific provision, which is not permissible.
Under tax law, it is usually the case that if a specific provision exists but does not apply to the facts of a case, then the general provision will also not apply. The court has clarified that this is not how GAAR provisions are supposed to be interpreted, as the law clearly states that GAAR provisions cannot take a backseat if SAAR doesn’t apply.
The court has said that the chapter containing GAAR provisions begins with a non-obstante clause, meaning that GAAR provisions have an overriding effect over and above the other existing provisions of law.
GAAR provisions are applicable in addition to or as a substitute for any other existing method of determining tax liability, the court said.
Therefore, whether GAAR will apply or SAAR will depend on the facts and circumstances of each case.
The arguments that GAAR could be invoked only if SAAR is inapplicable and that GAAR could not be invoked if SAAR is not triggered are incompatible with each other. It's like saying, "I win if it's heads; you lose if it's tails," said Dr. Dhruv Janssen-Sanghavi, founder of Janssen-Sanghavi and Associates.
More Tax Litigation On The Way?
Since a higher judicial authority has now interpreted the GAAR provisions, it might fuel the tax department's efforts to go after tax avoidance cases since the department now has a solid judicial precedent in its favour.
Jain said that although it might lead to more cases being filed, giving credence to its validity will not automatically translate into every tax avoidance case filed under GAAR going the tax department’s way.
Enquiries under GAAR are, by their very nature, fact-intensive, and the department will have to show that, in fact, tax avoidance was indeed the taxpayer's motive.Tarun Jain, Advocate & Tax Controversy Expert, Supreme Court of India
According to Janssen-Sanghavi, the ruling is unlikely to lead to a flurry of cases under GAAR, but it serves as an important reminder that tax advisors will have to account for new rules like the GAAR and the principal purpose test very seriously before coming up with clever schemes for aggressive tax planning.
