Discussion Paper on Direct Tax Code

Need for general anti-avoidance rule (GAAR)

24.1   Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner. Sectors that provide a greater opportunity for tax avoidance tend to cause distortions in the allocation of resources. Since the better-off sections are more endowed to resort to such practices, tax avoidance also leads to cross-subsidization of the rich. Therefore, there is a strong general presumption in the literature on tax policy that all tax avoidance, like tax evasion, is economically undesirable and inequitable. On considerations of economic efficiency and fiscal justice, a taxpayer should not be allowed to use legal constructions or transactions to violate horizontal equity.

24.2   In the past, the response to tax avoidance has been the introduction of legislative amendments to deal with specific instances of tax avoidance. Since the liberalization of the Indian economy, increasingly sophisticated forms of tax avoidance are being adopted by the taxpayers and their advisers. The problem has been further compounded by tax avoidance arrangements spanning across several tax jurisdictions. This has led to severe erosion of the tax base. Further, appellate authorities and courts have been placing a heavy onus on the Revenue when dealing with matters of tax avoidance even though the relevant facts are in the exclusive knowledge of the taxpayer and he chooses not to reveal them.

24.3   In view of the above, it is necessary and desirable to introduce a general anti-avoidance rule which will serve as a deterrent against such practices. This is also consistent with the international trend.

24.4   Under the Code, the General Anti-avoidance Rule (GAAR) will be invoked if the following three conditions are satisfied:-

Meaning of arrangement, etc.

24.5   An 'arrangement' will mean any transaction, conduit, event, trust, grant, operation, scheme, covenant, disposition, agreement or understanding, including all steps therein or parts thereof, whether enforceable or not. Therefore, if the motive behind individual steps is obtaining a tax benefit, but the overall scheme is not so, the individual steps will nevertheless be treated as an arrangement and the GAAR may be invoked.

24.6   An arrangement will also include any interposition of an entity or transaction where the substance of such entity or transaction differs from the form given to it.

24.7   The lack of commercial substance, in the context of an arrangement, shall be determined, but not limited to, by the following indicators:

24.8   The concepts of 'round trip financing' and 'accommodating party' will be defined in the Code.

Tax consequences of impermissible avoidance arrangements

24.9   If the conditions specified in paragraph 24.7 above are satisfied, the Commissioner will be empowered to declare the arrangement as an impermissible avoidance arrangement and determine the tax consequences of the assessee as if the arrangement had not been entered into. For this purpose, he may -

24.10   An arrangement declared as an impermissible avoidance arrangement shall be presumed to have been entered into or carried out for the main purpose of obtaining a tax benefit unless the party obtaining the tax benefit proves that obtaining a tax benefit was not the main purpose of the avoidance arrangement.

Treaty override

24.11   Under the Vienna Convention, international agreements are to be interpreted in 'good faith'. In case any international agreement/treaty leads to unintended consequences like tax evasion or flow of benefits to unintended person, it is open to the signatory to take corrective steps to prevent abuse of the treaty. Such corrective steps are consistent with the obligations under the Vienna Convention. Further, the OECD Commentary on Article 1 of the Model Tax Convention also clarifies that a general anti-abuse provision in the domestic law in the nature of "substance over form rule" or "economic substance rule" is not in conflict with the treaty. The general anti-abuse rule will override the provisions of the tax treaty. The Code provides accordingly.

Procedure for applying GAAR

24.12   The power to invoke GAAR is bestowed only upon the Commissioner of Income- tax. For this purposes the Code empowers him to call for such information as may benecessary. He is also required to follow the principles of natural justice before declaring an arrangement as an impermissible avoidance arrangement. He will determine the tax consequences of such impermissible avoidance arrangement and issue necessary directions to the Assessing Officer for making appropriate adjustments. The directions issued by him will be binding on the Assessing Officer.

Specific anti-abuse rules

24.13   These general anti-avoidance rules will be further supported by anti-avoidance rules to deal with the following circumstances:-

Please send your comments and suggestions to

directtaxescode-rev@nic.in