Every person wants to reduce his taxes and for this, they use many of the methods. Basically, taxes liabilities can be reduced by 3 ways; viz. Tax Planning, Tax Evasion, and Tax Avoidance.
Tax Planning is to save taxes by using the various exemption and benefits etc. available under the Income tax act itself e.g. Investing in notified investment, Setting up business in SEZ etc. Tax Planning is absolutely legal and allowed under the law.
Tax Evasion, in simple term, means Tax ki Chori (i.e. theft of Govt. revenue). It is simply using the unlawful means and methods e.g. claiming fake expense, claiming fake deduction etc. to reduce the tax liability. This is illegal and therefore there are various penalties and prosecutions under the Income tax act which deals with such cases.
Tax Avoidance is something which falls in between the Tax Planning and Tax Evasion. It is simply reducing the tax liability using the loopholes in the law. Any planning which is done as per legal requirements in such a way which defeats the basic purpose behind that provision.
Through the Tax Avoidances Govt. loses very heavy revenues each year and yet can’t punish the offenders as they plea that they haven’t committed any breach of the law.
Although, there are various specific sections which are dealing with the specific type of tax avoidance e.g. Section 40A(2), Section 2(22)(e), Section 40(a)(i)/(ia) etc. But these were the only specific section which deals with only certain specific cases.
But there might be many possible ways by which people can do tax avoidance and therefore to curb such kinds of general cases which has malafide intent General Anti Avoidance Rules (GAAR) were introduced.
So, let’s understand it in detail:
1. What is GAAR?
General Anti Avoidance Rules (GAAR) provision deals with such type of Arrangements which is entered into to obtain a tax benefit (i.e. to reduce the tax liability). GAAR is based on the principle that transactions must have to be real and the intent of arrangement/transactions must not be only Tax Avoidance.
2. When GAAR is applicable? [Sec. 95]
For applicability of GAAR, all 3 things mentioned below must be present:
(i). If any Arrangement or Transaction entered into by assessee is Impermissible Avoidance Arrangement (IAA) then such arrangement would be covered under the GAAR provisions.
(ii) Further, GAAR would be applicable where aggregate tax benefit in the relevant A.Y. arising to all parties in the arrangement is Exceeds Rs. 3 Crore.
(iii) The Arrangement/ Transaction must have been entered on or after 1st April 2017. (i.e. GAAR applicable from A.Y. 18-19 onward).
Note- Any Arrangement/Transaction entered into before 1st April 2017 shall be taken as GRANDFATHERED (in simple terms; old/obsolete) and therefore would not be covered by GAAR.
3. What is Impermissible Avoidance Arrangement (IAA)? [Sec. 96]
An Impermissible Avoidance Arrangement (IAA) means an Arrangement, the main purpose of which is to obtain Tax Benefit (i.e. to reduce tax liability) and;
The Arrangement satisfied any ONE of the following conditions (called Tainted Element Presence Test):
(a). It creates rights or obligations which are not generally created between persons dealing at arm’s length, OR
(b). It, directly or indirectly, misuse or abuse the provisions of this Act; OR
(c). It Lack/Deemed to Lack Commercial Substance in whole or part; OR
(d). It is entered into/carried out by such means or in such manners which are not generally employed for bonafide purposes.
When an arrangement is deemed as IAA then whatever would deem appropriate would be taken by authorities including denial of tax benefits under DTAA, lifting of the corporate veil, disregarding the location of transaction or party, deeming connected persons as one person.
Note- Burden of Proof (to prove any arrangement as not IAA) would be on Assessee.
4. When any arrangement does Lack/Deemed to Lack Commercial Substance?
An Arrangement would be deemed to lack commercial substance (i.e. taken as it was not commercially required) if:
(i) The Substance of an arrangement as a whole is different from individual steps or a part of the arrangement (i.e. what is intended to be shown by the form of arrangement).
(ii) It includes:
– Round Trip Financing (i.e. Fund is routed through such locations through which tax liability is reduced)
– An Accommodating Party
– Elements that have the effect of offsetting or canceling each other
Where the transaction involves one or more persons and the value, source, location, ownership or control of funds etc. are disguised (i.e. manipulated).
(iii) Such an arrangement involves such locations of any assets/transactions/party which have been manipulated just to obtain the tax benefit (i.e. reduce the tax liability) and there is no substantial commercial purpose behind it.
(iv) The Arrangement does not have significant effects upon the business risk/cash flow of any party to the arrangement. [means: Window dressing arrangements have been created just to avoid taxes].