Why GAAR in its current form should wait
The unequivocal mandate given to the Modi led NDA government will allow them to take a long term perspective while making policy decisions. The finance ministry led by Arun Jaitley has close to 15 days left to put together the dream budget and at the same time address ‘inclusive growth’ promised by the new regime.
Apart from expecting the measures to tame inflation, revive economic growth and improve fiscal health of the country, everyone would watch out for
approach of the finance ministry towards tax policies. But one of the most closely watched topic in this budget is GAAR.
India first proposed General Anti-Avoidance Rules (GAAR) in the Direct Tax Code (DTC) in 2009. Shortly, after the legislative proposals GAAR was widely criticized on account of uncertainties in its scope and application.
GAAR is an anti-tax avoidance rule designed to limit tax evasion which is
achieved through aggressive tax planning involving use of sophisticated structures. It largely empowers revenue authorities to inquire and deny the tax benefits of transactions or arrangements which do not have any commercial substance or rationale other than, achieving the tax benefit.
The GAAR is intended to be used to thwart tax planning that cannot be defeated in court by using a purposive interpretation of the law. It can also be used as a cheaper, quicker way to prevent or deter planning that could in fact fail to withstand a lengthy court challenge.
Countries which have a mature economy and friendly business environment like Germany, France, South Korea Sweden, Canada, and Australia have introduced GAAR. Emerging economies which are attracting foreign investment like South Africa have also introduced GAAR.
However, some of the developed nations like United Kingdom (UK) have introduced GAAR recently on 17th July 2013.The UK’s GAAR was implemented after a thorough study done by an independent study group and recommendations of various stakeholders before seeing the light of the day.
The UK’s GAAR is designed to stop abusive tax arrangements from achieving a tax advantage that is contrary to the intention of legislature. The UK GAAR does not out precisely restrain tax planning but it involves a practical choice between different courses of action that are taxed in different ways.
Although USA has not implemented GAAR, it has enacted several common-law doctrines such as substance over-form, sham transaction, step transaction, business purpose and the economic substance.
As a gradual shift towards the above concept, GAAR was first introduced in the Income-tax Act, 1961 by the Finance Act, 2012 to take effect from FY 2013-2014. However, following a strong criticism from business and investor communities, the UPA government had constituted a Committee headed by economist Mr. Parthasarathi Shome which inter alia recommended deferral of GAAR.
Consequently, the GAAR implementation got deferred to take effect from FY 2015-2016. It would be interesting to see as to how the new Government deals with GAAR implementation in the forthcoming budget i.e. whether it defers it further or makes no changes.
The scope of Indian GAAR is very extensive as it seeks to cover within its domain nearly all the arrangements which have an element of ‘tax benefit’ accruing. Therefore, prima-facie, various business arrangements resulting in tax benefit may arise for enquiring under the GAAR provisions and considering past experience these may result in extensive drawn tax litigation.
Inevitably GAAR have significant and penal consequences when applied. The intent of the lawmakers should be to enact a law that address the real trouble only and goes no further. To ensure the effectiveness of the law the systems need to be in place, GAAR would need to be managed transparently and with abundant due process proportionate with their often draconian consequences.
The character of a GAAR is to fill in statutory gaps to close the perceived “loopholes” in the statutes and that allow taxpayers to avoid taxes. There lies a danger that the implementing agencies may wield this weapon in an aggressive manner leading to undesirable consequences.
Before implementing the GAAR, it is therefore essential to introduce a charter of taxpayer rights which guarantees enforcement of tax laws in a fair, equitable and non-arbitrary manner which will help improve the perception of taxpayers, reduce compliance costs and reduce litigation.
Considering the current backdrop of the economy and at a time when the new government has just been formed, rolling out of GAAR would be ill-timed and could come as setback to India in terms of being recognized as an attractive investment and business destination.
As envisaged by the Modi led NDA government in their vision, the priority of the new regime is to focus on key agenda viz. propelling economic and inclusive growth, curbing inflation and adopting stable and predictable revenue policies.
By taking a cue from the western and other emerging economies, introduction of GAAR could be best deferred to a day when India would achieve its true potential in the world economy. In the interim, it would be worthwhile for the revenue to bestow their efforts in adopting best GAAR practices world over in the statute before implementation of the same in India.