CA T. P. Ostwal Material... · • Regular speaker in all international tax conferences symposiums, workshops, seminars and courses in India and abroad. • M/s T.P. Ostwal & Associates

3INTERNATIONAL TAX & FINANCE CONFERENCE 2011

CA T. P. Ostwal

• CA Final Rank holder

• Member of The Institute of Chartered Accountants of India since 1978

• Member of the CID TAG (Technical Advisory Group) of OECD Paris

• Member of the BIAC of OECD, Paris.

• First Vice President of the Executive Committee International Fiscal Association-Netherlands

• Ex-Chairman of International Fiscal Association – India Branch.

• Member of Emerging Issues Task Force on Non Resident Taxation formed by Ministry of Finance, Govt. of India.

• Member of Finance Sub Group of Construction Industry Development Council of Planning Commission of Govt. of India.

• Member of Expert Committee formed by Central Board of Direct Taxes (CBDT), Ministry of Finance, Government of India for framing Transfer Pricing Regulation in India.

• Member of Satawalekar Committee on Real Estate Mutual Fund in India.

• Member of Indian Council of Arbitration.

• Member - Taxation and International Committee’s in various organization.

• Member of Board of several companies listed and being listed.

• Contributed many papers reports on Indian tax position and delivered speech on subjects of International Taxation at various forums in India and abroad regularly.

• Professor at the University of Mumbai from 1976 to 1991.

• Visiting Professor at Vienna University Austria for teaching International Tax for LLM studies.

• Is actively involved in handling international tax issues on Cross-border Transactions, including Corporate Structuring / Restructuring, Joint Ventures and Collaborations, Valuations, Accounting and Auditing, IFRS, Company Law matters and Foreign Exchange Management Act related matters for a wide range of clients in India particularly in the field of Real Estate, Technology, Software and Telecommunication, Entertainment sectors.

• Is also active in several professional and charitable organizations in India.

• Co-author of publication “Transfer Pricing Manual” published by The Bombay Chartered Accountants Society & Chamber of Tax Consultants.

• Has been adjudge as 11th in the top 50 Tax Professionals in the world for the year 2006-07 by Tax-Business magazine of UK in Nov 2006.

• Regular speaker in all international tax conferences symposiums, workshops, seminars and courses in India and abroad.

• M/s T.P. Ostwal & Associates has been recognized as best 2nd Tier firm in India by International Tax Review for the year 2009 and 2010 consecutively.

• World tax magazine has recognized me as one of the leading Ten tax professionals advising Transfer Pricing matters in India

• Very recently appointed as a member of sub committee on Transfer Pricing for developing countries by United Nations.

General Anti Avoidance Rules

International Tax & Finance Conference, 2011 1

General Anti Avoidance RulesCA T. P. Ostwal

Table of Contents

1. An Introduction ................................................................................................................... 3

1.1. Concept of Tax Evasion, Tax Avoidance & Tax Planning ...................................... 3

1.2. Characteristics of impermissible tax avoidance schemes ........................................ 5

1.3. Cause & Effect Relationship ....................................................................................... 6

1.4. Governmental Responses to tax avoidance ............................................................... 7

2. GAAR in Various Jurisdictions ....................................................................................... 10

Rationale behind introducing Statute-based GAAR in a jurisdiction .......................... 10

3. Indian Scenario ................................................................................................................. 12

A. Position of law in India currently (Court-based GAAR) ....................................... 12

B. Intended legislative GAAR in Proposed DTC in India ........................................ 17

C. Analytical insight of the various provisions of GAAR in proposed DTC ........... 18

D. Critical Examination of procedural issues arising out of Intended legislative GAAR in Proposed DTC ........................................................................................... 28

E. Points to ponder ....................................................................................................... 29

4. The relationship between Domestic General Anti-Avoidance Rules (GAAR) and Tax Treaties ................................................................................................................ 29

4.1 Concept of Treaty Override & International Perspective ..................................... 29

4.2 Relevance of Treaty Override In Indian Context .................................................. 35

5. Is the abuse of a tax treaty addressed by domestic law principles or by the interpretation of the tax treaty? ...................................................................................... 38

6. The relationship between Domestic General Anti-Avoidance Rules (GAAR) and Domestic special anti-avoidance rules (SAAR)/Targeted Anti-avoidance rules (TAAR) ...................................................................................................................... 45

Case Studies for Discussion ....................................................................................................... 47

Conclusion ................................................................................................................................... 51

Appendix # 1 - Brief portfolio of countries having GAAR provisions under the law ............................................................................................................................ 52

Appendix # 2 – Bare Provisions of the GAAR under the Direct Tax Code, 2010 ............. 74

Bibliography ................................................................................................................................ 79


2 International Tax & Finance Conference, 2011

Economic activities have never been as global as they are today. International trade has shrunk the national borders and the globe has become one village. It has accelerated mobility of capital. Growth in international capital flow and trade has become massive which will further boost the mobility of economic activities across the borders. The accelerated level of globalization of economies and business enterprises has, as its natural consequence, lead to evolution of new and unique ways of doing business and arranging one’s commercial affairs world over – be it private individual or a business enterprise. This brings along not only the opportunities but also challenges and problems for the players of the world economy.

To address the challenges exposed or likely to be exposed by new world economy, tax administrations are also on look out for new ways and means to protect national tax revenues and attack on so perceived impermissible ways of mitigating tax obligations. Indian GAAR is one step in that direction. There are ever increasing number of countries introducing GAAR (general or specific) in the spectrum of tax regime.

The purpose of this paper is to give the international tax practitioners a brain teasing. Unlike any other paper on tax which is generally perceived to be dry, dull, unimaginative and above all boring, I have attempted to put some life in the subject which is going to be ever evolving, challenging and fascinating subject in our practice area. As professionals, our role is to assist our clients in unlocking the problem. But to do so, we need to understand not only the tax issues but also commercial or family issues and circumstances that are relevant to them. It is not enough simply to be able to repeat verbatim sections of the relevant tax codes. It is much more important to be able to relate to real life circumstances of the case and to give an advice which meets the objectives, not simply tax objectives.

With this in mind, I have attempted to write this paper. I am quite hopeful to learn from the deliberations of the brilliant participants and try to understand more than one answer to every problem which we all are going to face once much announced Direct Tax Code (‘DTC’) is implemented in India. The General Anti Avoidance Regulations or ‘GAAR’, as we call it, will unsettle lot of settled issues and would be new way of life, like old songs are played in new way, so to say ‘remix’.

[This space has been left Blank intentionally]



1. An Introduction Before introducing the concept of GAAR to the participants, it becomes imperative

to familiarize themselves with the concept and distinction between Tax Evasion, Tax Avoidance and Tax Planning:

1.1. Concept of Tax Evasion, Tax Avoidance & Tax Planning Tax Evasion has been defined by OECD to mean “illegal arrangements where liability

to tax is hidden or ignored, i.e. the taxpayer pays less tax than he is legally obligated to pay by hiding income or information from the tax authorities”. It would typically involve the non-payment of a tax that would properly be chargeable if the taxpayer had made a full and true disclosure of income and the allowable deductions. In various jurisdictions around the world, tax evasion is generally accompanied by penalties which may be, but are not always, criminal in nature. Common examples of tax evasion include a deliberate failure by a “cash” business to report the full amount of revenue received or the deliberate claiming of a deduction by a business for an expenditure it has neither incurred nor paid.

Tax Avoidance has various definitions in legal rulings and academic literature:-

a) Justice Reddy (in the legendary decision of McDowell) calls it the “art of dodging tax without breaking the law”

b) Black’s law dictionary states that tax avoidance is the “minimization of one’s tax liability by taking advantage of legally available tax planning opportunities”

c) OECD terms tax avoidance as “an arrangement of a taxpayer’s affairs that is intended to reduce his liability and that although the arrangement could be strictly legal is usually in contradiction with the intent of the law it purports to follow”

d) The European Court of Justice (ECJ) views tax avoidance as “artificial arrangements aimed at circumventing law”

e) The Carter Commission Report (Canada, 1966) stated that tax avoidance is “every attempt by legal means to reduce tax liability which would otherwise be incurred, by taking advantage of some provision or lack of provision in the law”

f) In the landmark US Supreme Court ruling of Helvering vs Gregory, the US court says “any one may arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes”

The common theme amongst all the definitions of tax avoidance is that there is a “grey area” of exploiting, albeit legally, the tax laws of countries to maximum benefit. It generally contains elements of artificiality (for e.g. as to the legal form adopted), and may often be considered to be contrary to the spirit of the law. However, its scope may vary from country to country, depending on attitudes of government, courts and public opinion. Examples of tax avoidance include locating assets in offshore jurisdictions, conversion of income to non- or lower-taxed gains, spreading of income to other taxpayers with a lower marginal tax rate, sale and lease-back arrangements, realizing capital gains from a subsidiary having substantially high book value instead of getting dividend, etc.



Tax Planning has been explained by OECD as “an arrangement of a person’s business and/or private affairs in order to minimize tax liability”. Examples of legitimate tax planning would involve taxpayer’s decision to operate a new business as a company or LLP or a partnership. Similarly, choosing between operating a branch or a wholly owned subsidiary also entails tax planning.

A distinction can easily be made between Tax Avoidance and Tax Evasion. The latter is clearly illegal; the former is legal. Another way to look at it is that tax avoidance maybe considered as a breach of social contract whereas tax evasion can easily be considered as a crime. There is no thin line but a gulf between the two; whereas, there is often a thin line between ‘acceptable tax avoidance’ [also known as Tax Planning] and ‘unacceptable tax avoidance’.

It is this thin line of difference between acceptable tax avoidance and unacceptable tax avoidance which creates serious problems for taxpayers as well as for revenue authorities for concluding whether a particular tax avoidance proposal is permissible or impermissible in law.

Analytic definitions of the point at which tax mitigation becomes tax avoidance are elusive. Lord Denning of Australian Court in the case of Newton v FCT (1958) has said that for an arrangement to constitute tax avoidance, “you must be able to predicate … that [the arrangement] was implemented in that particular way so as to avoid tax.” This definition brings us no closer to knowing what constitutes tax avoidance, because all it says is “tax avoidance arrangements are those arrangements that look like tax avoidance arrangements.” Nevertheless, the definition highlights the difficulty of exhaustively defining tax avoidance, or, indeed, the difficulty of defining tax avoidance in terms of legal rules at all.

As a general rule, the law does not require people to arrange their affairs so that they incur the greatest possible tax liability. When faced with two possible ways in which to organize their affairs, taxpayers are legitimately entitled to choose the option that requires them to pay the lesser amount of tax. There comes a point, however, where governments begin to think that taxpayers are going too far in their attempts to decrease their tax liability. At this point, taxpayers cease to engage in legitimate tax mitigation and embark on unacceptable tax avoidance. For Example: When issuing debentures, the income tax department may ask the issuer as to why has it chosen to issue debentures instead of preference shares simply for the reason that interest is tax deductible whereas dividend is not tax deductible.

Tax avoidance is perhaps best defined ostensibly, rather than by analysis, i.e. the best way to understand tax avoidance is simply to be shown examples. This exercise would prove to be an easier task than analyzing an exhaustive definition. Tax avoidance transactions tend to have a number of identifiable features, for example, artificiality, lack of business or economic reality, lack of true business risk, and the exploitation of statutory loopholes. Empirical evidence shows that that tax avoidance often involves taxpayers exploiting rules that were designed to reduce unfairness in the tax.



1.2. Characteristics of impermissible tax avoidance schemes Even though there is no test as simple as litmus test to categorize a tax avoidance

transaction into acceptable or impermissible tax avoidance transaction, let us try to examine some common characteristics of impermissible tax avoidance schemes:

a) Lack of Economic Substance: In many abusive avoidance schemes, the taxpayer purports to make a substantial

investment. This investment, however, is largely an illusion. Through various devices/schemes, the taxpayer remains insulated from virtually all economic risks, while creating a carefully crafted impression to the contrary.

In any investment, risk and return are related – the greater the risk, the greater the return. As a consequence, in so far as most abusive avoidance schemes typically involve little or no economic risk, they typically offer little or no opportunity for pretax gain. Rather, the return to the investor takes the form of the significant tax benefits promised by the arrangement. In this manner, a negligible pre-tax profit is transformed into a significant after-tax return. Indeed, the mismatch between a limited (or non-existent) potential for pre-tax profit and the promise of very significant tax benefits is often a good indicator of an abusive avoidance scheme.

b) Use of Tax-Indifferent Accommodating Parties or Special Purpose Entities: Most abusive avoidance schemes also involve the use of accommodating parties

or special purpose entities. In the context of an abusive avoidance scheme, the accommodating party is typically tax indifferent. Such parties may include foreign persons, partnerships, trusts, pension funds, and taxpayers that can either generate offsetting deductions to absorb any income they derive from their participation in a scheme or utilize existing assessed losses. In practice, these parties typically receive a fee (often in the form of an above-market return on investment) for the service of absorbing income or otherwise selling their tax-advantaged status to the other participants in the scheme. A larger deduction for one party, for example, typically means greater income for the other. Tax-indifferent parties, by design, work to disable and defeat that mechanism.

c) Unnecessary Steps and Complexity: Abusive avoidance schemes are often mind-numbingly complex. There are several

reasons for this. These schemes often require the completion of certain formalistic steps to claim the desired tax result. Steps may also be inserted to prop up a claim of business purpose. Similarly, a complex structure may be used to disguise the true nature of a scheme or as a device to cloak the tax shelter transaction from detection.

d) Tax haven arrangements: Schemes which make use of tax haven generally involve formation of entities

like captive insurance companies, captive finance subsidiaries and intangible property holding companies in such tax havens since tax havens typically attract geographically mobile activities. In many cases, the establishment of these



vehicles involves little or no change in business or commercial practice for the participating company, but can generate significant, ongoing tax savings.

1.3. Cause & Effect Relationship The various harms caused by impermissible tax avoidance schemes which give rise to

the need for introducing anti-avoidance measures in a jurisdiction are:

a) Short-Term Revenue Loss: The most immediate harm which comes to one’s mind is short-term revenue

loss. Impermissible tax avoidance schemes reduce the tax base of a jurisdiction resulting into short term revenue loss. Such revenue loss is usually short-term since effective anti-avoidance measures are introduced in long-term to invalidate such schemes.

b) Disrespect for the Tax System and the Law: Impermissible tax avoidance also encourages disrespect for the tax system – both

by the people who participate in such impermissible tax avoidance schemes and by others who perceive unfairness. The proliferation of arbitrary and contrived schemes also leads to a perception that the system is unfair. This may in turn discourage compliance, even by taxpayers that had not previously engaged in impermissible tax avoidance.

c) Increasing Complexity: Introduction of numerous specific anti-avoidance measures in response to

impermissible tax avoidance schemes increases the complexity in the tax laws. In this regard, governments normally suffer from the first mover disadvantage (i.e. it lays out delineated rules, which are then exhaustively analyzed and parsed by taxpayers and their advisers precisely in order to find and exploit loopholes). This complexity may sometimes therefore be self-defeating, but it invariably increases the compliance burden upon all taxpayers.

d) Costs to the Economy: At a basic level, to the extent that impermissible tax avoidance inevitably results

in new amendments, more complex legislation and increasingly comprehensive and detailed reporting requirements, administrative costs and compliance burdens swell for both taxpayers and the government. Additional costs are reflected in the resources that are diverted from productive investment to the development, marketing, implementation and subsequent to defend impermissible tax avoidance schemes.

At a deeper level, impermissible tax avoidance creates significant deadweight losses for the economy by distorting trade and investment flows. Sectors that provide a greater opportunity for tax avoidance tend to cause distortions in the allocation of resources from productive investments to activities that are, at best, marginally profitable on a pre-tax basis.



e) Unfair Shifting of the Tax Burden: In a tax context, “equity” is generally seen as having two aspects: horizontal

equity and vertical equity. ‘Horizontal equity’ is generally defined as a doctrine which holds that similarly situated taxpayers should receive similar tax treatment, i.e. taxpayers who earn the same amount of income or capital should be accorded equal treatment. Whereas, ‘Vertical equity’ is generally defined as a doctrine which holds that differently situated taxpayers should be treated differently, i.e. taxpayers with more income and/or capital should pay more tax.

Since the better-off sections of the society are more endowed to resort to such practices, impermissible tax avoidance leads to cross-subsidization of the rich. Impermissible tax avoidance thus has a tremendous impact upon the equity and fairness of the tax system.

f) Impairment of the ability of government to implement its various beneficiary schemes:

At a basic and obvious level, aggressive schemes can precipitate severe short-term revenue losses that limit government’s ability to pursue its economic and social agenda. Impermissible tax avoidance schemes seriously undermine the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner.

1.4. Governmental Responses to tax avoidance: Typically, governments combat avoidance by adding specific, targeted and often very

detailed rules to tax legislation, being rules that frustrate one kind of avoidance transaction or another. For instance, jurisdictions might allow taxpayer companies to carry losses forward and to set them off against the profits of future years. As an anti-avoidance measure, such jurisdictions tend to require certain minimum continuity of ownership between the loss year and the profit year. Tax statutes around the globe are replete with such rules. However, specific anti-avoidance rules or a targeted anti-avoidance rules cannot combat the more creative forms of tax avoidance that employ transactions that governments cannot predict. Consequently, many tax systems feature general anti-avoidance rules in addition to specific ones.

As tax avoidance activity has increased over the past few decades, governments have generally adopted various measures, both legislative and administrative, to discourage this phenomenon. It is illustrative to see how governments around the world react to this problem:

a) Legislative solutions: Most governments seem to rely on anti-avoidance statutes which are passed by their legislatures. Such legislations can be broken down into four categories and their distinction is very important:

a. SAAR – Specific anti-avoidance rules targeted at specific tax avoidance arrangements.

b. TAAR – Targeted anti-avoidance rules such as provisions of newly enacted section 94A of the Income Tax Act, 1961.



c. GAAR – General anti-avoidance rules which are as the name suggests a catch-call system for tax avoidance.

d. Bilateral measures are also pursued through the Treaties or Double Taxation Agreements (DTAA’s):

i. Specific anti-abuse rules found in tax treaties - This can be achieved via various clauses inserted in them. Examples of this include the “Beneficial Ownership” and “Limitation on Benefit” clauses one finds in many Treaties as also the use of Article pertaining to “Associated Enterprise”. The Treaties may also have specific anti-treaty shopping rules.

ii. Inclusion of general anti-abuse rules in tax treaties (dealt with in later part of this paper).

iii. Articles pertaining to Exchange of Information in Treaties are also used to counter tax avoidance.

b) Judicial solutions: The Courts across the world have been instrumental in evolving and developing various judicial doctrines to curb tax avoidance. These include the business purpose, substance over form, economic substance, step transaction, abuse of law and fraus legis approaches. These may alternatively be known as ‘Court-based GAAR i.e. CAAR’ or ‘Judicial anti-avoidance rules (JAAR)’.

c) Administrative solutions: Administrative measures are mainly to ensure compliance and/or to detect tax avoidance. They are usually carried out in the following ways:

a. By use of investigative powers when a GAAR exists

b. By use of taxpayer alerts & rulings – these typically discuss how an administration intends to apply statutory GAAR

c. By appointing GAAR panels to decide GAAR issues

There is considerable variation in the form that general anti-avoidance rules take in different countries. Nevertheless, the various forms have roughly the same effect, at least in theory. General anti-avoidance rules allow tax authorities to disregard schemes that would otherwise reduce tax liability. The transactions to which they apply are void for tax purposes. A transaction being void, the tax lies where it falls, though modern general anti-avoidance rules often allow the authorities to reconstruct a transaction to reflect the economic reality of the circumstances and to tax the taxpayer on the basis of the reconstructed transaction. For Example: Re-characterizing particular stream of payment such as excessive interest or dividend?

An example of a typical general anti-avoidance rule is section 99 of New Zealand’s Income Tax Act 1976 (New Zealand’s current rule is not so readily quotable because it is disaggregated into several elements, but it has roughly the same meaning and effect). Section 99 relevantly read:

“Every arrangement made or entered into, whether before or after the commencement of this Act, shall be absolutely void as against the



Commissioner for income tax purposes if and to the extent that, directly or indirectly,—

(a) Its purpose or effect is tax avoidance; or

(b) Where it has 2 or more purposes or effects, one of its purposes or effects (not being a merely incidental purpose or effect) is tax avoidance, whether or not any other or others of its purposes or effects relate to, or are referable to, ordinary business or family dealings,—

whether or not any person affected by that arrangement is a party thereto.”

Despite the great difference between the legal systems and cultures of the two countries, the corresponding German rule is too very similar effect:

“(1) The tax Act may not be circumvented by an abuse of possible legal arrangements. If there is such an abuse, the taxpayer shall be taxed as if he had chosen an adequate legal arrangement.

(2) Subsection 1 is applicable if its applicability is not excluded expressly by the law.”

Countries that have anti-avoidance rules broadly similar in form to New Zealand’s and Germany’s include Canada, South Africa, Hong Kong, and France. The rule in Australia was formerly similar, but since 1981 has been framed in much more detail. The United States and the United Kingdom do not have statutory general anti-avoidance rules, but they both have judicially developed anti-avoidance rules that can sometimes have roughly the same effect. The United Kingdom common law anti-avoidance doctrine was first propounded by the House of Lords in the case of W T Ramsay Ltd v IRC. The United States approach was established by the Supreme Court in the case of Gregory v Helvering. At the risk of gross over-simplification, both approaches essentially allow the court to look at a series of transactions and to determine whether the transactions have any economic purpose other than the avoidance of tax. In both countries i.e. UK and USA, there have been suggestions that the common law anti-avoidance doctrines are insufficient to combat tax avoidance and should be replaced by statutory general anti-avoidance rules. Civil law countries tend to rely on the “abuse of rights” concept, which forbids the use of rights for improper purposes. The different forms that general anti-avoidance rules take do not affect the associated rule of law issues; problems and justifications that concern general anti-avoidance rules are equally relevant to all of them.

Although it is generally accepted that general anti-avoidance rules apply to tax avoidance and not to tax mitigation, drawing the line between the two is often problematic. A literal application of general anti-avoidance rules would catch many legitimate transactions. General anti-avoidance rules therefore should mean something more than their bare words.

Probably, there are two meanings of avoidance: first, the ordinary meaning, and secondly the meaning of the word in most statutory general anti-avoidance rules. The second meaning may be a subset of the first. That is, there are perhaps some transactions that people might call avoidance but that are not “avoidance” in



the statutory sense. Statutory general anti-avoidance rules do not simply codify ordinary language.

It is important to emphasize that tax avoidance does not necessarily imply that entities are engaging in anything improper. There are numerous provisions in the tax laws that allow and/or encourage firms to reduce their taxes. In addition, in practice there are many areas in which the law is unclear, particularly for complex transactions, and person may take positions on their returns in which the ultimate tax outcome is uncertain. Our paper is descriptive in nature as we examine the properties of this new measure of anti avoidance i.e. provision relating to General Anti-Avoidance Rule.

2. GAAR in Various Jurisdictions

Rationale behind introducing Statute-based GAAR in a jurisdiction: It is easy to understand the need for SAARs as well as TAARs and their source of

evolution – typically by judicial rulings or as a reaction to a commonly used avoidance technique in the marketplace. However what is the rationale for having Statute-based GAAR provisions?

Justice Murphy said it best in FCT vs Hancock (Australian High Court):

“The resource of ingenious minds to avoid revenue laws has always proved inexhaustible and for that reason it is neither possible nor safe to say in advance what must be found….”

The advantages of GAAR are that given tax avoidance schemes are becoming increasingly complex and tough to anticipate via SAARs and TAARs, Governments across the world want to stop losing what they perceive as billions of dollars of revenue and so enacting GAAR provisions would act as a ‘catch-all’ scheme for tax avoidance in general.

On the downside, the real problem with GAAR is that it can end up promoting uncertainty. It is a good time to recollect what Adam Smith said about taxes – that certainty is valued more than fairness and simplicity. The GAAR may also be construed as contrary to the “Rule of Law” principle i.e. laws are meant to be reasonably certain or predictable.

In fact, the Canadian GAAR when introduced was challenged as unconstitutional on these grounds but the Canadian Supreme Court in the Canada Trustco Mortgage case held that broad, purposive interpretation of GAAR is appropriate.

A GAAR is basically an attempt to strike down avoidance that is not understood at the time of drafting. The difficulty with having such a broad scheme has been heavily debated in various countries as and when they grappled with the thought of introducing GAAR. For example the Taxation Review Committee, 1975, Australia debated:

“In framing legislation sufficiently all-embracing to deter tax avoidance, there is always the danger of penalizing those who have a genuine reason for entering into a bona fide transaction, which, if carried out by others, has the objective



that ought to be prevented. There is frequently such a very fine line to be drawn between the transaction which offends and the one which merits no condemnation”

It must be noted that developed countries like USA, UK don’t have statutory GAAR; rather judicial doctrines combined with SAAR’s (prospective & retrospective) and other administrative measures seem to be the right mix for them.

A really interesting question is whether GAAR really does slow tax avoidance; in fact, can there be an opposite effect? Waincymer’s research lead to his commentary on how when Barwick High Court (Australia) strictly interpreted GAAR, it lead to an increase in the level of tax avoidance in Australia! He states:

“One intuitive lesson to learn from the Australian experience is that when tax avoidance became virtually sanctioned by the High Court in the 1970’s, supermarket style off-the-shelf tax avoidance packages reached epidemic proportions. Having the Chief Justice of the High Court propound taxpayer rights would surely be a powerful rationalizing factor for taxpayers and advisers”

In a similar vein, noted Canadian tax expert Arnold considers the Canadian experience to demonstrate GAAR will only slow avoidance when interpreted purposively and when narrowly interpreted it may actually lead to more tax avoidance. He points out that when the Canadian Supreme Court in one of its rulings endorsed a purposive approach of the provisions, Revenue Canada responded by interpreting provisions literally. Further Revenue Canada announced it would issue advance tax rulings and issued a Declaration of Taxpayer Rights which provided that taxpayers “have a right to arrange affairs in order to pay the minimum tax required by law”. According to Arnold, response of taxpayers and their advisers to the approach of Revenue Canada was to engage in aggressive tax planning which ultimately lead to shortfalls in collections of taxes.

Internationally, it can be generally observed that every introduction of a new provision or an amendment is extensively explained through technical explanations by legislators and even before such provision is enacted or such amendment is brought about, a full and fair debate is allowed in the public domain.

Contrary to that, in India whenever a new provision/amendment in an existing provision is introduced in a Finance Act, an explanation is given by way of Memorandum to Finance Bill which apparently is to be regarded as the legislative intent/purpose of introducing the provision. But regrettably, the legislative intent is not put to public debate, let alone debate in the parliament wherein the Finance Bills are passed without the participation of opposition members who stage a walk-out! Further, it is noteworthy that there are various examples in the context of Indian Income Tax legislations where provisions are introduced in law and are left at the discretion of the tax payers to interpret the law. Another way of clarifying the intent of a provision/amendment in India is by way of Circulars of CBDT in India which apparently can be withdrawn at any time by CBDT citing frivolous reasons thus penalizing the honest taxpayers who may be diligently abiding by such circulars. A serious deficiency in conveying the legislative intent to taxpayers could be corrected by issuing Circulars proactively to clarify various aspects of the taxation of non-residents, the absence of which in today’s times leads to unnecessary litigation and complications. It should not



so happen that after the introduction of GAAR, that cross-border transactions whose tax implications are ambiguous would targetedly be governed by GAAR.

Would GAAR and tax payer’s right go hand in hand? If so, is our Indian concept of GAAR incomplete?

Before coming to the discussion about the position of law in India as well as the intended legislative GAAR in proposed DTC, the participants may like to have a background about how GAAR (Statute-based and Court-based) are prevalent in various overseas jurisdictions. The same have been given jurisdiction-wise in ‘Appendix #1’.

3. Indian Scenario

A. Position of law in India currently (Court-based GAAR) Apart from a few specific anti-abuse rules in Income Tax Act, 1961, the

development of anti-abuse or anti-avoidance principles in India in general has been by way of judge-made law. In India, Courts have drawn a thin line of distinction between “tax evasion” and “tax avoidance”.

In CIT vs A Raman and Co. ([1968] 67 ITR 11), the Supreme Court followed the dictum of Duke of Westminster’s (1936 AC 1) case. The Supreme Court held that avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed, is not prohibited. It was pointed out in the case that the tax payer may resort to a device to divert the income before it accrues or arises to him. Efficacy of the device was held not to depend upon consideration of morality, but on the operation of Income-tax Act. Thus, the judicial view in India was that it is open to a person to avoid payment of tax by disposing of his property in any way not forbidden by law and the question of assessee’s motives was wholly irrelevant.

The difficulty in following the above principal started when the Supreme Court pronounced its majority judgement in the case of McDowell & Co. Ltd vs Commercial Tax Officer ([1985] 154 ITR 148). The court clearly departed from the above views and expressly disassociated itself with the earlier observations of the Supreme Court echoing the sentiments of Westminster principle. The court enumerated the evil consequences of tax avoidance as follows:

1. Substantial loss of much needed public revenue.

2. Serious disturbance caused to the economy of the country by the piling up of mountains of black money, directly causing inflation.

3. Large hidden loss to the community by some of the best brains of the country involved in perpetual litigation.

4. Sense of injustice and inequality which tax avoidance arouses in the minds of those who are unwilling or unable to profit by it.

5. The unethical practice of transferring the burden of tax liability to the shoulders of the guileless, good citizens from those of the ‘artful dodgers’.

The court felt that there was as much moral sanction behind taxation laws as behind any other welfare legislation and it was a pretence to say that avoidance



of taxation was not unethical and that it stood on no less a moral plane than honest payment of taxation.

In the view of the court, the proper way to construe a taxing statute while considering a device to avoid tax was not to ask whether the provisions should be construed literally or liberally, nor whether the transaction was not unreal and not prohibited by the statute, but whether the transaction was as device to avoid tax and whether the transaction was such that the judicial process might record its approval to it. The court felt that it was neither fair nor desirable to expect the legislature to intervene and take care of every device to avoid taxation. It was up to the court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of emerging techniques of interpretation as was done in Ramsey’s case (1982 AC 300) to expose the devices for what they are really worth and to refuse to give judicial benediction. The Supreme Court further emphasized that tax planning may be legitimate provided it is within the framework of law and colourable devices cannot be part of tax planning. It is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. The Supreme Court also recommended that it is the obligation of every citizen to pay the taxes honestly without resorting to subterfuge.

The Income Tax Department started applying this case even in genuine transactions and in disallowing even genuine claims in tax assessments.

The principle laid down in the above case of McDowell has been considered in the subsequent two cases of CWT vs Arvind Narottam (173 ITR 479) and Union Bank of India vs Playworld Electronics Pvt Ltd (184 ITR 308) by the Supreme Court. In the first case, it is held that the language of the deeds of settlement, being plain and free from ambiguity, it was not open to the court to ignore the same and look at the “game of hidden purpose” behind the trust deeds which were in fact for the sole and exclusive benefits of the assessee. It was also observed in both the above cases that, though tax avoidance should not be encouraged on practical ideological grounds in the developing economy, no amount of moral sermons would change the people’s attitude unless public revenues were properly harnessed and utilized so as to avoid waste and ostentation in public expenditure.

Subsequently, Supreme Court delivered a landmark judgment in the case of Union of India vs Azadi Bachao Andolan ([2003] 263 ITR 706) diluting the principle as understood from McDowell’s case. In this case, the Supreme Court has clarified that what has been decided in McDowell’s case is tax planning for avoidance of tax which has doubtful or questionable character as to its bona fides and righteousness. Not all legitimate acts of a tax payer which, in the ordinary course of conducting his affairs a person does and under law he is entitled to do, can be branded as of questionable character. The Supreme Court has also clarified that the decision in McDowell’s case does not mean that any act of an assessee which results in reduction of his tax liability or in expectation of tax benefit in future, amounts to colourable device, a dubious method or a subterfuge



to avoid tax and can be ignored if the acts are unambiguous and bona fide. It was further observed that while the planning adopted as a device to avoid tax has to be deprecated, the principle cannot be read as laying down the law that a person should arrange his affairs so as to attract maximum tax liability, and every act which results in tax reduction, exemption of tax or not attracting tax authorized by law is to be treated as a device of tax avoidance.

Supreme Court in the case of Walfort Share and Stock Brokers Pvt Ltd. ([2010] 326 ITR 1) after referring to the case of McDowell and Azadi Bachao Andolan, held that a citizen is free to carry on his business within the four corners of the law; that, mere tax planning, without any motive to evade taxes through colourable devices is not frowned upon even by its judgment in McDowell’s case.

The Bombay HC in the case of Vodafone International Holdings B.V. vs. Union of India ([2010]329 ITR 126) reiterated the principles laid down in Azadi Bachao Andolan’s case. It stated that the following principles were firmly embedded in our jurisprudence:

(i) A transaction or arrangement which is permissible under law which has the effect of reducing the tax burden of an assessee does not incur the wrath of the law;

(ii) Citizens and business entities are entitled to structure or plan their affairs with circumspection and within the framework of law with a view to reduce the incidence of tax;

(iii) A transaction which is sham or which is a colourable device cannot be countenanced. A transaction which is sham or a colourable device is one in which the parties while ostensibly seeking to clothe the transaction with a legal form, actually engage in a different transaction altogether. A transaction which serves no business purpose other than the avoidance of tax is not a legitimate business transaction and in the application of fiscal legislation can be disregarded. Such transactions involve only a pretense and a facade to avoid compliance with tax obligations;

(iv) Absent a case of a transaction which is sham or a colourable device, an assessee is entitled to structure business through the instrument of genuine legal frameworks. An act which is otherwise valid in law cannot be disregarded merely on the basis of some underlying motive resulting in some economic detriment or prejudice. In interpreting a fiscal statute it is not the economic result sought to be obtained by making the provision which is of relevance and the duty of the Court is to follow the plain and unambiguous language of the statute.

Further, the Bombay HC also explained the doctrine of form and substance as existing in India in the context of tax planning in its judgment. It explained that there is recognition in our law of the principle that lawful forms of activity can legitimately be arranged by those who transact business to plan for tax implications. So long as the legal structures that are put into place and the instruments of law that are utilized have been utilized bona fide for a business purpose, fiscal law (absent statutory provisions to the contrary) does not



permit an enquiry into the motives of the assessee or an investigation into the underlying economic interest. But a transaction which is sham or, what the law describes as a colorable device, stands on an entirely different foundation. A transaction which is sham is one in which though parties employ a legal form, it is in reality a different transaction; one which in reality does not give rise to the legal rights and obligations which arise from its ostensible nature. A sham is ostensible but not real and borders on a fraudulent employment of legal form or structure in aid of collateral ends. Absent a case of a transaction which is sham, fraudulent or colorable, the law respects instruments and structures adopted by business entities within the framework of law in the pursuit of legitimate forms of business activity. The legal character of the transaction will not be disregarded in pursuit of substance. So long as parties have not chosen to conceal the nature of their legal relationship by a device which suggests to the contrary or something at divergence with the legal character assumed by them, the law respects their autonomy.

It further pointed out that the principle of law in India is that in interpreting fiscal legislation, the Court is guided by the plain language and the words used. The Court would not ignore a legal relationship which arises out of a business transaction in search of substance over form or in pursuit of the underlying economic interest.

It is interesting to take note of a petition filed by Vodafone Essar Gujarat Limited before the Gujarat HC (Company Petition No. 183 of 2009). The petition was filed for to obtain the sanction of the Court to a Scheme of Arrangement under Sections 391 to 394 of Companies Act, 1956, whereby its Passive Infrastructure Assets together with the Passive Infrastructure Assets of other group companies were to be demerged and transferred to Vodafone Essar Infrastructure Ltd free of liabilities and encumbrances and without any consideration. Post de-merger, the transferee was to be made a substantially owned company of a new company to be formed by all or some of the shareholders of the transferee. Thereafter, the transferee was to be amalgamated/ merged into Indus Towers Ltd. The Court held that the scheme appeared to be a camouflage to circumvent the mandatory provisions of the Income-tax Act since the transaction was a “conduit” to avoid capital gains because had it been entered into directly with Indus Towers, exemption u/ss 2(19AA) & 47(iii) would not be available and tax of about ` 3500 crores would be payable. The Gujarat HC came to the conclusion that the avoidance of tax was taking place only if the present scheme is sanctioned by the Court, otherwise not. The transferee was nothing but a paper company being only intermediate for transferring Passive Infrastructure assets from transferor companies to Indus for the purpose of tax evasion and thus did not grant sanction to the scheme. [It is to be noted that Vodafone Essar Gujarat Limited has filed an appeal against the order of the Gujarat High Court and the same is pending before the Division Bench.]

Whereas, with respect to petition filed by Vodafone Essar group companies before the Delhi High Court (Company Petition No. 334/2009), Delhi High Court granted approval to the scheme stating that the arrangement was in line



with Government’s policy of sharing of infrastructure. It further stated that simply because tax payable under the business structure adopted by the assessee was reduced, it did not make such adoption illegal or impermissible on the ground that it was against public interest. It finally commented that income tax authorities are free to move against any of the parties concerned, in case they are of the belief that there has been any impermissible evasion of payment of tax by the petitioners and that no action which may be a violative of a statute was being legitimized by approval of the Scheme.

In another interesting case, a writ petition was filed before the Karnataka High Court by a Cypriot Company (M/s Richter Holding Ltd) (Writ petition 7716/2011) challenging the show cause notice issued to it by the income tax authorities pertaining to the transaction of purchase of shares of a UK company from another UK company allegedly denoting transfer of 51% shares in Sesa Goa Ltd, India. Karnataka High Court stated that it may be necessary for the corporate veil to be lifted and examine the real nature of the transactions to ascertain the vital facts since lack of information provided by the taxpayer would make it difficult to ascertain the nature of transaction and as a consequence, it was premature to arrive at a conclusion that there was no tax avoidance and that the taxpayer was not liable to tax on capital gains in India.

Recently, in the case of Cosmo Films Limited (ITA 1404/2008), the Delhi High Court reiterated the position of law laid down in the case of Azadi Bachao Andolan that merely because an assessee gets a commercial advantage because of the factoring in of a tax benefit, it cannot be said that the transaction is not genuine. It also held that observations made in the case of McDowell is not good law in view of the case of Azadi Bachao Andolan where it was held that “tax planning may be legitimate provided it is within the framework of law”.

In a very recent consolidated judgement of Bombay High Court in the case of Aditya Birla Nuvo Limited (Writ Petition 730 of 2009, 345 of 2010), New Cingular Wireless Services Inc (NCWS) (Writ Petition 1837 of 2009) and Tata Industries (Writ Petition 38 of 2010), the court dismissed certain Writ Petitions filed by the petitioners wherein the transactions were held to be of a colourable nature.

In the Writ Petition filed by Aditya Birla Nuvo, the transaction pertained to sale of shares of Idea Cellular Ltd (Joint Venture company) by AT&T Mauritius to Aditya Birla Nuvo. As per the Joint Venture Agreement to establish Idea Cellular in India, its shares were allotted to AT&T Mauritius, being 100% subsidiary & “permitted transferee” of NCWS. Though the shares were allotted to AT&T Mauritius, all rights of voting, management, right to sell etc. were vested in NCWS. As per the Joint Venture Agreement, the liability to pay for the equity shares (which would be subsequently allotted in the name of AT&T Mauritius) was on NCWS. NCWS paid the amount towards equity shares through AT&T Mauritius by advancing a loan to AT&T Mauritius who in turn paid the amount for equity shares. On the sale of equity shares of Idea Cellular Ltd, the consideration received by AT&T Mauritius of USD 150 million was remitted to NCWS on the same day in the form of dividend and repayment of loan. While



denying the benefit of India-Mauritius DTAA, Bombay High Court held that form of payment for equity shares by NCWS through AT&T Mauritius was a “device” and that it was open to the assessing officer to discard the device and take into consideration the real transaction between the parties.

In the Writ Petition filed by Tata Industries Limited, instead of purchasing balance 50% shareholding of AT&T Mauritius in Idea Cellular Ltd, Tata Industries Ltd purchased 100% shareholding of AT&T Mauritius for the same consideration of USD 150 million which it had agreed to pay for purchase the shares of Idea Cellular Ltd from NCWS. It acceded to the viewpoint of the Revenue as to whether Tata Industries Ltd had paid USD 150 million for the shares of Ideal Cellular Ltd or for the shares of AT&T Mauritius which had no other assets other than Idea Cellular Shares. It also agreed to the prima facie opinion of the Revenue that the transaction between Tata Industries Ltd and NCWS for sale and purchase of shares of AT&T Mauritius was a “colourable transaction” and since in fact it was a transaction for the sale and purchase of shares of Idea Cellular Ltd.

To summarize the legal position as of today, it could be concluded that form over substance still prevails in India wherein the legal character of the transaction should not be disregarded in pursuit of substance unless tax is sought to be avoided by adopting colourable devices wherein lifting of corporate veil would nonetheless be permitted by authorities in such circumstances.

B. Intended legislative GAAR in Proposed DTC in India Given the concerns raised by the Revenue relating to the aggressive tax planning

by tax payers and it’s the slow pace of progress in amending certain Double Tax Avoidance Agreements, the Direct Taxes Code Bill, 2010 (‘DTC’) has proposed to introduce anti-avoidance measures in the domestic tax laws itself by according wide powers to the Revenue to invoke GAAR.

The proposed GAAR provisions do not envisage that every arrangement for tax mitigation would be liable to be classified as an impermissible avoidance arrangement. It is only in a case where the arrangement, besides obtaining a tax benefit for the assessee, is also covered by one of the four conditions i.e. it is not at arms length or it represents misuse or abuse of the provisions of the Code or it lacks commercial substance or it is entered or carried on in a manner not normally employed for bona fide business purposes, the GAAR provisions would come into effect. The various terms such as ‘impermissible avoidance arrangement’, ‘tax benefit’, ‘lacks commercial substance’, ‘bona fide business purposes’ , etc have been comprehensively defined in DTC.

Under DTC, the power to invoke GAAR is bestowed upon the Commissioner of Income-tax. For this purpose the Code empowers him to call for such information as may be necessary. 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 as if the arrangement had not been entered into and issue



necessary directions to the Assessing Officer for making appropriate adjustments. The directions issued by him will be binding on the Assessing Officer.

The Commissioner will take appropriate steps and comply with other procedural requirements of Sec. 154 of DTC.

In the proposed DTC, GAAR could be classified into three parts:

• Basic provisions — As given in Sec. 123 and Sec. 125.

• Definitions pertaining to GAAR — As given in various subsections of Sec. 124.

• Fundamental procedural provision – As given in Sec. 154 and Sec. 155.

C. Analytical insight of the various provisions of GAAR in proposed DTC: Drawing inference from the international experience towards GAAR, I have

attempted to demystify the provisions of GAAR in proposed DTC.

GAAR provisions may be invoked once a transaction is declared as ‘impermissible avoidance arrangement’. It therefore becomes imperative for the participants to thoroughly review the various definitions contained in various sub-sections of Sec. 124, the satisfaction of conditions of which could ultimately lead the Commissioner to declare a transaction as an ‘impermissible avoidance arrangement’.

• Concept of “Impermissible avoidance arrangement” The term ‘impermissible avoidance arrangement’ has been defined in Sec 124(15)

of DTC. The scope of this term extends to transactions which are entered into between parties resulting into any tax benefit and specifically meets any of the conditions laid down resulting into either abuse of law or commercial nature of the transaction. Remarkably, the definition of the term itself contains terminologies which have been defined in various other subsections of Sec 124.

For a transaction to be declared as an ‘impermissible avoidance arrangement’, it should essentially satisfy two conditions viz.:

(a) The main purpose of an arrangement, whether looked in part or whole or in any step of such arrangement therein, is entered to obtain tax benefit;

For the purpose of analysis and understanding of the overall definition of the term ‘impermissible avoidance arrangement’, which in turn contains various defined and undefined terms, I have tried to examine each and every aspect involved in the given definition separately. In the following paragraphs, various terms used therein, their basis of origination and issues relating to their interpretation are discussed.

First of all, it is noteworthy that the definition of the term emphasizes on a phrase “main purpose” which itself is undefined under the provisions of the DTC which can lead to ambiguity. However, for the purpose of my research and understanding of this term and to arrive at reasonable interpretation, I refer to the South African discussion paper on tax avoidance released in November 2005 which explains the word “main” in similar context as “generally construed to mean predominant”. It further goes to explain by way of an example that if



a transaction has both, a tax and a commercial purpose, then the test of main purpose would be satisfied only if the tax purpose is the predominant one. In light of above discussion, it is to be appreciated that the ‘main purpose’ test is a subjective and factual test which may differ from case to case. Further, Para 36 of approved Revised Commentary on Article 1 of the UN Model Double Tax Convention to be included in the next version of UN Model Double Tax Convention, albeit in the context of inclusion of general anti-abuse rules in a tax treaty, expresses the apprehension that the words “the main purpose” would impose an unrealistically high threshold that would require tax administrations to establish that obtaining tax benefits is objectively more important than the combination of all other alleged purposes, which would risk rendering the provision ineffective.

Let us consider:

A Pvt. Limited (‘APL’) is an Indian company engaged in manufacturing of inorganic chemicals having mainly industrial use. The gross annual turnover of the company is around US$ 50 million. Out of the total turnover, around US$ 30 million comprises of export sales. Over the years, APL has been able to penetrate European markets with the help of Mr. Jack working as an independent marketing agent for the European segment of the market. Mr. Jack is responsible for administering and monitoring operations in Europe, communicating with local dealers and representing APL before customers.

Considering a high volume market, APL intends to setup a central place of operation in European continent to serve as a storage facility to facilitate logistics of chemicals and thereby reduce delivery time. This will increase the sales from existing markets by 20% and will also result into new markets contributing around US$ 5 million to the gross turnover of the group. The growth rate is understood to be stable for next 5-7 years. For this purpose, APL is recommended by its international tax consultants to setup a branch in Poland. For recommending Poland, the factors considered by consultants are a) Poland is centrally located jurisdiction connecting major markets of APL perspective, b) It has favourable VAT regime for inorganic chemical products (assumed), c) Cheaper location from administrative point of view, d) Mr. Jack is resident of Poland and is handling major international operations for APL, e) Poland has corporate tax rate of 19% and f) India has a favourable DTAA with Poland where under branch profits of Indian company are not subject to further taxes in India when repatriated back because of the exemption method of elimination of double tax avoidance provided under Article 24.

Considering above advantages, APL decides to open a branch in Poland which will be responsible for selling and marketing its products in Europe, maintaining stocks (whenever necessary), invoicing and banking, developing new markets etc. Further, Mr. Jack will be appointed as Branch Manager in Poland.

Whether the objective of setting up of a branch in Poland would qualify the phrase “main purpose” with respect to the tax benefit obtained?



The term “arrangement” is defined in Section 124(3) of the DTC. The given definition is wide enough to cover any type of transaction, operation, scheme, agreement or understanding, irrespective of whether they are enforceable or not and also extends to include all steps therein or parts thereof.

Interestingly, the terminology used in the statute emphatically states that even though the main purpose of the ‘arrangement’ may not be to obtain tax benefit, but, if a ‘step therein’ has been executed to obtain tax benefit, even then the whole arrangement could be declared as an impermissible avoidance arrangement. This ideology follows from the South African experience wherein the South African Revenue Service while formally introducing legislative GAAR in South Africa, clarified that even though the purpose of a step in or part of an avoidance arrangement may be different from the purpose attributable to the avoidance arrangement as a whole, GAAR may be applied to such arrangement, in order to overcome a previous court ruling.

All the aforesaid terminologies have to be read in conjunction with the term “tax benefit” which has been defined in a wide manner to cover principally:

(i) a reduction, avoidance or deferral of tax or other amount payable under the provisions of the DTC or which would have otherwise been payable under DTC but for a tax treaty;

(ii) an increase in a refund of tax or other amount under the provisions of the DTC or as a result of a tax treaty in the relevant or any other financial year.

Following chart explains the scope of the term and correlates them with various situations covered by the scope of the term ‘tax benefit’;

Definition of the term ‘tax benefit’ includes even the benefit arising in accordance with the provisions of double tax avoidance agreement entered into by India. The benefit under the tax treaty may be either in the form or reduction of the rate of tax, elimination of tax by transferring right of tax to other nation, etc.



Let us consider:

PQR limited is a company incorporated in India engaged in providing management consultancy services to clients in India as well as abroad. Whenever PQR Ltd earns a contract to render management consultancy services to any entity outside India, it usually outsources the work to foreign consultants which reduces its costs with respect to international assignments. During Financial year 2012-13, PQR Ltd earned a contract to render management consultancy services to a Brazilian entity for a value equivalent to INR 100 million. As per estimates of PQR Ltd, the consultancy service would go on for a period of four months during financial year 2012-13. From the income of INR 100 million, WHT in Brazil as per DTAA was 15 million, but due to tax sparing clause in India-Brazil DTAA, PQR Ltd is entitled to a deemed credit of 25%.

The calculation of foreign tax credit in India would be as follows:

Particulars INR in million

Income earned in Brazil 100

Less: Expenses on payment to foreign consultant (30)

Net foreign income taxable in India 70

Tax @ 30% as per DTC 21

FTC entitlement of INR 25 million thus restricted to INR 21 million under DTC

It similarly earned INR 100 million from Indian contracts during FY 2012-13. TDS @ 10% under DTC has been deducted on Fees for Professional Services. An expenditure of INR 80 million has been incurred on earning the income from Indian contracts.

The following are the details of the computation of total income of PQR Ltd for FY 2012-13:

Particulars INR in million

Total Income taxable in India (100+100) 200

Less: Expenses (30+80) (110)

Total income earned from Ordinary Sources 90

Tax @ 30% as per DTC 27

Less: FTC & TDS (21+10) (31)

Tax payable by/(Refund to) PQR Ltd (4)

As per Sec 207 of DTC, there is no bar on availing FTC upto INR 21 million in this case since it does not exceed the Indian tax-payable in respect to foreign income as well as it does not exceed the Indian income tax payable on total income.

If the deeming tax credit provision would not have been available under the India-Brazil DTAA, then the total tax credit consisting of FTC+TDS would have been 15+10=25 and resultantly, there would have been a tax payable of INR 2



million. Because of the benefit provided in the DTAA, instead a refund of INR 4 million is arising to PQR Ltd.

Can the aforesaid benefit provided under a tax treaty qualify to be a ‘tax benefit’ under GAAR?

Another fundamental question which arises is when one can trigger the GAAR provisions, at the time when actual tax benefit arises or when tax benefit accrues to the parties or even at the stage much earlier then it is accrued or arisen i.e. at the planning stage. Ironically an “impermissible avoidance arrangement” has been defined to mean a step in (or a part or whole of) an arrangement, whose main purpose is to obtain a tax benefit and if it lacks commercial substance or bona fide purpose.

The definition suggests that existence of a tax benefit is a prerequisite to attract GAAR provisions. The definition of tax benefit is wide enough to even include any deferral of tax. Deferral of tax, as understood internationally, means postponement of the payment of tax liability. At many instances, a transaction or arrangement may not result into an immediate tax benefit or even a deferral of an immediate tax benefit. These instances are well understood in scenario where overseas inbound or outbound investment structures are planned and created methodically, resulting into no tax benefit at the planning stage. The best example for the same can be setting up of an international business holding company with the purpose of holding investments in various operating companies. However, in such cases, tax benefits may arise at a later stage when operating companies start generating profits and surplus funds are repatriated either way of dividends or interests as the case may be.

Now, once the condition of obtaining tax benefit is met, one has to look at the specific conditions laid down hereunder to deem a particular transaction/arrangement as an impermissible avoidance arrangement. If a particular transaction is determined to be covered under the scope of either or one or more of these conditions then the transaction shall be declared as impermissible if it also results into tax benefit. Here, it is important to note that these criteria of falling under either of these conditions is required to be met along with the basic criteria of obtaining tax benefit.

Each of these conditions along with appropriate situations covered under each of such condition and various issues arising out of each of them is discussed in the following paragraphs.

(b) To establish a arrangement as an impermissible avoidance arrangement, tax benefit is to be looked at in conjunction with any of the given four conditions:



• Under the first criteria, if any unreasonable right(s) or obligation(s) are created between the parties to the arrangement which normally would have not been created between two persons dealing at arm’s length then such arrangement shall be deemed to be impermissible. The criteria laid down in this condition aims to test the motive of the parties getting into an arrangement. However, the word arm’s length is too subjective. Inferences can be taken from the existing transfer pricing regulations where still globally there is no consensus as to what is arm’s length. Perhaps, an interesting comparison can be made on the scope of the term ‘arm’s length’ when used in the context of transfer pricing provisions (which are SAAR) whereas in the context of GAAR. Under the transfer pricing, arm’s length principle is applicable where arrangement is between two associated enterprises, whereas in light of the present definition even the arrangement between parties (unassociated), dealing in normal commercial terms, may be construed to be not at arm’s length. The effect of clause (a) of Sec 124(15) can be understood from the following example:

Mee Ltd. (‘ML’) a Cypriot limited liability company has a subsidiary in India i.e. Mee Pvt. Ltd.(‘MPL’). ML had setup MPL with a minimum capital contribution of ` 100,000. For additional funding, ML has given unsecured loan of `50 million at the interest rate of 10%p.a to MPL.

We assume that the return on investment of MPL is around 15%. Accordingly, the income (before interest and tax) of MPL will be around ` 7.5 Mn. As a result of debt funding by ML to MPL to the tune of ` 50 Mn., MPL will claim be able to claim deduction of interest amounting to ` 5 Mn, thereby reducing taxable income in India to ` 2.5Mn.

In the above example, presuming that there is no thin capitalisation regulation in India, ML funded MPL merely to avail the benefit of interest deduction thereby lowering the tax liability in India. In such a scenario, the transaction of funding by debt would be treated as impermissible avoidance arrangement as no third



party would have lent ` 50 Mn. to a company having share capital of ` 0.1 Mn.

Ironically, Indian transfer pricing laws are still evolving and revenue authorities acknowledge the fact that there is far more scope of development of the law in the country. In fact, there is plethora of disputes between the tax payers and revenue authorities under the transfer pricing regime. Almost every day we come across a new judgment with new interpretation on the subject. In such a scenario, it can be foreseen that applicability of GAAR on the basis of arm’s length principle will merely give rise to more litigation.

• The second criteria emphasize the use of the provisions of the code to effectively reduce the tax liability. Section 124(15)(b) uses the term ‘misuse or abuse’ of the provisions of the DTC which covers under its scope any arrangement which results into misuse or abuse of the provisions of the code. In order to understand the difference between the word ‘misuse’ and ‘abuse’ reference can be had to Canada Ruling in case of OSFC Holdings wherein court stated that:

“…the misuse analysis looks to specific provisions in isolation from the broader scheme of the ITA, while the abuse analysis looks to the purpose, scheme or policy reflected in the provisions of the ITA as a whole…”

The phrase ‘misuse or abuse of the Code’ has not been defined in the GAAR. It is an irony that originally it was claimed that DTC would simplify the tax laws in India, but here is another instance wherein confusion has been increased in the name of simplification.

• In the third criteria, lack of commercial substance has been addressed. Section 124(15)(c) states that an arrangement, either in part or whole, shall be treated as an impermissible, if it lacks commercial substance. Further, the term “lacks commercial substance” has been defined in the section 124(19). A step in, or a part or whole of an arrangement shall be deemed to be lacking commercial substance if it falls under any of the following as discussed in following paragraphs;

• If it does not have a significant effect upon the business risks, or net cash flows, of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained but for the provisions of section 123 of DTC.

The first deeming situation given above uses the word ‘significant’. It is unclear as to what is the meaning of the word ‘significant’ as it is used in connection with effect on the business risk or net cash flow. The overall concept of the aforesaid provision is to cover within its scope the arrangements or transactions which are internationally known as sham transactions and is essentially an articulation of the “economic substance doctrine”.

• If the legal substance, or effect, of the arrangement as a whole is inconsistent with, or differs significantly from, the legal form of its individual steps.

This condition is essentially an articulation of the internationally known “substance over form doctrine”, where the legislative intent is to prevent



transactions entered merely to avail the tax benefit with no legal substance thereby resulting into abuse of provision of the law.

• If it includes, or involves any of the following:

i. round trip financing without regard to whether or not the round tripped amounts can be traced to funds transferred to, or received by, any party in connection with the arrangement; or the time, or sequence, in which round tripped amounts are transferred or received; or the means by, or manner in, which round tripped amounts are transferred or received;

ii. an accommodating or tax indifferent party (for example, use of conduit entity/person)

iii. any element that have the effect of offsetting or cancelling each other; or

iv. a transaction which is conducted through one or more persons and disguises the nature, location, source, ownership, or control of the fund; (for example, use of colourable devices or use of sham entities or hiding behind the corporate veil)

The term Round trip Financing is used since past few years in the context of Foreign Exchange Management Act, 1999, however it has been nowhere defined. It is a term which is coined by the professional fraternity to denote a particular type of an arrangement used for circulating one’s own funds in a way that it gets reinvested from where they originated. It is the first time that in DTC, Sec 124(21) defines the term “Round trip financing”. The definition is an inclusive definition which includes financing in which funds are transferred among the parties to the arrangement and the transfer of the funds would result, directly or indirectly, in a tax benefit but for the provisions of section 123 of the DTC or significantly reduce, offset or eliminate any business risk incurred by any party to the arrangement.

From the analysis of definition of the term ‘Round Trip Financing’ given under the DTC it is understood that the aim of the definition is to prevent transactions entered into between parties merely for the purpose of availing tax benefit. One can take a simple example to understand the basis of the round trip financing. X Ltd., an Indian company, invests US$ 10 Million in newly setup Singapore wholly owned subsidiary which in turn invests back in India either directly into X Ltd. or indirectly through investment in another Indian company which invests in X Ltd.

The term ‘accommodating party’ is also defined in the DTC. Sec 124(1) defines “Accommodating party” to mean a party to an arrangement who, as a direct or indirect result of his participation, derives any amount in connection with the arrangement, which shall —

(a) be included in his total income which would have otherwise been included in the total income of another party;



(b) not be included in his total income which would have otherwise been included in the total income of another party;

(c) be treated as a deductible expenditure, or allowable loss, by the party which would have otherwise constituted a non-deductible expenditure, or non allowable loss, in the hands of another party; or

(d) result in pre-payment by any other party;

The term ‘Accommodating Party’ can be understood by way of a simple example: X Pvt. Ltd. is an Indian company having surplus funds generated out of operations. X. Pvt. Ltd. enters into arrangement with Y Ltd. and A Ltd. where under, X Pvt. Ltd. will invest in the Y Ltd. by subscribing the shares of Y Ltd. Y Ltd will in-turn give loan to A Ltd., a Cypriot listed company. A Ltd. will re-lend this amount to X Pvt. Ltd.

On completion of the above transaction as per the pre-decided arrangement, X Pvt. Ltd. will be able get its own funds back into India and additionally will also be able to claim the interest payable on loan from A Ltd. as a deductible expenditure.

In the above example, A Ltd. may be treated as the ‘accommodating party’ wherein the income which would have accrued to X Ltd. is reduced by way of claiming interest paid/payable to A Ltd. as a deductible expenditure.

Let us consider

X Ltd. and Y Ltd. are two group companies. X Ltd. has significant losses and depreciation which are carried forward and available for set off in next 3 years. Y Ltd. is highly successful and high tax paying company.

X Ltd. decided to merge with self Y Ltd, so that its losses can be setoff against the profits of the merged entity. The said merger has full commercial justification. After merger X Ltd. changes its name to Y Ltd. with the permission of ROC. In commercial world, the tax payers call it as a ‘Reverse Merger’.

Whether GAAR in DTC will apply to the said Reverse Merger planned by the group.



• The fourth criteria relates to the test of “Bona fide Business Purpose”. The term “bona fide purpose” has been defined in the Sec. 124(10) to include the purpose which creates rights or obligations that would normally be created between persons dealing at arm’s length and would not result, directly or indirectly, in the misuse, or abuse, of the provisions of this DTC. Interestingly, one would wonder what could have been the purpose of re-iterating the two conditions laid down in the definition of the term “impermissible avoidance arrangement” identically once again in the definition of bona fide purpose.

• Consequences of an arrangement being declared as impermissible avoidance arrangement:

Various consequences could follow on an arrangement being determined as an ‘impermissible avoidance arrangement’ on the basis of various parameters discussed in aforementioned paragraphs. (The same can be read from bare provisions given in ‘Appendix # 2’ which are self-explanatory in nature).

It would be intriguing to imagine what issues could arise once an arrangement is determined as an ‘impermissible avoidance arrangement’.

Let us consider:

Paul Ltd. of U.K. (‘P Ltd.’) invested in Laurel B.V. (‘L B.V.’) of Netherlands. The L B.V. invested in a BVI wholly owned subsidiary which in turn invested in a Mauritius subsidiary (‘Paurel Ltd’). Paurel Ltd. invested in an Indian company. Paurel Ltd. claims ‘Nil’ capital gains tax under India-Mauritius DTAA as per Article 13. Revenue authorities in India disallow the treaty benefit u/s. 291 of the DTC. Further, it is to be noted that India also has tax treaties with Netherlands & U.K.

Can Paul Ltd. claim consequentially any of the treaty benefits under India-Netherland or India-UK DTAA once it is denied benefit under India-Mauritius DTAA?

• Procedures in applying GAAR:

DTC 2010 provides for the Commissioner to serve notice on the taxpayer to enable it to provide any evidence or particulars on which it may rely in support of its claim that GAAR does not apply. Thereafter, the Commissioner shall pass an order declaring whether the arrangement is an impermissible avoidance arrangement or not. It is not clear whether it would be mandatory for the Commissioner to state reasons as to why GAAR could be applicable to a particular arrangement, while issuing notice to a taxpayer.

Once the arrangement is declared to be an impermissible avoidance agreement, the Commissioner issues directions to the Assessing Officer (AO), the first level of the Tax Authority, for making appropriate adjustments. The AO is bound to follow these directions and issue a draft order to the taxpayer.

The taxpayer can, on receipt of the draft order from the AO, within a period of 30 days, file objections before the Dispute Resolution Panel (DRP), a collegium of three Commissioner-level tax officers, constituted by the CBDT. The DRP may call for and examine the record of any proceeding relating tothe draft order and make such further inquiry, as it thinks fit. Thereafter, the DRP, after giving an opportunity to both the



taxpayer as well as the AO, may confirm, reduce or enhance the variations proposed in the draft order. The direction of the DRP is binding on the AO. The taxpayer can appeal against this directly with the second appellate authority i.e. the Income Tax Appellate Tribunal.

Burden of proof: The burden of proof vests with the taxpayer to establish that the tax benefit was not the main purpose of the arrangement. Furthermore, an arrangement is presumed to have been entered into/carried out for the main purpose of obtaining tax benefit, if the main purpose of a step or part of the arrangement is to obtain a tax benefit, even if the main purpose of the whole arrangement may not be to obtain the tax benefit.

After going through the procedural provisions, I feel the need to comment here that the powers conferred on the Commissioner are alarming from a sense that it could result in an “abuse” of power. For instance, the Commissioner could re-characterise any “avoidance arrangement” or step therein/ thereof, to his own interpretation (thereby classifying such “avoidance arrangement” as impermissible in nature) even if such interpretation is not in accordance with the taxpayer’s interpretation or intention.

Such interpretation could lead to grave consequences for the taxpayer, should he not be able to satisfy the Commissioner during the applicable notice period, as a lengthy and costly court battle could ensue. In my opinion, such power on the side of the Commissioner could disturb the equilibrium between the power of the fiscus and the right of the taxpayer to conduct his business according to the principles laid down in the case of Azadi Bachao Andolan.

D. Critical Examination of procedural issues arising out of Intended legislative GAAR in Proposed DTC:

Various issues arise on close examination of DTC provisions relating to GAAR. The participants may discuss amongst themselves the following points:

1) What could be the implication of Sec 123(2) where it is provided that the provisions of GAAR may be applied in alternative for or in addition to any other basis for making an assessment?

2) At what point in time could GAAR be invoked:

• before assessment takes place? (For Example: If CIT has the information of a tax payer entering into impermissible avoidance arrangement)

• at the time of assessment? (For Example: If AO discovers an impermissible avoidance arrangement during the assessment and makes an internal reference to the CIT)

• after the completion of assessment? (Refer Sec. 154 of DTC)

3) What about applicability of GAAR to transactions entered into prior to 1st April, 2012? (Refer Sec 318)

4) Can re-opening of assessment be done on the premise of invoking GAAR provisions? (Refer Sec 159)

5) Is the order passed by CIT u/s 154 per se appealable independent of the order passed by the AO u/s 155? (Refer Sec 183)



6) Is DRP the only remedy against the order passed by AO u/s 155 on directions from the CIT? (Refer Sec 155, Sec 178, Twenty-First Schedule of DTC, Alternative remedy clarified by CBDT under current Transfer Pricing provisions)

7) Advance Ruling and GAAR:

• Can a non-resident obtain an advance ruling in respect of GAAR? (Refer Sec 258)

• If advance ruling itself is allowed to be admitted, can it be concluded that transaction is not an impermissible avoidance transaction? (Refer Sec 258, Sec 124(15))

• If advance ruling is pronounced in favour of applicant, can CIT invoke GAAR thereafter? (Sec 260)

8) If GAAR is invoked and consequent adjustments are made, could it be considered as under-reporting of tax bases? Can penalty be levied in such cases? (Refer Sec 230)

9) Would compensatory adjustments be allowed once adjustments are made to the income of a taxpayer? (Refer Article 9.2 of OECD model tax convention, Sec 92 of Income-tax Act, 1961)

E. Points to ponder:

• Should the onus/burden of proof before invoking GAAR be wholly on the taxpayer?

• GAAR will override tax treaties and may create issues with treaty partners.

• There is too much discretionary power given to CIT. What about accountability?

• Aggrieved by the order of CIT, an application can be made before the DRP. However, considering the past experience of DRP, whether such an option given under the law would be able to provide justice to the aggrieved tax payer. Any adjudicating body or institution shall be independent and shall act independently with regard to the fact of each case. In light of the present experience of DRP, a mode of further appeal against the order of CIT by way of SLP before the High Court and Supreme Court should be an alternative remedy available to the taxpayer.

• Shouldn’t impermissible avoidance arrangements be specified by way of notifications and updated like it is followed in Australia?

• Absence of correlative adjustments could lead to potential economic double taxation

• Would safe-harbour rules and/or guidance on threshold debt-equity ratios be provided?

• What impact will it have on domestic and international commerce in India? Will it drive capital away? Like transfer pricing, will it add to our international tax disputes?

4. THE RELATIONSHIP BETWEEN DOMESTIC GENERAL ANTI-AVOIDANCE RULES (GAAR) AND TAX TREATIES:

4.1 CONCEPT OF TREATY OVERRIDE & INTERNATIONAL PERSPECTIVE: Domestic GAARs have an international focus and/or international effect. Thus, they

interplay with the DTAAs. Various interesting questions arise about the relationship between Domestic GAAR and Tax Treaties in such situations.



Do the relevant Domestic GAAR-

• complement tax treaties?

• do they limit the application of treaties?

• are they limited by tax treaties?

• are they designed to circumvent limitations in treaties?

• Before one can examine the relationship between Domestic GAAR and tax treaties, the interaction between tax treaties and domestic law in general has to be first looked into:

The main purpose of tax treaties is to allocate taxing rights between two states & to avoid double taxation of income, capital and estates by modifying the domestic law of the contracting states. Being restricted to cross-border taxation of residents of the two contracting states, tax treaties are equivalent to special legislation (leges specials) compared to the contracting states’ general tax law (lex generalis). Thus according to the old law “Lex specialis derogate legi generali” (“special legislation overrides general legislation”), treaties override the domestic tax law that is effective at the time of their implementation. Under a supplementary rule of “Lex posterior generalis non derogart legi priori speciali” (“later general legislation does not overrule earlier special legislation”), changes of domestic tax law normally will not affect existing treaties. This latter rule does not apply, however, if the legislature, when changing the general law, expressly or implicitly intended to repeal the special law. General law then overrules the special (domestic) legislation. A legislation that contradicts an existing international treaty, however, is a violation of international law.

From an international law perspective, there is no fundamental legal difference between tax treaties and treaties concerning other subject matters. The Vienna Convention on Law of Treaties contains a very wide definition of the term “treaty” in article 2(1)(a), according to which “treaty” refers to “an international agreement concluded between states in written form and governed by international law, whether embodied in a single instrument or in two or more related instruments and whatever its particular designation”. There is no provision in the VCLT dealing specifically with tax treaties, but the same holds true for most other particular category of treaties including tax treaties. Article 26 [Pacta sunt servanda] of Vienna Convention on the Law of Treaties states that every treaty in force is binding upon the parties to it and must be performed by them in good faith. Further Article 27 [Internal law and observance of treaties] states that a party may not invoke the provisions of its internal law as justification for its failure to perform a treaty. Both the aforesaid articles suggest that a tax treaty should generally prevail over the domestic law.

The relationship between tax treaties and domestic law cannot be summarized in a broad statement such as “tax treaties prevail over domestic law”. The interplay between the provisions of tax treaties and those of domestic law is considerably more complex. There are three main levels at which the provisions of tax treaties and those of domestic law interact:

1. The application of treaty provisions is to a large extent affected by the provisions of domestic law. Eg: Article 4 of a treaty defines the treaty term “resident



of contracting state” by reference to the domestic tax rules that determine comprehensive liability to tax.

2. The provisions of tax treaties may affect the application of the provisions of domestic law. Eg: The domestic laws of countries provide that double taxation will be eliminated through the exemption method in the case of incomes arising in countries with which there is a tax treaty.

3. The provisions of tax treaties and those of domestic law may conflict.

I now focus on the situations in which abuse of tax treaty takes place:

Para 9.1 of Commentary on Article 1 of OECD Model Tax Convention on Income and on Capital (July 2010) raises two fundamental questions:

• Whether the benefits of tax conventions must be granted when transactions that constitute an abuse of the provisions of these conventions are entered into?

• Whether specific provisions and jurisprudential rules of the domestic law of a Contracting State that are intended to prevent tax abuse conflict, with tax conventions?

As regards the first question, the commentary concludes in Paras 9.4 and 9.5 that the States do not have to grant the benefits of a double taxation convention where arrangements that constitute an abuse of the provisions of the convention have been entered into. It further states that a guiding principle would be that the benefits of a double taxation convention should not be available where;

(a) a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position; and

(b) obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions.

Para 27 of approved Revised Commentary on Article 1 of the UN Model Double Tax Convention to be included in the next version of UN Model Double Tax Convention further provides guidance for the application of the aforesaid principle. It states that in order to minimize the uncertainty that may result from the application of the aforesaid approach, it would be important that the guiding principle should be applied on the basis of objective findings of facts and not the alleged intention of the parties. Thus, the determination of whether a main purpose for entering into transactions or arrangements is to obtain tax advantages should be based on an objective determination, based on all the relevant facts and circumstances, of whether, without these tax advantages, a reasonable taxpayer would have entered into the same transactions or arrangements.

With regard to the second question as to whether domestic anti-abuse provisions conflict with the tax treaties, the commentary states that an abuse of treaty can be viewed differently by difference states. One view taken by the contracting states could be that any abuse of the provisions of a tax convention would be characterised as an abuse of the provisions of domestic law under which tax will be levied on account of the fact that taxes are ultimately imposed through the provisions of domestic law, as restricted (and in some rare cases, broadened) by the provisions of tax conventions.



For example, if tax is reduced because of the improper use or abuse of the provisions of a tax treaty, there is abuse of domestic law subject to any domestic anti-avoidance rules. In such cases, there could arise a conflict between the domestic anti-abuse provisions and the tax treaties when the domestic anti-abuse provisions prevent the treaty benefits. The other possible view is that such abuses are to be treated as abuses of the convention itself, as opposed to abuses of domestic law. These States, however, then consider that a proper construction of tax conventions allows them to disregard abusive transactions, such as those entered into with the view to obtaining unintended benefits under the provisions of these conventions. This interpretation results from the object and purpose of tax conventions as well as the obligation to interpret them in good faith (refer Article 31 of the Vienna Convention on the Law of Treaties). In such cases, treaty abuse is prevented by principles of interpretation of tax treaties itself and hence the question of conflict between domestic anti-abuse provisions and tax treaties does not arise. (In Section 5, it is examined in greater detail how the treaty abuse if viewed differently by different countries and how its prevention is enforced in practicality)

In case the first view is adopted by a contracting state, after the 2003 changes to the OECD Model Tax Convention on Income and on Capital, Para 9.2 & Para 22.1 of commentary on Article 1 conclude that domestic anti-abuse regulations are part of the basic domestic rules set by domestic tax laws for determining which facts give rise to a tax liability and that these rules are not addressed in tax treaties and are therefore not affected by them in case of abuse of treaties. Thus, as a general rule there will be no conflict. It simply means that the domestic anti-avoidance rules may be applied to determine the character of amounts or transactions for domestic tax purposes. The provisions of the tax treaty then apply to the amounts or transactions as characterized pursuant to such domestic anti-avoidance rules. The Commentary also explains by way of an example that to the extent that the application of the anti-abuse rules results in a re-characterization of income or in a redetermination of the taxpayer who is considered to derive such income, the provisions of the Convention will be applied taking into account these changes. (This interpretation of OECD may not be followed by all countries as is seen from the example given later below by Professor Stef van Weeghel of Netherlands).

It is to be noted here that some countries disagree with the interpretation given in OECD model that there is generally no conflict between anti-abuse provisions of the domestic law and the provisions of the tax convention as can be seen from the ‘Observations on the Commentary’ given towards the end of Commentary on Article 1. For example, Luxembourg expresses that absent an express provision in the Convention, a State can only apply its domestic anti-abuse provisions in specific cases after recourse to the mutual agreement procedure, whereas, Netherlands maintains that the compatibility of such rules and provisions with tax treaties is, among other things, dependent on the nature and wording of the specific provision, the wording and purpose of the relevant treaty provision and the relationship between domestic and international law in a country. On the other hand, Switzerland has made an observation in the commentary that the domestic rules on abuse must conform to the general provisions of tax conventions indicating an inclination towards tax treaties over its domestic rules.



The conclusion drawn in Para 9.2 of the Commentary seems to be somewhat misplaced. If the domestic anti-avoidance rule is the similar to the guiding principle as given Para 9.5 of OECD Model Tax Convention, then no conflict should arise. As a matter of fact, even Para 26 approved Revised Commentary on Article 1 of the UN Model Double Tax Convention to be included in the next version of UN Model Double Tax Convention acknowledges that the elements of guiding principle given in Para 9.5 of Commentary on Article 1 of OECD Model Tax Convention are found explicitly or implicitly in general anti-avoidance rules and doctrines developed in various countries. But if the domestic rule differs, then one would have to see whether tests under the domestic rule as well as the treaty are satisfied. If the treaty test is not met but the domestic rule applies, then there is no abuse of treaty itself. Thus, the domestic anti-avoidance rules that do not meet the test of Para 9.5 of Commentary on Article 1 of OECD Model Tax Convention conflict with the provisions of the tax treaty and the application of such domestic rules could be precluded by the tax treaty as per the interpretation given in Para 9.5 of the Commentary on Article 1 of OECD Model Tax Convention. The conclusion in Para 9.1 of the Commentary on Article 1 of OECD Model Tax Convention also results in oversimplification of the determination of facts on one hand and a re-characterization of established facts pursuant to the application of an anti-avoidance rule on the other. There may be a situation wherein the facts have been properly determined, but then the application of a domestic anti-avoidance rule leads to a legal conclusion that the facts as determined result in the frustration of the purpose of a provision of domestic law. The key issue here would be whether the re-characterization or redetermination that then follows under the substance over form or anti-abuse rules conflicts with the provision of tax treaties?

Many countries clearly have provisions in their domestic law which allow treaty override by domestic anti-abuse provisions while others countries do not allow treaty-override.

Let us see some examples:

• The US Constitution states that the provisions of international agreements and those of domestic legislation have equal status. There is no superior status given in the United States to treaty arrangements,

• France and the Netherlands expressly state that international agreements do take precedence over subsequent domestic legislation. Particularly in Netherlands, the determination that a transaction was a sham and subsequent determination of the true nature of the transaction and also “independent determination” of the facts for tax purposes would certainly be followed for tax treaty purposes, but re-characterization of transactions for domestic tax purposes pursuant to the fraus legis doctrine (abuse of law doctrine) has so far not been respected for tax treaty purposes.

• In Canada, there was doubt whether the statutory GAAR applied to tax treaties, but this doubt was removed with retroactive effect by an amendment to the effect that GAAR applies to “transactions that misuse or abuse a treaty” and where necessary, overrides treaties.

• Germany has enacted domestic legislation unilaterally in the past that has constituted treaty override and the European Court of Justice has accepted treaty overrides by Germany in several judgements.



• Countries such as those of Luxembourg and Belgium also limit the ability of subsequent domestic legislation to amend the provisions of those agreements.

An interesting example given by Professor Stef van Weeghel of Netherlands on the complexity created by varying provisions in different countries with regard to treaty override is worth looking at. In Netherlands, re-characterization is done for domestic law purposes and not for treaty purposes, whereas in New Zealand and USA, the re-characterization pursuant to factual approach is also adopted for treaty purposes. Potentially different outcomes can arise depending on whether the factual (or perhaps in the United States the interpretive) approach is adopted and then followed for treaty purposes, or whether facts are re-characterized under a domestic abuse of law doctrine, for the treatment of a sale of shares as a dividend distribution. In the United States and New Zealand, a transaction in which a shareholder sells shares in a company to a company controlled by this shareholder, with a view to realizing the retained earnings as a capital gain rather than as a dividend, in order to obtain more favourable capital gains treatment, would be treated as a dividend using the factual approach (or perhaps in the United States the interpretive approach), but in the Netherlands that treatment used to be the result of re-characterization with application of the fraus legis doctrine. In the approach followed by New Zealand and the United States, the dividend treatment also applies for tax treaty purposes. However, in the Netherlands the re-characterization would be inconsistent with tax treaty obligations and for tax treaty purposes the sale would result in a capital gain, because the abuse would not be regarded as an abuse of the tax treaty. A capital gain derived by a resident of the United States in respect of shares in a company resident in the Netherlands could thus be regarded as a dividend (a) for US domestic law purposes, (b) for the Netherlands–USA tax treaty in the interpretation by the United States, and (c) for Dutch domestic law purposes (under prior law), but as a capital gain for the Netherlands–USA tax treaty in the interpretation by the Netherlands.

Many countries even have specific provisions in their treaty which allow application of domestic anti-avoidance provisions. Para 36 of approved Revised Commentary on Article 1 of the UN Model Double Tax Convention to be included in the next version of UN Model Double Tax Convention expresses that a country which does not feel confident that its domestic law and approach to the interpretation of tax treaties would allow it to adequately address improper uses of its tax treaties could consider including a general anti-abuse rule in its treaties. The countries that report occasional inclusion of these treaty provisions are Austria, Belgium, Canada, China, Denmark, Italy, Korea, Luxembourg, the Netherlands, Portugal, Russia, Singapore, Sweden, Switzerland and Ukraine, whereas the current tax treaty policy of Germany and Israel seems to be to always include a provision that allows the application of domestic anti-avoidance rules, even though in both countries the doctrine is that domestic general anti-avoidance rules can be applied in interpreting tax treaties, and the incorporation of the treaty provision allowing the application of the domestic general anti-avoidance rule must be seen as an amplification of that position.

Some examples of such specific treaty provision allowing application of domestic anti-avoidance provisions can be quoted as follows:



• Clause 4 of Protocol to Israel-China DTAA: “A competent authority of a Contracting State may, subject to the domestic laws and procedures of that State with respect to the treatment of artificial transactions, deny the benefits of this Agreement to any person, or with respect to any transaction, if in its opinion the granting of those benefits would constitute an abuse of the Agreement according to its purposes”.

• Article 26 (Miscellaneous Rule) of China-Singapore DTAA: “Nothing in this Agreement shall prejudice the right of each Contracting State to apply its domestic laws and measures concerning the prevention of tax avoidance, whether or not described as such, insofar as they do not give rise to taxation contrary to the Agreement.”

• Article 29(1) [Limitation of Benefits] of India-Luxembourg DTAA : “Nothing in this Agreement shall affect the application of the domestic provision to prevent tax evasion.”

A drawback of including such a provision is brought out in Para 37 of approved Revised Commentary on Article 1 of the UN Model Double Tax Convention to be included in the next version of UN Model Double Tax Convention. Para 37 states that many countries would consider that including such a provision in their treaties could be interpreted as an implicit recognition that, absent such a provision, they cannot use other approaches to deal with improper uses of tax treaties. This could be particularly problematic for countries that have already concluded a large number of treaties that did not include such a provision. It further states that it is for this reason, that the use of such a provision would probably be considered primarily by countries that have found it difficult to counter improper uses of tax treaties through other approaches. Such interpretation could also be adopted in India, now that the recent DTAA with Luxembourg contains a provision allowing application of domestic GAAR, whereas nearly all other tax treaties of India do not contain such a provision.

Other countries like Finland, Norway, Serbia do not have provisions in their treaties that allow the application of a domestic general anti-avoidance rule.

Considering diverse international practices on the subject, an afterthought which comes to me is that if two contracting parties are agreeing something, really should they stick by their agreement, rather than being able, unilaterally, to override them?

4.2 RELEVANCE OF TREATY OVERRIDE IN INDIAN CONTEXT: CBDT vide circular no. 333 of 1982 has clarified the legal position that where a specific

provision is made in the double taxation avoidance agreement, that provision will prevail over the general provisions contained in the Income Tax Act, 1961. Time and again, a number of different courts in India have also held that the provisions of DTAA would prevail over the provisions of ITA. But still today, one can find a provision in the Income-tax Act, 1961 which is a typical example of treaty override. Sec. 206AA of ITA mandates the payer to deduct tax at higher of 20% or rates in force irrespective of lower rates notified in the various tax treaties signed by India if PAN is not obtained/provided by the payee.

In case of conflict between domestic law and treaty, certain principles for interpretation of treaty emerging from the decision of Ram Jethmalani vs. Union of India (known



as black money judgment) can be referred to. While reaching its conclusion, Hon’ble Supreme Court referred to the ‘General Rule of Interpretation’ contained in the Article 31 of the Vienna Convention which provides that “treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.” The Supreme Court observed that though India is not a party to the Vienna Convention, the principles of customary international law and principle of interpretation contained therein provides a broad guideline for the appropriate manner of interpreting a treaty in the Indian context also.

Reference was made to the decision of Union of India v. Azadi Bachao Andolan, approvingly noting Frank Bennion’s observations that a treaty is really an indirect enactment, instead of a substantive legislation, and that drafting of treaties is notoriously sloppy, whereby inconveniences obtain. The broad principle of interpretation, with respect to treaties, and provisions therein, would be that ordinary meanings of words be given effect to, unless the context requires or otherwise. However, the fact that such treaties are drafted by diplomats, and not lawyers, leading to sloppiness in drafting also implies that care has to be taken to not render any word, phrase, or sentence redundant, especially where rendering of such word, phrase or sentence redundant would lead to a manifestly absurd situation, particularly from a constitutional perspective. The government cannot bind India in a manner that derogates from Constitutional provisions, values and imperatives.

But what happens when there is a question of treaty abuse? Should the benefits of DTAA be given despite allegation of treaty abuse by taxpayers or should they be denied (denoting treaty override)?

Supreme Court decision in the case of Union of India v/s Azadi Bachao Andolan (supra) has upheld the constitutional validity of India-Mauritius DTAA even though it was alleged that it was being misused by resident of third countries by taking advantage of Article 13.4 of India-Mauritius DTAA. (It has been dealt with in greater detail in Section 5).

AAR in the case of E*trade Mauritius Ltd has applied the judgment of SC in Azadi Bachao Andolan and concluded that in Azadi Bachao Andolan case (supra), the Supreme Court found no legal taboo against ‘treaty shopping’. Treaty shopping and the underlying objective of tax avoidance/mitigation could not be equated to a colorable device. While applying the decision of the SC, it also stated that SC held that the motive of tax avoidance is not relevant so long as the act is done within the framework of law, the ‘treaty shopping’ through conduit companies is not against law and the lifting of corporate veil is not permissible to deny the benefits of a tax treaty.

In contrast to the above, in the recent decision of Bombay High Court in the case of Aditya Birla Nuvo Limited, in what maybe likened to ‘treaty override’, the Bombay HC denied treaty benefit to a Mauritian entity by holding that India-Mauritius DTAA did not apply to the sale of shares by a Mauritian entity to an Indian entity since the ownership of the such shares could not be said to have been with the Mauritian entity. (It has been dealt with in greater detail in Section 5 below).

Thus, the current position under the Income Tax Act, 1961 also does not seem to be free from controversy as to whether treaty benefits should be available when peculiar



tax planning involving the use of a particular treaty even though Sec 90(2) states categorically that the benefits of a treaty should be granted to a tax payer if they are more beneficial to the tax payer.

Proposed DTC however is unequivocal by providing that treaty override under DTC would be permissible. Sec 291 [Agreement with foreign countries or specified territory] relevant sub-clauses are reproduced below:

(8) Where the Central Government has entered into an agreement under sub-section (1) or sub-section (2), or has adopted an agreement entered into by the specified association under sub-section (4), as the case may be, then the provisions of this Code shall apply in relation to the assessee to whom such agreement applies, to the extent they are more beneficial to him.

(9) Notwithstanding anything in sub-section (8), the provisions of this Code relating to—

a) General Anti-Avoidance Rule under section 123;

b) levy of Branch Profit Tax under section 111; or

c) Control Foreign Company Rules referred to in the Twentieth Schedule,

shall apply to the assessee referred to in sub-section (8), whether or not such provisions are beneficial to him. (emphasis supplied)

The original discussion draft on DTC explains treaty override as follows:

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.

Even though the rationale behind providing for treaty override in DTC seems to be in agreement with the guiding principle given in Para 9.5 of Commentary on Article 1 of OECD Model Tax Convention, the conclusion drawn by OECD with regard to treaty conflict itself seems to be misplaced and over-simplified (as discussed before in Section 4). Further, in the context of treaty override as provided in the DTC, it would be interesting to see how the GAAR provisions would interact with specific anti-avoidance rules when provided in the treaty itself. For example, A ‘person’ may satisfy all the conditions laid down in the LOB clause in a particular treaty, but the Commissioner considers the transaction as an impermissible avoidance arrangement. In this regard, it may be noted that Para 9.6 of Commentary on Article 1 of OECD Model Tax Convention states that specific provisions in the treaty can be used in conjunction with/supplementary to domestic GAAR to prevent treaty abuse. It further states that such specific provisions can be adopted if a country feels that its domestic GAAR lacks



the principles necessary to properly address any specific abuse strategy. It would be interesting to see how the judiciary would adjudicate on the issue of treaty override after DTC is introduced.

5. IS THE ABUSE OF A TAX TREATY ADDRESSED BY DOMESTIC LAW PRINCIPLES OR BY THE INTERPRETATION OF THE TAX TREATY?

As per Commentary on Article 1 of OECD Model Tax Convention on Income and on Capital, the most prevalent form of abuse of tax treaty if treaty shopping. In recent years a number of treaty shopping cases have gone through the courts in a number of countries and the outcome of these cases and the reasoning of the courts provide for an array of diverging positions. Clearly, certain blatant forms of treaty shopping are addressed through the inclusion of the beneficial ownership condition in tax treaties and by the interpretation of this term, while general safeguards are such as specific provisions in treaties allowing application of domestic anti-avoidance provisions are also included.

One can refer to some international cases like Indofoods vs. JP Morgan in the United Kingdom, the Prévost and MIL Investments cases in Canada, which indicate the way that courts are thinking in relation to beneficial ownership. But there are very few cases which have looked at whether a treaty should apply at all. There have been some cases, however, which look at whether the object and the purpose of the treaty is being fulfilled. Article 31 of the Vienna Convention on the Law of Treaties states:

“The treaty should be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.”

With this in mind let us look at the title of a tax treaty. The wording says, “Agreement between X country and Y country for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to taxes on income.” So the question one should really ask, when you are using a tax treaty, is “Are the taxes of just one country being avoided or, in fact, is double taxation being avoided?” And the second question is, “Am I creating something that actually assists with fiscal evasion rather than preventing it?”

In the judgment in the Yanko-Weiss case, it was held that a general anti-avoidance concept is implicit when you apply double tax treaties. (The aforesaid case is discussed in greater detail and the relevant extract from the judgement is also given below on Page 51).

• INTERNATIONAL EXPERIENCE:

Countries such as Finland, New Zealand, Norway, Venezuela reportedly address the abuse of the treaty through interpretation of the treaty itself, as also with reference to Article 31 [General rule of interpretation] of Vienna Convention on the Law of Treaties. Whereas countries such as China, Estonia, France, Ireland, Korea, Luxembourg, Poland, South Africa reportedly address abuse of tax treaties by applying domestic anti-abuse principles.

Some interesting international case laws deserve mention in this regard:



MIL (Investments) SA vs The Queen {[2006] 5CTC 2552 (TCC)} [Canada]:

MIL Investments (MIL) was a company resident in the Cayman Islands and it owned shares in Diamond Field Resources Ltd (DFR), a company resident in Canada. MIL entered into several transactions. In a tax free transaction it exchanged a number of DFR shares for other shares. Subsequently, MIL reincorporated in Luxembourg and became a resident of Luxembourg for Luxembourg tax purposes. MIL then sold some of the shares it had received in exchange for the DFR shares and later it disposed of its entire interest in DFR, realizing a significant capital gain. That capital gain was taxable under Canadian domestic tax law, but if MIL could successfully invoke the protection of article 13 of the Canada–Luxembourg income tax treaty, the gain would be exempt from taxation in Canada. The Canadian tax authorities argued that MIL could not rely on the Canada–Luxembourg tax treaty, invoking the Canadian GAAR.

Although the Canadian court was receptive to the GAAR argument, it found that one of the conditions for the application of the GAAR, an avoidance transaction, was not present. The court found that the sale of the DFR shares was not an avoidance transaction and even if the other transactions would have been avoidance transactions, the absence of an avoidance motive with respect to the sale of the DFR shares prevented application of the GAAR and, accordingly, MIL prevailed. The court tested the transaction against the Canadian GAAR, a domestic anti-avoidance rule that by operation of domestic law was deemed to apply to tax treaties (with retroactive effect), but then went on to test whether there was an anti-abuse rule inherent in the treaty that was violated, which it found not to be the case. The court in fact rejected the notion that there was an anti-abuse rule inherent in the treaty and referred in this respect to paragraph 7 of the commentary to Article 1 OECD MC of 1977 which stated that taxpayers may exploit the differences in tax levels as between States and the tax advantages provided by various countries’ taxation laws, but it is for the States concerned to adopt provisions in their domestic law, to counter possible manoeuvres. The Court ruled that if Canada was concerned about the preferable tax rates of its treaty partners, it ought to renegotiate the treaties instead of applying the GAAR. The court also noted that using one foreign country over another as an avenue of investment into Canada was not improper as such.

The decision of the Tax Court in MIL (Investments) has been appealed to the Federal Court of Appeal.

Garron Family Trust (Trustee of) vs R {2009 TCC 450 (TCC)} [Canada]

In the Garron case, shares in a Canadian company were, after a reorganisation, owned by a trust arguably resident in Barbados. The shares were sold by the trust and an exemption from Canadian tax was claimed based on the capital gains article in the Barbados–Canada tax treaty. The court found that management and control of the trust were in Canada and concluded that it was a resident of Canada for purposes of the treaty. In an interesting obiter dictum, the court considered whether (a) a Canadian deemed residence rule, (b) a Canadian attribution rule, and/or (c) the GAAR would have resulted in taxation of the gain in Canada, should management and control of the trust have been in Barbados. Based on the plain meaning of the treaty text and the fact that for another Canadian attribution rule the treaty contained a proviso, the attribution



rule was deemed inconsistent with the treaty. Moreover, the court determined that even if the facts justified the conclusion of deemed residence in Canada, either based on the applicable rule of domestic law or based on GAAR, that would not result in an abuse of the treaty, and the court referred to the plain language of the treaty and the absence of any indication that the contracting states had wished to preserve Canada’s right to tax the gain.

It may be noted here that Garron case is in line with the MIL case. The case is under appeal to Supreme Court of Canada.

Paul Antle & Renee Marquis-Antle Spousal Trust vs The Queen {2009 TCC 465 (TCC)} [Canada]

Even though this case was relating to the judicial doctrine of sham entity, the Tax Court found that relying on a treaty provision to avoid application of an anti-avoidance provision of the Act was inherently abusive. The court concluded that the transactions abused the Act and the Treaty and were subject to the GAAR. Applying the GAAR analysis, the court denied the benefit of capital gains exemption.

This case is also under appeal to the Supreme Court, though the Federal Court upheld the tax court’s judgment.

Yanko-Weiss Holdings (1996) Ltd vs Hulon Assessment Officer {(Request number 5663/07)} [Israel]

Yanko-Weiss Holdings was a company that was tax resident in Israel. It owned shares in a subsidiary that was also resident in Israel. In 1999 Yanko-Weiss Holdings moved its effective management to Belgium and became a resident of Belgium under Belgian tax law. In the following year it received a dividend from its Israeli subsidiary and claimed the reduced dividend withholding pursuant to the Belgium–Israel income tax treaty. The Israeli tax authorities refused Yanko-Weiss Holdings the benefit of the tax treaty, arguing that there was no economic purpose for its residence in Belgium and that the emigration to Belgium should be regarded as a sham. The Israeli court, in a preliminary procedure, confirmed that treaty benefits could indeed be denied in the presence of a sham transaction. The Israeli court’s decision was based on several arguments including the OECD’s position as reflected in the commentary to the OECD model income tax treaty and the Vienna Convention. The court noted that although the OECD’s position does not bind Israel, it has a significant influence on the interpretation of tax treaties.

It is to be noted that while the Yanko-Weiss Holdings case is only a preliminary proceeding, in which it was determined whether the Israeli tax authorities could invoke the sham argument, either based on “proper determination of the facts” or on abuse of the treaty, it still has to be determined whether the emigration of Yanko-Weiss Holdings to Belgium indeed was a sham or abusive.

Extract from the above judgement:

“… The rise in the transformation of markets to global markets, the ease with which capital is moved, and tax regimes which have seen the interests of the State requiring incentives, including the attracting of foreign investments while creating tax shelters, all of these factors have created opportunities for assessees



holding several residencies or citizenships, as well as to tax planners to transcend borders and to create holding structures which exploit contradictions and differences between different national tax regimes, in order to reduce their tax burden or that of their clients. …

In this context an excellent example is, in the words of the philosopher Ludwig Wittgenstein, as follows:

“…there is no such thing as a literal meaning apart from the context that makes it meaningful.” …

Wittgenstein gives an interesting example: If it will be said to someone “Teach the children a game” and he will teach them to gamble in a game of dice, was it necessary to instruct expressly by saying that one should not teach children to gamble with dice? It is clear that the word “play” includes gambling with dice. However, it is clear that it was not intended that gambling will be presented to children. This example … has implications for the interpretation of treaties. It teaches that frequently the literal translation of a text may include a possible understanding that would never have crossed the minds of the drafters of a treaty. Therefore, one should read its provisions in the context of the intent of its drafters. We may add that the intent of the drafters is also connected to the present tax environment, to the tax administrations as they have developed and changed since the drafting of the treaty up to the time it is being interpreted, to the provisions of international law such as Article 31 of the Vienna Convention, and to the adoption of the doctrine that stands at the core of the legal system in Israel, the doctrine of good faith.

A tax treaty is designed, first and foremost, to create a situation in which an assessee, who is trapped in the tax networks of two contracting States, will not be exposed to double taxation. Tax treaties were not designed, nor can it be said that any such intent existed, whether they include express provisions or not, for use that will be made of them in a manner which is not in good faith and in an acceptable manner, or that use can be made of them which constitutes improper use of provisions set forth and the benefits which they grant. The States which conclude a treaty are entitled to raise arguments against such. They can do so by virtue of provisions of domestic law, which contain anti-avoidance provisions which are the basis for determining tax liability. The determination of liability is set forth first and foremost by domestic law. The domestic law gives effect to the treaty, whether with an equal status or a superior status, in order to set forth the scope of tax liability in a manner such that there will not be exposure to double taxation. To illustrate, if it will be determined, further to a claim of reclassification, or by virtue of the authority to claim on the basis of artificiality, that one must regard income as revenue income and not as capital income, thereafter it will be to apply treaty provisions. That is, first one determines the nature of the income, and thereafter the provisions of the treaty will be applied. Not in every case where there is an argument of improper use, is the application of the treaty denied. Once the nature of the liability is determined, there should be an attempt, notwithstanding the use of anti-avoidance measures, to apply the main points which prevent double taxation, while at the same time



using measures which the treaty provides, for example, the mutual agreement procedure, inter alia.

An additional justification for the use of anti tax-avoidance measures against treaty abuse is found in the implied condition which is to be read into every treaty, that they are not to be used for improper purposes. This is based in part on Article 31 of the Vienna Convention.

Article 31 of the Vienna Convention applies to the provisions of international treaties, including Conventions for the Prevention of Double Taxation:

“1. A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in light of its objects and purpose.

…

4. A special meaning shall be given to a term if it is established that the parties so intended.”

… The doctrine of “preventing improper use” is capable of including additional standards and anti-avoidance measures, in addition to that of artificial transactions: for example, substance over form, reclassification, the commercial essence of the transaction, etc. … One can say that the treaties for the prevention of double taxation to which Israel is a party are to be read as if they contain limitation on benefits provisions in cases where it is proven that there exists improper use of a tax treaty, according to standards of the domestic law and international law.

This approach is in line with the interpretation of the OECD of recent years (since 2003) from its Model Convention …

In the Commentary to Article 1 of the Model, in paragraph 7 it is stated:

“ The principal purpose of double taxation conventions is to promote, by eliminating international double taxation, exchange of goods and services, and the movement of capital and persons. It is also a purpose of tax conventions to prevent tax avoidance and evasion.” (the emphasis does not appear in the original)

… The Commentary continues in paragraph 9.3 and clarifies:

“This interpretation results from the object and purpose of tax conventions as well as the obligation to interpret them in good faith (see Article 31 of the Vienna Convention on the Law of Treaties).”

… para 9.4 of the commentary summarizes that, according to the two perspectives referred to above, benefits should not be granted by tax treaties when speaking of an arrangement which constitutes improper use of its provisions …”

A Holding ApS, {2A.239/2005=International Tax Law Reports 8 (2006)} [Switzerland]

A Holding ApS, a company resident in Guernsey had interposed a Danish holding company, A Holding, in order to own the shares in a company resident in Switzerland. A Holding was a mere holding company, without any economic activity in Denmark,



which clearly had been organised only with a view to obtaining the benefits of the Denmark– Switzerland income tax treaty. A Holding received a dividend from its Swiss subsidiary and invoked the benefits of article 10 of the tax treaty. The Swiss tax authorities denied the benefit of the treaty, arguing that A Holding had only been organized with a view to obtaining treaty benefits and that granting these benefits would be tantamount to an abuse of the treaty. The Court concluded that the doctrine of “abuse of rights” applied in construing tax treaties even in the absence of specific anti-avoidance provisions in the treaties. The Court also concluded that the abuse of rights doctrine was recognized in Switzerland and the rest of Europe as a general principle of law and that this principle was also recognized in Denmark.

Xinjiang anti-treaty shopping case {Notice No. 1076 issued on 30/12/2008 by State Administration of Taxation} [China]

In this case a number of transactions took place and in one of these a company arguably resident in Barbados sold shares in a Chinese company with a capital gain that was taxable in China but for the application of the capital gains article in the Barbados–China tax treaty. That tax treaty does not contain an anti-avoidance proviso or an LOB clause. The notice issued by the Chinese tax authority indicates that information had been exchanged with the US competent authority from which it was concluded that the three board members of the company that was invoking the treaty benefits were US citizens with the same US address. Apparently, the Barbados tax authorities did not provide proof of the residence status of the Barbados company. The Chinese tax authorities arrived at the conclusion that the Barbados company was not resident in Barbados for the purposes of the Barbados–China tax treaty and denied the treaty benefits.

It is to be noted that the transactions took place before 2008, the year when China’s new income tax law and the general anti-avoidance rule (GAAR) became effective. Therefore the GAAR technically did not apply to the case. However, the State Administration of Taxation (SAT) took the opportunity to issue a public notice, which commented on the details of the case and encouraged local tax authorities to learn from the experience of the Xinjiang tax authorities in combating tax-avoidance transactions.

• HOW TREATY ABUSE HAS BEEN DEALT WITH IN INDIA?

The most celebrated judgment in the context of treaty abuse in India is that of Azadi Bachao Andolan (supra). The various observations made by Supreme Court in the context of treaty abuse are given below:-

• It is rightly urged by the counsel for the appellants that if it was intended that a national of a third State should be precluded from the benefits of the DTAC, then a suitable term of limitation to that effect should have been incorporated therein. Article 24 of the Indo-US Treaty on Avoidance of Double Taxation specifically provide the limitations subject to which the benefits under the Treaty can be availed of. One of the limitations is that more than 50 per cent of the. beneficial interest, or in the case of a company more than 50 per cent of the number of shares of each class of the company, be owned directly or indirectly by one or more individual residents of one of the Contracting States. Art. 24 of the Indo-U.S.



DTAC is in marked contrast with the Indo-Mauritius DTAC. The appellants rightly contend that in the absence of a limitation clause, such as the one contained in art. 24 of the Indo- U.S. Treaty, there are no disabling or disentitling conditions under the Indo-Mauritius Treaty prohibiting the resident of a third nation from deriving benefits thereunder.

• There is no doubt that, where necessary, the Courts are empowered to lift the veil of incorporation while applying the domestic law. In the situation where the terms of the DTAC have been made applicable by reason of s. 90 even if they derogate from the provisions of the IT Act, it is not possible to say that the principle of lifting the veil of incorporation should be applied by the Court. The whole purpose of the DTAC is to ensure that the benefits thereunder are available even if they are inconsistent with the provisions of the Indian IT Act. Therefore, the principle of piercing the veil of incorporation can hardly apply to a situation as the present one.

• The maxim “Judicis est jus dicere, non dare” pithily expounds the duty of the Court. It is to decide what the law is, and apply it; not to make it.

• The weighty recommendations of the Working Group on Non-resident Taxation are again about what the law ought to be, and a pointer to the Parliament and the Executive for incorporating suitable limitation provisions in the treaty itself or by domestic legislation. This per se does not render an attempt by resident of a third party to take advantage of the existing provisions of the DTAC illegal. The recommendations of the Working Group of the JPC are intended for Parliament to take appropriate action. The JPC might have noticed certain consequences, intended or unintended, flowing from the DTAC and has made appropriate recommendations. Based on them, it is not possible to say that the DTAC or the impugned circulars are contrary to law, nor would it be possible to interfere with either of them on the basis of the report of the JPC.

• The principles adopted in interpretation of treaties are not the same as those in interpretation of statutory legislation. An important principle which needs to be kept in mind in the interpretation of the provisions of an international treaty, including one for double taxation relief, is that treaties are negotiated and entered into at a political level and have several considerations as their bases. There are many principles in fiscal economy which, though at first blush might appear to be evil, are tolerated in a developing economy, in the interest of long-term development. Deficit financing, for example, is one; treaty shopping, is another. Despite the sound and fury of the respondents over the so called ‘abuse’ of ‘treaty shopping’, perhaps, it may have been intended at the time when Indo-Mauritius DTAC was entered into : whether it should continue, and, if so, for how long, is a matter which is best left to the discretion of the executive as it is dependent upon several economic and political considerations. This Court cannot judge the legality of treaty shopping merely because one section of thought considers it improper.

Since the pronouncement of the landmark judgement of Azadi Bachao Andolan, in the context of treaty abuse, one can refer to a very recent judgement of Bombay High Court in the case of Aditya Birla Nuvo Limited (supra).



In the Writ Petition filed before the Bombay HC, the Aditya Birla Nuvo Ltd challenged the jurisdiction of the assessing officer in the context of notice issued under Sec. 163 treating it as the agent of New Cingular Wireless Services Inc (Parent company of AT&T Mauritius) for income accruing/arising to them from the sale of shares of Idea Cellular Ltd (Joint Venture company established in India) by AT&T Mauritius to the assessee. Aditya Birla Nuvo Ltd support on India-Mauritius DTAA and CBDT Circular 789 of 2000 to claim that the right to tax capital gains accruing/arising to AT&T Mauritius was in Mauritius under India-Mauritius DTAA since it was the shares were held in its name and since it had been issued tax residency certificate by Mauritius tax authorities, it was sufficient proof of its tax residency in Mauritius to claim the benefits of India-Mauritius DTAA. Bombay HC after thoroughly examining the facts came to the conclusion that AT&T Mauritius was not the beneficial owner of the shares and thus the benefits of India-Mauritius could not be given to capital gains accruing/arising to AT&T Mauritius. It held that the benefits of India-Mauritius DTAA could be given only to investments made in India by Mauritian entities. Since in this case the investment had not been made by AT&T Mauritius but by New Cingular Wireless Services Inc, India-Mauritius DTAA had no relevance in the aforesaid case.

It is interesting to note here that even though the concept of ‘beneficial owner’ is not given in Article 13 of India-Mauritius DTAA (i.e. for treaty interpretation and application purposes), rather than prima facie relying on tax residency certificate of AT&T Mauritius as well as to the fact that AT&T Mauritius was the entity to whom the shares had been issued (particularly after the decision in the case of Azadi Bachao Andolan and E*trade Mauritius Ltd), it deciphered the factual matrix and historical background of the transaction to come to the conclusion that AT&T Mauritius could not be regarded as the ‘legal owner’ leave alone ‘beneficial owner’.

An interesting observation can be made in the definition of “impermissible avoidance arrangement” given in Sec 124(15)(b) of DTC wherein ‘misuse or abuse of provisions of DTC’ would get covered within its ambit. In certain countries, the double tax treaties entered into by them become a part of the domestic law and therefore treaty abuse may automatically get covered by GAAR provisions prevalent in those countries. In India, at present the tax treaties do not become a part of the domestic tax law but beneficial treatment is given to the tax treaties entered into by India by virtue of Sec 90(2) of ITA. In this context, one may wonder whether abuse of treaty would also be covered within the phrase ‘misuse or abuse of provisions of DTC’?

6. THE RELATIONSHIP BETWEEN DOMESTIC GENERAL ANTI-AVOIDANCE RULES (GAAR) AND DOMESTIC SPECIAL ANTI-AVOIDANCE RULES (SAAR)/TARGETED ANTI-AVOIDANCE RULES(TAAR):

Even if the domestic anti-avoidance rules may not conflict with the tax treaty, a question which arises is how would GAAR interact with Domestic Special Anti-Avoidance Rules (SAAR)/Targeted Anti-Avoidance Rules (TAAR)? Under current Income-tax Act, 1961, there are several SAAR/TAAR provided, such as Sec 2(22)(e), Sec 40A(2), Sec 50C, Sec 56(2)(vii)/(viia), Sec. 92 to 92F, Sec 93, Sec 94A. Similarly, these SAAR/TAAR along with additional SAAR/TAAR such as CFC have been provided in DTC albeit at different section numbers.



When a transaction has already been subjected to domestic SAAR/TAAR, would it be still open to be challenged under GAAR?

As discussed previously, a special provision in a particular legislation overrides the general provision in the legislation. Further, it has also been accepted by various courts in India that if there are two conflicting provisions in an Act (including Income-tax Act, 1961), then the special provision will prevail as the same would exclude/restrict the application of the general provision.

Following this principle one could arrive at a conclusion that once SAAR/TAAR is applied to a transaction, it should not be governed by GAAR again. Sec 123(2) of DTC mentions that the provisions of GAAR “may be applied in the alternative for or in addition to any other basis for determination of tax liability in accordance with such guidelines as may be prescribed”. In the absence of specific guidelines in this regard, it would be inappropriate to reach any conclusion, however, it is pertinent to make an observation here that the original discussion paper on DTC states that GAAR would be “further supported” by SAAR/TAAR. In such circumstances, what meaning is to be given to the word “supported”? Does it mean that SAAR/TAAR in DTC would merely be supplementary to GAAR? Or has been worded in such a way since specific tax avoidance rules can only be drafted once a particular avoidance strategy has been identified?

Let us consider:

KPG Pvt Ltd (‘KPL’) in India is a group company of KPG Group which is a Netherland based MNC group. All the group companies of KPG Group have entered into a ‘Cost Contribution Arrangement (CCA)’ whereby the marketing strategies for the group as a whole are planned as well as executed by KPG BV and the total expenditure for the group as a whole is allocated to various entities across the world. India being a growing market, KPL has been allocated a share of 40% of total marketing costs as per the scale of marketing operations carried out in India. During the Transfer Pricing assessment, the TPO has accepted such expenditure allocation to KPL. After the completion of TP assessment, suppose the CIT feels that the expenditure allocation to KPL is excessive, can he then declare such transaction of cost allocation as ‘impermissible avoidance arrangement’? Would it not amount to change of opinion if the CIT so declares?



Case Studies for DiscussionSome of the case studies though theoretical involves more than one issue and hence are placed at the end of the paper as under:

Case Study 1:

X Ltd. a resident of India, owns shares in a company located in country A (“A Ltd”) which is EU member state. Withholding tax (“WHT”) would normally be levied on the dividends distributed by A Ltd to X Ltd. In order to benefit from the EU directive (90/435/EEC) or tax treaty and thus avoid paying the WHT, X Ltd. interposes a Cypriot company (“IHC Ltd.”) to hold its investment in A Ltd before A Ltd. commences its operations. Further, X Ltd. transferred the shares of A Ltd. to IHC Ltd. at fair market value.

In this present case, following questions need to be answered considering provisions of GAAR;

(i) Should the beneficial owner of the dividends be considered and therefore construe this as an abuse to apply the GAAR despite the fact that the tax treaty contains no provision in this regard.

(ii) Assume that before interposing IHC Ltd., A Ltd. made sizable profits and has book value higher than original capital contributed by X Ltd. and A Ltd. first declared dividend to X Ltd. which reduced the book value and thereafter X Ltd. transferred shares of A Ltd. to IHC Ltd. thereby resulting into negligible capital gains. Whether GAAR would apply on transfer of shares of A Ltd. made at market value to IHC Ltd. after declaration of dividends?

Now let us also consider a case where, X Ltd. setup another subsidiary Y Ltd. in India for carrying on business in India. IHC Ltd. is considering investing in Y Ltd. out of its accumulated profits (earned from dividends declared by A Ltd.). It is further assumed that the investments to be made by IHC Ltd. in Y Ltd are in compliance with the FDI guidelines. Whether investment by IHC Ltd. into Y Ltd. can be treated as ‘Round Trip Financing’ as defined under DTC?



Case Study 2: A US based multinational company (‘Parent Co.’) registered in Delaware has a subsidiary in Singapore (‘Sing. IHC’) which serves as its regional holding company i.e. the Singapore Company holds business investments in its operating subsidiaries in countries like China, Indonesia, Malaysia, etc. The US Parent Co. decides to set up an operating company in India (‘Indian Co’). For doing so it has options i.e. to hold investments in India either directly from US or through Singapore IHC. Generally, it would be rational decision to hold investment in Indian Co. through the Singapore IHC which also holds investments in many of its other operating subsidiaries in the region. We further assume that the Singapore IHC satisfies the limitations of benefit (‘LOB’) clause of the Singapore-India Tax Treaty (the annual spend of SGD 200,000 amongst other conditions), there should ordinarily be no question of applicability of the Singapore-India Tax Treaty vis-à-vis such investment by the Singapore holding company in Indian Op. Co. Perhaps, the situation in the context of the proposed GAAR will give rise to following issues:

• Would this be termed as an arrangement whose main purpose is to obtain the tax benefit i.e. avoidance of tax under the Indian DTC because of the existence of the capital gains exemption under the Singapore-India Tax Treaty?

• Whether the in the light of proposed GAAR in the Indian DTC, above transaction interposing Singapore IHC could raise a concern of lacking commercial substance even if there are genuine commercial transactions.

Case Study 3:Mr. A is the promoter of XYZ Goods Pvt Ltd. XYZ Goods Pvt Ltd is engaged in the manufacture and sale of sports goods in India. Mr. A is 82 years old and wants to retire gracefully. As a step towards retirement, he has stepped down from the post of CEO of the company and is now only the Chief Mentor for the company and does not look into day to day affairs. Mr. A owns 85% share capital of his company and remaining 15% are held by the middle and top level management. XYZ Goods Pvt Ltd is currently valued at ` 52 crores.

Mr. A has a grandson Mr. K who is 24 years old. K has received admission in National University of Singapore for 15 month MBA program starting academic year 2012-13 (starting July 2012). As a measure of succession planning, Mr. A gifts his holding in XYZ Goods Pvt Ltd. to his grandson, who he wishes would join his company after his studies are completed.

After K completes his studies at NUS, K changes his mind and no longer wants to join XYZ Goods Pvt Ltd but wants to pursue a career in investment banking in US. K has become a resident for calendar year 2013 in Singapore. Since K no longer intends to join XYZ Goods Pvt Ltd, he wants to dispose off the shares and remit the sale proceeds to his grandfather as a gift. Tax advisors to K advice K that he should dispose off all his holding before he goes to US since US tax laws are draconian. Also further that being a Singapore resident, if K would sell his shares before leaving for US, the capital gains would be exempt under Article 13(4) of India-Singapore DTAA. A private investor approached K in Singapore for his stake sale. He therefore sells the entire stake gifted to him by his grandfather, then remits the money back to his grandfather and leaves for US.



Can the aforesaid transaction be characterized as ‘impermissible avoidance transaction’ under GAAR if:

1. The events as elaborated above have taken place genuinely;

2. The events as elaborated above had been pre-planned.

Case Study 4:N Ltd. is a company in India (Country A). It has a branch and subsidiary in Italy (Country B). The principle is that the country where a branch is located (Italy) allows the branch to act as the top entity in that country’s tax group, whereas India (the country of the head office) allows relief for the loss of the foreign branch. In present case N Ltd. having the foreign branch in Italy, suffers tax losses on account of interest paid on debt taken to fund subsidiary operations. While consolidating in India for tax purposes, losses of the branch would be set off against the profits of H.O. N Ltd. However, considering the group taxation regime being adopted in Italy, the Italian branch losses would be adjusted against the income of the O Ltd. Since the benefit of loss at branch is claimed twice both in two different countries, Can Indian tax authorities apply the provisions of GAAR?



Case Study 5:With the progress of globalization, retail groups have increasingly sourced their goods from outside India. This has allowed a business model to be developed where procurement is carried out by a company set up in an appropriate low-tax jurisdiction.

Let us consider a case where presently, A Ltd. India is procuring goods from different suppliers in various jurisdictions for distribution to its stores in India and also globally. Due to increased globalization and sophisticated logistic facilities available at substantially lower rates and also due to connectivity, A Ltd. is contemplating to setup Procurement Co. with all support staff and infrastructure facilities at UAE to procure the goods from global suppliers and also distribute them to Store companies worldwide including India retaining substantial margins at UAE due to various functions performed, assets used and risks (stock being lost or damaged through theft or accident, or becoming obsolete) borne by that company. If the procurement company is not, taxed in the countries where purchases take place, A Ltd. may be able to ensure that the profits of the procurement company are taxed only in UAE where there is no income tax.

A Ltd. wants to take advantage of the group discussion taking place at Mysore in BCAS’ RRC and know in advances before DTC comes into operation, applicability of GAAR provisions.

Whether provisions of GAAR apply in re-structuring contemplated by A Ltd.?



ConclusionA perusal of birds’-eye view of tax avoidance and its counter measures presented in this paper would reveal that tax avoidance is a complex and evolving game and to counter this there are a plethora of techniques practiced by countries around the world ranging from judicial doctrines, SAAR, TAAR and GAAR to administrative measures. It seems to one that various countries are trying to constantly play catch-up with the evolving tax avoidance techniques in a never-ending cat and mouse game.

The key issue is not so much that India is introducing GAAR. What is worrying is the unfortunately frightening certainty of there being uncertainty and unpredictability for the taxpayers in the GAAR implementation by the Indian Revenue authorities. After all, the devil is in the details when it comes to GAAR due to its sweeping reach.

The unanswered questions on the back of everyone’s mind could, no doubt, be:

a) Whether GAAR will be misused as a catch-all mechanism by the Indian Revenue authorities? The past and current behavior of the Revenue Authorities could probably be cause of sleepless nights for the taxpayer once the GAAR provisions are in place. More so, Indian revenue authorities do not want to have clarity on any issues on its own and always have left it to the courts to decide all controversial issues. Whatever limited clarity it had in Indian regulations through Circular 23 of 1969 has also been withdrawn. It is quite an enigmatic situation or “catch 22” situation for the tax payers.

b) How will the Indian Courts interpret the GAAR provisions? Historically, they have been favourable to tax payer when it comes to things like Treaty Shopping (refer Azadi Bachao Andolan) but of late there appears to be a seismic shift in judicial thinking (refer recent judgment of Bombay HC in case of Aditya Birla Nuvo).

And an even more fundamental question is - whether India really needs a GAAR and why won’t the current system of a combination of judicial rulings and SAAR’s and TAAR’s suffice? I hope that the Indian DTC GAAR is not a case of “calm before the storm”. Whether calm or storm, for professionals like us, it is always an opportunity to learn at the cost of others and also earn our day to day livelihood. Participants, I am quite optimistic that one will have meaningful debate which will invariably enrich me, to say for myself.



APPENDICES

Appendix # 1 – Brief portfolio of countries having GAAR provisions under the law

1. Australia Under Part IVA of Income Tax Assessment Act 1936, three elements have to be

found for applications of GAAR provisions: a scheme, a tax benefit, and an objective conclusion (not having regard to the parties’ actual intentions) that the dominant purpose of the scheme was to obtain the tax benefit. Part IVA of the allows the Commissioner to cancel the effects of any tax benefits which a taxpayer derives from an agreement or other arrangement if it could be concluded that a person (not necessarily the taxpayer) entered into or carried out the arrangement for the sole or dominant purpose of enabling the taxpayer, or the taxpayer and other persons, to obtain a tax benefit (not necessarily the tax benefit the taxpayer in fact derives).

In determining if a tax benefit is obtained, there is a comparison of the actual tax position and that which would (or might reasonably be expected to) have been the position if the scheme had not been entered into by the parties. A tax benefit is obtained in any of the following cases where the event would not have occurred but for the scheme:

1. an amount is not included in assessable income;

2. a deduction is allowed;

3. withholding tax is not payable for an amount paid;

4. a company derives a franking credit benefit of a defined type;

5. property is disposed of under a dividend stripping scheme;

6. a capital loss is incurred;

7. a foreign tax credit is allowed; or

8. amounts are converted to discount capital gains.

The purpose of an arrangement is not ascertained by examining what was in the mind of the person who entered into it (i.e., subjective / purposive), but by drawing an inference from certain specified external circumstances (i.e. objective), including:

• the manner in which the arrangement was entered into or carried out:

• the form and substance of the arrangement:

• the time at which the arrangement was entered into and the length of the period during which it was carried out:

• the financial effects of the arrangement; and

• any association between the taxpayer and any other person connected with the arrangement.

When the Commissioner cancels a tax benefit under Part IVA, he can make compensating adjustments if he considers it fair and reasonable to do so.



The Australian Taxation Office has laid down procedure vide practice statement PS LA 2008/15 whereby it can notify aggressive tax planning arrangements and how it would deal with the same.

2. Canada The Canadian tax authorities use a general legislative anti-avoidance rule as well as

rely on judicial anti-avoidance doctrines to combat tax avoidance.

The judicial anti-avoidance doctrines most often relied upon by the Canadian tax authorities are sham, legally ineffective transactions and substance over form.

In Canada, the legislative GAAR is found in Part XVI of the Canadian Income Tax Act. The Canadian GAAR only applies if two broad elements are satisfied. Firstly, an avoidance transaction must have occurred. An avoidance transaction is defined as any transaction that results in a tax benefit unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit. Secondly, it may reasonably be concluded that the transaction would, excluding the operation of the GAAR, have resulted directly or indirectly in an abuse or a misuse of the tax laws, including regulations and treaties. It is not always clear what will constitute such a misuse or abuse in any specific situation.

For GAAR purposes, a transaction includes an arrangement or event. For purposes of the Canadian Income Tax Act, a series of transactions or events includes any related transactions or events completed in contemplation of the series. Further, a tax benefit is a reduction, avoidance, or deferral of tax or other amount payable under the Canadian Income Tax Act. It also includes an increase in a refund of tax or other amount under the ITA.

If a transaction is an “avoidance transaction”, the ensuing tax consequences will be determined in a reasonable manner with the object of denying the “tax benefit” that would otherwise result. For example, the following might occur:

• the disallowance of deductions and tax credits;

• the allocation of a deduction, tax credit, income or loss to another person;

• the re-characterization of any payment or other amount; or

• the ignoring of tax effects that would otherwise result from applying other provisions of the ITA.

If other taxpayers are affected by a determination under the GAAR, they may request a relieving adjustment to avoid double taxation.

The Canadian GAAR explicitly applies to the provisions of Canada’s tax treaties.

3. New Zealand The general anti-avoidance provision in New Zealand is very long-standing, having been

introduced in 1878, and extended to income tax in 1891. As a result, there is a good deal of complex jurisprudence as to its scope and role.



Sec. BG1 of the New Zealand Income Tax Act, 2007 (NZITA) contains the general anti-avoidance provision. It provides that every arrangement made or entered into is absolutely void against the Commissioner of Inland Revenue (CIR) for income tax purposes if and to the extent that, directly or indirectly, one of its purposes or effects (other than merely incidental purposes or effects) is tax avoidance. The GAAR relies on the definitions of ‘arrangement’, ‘tax avoidance’ and ‘tax avoidance arrangement’. “Tax avoidance” is defined to include altering the incidence of any income tax, relieving any person from any liability to pay income tax or avoiding, reducing or postponing any liability to income tax. If an arrangement is found to be void under Sec. BG1 of the NZITA, the CIR can adjust a person’s assessable income to counteract any tax advantage from the arrangement.

Sec. BG1 of the NZITA applies notwithstanding the presence of specific anti-avoidance provisions unless the latter expressly exclude application of Sec. BG1 of the NZITA. Sec. BG1 of the NZITA applies when income tax is avoided, i.e. where a tax liability is reduced without involving the taxpayer in loss or expenditure resulting in that reduction. Sec. BG1 of the NZITA does not apply to tax mitigation, i.e. where a taxpayer mitigates his tax liability by reducing income or incurring expenditure where the NZITA affords a reduction in the tax liability (CIR vs. Challenge Corporation Ltd (1986) 8 NZTC 5,219). However, this does not mean that the courts will still not take account of the purpose of the arrangement and whether, as a result of entering the arrangement, the taxpayer obtains an unfair advantage over other taxpayers (Hadlee and Sydney Bridge Nominees Ltd vs. CIR (1991) 13 NZTC 8,116).

In December 2008 the Supreme Court released its decisions in two important cases dealing with the application of the GAAR, Ben Nevis Forestry Ventures Ltd vs. Commissioner of Inland Revenue ([2009] 2 NZLR 289 (SC)) and Glenharrow Holdings Ltd. vs. Commissioner of Inland Revenue ([2009] 2 NZLR 539 (SC)), which dealt respectively with income tax and goods and services tax (GST – the New Zealand value added tax). The GAAR that apply to the two taxes are not materially different from one another.

These were the first decisions by the new Supreme Court on the vexed question of when proper tax planning crosses the line into impermissible tax avoidance. Although the Court found the taxpayers correctly applied the black letter law in each case, their arrangements were void on the grounds the taxpayers had not truly borne the economic burden required under the particular provisions to warrant the considerable tax benefits obtained.

4. United States The US is a common law jurisdiction. It does not currently have a general statutory

anti-avoidance rule. However, a number of doctrines have been used by the courts to disallow or re-characterize transactions that are undertaken for tax avoidance purposes. These doctrines include the business purpose, economic substance, step transaction, substance over form and sham transaction doctrines. These judicially developed anti-abuse doctrines may be applied in the international context, including when tax treaties are involved.



Substance over form: The “substance over form” doctrine is typically used to disallow tax benefits arising

from transactions in which form differs from substance. In the treaty context, the “substance over form” principle has been used to disregard intermediate entities as mere “conduits” or “shams” used to obtain tax treaty benefits.

Anti-abuse doctrines in US tax law are generally considered to emanate from the US Supreme Court decision in Gregory v. Helvering. In Gregory, a taxpayer established a temporary subsidiary to convert ordinary income to capital gains. The taxpayer was the sole shareholder of a corporation that owned securities with a built-in gain. Rather than have the corporation sell the securities and then distribute the proceeds as an ordinary income dividend, the taxpayer had the corporation transfer the securities to a newly formed, temporary corporation, which was distributed by the first corporation to the taxpayer, and which then liquidated and distributed its assets (the securities) to its sole shareholder (the taxpayer). The taxpayer then sold the securities and claimed that the proceeds were capital gains.

The US Supreme Court, affirming a lower-court decision, disregarded the purported reorganization, stating that the transaction was:

“Simply an operation having no business or corporate purpose – a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. . . . The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction, upon its face, lies outside the plain intent of the statute. To hold otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.”

Sham transaction: In a sham transaction, the tax payer gives effect to a transaction which it does not

carry out or does not intend to carry out or is a cover up for another transaction or relationship. A sham transaction essentially conceals the true nature or reality of a transaction that exists in form only. In short, the legal form is retained but the underlying substance is not genuine in law.

A landmark judgment regarding Sham Transactions is the Knetsch case. In this case, the taxpayer borrowed money at 3.5% to make a return of 2.5% from an investment in annuity issued by insurance company. Investment income was taxed at lower capital gains rate and the interest payments were fully deductible for tax purposes. US Supreme Court treated the transaction as a sham & disallowed the interest paid on the loan. Held there was “nothing of substance to be realized beyond a tax deduction”.

Step transaction doctrine: Under the step transaction doctrine, formally separate steps of a transaction may be

treated as a single transaction for tax purposes. The step transaction doctrine may be viewed as another variation of the “substance over form” principle. In determining whether steps should be integrated under the step transaction doctrine, courts and



the IRS typically have applied three alternative tests. In the strictest test the “binding commitment” test, a series of transactions will be “stepped together” only if, at the time the first step occurs, there is a binding commitment to undertake the subsequent steps. In the “mutual interdependence” test, a series of transactions will be stepped together if the steps were “so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series”. Under the “end result” test, a series of transactions will be stepped together if the parties’ intent at the commencement of the transactions was to achieve the particular result and the steps were all entered into to achieve that result.

Economic substance doctrine: The economic substance doctrine is a judicial doctrine intended “to prevent taxpayers

from claiming tax benefits of transactions, which, although they may be within the language of the Code, are not the type of transaction Congress intended to favor”. Courts typically evaluate whether (a) the transaction has objective economic substance (i.e. a change in the taxpayer’s economic position) and (b) the taxpayer has a subjective non-tax business purpose for entering into the transaction. The economic substance doctrine generally has not been used to invalidate the results of transactions involving the abuse of tax treaties.

Business purpose doctrine: The business purpose doctrine generally requires that a taxpayer have a business

reason, other than avoidance of taxes, for entering into a transaction. Certain tax rules, such as the rules according tax-free status to certain reorganizations, require a business purpose. In the absence of an explicit Code or regulatory business purpose requirement, the business purpose doctrine typically is used by courts via incorporation into other judicial anti-abuse doctrines, the most significant of which is probably the economic substance doctrine.

5. South Africa In South Africa, tax avoidance is combated by applying judicial doctrine of substance

over form as well as statutory GAAR. A new GAAR was inserted into the Income-tax Act 58 of 1962 in 2006 as the legislature was of the opinion that the previous anti-avoidance rule (contained in section 103(1) of the Act) was not effective enough.

The new GAAR is aimed at impermissible tax avoidance schemes. GAAR may be invoked where the taxpayer has entered into a transaction, operation or scheme (“the arrangement”) that meets the following conditions:

• it has the effect of avoiding or postponing liability for any tax, duty or levy imposed under any South African tax law that is administered by the SARS; and

• it either

• was carried out in a manner not normally be employed for bona fide purposes other than tax avoidance; or

• lacks commercial substance; or



• has created rights or obligations which would not normally be created between persons dealing at arm’s length; or

• would directly or indirectly result in misuse or abuse of any provision of the Income-tax Act.

Lack of commercial substance is evidenced by the following:

1. the arrangement, while conferring a significant tax benefit on a party, does not have a significant effect on any party’s business risks or net cash flows from the arrangement (apart from those attributable to the tax benefit);

2. the legal substance of the arrangement as a whole is inconsistent with, or differs significantly from, the legal form of its individual steps;

3. the presence of round trip financing (described as a funds transfer between the parties that significantly offsets, reduces or eliminates any business risk incurred by a party to the arrangement);

4. the presence of an accommodating or tax-indifferent party (described as a party for whom the amounts received from the arrangement are not subject to normal tax, or the tax liability is significantly offset by an expenditure incurred by this party in terms of the arrangement);

5. The presence of elements that have the effect of offsetting or cancelling each other.

In addition, the tax avoidance motive is presumed where the arrangement directly or indirectly results in a misuse or abuse of any provisions of the Income-tax Act.

If the above requirements are met, the SARS may:

• disregard, combine or recharacterize the arrangement or any step thereof;

• disregard any accommodating or tax indifferent party or treat this party and any other party as one and the same person;

• determine the parties who are connected persons in respect of each other as one and the same person;

• reallocate any income or expenditure between the parties;

• re-characterize any income of a capital nature as income of a revenue nature;

• treat the transaction as if it has not been carried out, or in any other manner that in the SARS’s view is adequate for the prevention or diminution of the tax benefit.

Where it is proved that the arrangement would result in a tax benefit, the tax avoidance motive will be presumed, until the party obtaining the tax benefit proves that, reasonably considered in the light of relevant facts, the tax benefit was not the sole or main purpose of the arrangement. In short, the taxpayer can rebut the presumption of tax avoidance by demonstrating a bona fide commercial reason for either the whole arrangement or any step thereof that carries the characteristics described above.



South African GAAR requires the Commissioner to give a taxpayer notice that he or she believes that the GAAR may apply to the taxpayer. The taxpayer may then submit reasons why the GAAR should not apply, before the Commissioner may apply the GAAR.

As the new GAAR is a relatively new provision, no court cases exist on its interpretation.

6. United Kingdom The UK does not have a General Legislative anti- avoidance rule. However, Jugde made

anti-avoidance rule have been developed by Courts by building on WT Ramsay Ltd vs. IRC and Eilbeck vs. Rawling (1981) 1 AER 865, and as laid down by Lord Brightman in Furniss vs. Dawson (1984) STC 153 and reaffirmed in IRC vs. McGuckian (1997) 3 AER 817, transactions will be disregarded for tax purposes where:

1. There is a composite or a preordained series of transactions which may or may not include the achievement of business purposes; and

2. Steps are inserted which have no commercial purpose other than the avoidance of a tax liability.

The Courts are free to examine the real economic substance of the transaction.

The Disclosure of Tax Avoidance Schemes (DOTAS) regime came into force on 1 August 2004 which introduced an obligation to report to HMRC certain tax avoidance arrangements. Where an arrangement is notifiable, the promoter must, within a specified time, provide HMRC with details of the arrangement. In certain cases, the obligation to report is shifted from the promoter to the user of the scheme.

Recently HM Treasury announced that a notified a study group of experts will work on the study to explore the case for a GAAR in the United Kingdom. The topics that the study group will consider include:

— Consideration of the existing experience with GAARs and other anti avoidance principles in other jurisdictions;

— What a UK GAAR could usefully achieve; and

— What the basic approach of a GAAR should be

The study will also consider whether or not a GAAR could deter and counter tax avoidance, at the same time providing certainty, retaining a tax regime that is attractive to business, and minimizing costs for businesses and HM Revenue & Customs.

7. Belgium General anti-avoidance provisions were introduced by the Law of 23 July 1993 which

applies to transactions concluded from 31 March 1993 (Art. 344(1) ITC). The tax authorities may disregard the characterization given by the parties and recharacterize any transaction or series of transactions entered into by the taxpayer if the authorities can establish (by presumption or proof) that the characterization chosen by the taxpayer was with sole purpose to avoid tax. However, the taxpayer can overcome such proof by establishing that the transaction was also entered into because of legitimate financial or economic needs.



8. Austria It is a well-established principle of Austrian tax law that taxpayers are free to arrange

their economic affairs in the manner they deem most beneficial for them but within broad limitations under GAAR.

Sec. 22 of the Federal Fiscal Code provides that tax liability cannot be circumvented or reduced by an abuse of legal forms or arrangements. If such an abuse has been established, the tax authorities may compute the tax as if such abuse had not occurred. Additionally, Sec. 23 of the Federal Fiscal Code provides that sham transaction will be disregarded and that taxation will be based on the facts the taxpayer sought to conceal. In such cases the tax authorities are required to prove its contention.

The true meaning of Sec. 22 is under dispute in Austria and has resulted into two main schools of thinking. The prevailing opinion amongst legal scholars is that sec. 22 is merely an expression of an economic approach of taxation, leading to a specific focus on systematic and teleological interpretation (so-called Innentheorie). While Austrian tax administration and Austrian courts view sec. 22 as a provision that supplements other substantive provisions (so-called Aussentheorie). In addition, a transaction cannot, under the case law of the Supreme Administrative Court, be successfully challenged by tax authorities if a tax benefit, which is the main purpose of the transaction, has been provided for in the domestic tax law or any Austrian tax treaty (e.g. tax sparing).

However, the Austrian Constitutional Court takes the position that attention must be paid to the purpose and the economic background of the law when interpreting the tax rules the taxpayer wants to circumvent.

9. Cyprus As per Sec. 33 of the Assessment and Collection of Taxes Law, The Commissioner of

Income Tax may disregard any artificial and/or fictitious transactions and assess tax on the person concerned, accordingly.

10. China The new EIT Law introduced a first-time general anti-avoidance provision in 2008.

Article 47 of the EIT Law provides that the tax authority has the authority to make adjustments to cases where enterprises enter into arrangements lacking justified commercial reasons.

The following are the targets of a general anti-avoidance rule investigation:

— abuse of tax incentives;

— abuse of treaties;

— abuse of the corporate structure;

— use of tax havens for the avoidance of taxes; and

— other business arrangements without bona fide commercial purposes.

Tax authorities are required to follow the principle of substance-over–form and take the following factors into account in the application of general anti-avoidance rules:



— form and substance of the arrangement;

— time of establishment and duration of the arrangement;

— form of implementation;

— inter-relationship between the steps and components of the arrangement;

— changes in financial situations affected by the arrangement; and

— tax consequences of the arrangement.

11. Hong Kong Anti-avoidance rules are to be found in Secs. 61, 61A of the Inland Revenue Ordinance

(IRO). Taxation assessor while determining a person’s liability to taxation may disregard transactions that reduce or would reduce the amount of tax payable, and which appear to be artificial or fictitious (Snook vs. London and West Riding Investments Ltd. (1967) 1 All ER 518).

Sec. 61A of the IRO is loosely modeled on the Australian legislation contained in Part IVA of the Australian Income Tax Act. The legislation has been effective as from 13 March 1986. Where a conclusion is reached that a transaction is entered into after that date was carried out with the sole or dominant purpose of gaining a tax advantage by referring to the following seven matters listed in Sec. 61A, the Assistant Commissioner may disregard the transaction or issue an assessment to counter the advantage which would otherwise accrue to the taxpayer:

a) the manner in which the transaction was entered into or carried out;

b) the form and substance of the transaction;

c) the result in relation to the operation of the IRO that, but for Sec. 61A, would have been achieved by the transaction;

d) any change in the financial position of the relevant person that has resulted, will result, or may reasonably be expected to result, from the transaction;

e) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant person, being a change that has resulted or may be reasonably expected to result from the transaction;

f) whether the transaction has created rights or obligations which would not normally be created between persons dealing with each other at arm’s length under a transaction of the kind in question; and

g) the participation in the transaction of a corporation resident or carrying on business outside Hong Kong.

It has been held that where all the matters are not present to determine whether Sec. 61A is applicable, the matters which are present are considered.

The practice notes issued by the Commissioner state that Sec. 61A will only be used in cases of blatant tax avoidance or contrived tax avoidance arrangements but should not



affect normal commercial transactions. Sec. 61A has been extensively used in Salaries and Profits Tax cases.

12. Hungary There is a general anti-avoidance rule which allows the tax authorities to ignore the

legal form of an arrangement between entities and to look at the actual substance or genuine purpose of a contract or transaction. Further costs, expenditures and losses related to a contract or a transaction are not deductible for corporate income tax purposes if the purpose of such contract or transaction is merely to achieve tax advantages. Hungarian GAARs are very similar to German and Austrian tax law provisions.

An “abuse of law” doctrine applies in Hungary to contracts and transactions entered into or performed. This means that rights and transactions must be exercised and carried out properly and lawfully, in line with their specific purpose. The doctrine allows the tax authorities to assess, on the basis of all relevant facts and circumstances, tax liabilities stemming from contracts, transactions or other arrangements which are considered to have the sole purpose of circumventing tax provisions and avoiding taxes.

13. Switzerland The General Anti-Avoidance Doctrine laid down by the Federal Supreme Court states

that a transaction may be disregarded for tax purposes if the following three conditions are fulfilled:

1) the legal structure used by the taxpayer is abnormal or artificial and has no commercial basis

2) tax considerations are deemed to be the only motive for the transaction; and

3) the transaction results in a significant tax benefit for the taxpayer.

If all the conditions are fulfilled then, in such a case, the real facts are disregarded and replaced by those facts that would have been appropriate to achieve the intended objective. These deemed facts fulfill the statutory requirements of the taxable event and, consequently, trigger the taxable event.

Therefore even though there is no statutory provision in Swiss federal individual and corporate income tax law, this doctrine laid by the Federal Supreme Court exists in Swiss federal income tax laws.

14. Turkey Turkish Tax Procedure Law provides the general anti-abuse provision under the rules

on the burden of proof. According to this provision, the true substance of the taxable event and the transactions related to this event prevails. In a case where a situation is not usual and ordinary, and does not follow the economic, technical and commercial necessities, the burden of proof rests on the taxpayer.

The general anti-abuse provision allows the tax authorities to disregard a civil law form used by a taxpayer seeking a result of another legal form which would avoid taxation and to replace it with another form which reflects the true situation.



Under a specific anti-avoidance rule, which was included in the Corporate Income Tax Law (Sec. 30(7)) with effect from 1st January 2006, payments to recipients in low-tax jurisdictions are subject to a 30% withholding tax. In particular, this withholding tax is levied on payments made by a resident company to:

1) its foreign permanent establishment engaged in any activity in a low-tax jurisdiction;

2) a company resident in a low-tax jurisdiction; and

3) a non-resident company’s foreign permanent establishment engaged in any activity in a low-tax jurisdiction.

Payments not subject to this withholding tax include insurance and reassurance premiums, and the principal and interest on loans taken from foreign financial institutions.

The decision whether a jurisdiction is deemed to be a low-tax jurisdiction is made on the basis of a comparison between the Turkish tax burden and that of the other jurisdiction. An expected list of low-tax jurisdictions is yet to be issued by the Council of Ministers.

15. Singapore Singapore has a specific provision, Sec 33 under its income tax laws relating to general

anti-avoidance provision. It empowers the Comptroller to counteract any arrangement that has the purpose or effect of avoiding or reducing tax by:

1) disregarding the arrangement;

2) varying the arrangement; or

3) making appropriate adjustments, including:

— recomputing the gains or profits; or

— re-evaluating the tax liability.

“Arrangement” is defined as meaning “any scheme, trust, grant, covenant, agreement, disposition, transaction and includes all steps by which it is carried into effect”.

The provision applies where the Comptroller is satisfied that the purpose or effect of any arrangement is directly or indirectly to:

1) alter the incidence of any tax payable by any person;

2) relieve any person from any liability to pay Singapore income tax or file a Singapore income tax return; or

3) reduce or avoid any liability imposed or to be imposed on any person under the Income-tax Act

Sec. 33 does not apply to arrangements entered into before 29 January 1988 nor does it apply to arrangements entered into for bona fide commercial reasons. However, even if the arrangement is for a bona fide commercial reason, the taxpayer must still prove that tax avoidance is not one of the main purposes of the arrangement. This is a subjective test requiring a look into the mind of the taxpayer to discover whether



tax avoidance is one of his main purposes. If such is his purpose, the Comptroller is empowered to disregard, vary and make adjustments to the arrangement whether or not a bona fide commercial reason exists.

The Comptroller will take into consideration whether the transaction is artificial, that is, whether the transaction is so inspired by tax considerations that it no longer retains the nature of a trading transaction. The Comptroller will also consider whether various intermediaries or transactions have been interposed to reduce or avoid tax and whether transfer pricing has occurred.

Although Sec. 33 of the income tax act is widely drawn, the Inland Revenue Authority of Singapore has expressed the view that it is targeted only at blatant and artificial tax avoidance schemes, and not intended to catch genuine commercial arrangements with incidental tax avoidance effects.

16. Russia Russian tax law does not provide for a general anti-avoidance rule comparable

to the substance-over-form principle. The courts and tax authorities, however, apply the concept of “unjustified tax benefit”, the meaning of which is clarified by court decisions. The Russian Supreme Arbitration Court gave certain criteria that might be indicative of tax evasion and therefore of “unjustified tax benefit”. The unjustified tax benefit doctrine operates with the concepts of fictitious/sham transactions, taxpayers’ due diligence and legal reclassification of transactions. The cornerstone of the unjustified tax benefit concept is the assumption that a taxpayer is acting in good faith. The assumption is rebuttable, though. The tax authorities may challenge use of tax benefits by the taxpayers in certain circumstances, for example:

1) where the transactions are documented or accounted for by the taxpayer contrary to their true economic substance;

2) where the activities of the taxpayer had no underlying reasonable economic grounds (no business purpose);

3) where the taxpayer was unable to perform the documented or accounted transactions or to achieve the reported economic goals due to lack of time or resources (e.g. staff, production capacity, etc.);

4) where the taxpayer had a relationship with the counterparties (either customers or suppliers) who were knowingly involved in tax evasion (in particular, this concerns individuals or legal entities affiliated with the taxpayer).

However certain factors per se, may not be deemed to be evidence of unjustified tax benefit, these include:

1) the absence of ability to produce or deliver goods or services under a contract;

2) absence of qualified personnel or equipment necessary for fulfilling contractual obligations;

3) Supplementary indications include one-time unusual transactions;

4) wide use of intermediaries;



5) tax offences committed in the past;

6) conducting business mainly with contractors committing tax offences and;

7) conducting transactions outside of the taxpayer’s “seat”.

In case of a conflict between the legal form and the substance of a transaction, a court must define tax obligations in accordance with its substance.

17. Spain Spanish legislation contains a wide range of anti-avoidance measures, specifically

articles 13 (certification), 15 (conflict in application of tax provisions), and 16 (simulation) of the General Tax Law (GTL). These allow the tax administration to eliminate tax advantages that the taxpayer can sometimes obtain by using acts or legal transactions that have a legal form that does not correspond to or is not typical of the economic result obtained.

Article 15(1) of the new GTL considers there to be conflict in application of tax provisions when a taxable event is completely or partially avoided or the tax base or debt is reduced through acts or transactions that all have the following characteristics:

(a) that those acts or transactions taken in isolation or in the aggregate are notoriously deceptive or improper to attain the result obtained;

(b) that from their implementation no relevant legal or economic effects result, distinct from tax savings and the effects that would have been obtained through the usual or proper acts or transactions.

Article 15 of the GTL of 2003 objectifies the budget for the application of the anti abuse clause, which would be implemented on acts or transactions that from an objective standpoint were “notoriously deceptive or improper to attain the obtained result”, and whose legal and economic effects are not distinct from tax savings and whose effects could have been obtained through the customary or proper acts and transactions.

Article 16 of the GTL, provides that tax can be levied by reference to the substance and not the legal form of a transaction.

18. Sweden The Law against Tax Avoidance applies to the national (corporate and individual)

income tax and the municipal income tax (applicable to individuals). According to this law, a transaction may be deemed a method of tax avoidance, and the transaction may be disregarded for tax purposes, if all of the following requirements are met:

1) the transaction, alone or in conjunction with another transaction, results in significant tax benefit for the taxpayer;

2) the taxpayer is, directly or indirectly, a party to the transaction;

3) such tax benefit is assumed to have been the predominant reason for the transaction; and



4) recognizing the transaction for tax purposes would be in violation of the spirit or purpose of the law

The tax agency on its own accord cannot apply the Anti-Avoidance Act, it has to request the courts to do so. There also exist the doctrine of substance over form and the courts are not bound by the legal form of the transaction and can disregard the transactions which are sham or pseudo-events.

19. Denmark There is no statutory general anti-avoidance provision, but the courts have, in several

cases, applied a substance-over-form principle. The burden of proof lies, as a starting point, with the tax authorities if they seek to disqualify corporate transactions for tax purposes with reference to the substance-over-form principle.

In October 2003, the Danish Supreme Court issued a significant decision suggesting that the substance-over-form principle has a narrow scope of application and may only be applied for the purpose of rejecting tax benefits which were created as a result of an actual tax loophole.

20. Portugal The Code on Tax Procedure and Appeals (CPPT) contains a general anti-avoidance

provision. Under Article 63 of the CPPT, a transaction is void if it is proven that its principal objective, or one of the principal objectives, was the reduction or elimination of tax that would otherwise be due. In such a case, the transaction will be subject to normal taxation. The procedure of adjustment may be initiated within 3 years from the beginning of the following year or the completion of the legal acts and agreements subject to the anti-avoidance provisions.

Unless otherwise indicated in the law, the use of the anti-avoidance provision also requires that such decision include the following:

1) the description of the agreement signed or the operation or act performed by the taxpayer and its true economic substance;

2) the indication of the elements that undoubtedly prove that such act, contract or transaction had, as its sole or main intention, the reduction or elimination of tax which would be otherwise due. When using the anti-avoidance provision, the tax authorities must prove what was the act, contract or transaction which was not carried out and which would have had the same economic effect; and

3) the description of the acts of similar economic substance that could have been carried out instead of the act, contract or transaction that was carried out (in substitution of the one that was intended to be carried out, but it was not since it was not tax efficient), and the legal provisions that would have then applied.

The tax authorities cannot, however, apply this anti-avoidance provision without giving the taxpayer an opportunity to present his arguments in advance. The right granted to the taxpayer to challenge the tax authorities’ views may be exercised within 30 days of the date on which the relevant notice was served to the taxpayer.



In addition, the Corporate Income Tax Code contains rules on tax-driven mergers, divisions, transfers of assets or exchanges of shares and rules on payments made to entities resident in a low-tax jurisdiction.

The anti-avoidance provision cannot be applied if the taxpayer had requested a ruling arguing the same facts on which the agreement or the operation has been based and the tax authorities had not replied within a 90-day period after the ruling application was filed.

Portugal has also introduced a tax disclosure regime for tax planning, whereby entities that render services on tax and compliance issues are mandatorily obliged to report to the Portuguese tax authorities any proposed tax planning exclusively or predominantly aimed at achieving a tax advantage. The rule may be perceived as also having an international effect, since among the listed transactions that should mandatorily be disclosed are those involving low-tax jurisdictions and financial transactions involving the use of hybrids, which are commonly structured in a cross-border setting.

21. Poland Polish General Tax Act contains provisions relating to general anti abuse. This new

provision determines how the tax authorities should interpret the legal relations between the taxpayers. In doing so the authorities must take into account the aim and the commonly agreed intention of the parties, and not only the literal content of their statements. Consequently if under the cover of a simulated legal act, another legal act has been concluded, the tax consequences should be derived from the hidden legal act and not from the pro-forma contract. This serves to establish the existence or non-existence of a particular right or legal relation in civil law. Thus, it does not give them any powers to reinterpret such relations or to reattribute income to another person. Further, in case of doubt such determination must be made via civil proceedings in common courts whose decisions are binding upon the tax authorities.

22. Brazil The National Tax Code provides a general anti-avoidance provision, under which tax

authorities may disregard juridical acts and contracts provided that their main purpose is the reduction or elimination of tax that would otherwise be due. The general anti-avoidance rule is applicable to both domestic and international transactions artificially carried out with the sole intention of tax evasion or tax avoidance. After the enactment of general anti-avoidance provision in 2003, the courts decision on domestic planning lead to conclusion that only tax evasion (duly proven by evidence) and tax avoidance acts without an underlying legal cause may attract general anti-avoidance provisions.

23. Malaysia Anti-evasion rules include:

• A person who leaves or attempts to leave Malaysia without paying outstanding taxes and penalties is liable to a fine of between MYR 200 and MYR 2,000 or to imprisonment for up to 6 months or both

• Furthermore, the DGIR (Director General of Inland Revenue) may issue a certificate and request preventing departure (Sec. 104 ITA). The DGIR does not have to show that the taxpayer intends to leave Malaysia permanently



• Customs clearance from any port, aerodrome or airport in Malaysia may be refused to any ship or aircraft wholly or partly owned or chartered by a person who has failed to pay tax for more than 3 months on his sea or air transport business until the tax is paid

Tax may be recovered by the government by civil proceedings as a debt due to the government. The Court may not entertain any plea that the tax is excessive, incorrectly assessed, under appeal or incorrectly increased. Sec. 106(3) of the Income Tax Act 1967 renders a judgment, obtained in any civil proceedings to recover income tax due and payable, not susceptible to subsequent attack by the taxpayer on the grounds that the judgment sum was excessive or incorrectly assessed.

24. Luxembourg Luxembourg tax law primarily refers to general tax rules to counteract tax avoidance in

an international context. This is mainly due to the fact that the Luxembourg legislator has not implemented any specific controlled foreign company (CFC) legislation (and has not declared any intention to do so) and may not introduce any treaty overriding clauses as treaties are considered to be specific law that prevails over domestic law. The general anti avoidance provisions with international focus or effect can be is outlined as follows:

• Anti – abuse provision

Luxembourg tax law defines in general anti abuse concept: “Taxes may not be evaded or mitigated by abuse of forms or constructions which are legal under civil law. In the case of abuse, taxes should be levied as they would have been levied under the legal construction appropriate to the economic operations, facts and circumstances”.

In application of the general anti-abuse provision the Luxembourg tax authorities may, for instance, disallow tax benefits achieved by implementation of an abusive legal structure. It is, however, a jurisdictionally recognized principle that the taxpayer may, from all possible structures, choose the least taxed one. A structure is considered abusive in principle where the taxpayer establishes a structure which will serve to reduce taxes and which is not justified by economic or other non-tax arguments, or is inappropriate for the realization of the purpose of the transaction.

• Simulation

Under the concept of simulation a pretended legal or other transaction is disregarded for Luxembourg tax purposes if the tax authorities are aware of the fact that the involved parties do not really intend the pretended transaction but are using this transaction only to hide the real transaction. Under this concept for instance a simulated domicile would be disregarded.

• Substance over form principle

Based on the principle that tax collection must be based on the economic capability of the taxpayer, it is a generally applied principle in Luxembourg tax law that a transaction is to be analyzed based on its economic substance



instead of its legal form if the economic substance varies from the legal form. In application of this principle legal debt may, for instance, under certain conditions for tax purposes be qualified as equity.

• Economic ownership

Generally, assets which are in a taxpayer’s legal ownership and possession are for fiscal purposes allocated to this legal owner. However, if the economic owner of an asset is not identical with the legal owner, the asset will generally for fiscal purposes be allocated to the economic owner of the asset. The economic owner of an asset is defined as “someone who generally exercises the effective authority over an asset in such a way that he is able to exclude the owner of the asset from his economic influence on the asset during the expected lifetime of the asset”.

25. Ireland There is no presumption or inference that a transaction disclosed under the rules is

necessarily a tax avoidance transaction within the General Anti-Avoidance Rule.

Two provisions are potentially relevant, one statutory (section 811) and one a civil law concept (“abusive practice”).

Section 811 allows the Irish Revenue Commissioners to form an “opinion” that a transaction or series of transactions constitutes a “tax avoidance transaction”, to then calculate the “tax advantage” of this deemed avoidance transaction and to withdraw this advantage by determining the “tax consequences”. A tax avoidance transaction is one where the Irish Revenue Commissioners form the opinion that a transaction gives rise to a tax advantage (e.g. a reduction, avoidance or deferral of tax) and is undertaken primarily to obtain such advantage.

Section 811 provides that a transaction will not be caught if it is undertaken for bona fide business purposes and not primarily for tax avoidance purposes or was undertaken to make use of a relief in a non-abusive manner. The Irish Revenue Commissioners’ opinion may be appealed only on grounds specified in the section, before the Irish Appeal Commissioners with a right of rehearing available to a taxpayer before the Irish Circuit Court, the Irish High Court and the Irish Supreme Court.

Abusive practice — A body of anti-avoidance law is developing at European level through the European Court of Justice. There is overlap between the doctrine of abusive practice and section 811. In both cases, for a transaction to be considered to be abusive, or giving rise to tax avoidance, a tax advantage must exist. In both cases the tax advantage must be the primary purpose of the transaction. European doctrine uses the term “essential aim” while section 811 uses the term “primary purposes”.

In general, the Irish courts have refused to depart from a strict legal analysis even if a transaction is highly artificial and designed primarily or exclusively in order to avoid or reduce a tax burden. In some cases, the legislation is couched in broadly substantive (rather than legalistic) terms, leaving greater latitude to the courts. In other cases, reliefs or exemptions may be denied if there is a primary (or possibly any) tax avoidance purpose, although what is meant by avoidance in these contexts is debatable.



A taxpayer will be liable to interest plus a surcharge of 20% on any additional tax due as a result of a transaction being successfully challenged under these provisions by the Revenue Commissioners. The Revenue Commissioners’ opinion must be upheld on appeal unless it is unreasonable. These penalties may be avoided and a stricter burden placed on the Revenue Commissioners to justify their opinion if the taxpayer discloses full details of the transaction to the Revenue within 90 days of the commencement of the transaction. Where such a disclosure has been made, the Revenue must form their opinion within 2 years from the date thereof. Where all parts of the avoidance transaction occurred prior to 19th February 2008, a less onerous regime applies. There are no provisions for advance clearances.

With effect from 17th January 2011, there are mandatory disclosure obligations in force for promoters of certain tax avoidance schemes, which display specific features as laid down by the legislation. The promoter (generally a tax adviser or a bank) is required to furnish prescribed details of the scheme to the Revenue Commissioners shortly after they are first marketed or made available for use. Alternatively, where the promoter is based offshore or claims legal professional privilege, or the user has entered into a transaction not involving a promoter, the user instead must provide the necessary information.

26. Korea Generally, as far as anti-tax avoidance regimes are concerned, Korean tax laws contain

substance over form provisions and a number of specific anti-tax avoidance provisions. In other words, Korea has not legislated any general anti-avoidance rules other than substance over form provisions in its domestic tax law particularly designed to combat only tax avoidance cases. In so doing, Korean tax law has failed to clearly define the concept of tax avoidance and the benchmark criteria generally applicable to deny tax benefits.

The substance over form principle was codified in the BNTA during the 1960s. Since then, it has further developed to encompass the concepts of step transactions, economic substance, and the purpose of unduly claiming benefits, which constitute the main conceptual elements of the general anti-avoidance rule in many foreign countries. This development culminated in the parallel adoption of the aforementioned rule in the Law for Coordination of International Tax Affairs (LCITA), which purports to expand the applicable scope of the principle even to cases subject to tax treaty application.

Article 14 of the BNTA consists of three paragraphs. The first paragraph states the taxation principle based upon real ownership – not nominal ownership – and the second one prescribes a principle that taxation should follow substance regardless of name or form. The third paragraph, newly introduced in December 2007, contains the taxation principle based on the economic substance of the overall transaction by integrating a series of supposedly separate steps in a transaction.

“Article 2-2 of the LCITA (Taxation based on the substance over form principle applicable to cross-border transactions)

• In the case of a cross-border transaction, if a person to which any income, revenue, property, activity or transaction that is the subject of taxation is



attributable in name is different from a person to which such income, revenue, property, activity or transaction is attributable in substance, the latter mentioned person shall be the taxpayer, and tax treaties shall be applied accordingly.

• In the case of a cross-border transaction, provisions regarding the calculation of the tax base shall be applied based on the substance of the relevant income, revenue, property, activity or transaction, regardless of any term used to refer to them or forms thereof, and tax treaties shall be applied accordingly.

• If a cross-border transaction recognized as having been consummated for the purpose of unduly claiming benefits under tax treaties and the LCITA by way of indirect means involving a third party or use of two or more activities or transactions, tax treaties and the LCITA shall be applied by regarding it as being entered into directly or as a single continuous activity or transaction, depending on the economic substance.”

Paragraph 3 above is particularly significant in a sense that it introduced some important concepts comprising the main conceptual elements of a general anti-avoidance rule in many foreign countries, such as step transactions, economic substance, and the purpose of unduly claiming benefits, into the LCITA.

27. Germany The general anti-abuse provision in Germany is in Sec. 42 of the General Tax Code

(GTC). Under the old version of that section, a structure was considered an abuse if it was unusual and if it was chosen exclusively for fiscal reasons. From 1 January 2008, the amended Sec. 42 of the GTC is applicable if an inappropriate legal structure is chosen that leads to a tax advantage for which the taxpayer cannot provide significant non-tax reasons. A legal structure is considered inappropriate if the taxpayer or a third party generates a tax benefit that is not intended by the law. Indicators for an inappropriate legal structure are:

• if a third party, on considering the economic facts and effects of the structure, would not have chosen the same legal structure without the generated tax benefit;

• the interposition of relatives or other closely related persons or companies solely for tax purposes; or

• the transfer or shifting of income or capital assets to other legal entities solely for tax purposes.

The amended section also includes a clear hierarchy, i.e. specific anti-abuse rules according to applicable tax laws have to be applied on a step-by-step basis, after which the general anti-abuse provision can become applicable. If there is an abuse of law, the structure is disregarded for tax purposes, and the tax arises in the same way as if a normal structure had been used.

28. France French tax law provides for three general anti-abuse provisions which may have an

international effect:



• the abuse of law procedure allows the France tax authorities (FTA) to disregard a legal arrangement when certain conditions are met;

• aside from the abuse of law, the FTA may reclassify a transaction based on the actual intent of the parties. The difference from the abuse of law may be very slight but this provision applies even where the intention may not be tax avoidance;

• the abnormal act of management provision allows the FTA to challenge the tax deductibility of an expense which is not made in the interest of the taxpayer/ company, i.e. which does not correspond to a sound business decision. It is applicable both to domestic and international arrangements.

The 2008 Amending Finance Act extended the scope of the abuse of law with the introduction of the general principle of fraus legis. The legal definition of the abuse of law now includes contracts, conventions or any other arrangements which are:

(a) either fictitious or

(b) real, but where the transaction aims solely at evading tax normally due, and results in a tax advantage the grant of which would be, notwithstanding the formal application of the conditions laid down by the provisions of laws or other relevant texts, contrary to the purpose of those provisions.

The abuse of law, which now includes fraus legis, may apply to every tax benefit. It may still trigger an 80 per cent penalty, which is reduced to 40 per cent for tax -payers who did not initiate the abuse of law or were not its main beneficiaries. All parties involved in a transaction regarded as an abuse of law may be held jointly liable. The burden of proof on the intention to conceal or disguise income for tax avoidance purposes must be demonstrated by the FTA unless the review by an independent committee is in favour of the FTA.

In summary, the application of the abuse of law theory broadly depends on a case-by-case analysis and on whether the FTA is able to demonstrate the absence of a single business purpose and, if so, a contradiction with the objective of the tax measure which is claimed by the taxpayer.

29. Israel Section 86 — The main Israeli domestic anti-avoidance provision is section 86 of the

Israeli Tax Ordinance. This is a general anti-avoidance provision which permits a tax assessing officer to disregard a transaction which is sham, artificial or fictitious, or one in which the principal objective is an improper avoidance or reduction of tax.

Substance over form -— In addition to the specific provisions of section 86, the Israeli courts have recognized the “substance over form” doctrine as an accepted principle of Israeli law. In essence, the “substance over form” doctrine enables the ITA to recharacterize transactions according to their economic substance rather than according to the actual form.

The main difference between section 86 of the Tax Ordinance and the “substance over form” doctrine lies in the burden of proof. Usually, under Israeli law, the burden of proof is on the taxpayer to demonstrate that the assessment which was issued by the



ITA is not correct. However, if the ITA bases its assessment on the above section 86, it reverses the burden of proof with the result that it is the ITA which is required to justify its position. On the other hand, if the ITA bases its assessment on the “substance over form” doctrine, then the burden of proof remains with the taxpayer who should demonstrate that the ITA’s assessment is incorrect.

Both section 86 and the “substance over form” doctrine apply in international as well as in domestic situations. Although there is no case law in Israel which directly deals with these anti-avoidance provisions within an international context, these two doctrines are usually used by the ITA in cases having an international aspect as well.

30. Japan Japan has for a long time countered taxpayers’ attempts to avoid Japanese taxation,

particularly in the international context. These involve both Japanese source-based taxation on foreign taxpayers, and Japanese residence-based taxation on Japanese resident taxpayers.

• Taxation upon substantial income earner provisions Section 11 of the Corporation Tax Act (CTA) provides that “where a person to

whom the revenue from assets or business seems to be legally imputed is merely nominal, that is, the person does not enjoy the revenue, but a corporation other than the said person is enjoying the revenue, the revenue shall be considered as being reverted to the corporation which enjoys the revenue, and the provision of this Act shall apply.”

Section 12 of the Income-tax Act (ITA) has substantially the same provision. While there are debates among commentators on the meaning of these provisions, the prevailing understanding is that these provisions require that taxation shall be made not upon a mere nominal party to whom the relevant income is claimed to be attributed (e.g. a party whose name appears on contracts giving rise to the relevant income) but upon a party who is a true and substantial legal owner and earner of the relevant income (i.e., the true party in a legal sense).

These are “old-and-cold” provisions contained in the ITA and the CTA from long ago, and are very generally and broadly written. Despite this, even today these provisions are often used as a tool for the Japanese tax authority to disallow tax avoidance transactions, especially international ones involving abusive use of tax treaties.

• General provision on computation of corporate taxable income Section 22(2) of the CTA provides that “in computing taxable income for each

accounting period of a Japanese corporation, the amount to be included in gross revenue in the accounting period shall, unless otherwise provided, be the amount of revenue in the said accounting period from sales of assets, onerous or gratuitous transfer of assets, or rendering of service, or gratuitous acquisition of assets, or any transactions other than capital transactions”.

The Japanese courts and the tax authority have interpreted this provision as mandating corporate taxpayers to recognize taxable income which will equal the



fair market value of the assets sold or services provided by the taxpayer, even if no consideration is actually received or the consideration received is below the fair market value. In this sense, this provision will effectively function to impute income of corporate taxpayers on a fair market value basis so long as they engage in taxable transactions. Because such imputation of income on a fair market value basis will apply to transactions where foreign persons are counterparties, this will have an effect of discouraging tax-avoiding transactions intended to shift capital gains out of Japan while untaxed in Japan.

• General provision on Japan source income taxable on foreign taxpayers Section 161(1) of the ITA and section 138(1) of the CTA provide for an item of

Japan source income taxable upon non-residents and foreign corporations, that is, “income derived from management and ownership of property located in Japan”.

This item is provided as a catch-all to capture income that does not fall under any of the other specifically enumerated items of Japan source income (e.g. interest, dividends, etc.). Moreover, under Japanese tax rules, non-residents and foreign corporations earning “income derived from management and ownership of property located in Japan” are subject to tax in Japan and must file tax returns to report that income, even if they have no PE within Japan.

• Finding a PE in Japan Japanese domestic tax laws, or the ITA and the CTA, embrace a concept

substantially similar to the PE as generally provided in tax treaties. The concept of a PE, whether it is provided in domestic tax laws or tax treaties, is not by itself an anti-avoidance provision. However, in practice, where tax avoidance by foreign tax payers substantially doing business in Japan (who, however, in most cases, intentionally avoid having a PE in Japan as a matter of structuring) becomes an issue, finding a PE of the foreign taxpayer in Japan is clearly recognized as one of the possible measures to secure Japanese source-based taxation from the foreign taxpayer.

Because finding a PE is essentially a matter of fact-finding, the tax authority must be able to conclude that, based upon all the relevant facts and circumstances concerning the case, the foreign taxpayer has a branch, office or other fixed place of business in Japan, or a so-called dependent agent in Japan. With respect to such an approach, some practitioners say that the tax authority can sometimes be rather “aggressive” in taking its position that the foreign taxpayer has a PE in Japan in light of the relevant facts and circumstances.

• General substance over form statutes Section 132 of the CTA is a provision that enables the tax authority to disregard

the legal form of the transaction adopted by the taxpayer, and recharacterize the transaction solely for tax purposes and assess tax on that basis, where the taxpayer is a “family corporation” (generally meaning a corporation a majority of shares of which are owned by three or fewer shareholders and their special related parties).



Section 132-2 is a similar provision, which specifically applies to corporate reorganization transactions (merger, divestiture, etc.), and which enables the tax authority to assess tax upon parties to the reorganization as well as their corporate shareholders, by ignoring the legal form of the reorganization transaction, like section 132.

These are statutory provisions that will expressly authorize the tax authority to tax on the basis of substance over form. It is generally interpreted that sections 132 and 132-2 can be invoked if the legal form of the transaction adopted by the taxpayer is so unusual or irregular from a viewpoint of economically reasonable persons that it has no legitimate reason or business purpose other than avoiding tax. These provisions would apply to foreign corporate taxpayers as well.

The Japanese tax authority may regard these provisions as a “last resort” where no other specific provision could work, and there remains uncertainty as to what specific facts and circumstances will be found to meet the “economically unreasonable” standard mentioned above for these provisions to be invoked (meaning that it is not certain whether an assessment can be sustained if disputed in court).

Appendix # 2 – Bare Provisions of the GAAR under Direct Tax Code, 2010

1. BASIC SECTIONS:

1.1. Sec 123 [General anti avoidance rule] (1) Any arrangement entered into by a person may be declared as an impermissible

avoidance arrangement and the consequences, under this Code, of the arrangement may be determined by—

(a) disregarding, combining or re-characterizing any step in, or a part or whole of, the impermissible avoidance arrangement;

(b) treating the impermissible avoidance arrangement—

(i) as if it had not been entered into or carried out; or

(ii) in such other manner as in the circumstances of the case, the Commissioner deems appropriate for the prevention or diminution of the relevant tax benefit;

(c) disregarding any accommodating party or treating any accommodating party and any other party as one and the same person;

(d) deeming persons who are connected persons in relation to each other to be one and the same person;

(e) reallocating, amongst the parties to the arrangement—

(i) any accrual, or receipt, of a capital or revenue nature; or

(ii) any expenditure, deduction, relief or rebate; or



(f) re-characterizing—

(i) any equity into debt or vice versa;

(ii) any accrual, or receipt, of a capital or revenue nature; or

(iii) any expenditure, deduction, relief or rebate .

(2) The provisions of sub-section (1) may be applied in the alternative for, or in addition to, any other basis for determination of tax liability in accordance with such guidelines as may be prescribed.

(3) The provisions of this section shall apply subject to such conditions and in the manner as may be prescribed.

1.2. Section 125 [Presumption of purpose](1) An arrangement shall be presumed to have been entered into, or carried out, for

the main purpose of obtaining a tax benefit unless the person obtaining the tax benefit proves that obtaining the tax benefit was not the main purpose of the arrangement.

(2) An arrangement shall be presumed to have been entered into, or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit.

2. DEFINITIONS - (IN ORDER OF RELEVANCE) 2.1. Sec 124(15) “Impermissible avoidance arrangement” means a step in, or a part or

whole of, an arrangement, whose main purpose is to obtain a tax benefit and it—

(a) creates rights, or obligations, which would not normally be created between persons dealing at arm’s length;

(b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Code;

(c) lacks commercial substance, in whole or in part; or

(d) is entered into, or carried out, by means, or in a manner, which would not normally be employed for bona fide purposes;

2.2. Sec 124(3) “Arrangement” means any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes any of the above involving the alienation of property;

2.3. Sec 124(25) “Tax benefit” means—

(a) a reduction, avoidance or deferral of tax or other amount payable under this Code;

(b) an increase in a refund of tax or other amount under this Code;

(c) a reduction, avoidance or deferral of tax or other amount that would be payable under this Code but for a tax treaty;



(d) an increase in a refund of tax or other amount under this Code as a result of a tax treaty; or

(e) a reduction in tax bases including increase in loss,

in the relevant financial year or any other financial year.

2.4. Sec 124(19) “Lacks commercial substance”— a step in, or a part or whole of, an arrangement shall be deemed to be lacking commercial substance, if—

(a) it does not have a significant effect upon the business risks, or net cash flows, of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained but for the provisions of section 123;

(b) the legal substance, or effect, of the arrangement as a whole is inconsistent with, or differs significantly from, the legal form of its individual steps; or

(c) it includes, or involves—

(i) round trip financing without regard to,—

(A) whether or not the round tripped amounts can be traced to funds transferred to, or received by, any party in connection with the arrangement;

(B) the time, or sequence, in which round tripped amounts are transferred or received; or

(C) the means by, or manner in, which round tripped amounts are transferred or received;

(ii) an accommodating or tax indifferent party;

(iii) any element that have the effect of offsetting or cancelling each other; or

(iv) a transaction which is conducted through one or more persons and disguises the nature, location, source, ownership, or control, of the fund;

2.5. Sec 124(21) “Round trip financing” includes financing in which—

(a) funds are transferred among the parties to the arrangement; and

(b) the transfer of the funds would—

(i) result, directly or indirectly, in a tax benefit but for the provisions of section 123; or

(ii) significantly reduce, offset or eliminate any business risk incurred by any party to the arrangement;

2.6. Sec 124(14) “Funds” includes—

(a) any cash;

(b) cash equivalents; and

(c) any right, or obligation, to receive, or pay, the cash or cash equivalent;



2.7. Sec 124(10) “Bona fide purpose” shall not include any purpose which—

(a) has created rights or obligations that would not normally be created between persons dealing at arm’s length; or

(b) would result, directly or indirectly, in the misuse, or abuse, of the provisions of this Code;

2.8. Sec 124(1) “Accommodating party” means a party to an arrangement who, as a direct or indirect result of his participation, derives any amount in connection with the arrangement, which shall—

(e) be included in his total income which would have otherwise been included in the total income of another party;

(f) not be included in his total income which would have otherwise been included in the total income of another party;

(g) be treated as a deductible expenditure, or allowable loss, by the party which would have otherwise constituted a non-deductible expenditure, or non allowable loss, in the hands of another party; or

(h) result in pre-payment by any other party;

3. PROCEDURAL SECTIONS:

3.1. Sec 154 [Determination of an impermissible avoidance agreement and consequences thereof]:(1) The Commissioner shall, for the purposes of section 123, serve on the assessee a

notice requiring him, on a date to be specified therein to produce, or cause to be produced, any evidence or particulars on which the assessee may rely in support of his claim that the provisions of section 123 are not applicable to him.

(2) After hearing the evidence and after taking into account such particulars as the assessee may produce, the Commissioner shall pass an order declaring an arrangement as being an impermissible avoidance agreement or otherwise for the purposes of section 123.

(3) Upon declaring an arrangement as an impermissible avoidance agreement, the Commissioner shall—

(a) issue directions to the Assessing Officer to make such adjustment to the total income, or the tax liability, of the assessee; and

(b) forward or cause to be forwarded a copy of such order—

(i) to the assessee; and

(ii) to the jurisdictional Commissioner of the other party to the arrangement, who shall then proceed under this section against such other party and the provisions of this section shall apply accordingly.

(4) No order under sub-section (2) shall be issued after a period of twelve months from the end of the month in which the notice under sub-section (1) is issued.



3.2. Sec 155 [Assessment] (1) The Assessing Officer shall, consequent to a notice issued under sub-section (2)

of section 150, by an order in writing, make an assessment of the tax bases of the assessee after taking into account—

….

(e) the direction of the Commissioner under section 154, if any;

(4) The Assessing Officer shall, notwithstanding anything in this Code, in the first instance, forward a draft of the proposed order of assessment (hereinafter in this section referred to as the draft order) to the eligible assessee if he proposes to make any variation in the income or loss returned which is prejudicial to the interests of such assessee.

(5) On receipt of the draft order, the eligible assessee may, within a period of thirty days of the receipt by him of the draft order,—

(a) file his acceptance of the variations to the Assessing Officer; or

(b) file his objections, if any, to such variations to—

(i) the Dispute Resolution Panel; and

(ii) the Assessing Officer.

(6) The Assessing Officer shall complete the assessment on the basis of the draft order, if—

(a) the eligible assessee intimates to the Assessing Officer the acceptance of the variations; or

(b) no objections are received within the period specified in sub-section (5).

(7) The Assessing Officer shall, notwithstanding anything in section 163, pass the assessment order within a period of one month from the end of the month in which—

(a) the acceptance is received; or

(b) the period of filing of objections under sub-section (5) expires.

(8) Upon receipt of the directions issued under sub-section (2) of section 158, the Assessing Officer shall, in conformity with the directions, complete the assessment within a period of one month from the end of the month in which the direction is received notwithstanding anything in section 163, without providing any further hearing in the matter.

(9) In this section, “eligible assessee” means—

……..

(c) any person in whose case the variation arises as a consequence of the directions of the Commissioner under sub-section (3) of section 154; or

……….

(emphasis supplied in Sec 155)



BIBLIOGRAPHY

• IFA Cahier Volume 95a - Tax treaties and tax avoidance: Application of anti-avoidance provisions, 2010 Rome Congress of International Fiscal Association

• Discussion paper of DTC (Original and Revised)

• OECD Model Tax Convention on Income and Capital & Commentary on the Articles of OECD Model Tax Convention [July 2010]

• Secretariat Note: As finalized by The UN Tax Committee by written procedure for inclusion in the next version of the United Nations Model Double Taxation Convention Between Developed And Developing Countries - June 2009,

• Discussion Paper on Tax Avoidance and Section 103 of Income Tax Act, 1962 (Prepared by South African Revenue Service – November 2005) & Revised Proposals (September 2006)

• New Developments: Recent Changes Affecting International Tax Planning by Roy Saunders, itpa Journal of International Tax Planning Association (August 2009)

• The New General Anti-Avoidance Rule: A Comprehensive Discourse On This Statute (Article on South African GAAR by IZAK DANIEL PETRUS LOUW, a Postgraduate Diploma: Tax Law student)

• Discussion paper on Improving the operation of the anti-avoidance provisions in the income tax law by Australian Government (18th November 2010)

• Basic International Taxation by Roy Rohatgi

• International Tax Planning and Prevention of Abuse (Doctoral Series-Volume 14 submitted by Luc De Broe)

• Tax Treaties and Domestic Law (EC and International Tax Law Series, Volume 2 - IBFD)

• Fundamentals of International Tax Planning by Chris Finnerty, Paulus Merks, Mario Petriccione and Raffaele Russo.

• Research Paper on ‘Tax Avoidance in the 21st Century’ by David G Duff

• Paper titled ‘Does the Use of General Anti-Avoidance Rules to Combat Tax Avoidance Breach Principles of the Rule of Law’ by Rebecca Prebble and John Prebble presented at Critical Tax Conference at Saint Louis University School of Law Center for International and Comparative Law.



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Reference Material


Ants Philosophy

Ants Never Quit• If they’re headed somewhere and you try to stop them, they’ll look for another

• They’ll climb over, they’ll climb under, they’ll climb around.

• They Keep Looking for another way.

Lesson :To never quit looking for a way to get where you’re supposed to go.

Ants Think Winter All Summer• You can’t be so naïve as to think summer will last forever.

• So ants are gathering their winter food in the middle of summer.

• You’ve got to think rocks as you enjoy the sand and sun.

Lesson :It is important to be realistic. Think ahead.

Ants Think Summer All Winter• During the winter, ants remind themselves. “This won’t last long; we’ll soon be out of

here.”

• At the first warm day, the ants are out.

• If it turns cold again, they’ll dive back down, but then they come out the first warm day.

Lesson :Stay Positive at all times.

All-That-You-Possibly-Can• How much will an ant gather during the summer to prepare for the winter?

• All that he possibly can.

Lesson :Do all you can……. and more!

Four-Part Philosophy1) Never Give Up,

2) Look Ahead

3) Stay Positive

4) Do All You Can

“Don’t be encumbered by history, just go out & do something wonderful”

(Sourced from the World Wide Web)

Documents

CA T. P. Ostwal Material... · • Regular speaker in all international tax conferences symposiums, workshops, seminars and courses in India and abroad. • M/s T.P. Ostwal & Associates