Direct Tax Alert - GAAR can be applied despite SAAR under section 94(8) of the Income Tax Act, 1961

BACKGROUND

Prior to the codification of General Anti-Avoidance Rules (GAAR) in Chapter X-A¹of the Income Tax Act, 1961 (IT Act), tax avoidance in India was governed by the judicial principles or Judicial Anti-Avoidance Rules (JAAR). There were provisions already present in the IT Act to deal with tax avoidance through specific and identifiable types of transactions which are collectively known as ‘Specific Anti-Avoidance Rules’ (SAAR). Over the years, SAARs have been incorporated in the tax laws as measures to tackle tax avoidance, as and when such transactions/mechanisms have come to light. GAAR provisions which are effective from Fiscal Year (FY) 2017-18 have the impact of treating an arrangement as an Impermissible Avoidance Arrangement (IAA) when its main purpose is to obtain a tax benefit and it contains any of the tainted elements² in an arrangement.

Since SAAR as well as GAAR tackle tax avoidance, there is certainly an overlap in both concepts. However, considering that SAARs are specific provisions, one could say that transactions covered by SAAR would not be examined under GAAR since ‘specific prevails over general’. On the other hand, if a transaction does not pass the parameters for invoking SAAR but gets covered under the ambit of GAAR, one can question the underlying intent and bring such a transaction to tax by invoking GAAR.  In this regard, recently, the Telangana High Court3 had an occasion to examine whether a transaction could be termed as IAA thereby invoking GAAR when SAAR under section 94(8)⁴ of the IT Act is also relevant to the said transaction.

We, at BDO in India, have summarised the ruling of the Telangana High Court and provided our comments on the impact of this decision.

FACTS OF THE CASE

• The taxpayer, a tax resident of India, had purchased shares of an Indian company. The company subsequently issued bonus shares in the ratio of 5:1. Considering the reduction in share price pursuant to the bonus issue, the taxpayer immediately sold these shares to another company (purchaser) at the reduced price, resulting in a short-term capital loss of INR 4,620mn. The taxpayer set off this short-term capital loss against the long-term capital gains, made on another transaction.

• The purchaser to whom such shares were sold by the taxpayer did not have sufficient sources of funds to buy these shares. The funds in this regard were provided by another shareholder of the company. As such, the money so funded was returned by way of rotation of funds from within the group itself.

• According to the tax officer, the aforesaid transaction was ‘round tripping of funds’ with no commercial substance. Further, the entire exercise had been done to avoid the payment of tax by creating a loss, without any economic, rational and commercial substance.

• The taxpayer argued that these transactions fell under the scope of SAAR i.e., section 94(8) of the IT Act, which deals with bonus stripping for mutual fund units and not shares.  

• However, the tax officer treated these transactions as IAA under GAAR and issued a notice under section 144BA⁵ of the IT Act to the taxpayer and sought objections from the taxpayer.

• The taxpayer while submitting objections rebutted all the allegations and did not accept the tax officer’s view that the transaction is IAA as per GAAR. The taxpayer contended that since the transactions undertaken fell under Chapter X of the IT Act dealing with SAAR, what was specifically excluded from the provisions curbing bonus stripping by way of SAAR could not be indirectly curbed by applying GAAR.

• The taxpayer filed a writ petition before the Telangana High Court against the notice issued by tax officer.

HIGH COURT RULING

The Telangana High Court made the following observations while ruling in favour of the tax authorities:

• Specific provision of law vs. general provision of law

  • In the present situation, the special provision of law (i.e. Section 94(8)) was already there in the IT Act, whereas the general provision of law (i.e., GAAR) was subsequently enacted by way of an amendment.

  • Normally, it is the vice-versa, i.e., the general provision of law is already in force and the special provision of law is subsequently enacted. It is only in such circumstances, that various courts have consistently held that when a special provision of law stands enacted, then the general provision of law cannot be invoked.

  • Thus, considering that the taxpayer’s case is different, the argument that since there is a special provision relating to avoidance of tax envisaged under the IT Act, the general provision of the law of anti-avoidance cannot be applied, is unacceptable.   

• Non-obstante clause under GAAR

  • Section 95(1) of the IT Act, dealing with the applicability of GAAR provisions starts with a non-obstante clause (i.e. notwithstanding anything contained in the IT Act). Thus, the provisions of Chapter X-A i.e. GAAR have an overriding effect over and above the other provisions of the law.

• Provisions of SAAR

  • At the relevant point in time, section 94(8) of the IT Act dealt with only the buying and acquiring of units within a period of 3 months prior to the record date.

  • The taxpayer’s argument that the SAAR should take precedence over the GAAR is fundamentally flawed and lacks consistency. The reason being the taxpayer’s own previous assertion that section 94(8) of the IT Act was not applicable to the shares during the relevant time frame. 

  • Further, section 94(8) of the IT Act might be relevant in simple, isolated cases of issuance of bonus shares, provided such issuance has a commercial substance. However, this provision did not apply to the present case, as the issuance of bonus shares here is evidently an artificial avoidance arrangement that lacks any logical or practical justification.

• Legislative intention of GAAR

  • Before the formal codification of the GAAR into the IT Act, the judicial system had already established its own set of rules known as the JAAR, which operated under the principle of ‘substance over form’, essentially seeking to uncover misleading structures or transactional arrangements that lacked real commercial substance.

  • These anti-avoidance rules were used to ensure that all transactions were conducted transparently and within the spirit of the law. The legal amendments that followed were driven by the judiciary’s firm commitment to uphold these anti-avoidance principles, using the power of law to enforce them.

  • As a result, a new Chapter X-A was added to the IT Act, which provides a detailed account of various types of transactions that could be potentially viewed as illegal tax avoidance arrangements.

  • Chapter X-A lists these types of transactions, provides an extensive definition of conditions that render a transaction devoid of commercial substance and also lays out the potential consequences that such transactions could face.

  • Furthermore, section 100 of the IT Act clarifies that Chapter X-A is applicable in addition to or as a substitute for any other existing method of determining tax liability. Therefore, it emphasises the legislative intention that the GAAR provisions should act as an all-encompassing safety net. It is designed to capture all illicit arrangements, ensuring that tax on these arrangements is calculated using the provisions of Chapter X-A.    

• 2012 Shome Committee Report

  • The taxpayer’s reliance on the 2012 Shome Committee Report that where SAAR is applicable to a particular transaction, then GAAR should not be invoked, is misconstrued.

  • The Committee’s stance that SAAR should generally supersede GAAR mainly pertains to international agreements, not domestic cases as this. This stand, as per the report, was further substantiated by the Finance Minister’s declaration, which stated that the applicability of either GAAR or SAAR would be determined on a case-by-case basis.

  • The subsequent introduction of a Rule under Section 95 and Section 100 of the IT Act indicates that Chapter X-A could be used in conjunction with, or as a substitute for, other sections of the IT Act.

  • Further, the Finance Bill, 2013 only incorporated some of the expert committee’s recommendations and the Central Board of Direct Taxes (CBDT) also clarified that both GAAR and SAAR would be applied depending upon the specifics of each case.

  • The taxpayer’s assertion that the facts of the case are irrelevant in determining the application of general law is fundamentally flawed. This stance was already addressed and refuted by the Hon’ble Supreme Court in the case of M/s. S. Zoraster and Company⁶ which clarified that laws must be interpreted based on the specific facts of each case.

• Commercial motive and tax avoidance

  • The current arrangement is being scrutinised as it is considered devoid of commercial substance as per Section 97⁷ of the IT Act. It creates extraordinary rights and obligations that seem to be conducted not in good faith. These unusual rights and obligations are not in line with the general principles of fair dealing, leading to the conclusion that it is an IAA under section 96 of the IT Act.

  • The Vodafone judgement⁸ provides crucial insight into this issue. The judgement implies that the business intent behind a transaction could serve as a strong piece of evidence that the transaction is not a deceptive or artificial arrangement. It places the burden of proof on the tax authorities to prove any fiscal misconduct and to provide sufficient evidence of any alleged wrongdoing. 

  • In stark contrast to the above, section 96(2) of the IT Act places responsibility on the taxpayer to disprove the presumption of a tax avoidance scheme.

  • The tax officer has clear and convincing evidence to suggest that the entire arrangement was intricately designed with the sole intent of evading tax. The taxpayer has not been able to provide substantial and persuasive proof to counter this claim.

  • Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. The same view has been affirmed by the Hon’ble Supreme Court in the case of McDowell & Co. Limited⁹.

  • The tax authorities have persuasively shown that the transactions in the instant case are not permissible tax avoidance arrangements. Therefore, the provisions of Chapter X-A i.e., GAAR would be applicable. 

BDO IN INDIA COMMENTS

The Telangana High Court ruling is the first High Court ruling after almost 7 years of GAAR coming into effect. The interplay between SAAR and GAAR has been a highly debated issue ever since GAAR was introduced. The CBDT has clarified that GAAR and SAAR may co-exist, however, it may apply depending on the facts and circumstances of each case.

In the present case, Telangana High Court deals with the interplay of section 94(8) of the IT Act and section 95 of the IT Act (i.e. GAAR). Since section 95 of the IT Act starts with a non-obstante clause, the Telangana High Court upheld the invocation of GAAR. The decision clarifies that taxpayers cannot rely solely on SAAR provisions to shield IAA from scrutiny under GAAR. Further, the decision emphasises the importance of ‘substance over form’ in financial transactions.