General Anti Avoidance Rules -an Overview

General Anti Avoidance Rules -an Overview


GAAR GAAR TAAR TAAR Anti Anti Avoidance Avoidance provisions provisions SAAR SAAR JAAR JAAR 4 FRAMEWORK OF GAAR 95 Applicability of GAAR 96 Impermissible Avoidance Arrangement (IAA)

97 Arrangement to lack commercial substance 98 Consequences of IAA 99 Treatment of connected person and accommodating party 100 Application of Chapter X-A (Provisions in lieu of / in addition to) 101 Guidelines and conditions 102 Definitions 144BA Rule 10U Administration of GAAR Exclusions

Rule 10UA Determination of consequences of IAA Rule 10UB Notices and forms Rule 10UC Time Limits Circular No. 7 of 2017 FAQs on GAAR PRE-CONDITIONS FOR INVOCATION OF GAAR Taxpayer Taxpayerhas hasentered enteredinto intoan anarrangement arrangement Tax Taxbenefit

benefitarises arisesfrom fromthe thearrangement arrangement Main Mainpurpose purposeof ofthe thearrangement arrangementisisto toobtain obtaintax taxbenefit benefit One Oneor ormore moretainted taintedelements elements(set (setout outininlaw) law)are arepresent presentininthe the

arrangement arrangement 7 MANDATE OF GAAR The assessee is bound to not to get into IAA Entering into IAA is not barred by law It is only at the instance of AO, can an arrangement be declared as IAA Unlike Sec. 92, which make a suo motu mandate, here the assessee is not bound to suo motu declare his arrangement as IAA It resembles the concept in Sec. 14A read with Rule 8D which can be invoked only at the instance of revenue : Holcim India P Ltd [Delhi HC 2014-TIOL1586-HC-DEL] Section 90(2A) and 90A(2A) of the ITA provides for GAAR overriding the treaty 8 APPLICABILITY OF GAAR As per Rule 10U, GAAR does NOT applies to: an arrangement where the tax benefit in the relevant assessment year arising, in aggregate, to all the parties to the arrangement does not exceed a sum of Rs. 3 crore; a Foreign Institutional Investor, (i) who is an assessee under the Act; (ii) who has not taken benefit of an agreement referred to in section 90 or section 90A as the case may be; and (iii) who has invested in listed securities, or unlisted securities, with the prior permission of the competent authority, in accordance with the Securities and

Exchange Board of India (Foreign Institutional Investor) Regulations, 1995 and such other regulations as may be applicable, in relation to such investments; a person, being a non-resident, in relation to investment made by him by way of offshore derivative instruments or otherwise, directly or indirectly, in a Foreign Institutional Investor; 9 GRAND FATHERING Any income accruing or arising to, or deemed to accrue or arise to, or received or deemed to be received by, any person from transfer of investments made before 1st April 2017 by such person Rule 10U(1)(d) Except Without prejudice to the provisions of clause (d) of sub-rule (1), the provisions of Chapter X-A shall apply to any arrangement, irrespective of the date on which it has been entered into, in respect of the tax benefit obtained from the arrangement on or after 1st April 2017. Rule 10U(2) 10 IMPERMISSIBLE AVOIDANCE AGREEMENT S 96 Essential two conditions: 1. The Main Purpose + Obtain Tax Benefit (part or whole or in any step of such arrangement) 2. Either of the given four conditions: a) Not at Arms Length b) Represents Misuse or Abuse of the provisions of the Act

c) Lacks Commercial Substance d) Entered or carried on in a manner not normally employed for Bona-fide Purposes. "arrangement" means any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding; 11 PRESUMPTION OF PURPOSE [96(2)] Burden of proof to prove that main purpose of arrangement is not to obtain tax benefit is on taxpayer. it seems that section 96 casts a presumption of purpose only for primary condition of tax benefit being main purpose Section 96(2) does not refer to tax benefit being one of the main purpose Burden of proof to establish satisfaction of 1 of the 4 tests of tainted element on tax authority Arrangement presumed to have been entered into for main purpose of obtaining tax benefit even if:

Main purpose of whole arrangement is not to obtain tax benefit but Main purpose of step in, or a part of, the arrangement is to obtain tax benefit 12 ARRANGEMENT [SEC 102(1)]; STEP [SEC 102(9)] Arrangement means any step in, or part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding. Step includes a measure or an action, particularly one of series taken in order to deal with or achieve a particular thing or object in the arrangement. Canada Ruling- OFSC Holdings: interpreting series of transaction Held that related transaction is completed in contemplation of a series where the parties knew of the series and took it into account

13 TAX BENEFIT [SEC 102(10)] a Reduction Reductionor oravoidance avoidanceor ordeferral deferralof oftax tax b e f Increase Increaseininaarefund refundof oftax tax c Reduction Reductionor oravoidance avoidanceor

ordeferral deferralof oftax taxdue dueto totax taxtreaty treaty d Increase Increaseininaarefund refundof oftax taxdue dueto totax taxtreaty treaty Reduction Reductioninintotal totalincome income Increase Increaseininloss loss 14

LACKS COMMERCIAL SUBSTANCE [S 97] (a) the substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part; or 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. (d) 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 this Chapter). 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. 15 S97 - LACKS COMMERCIAL SUBSTANCE (b)(i) it involves or includes round trip financing; S.97(2): Round trip financing includes any arrangement in which, through a series of transactions (a) funds are transferred among the parties to the arrangement; and (b) such transactions do not have any substantial commercial purpose other than obtaining the tax benefit (but for the provisions of this Chapter),

F. Co. FDI ODI without having any regard to (A) whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement; (B) the time, or sequence, in which the funds involved in the round trip financing are transferred or received; or (C) the means by, or manner in, or mode through, which funds involved in the round trip financing are transferred or received. I. Co. 16 S97 - LACKS COMMERCIAL SUBSTANCE (b)(ii) it involves or includes an accommodating party S.97(3): A party to an arrangement shall be an accommodating party, if the main purpose of the direct or indirect participation of that party in the arrangement, in whole or in part, is to obtain, directly or indirectly, a tax benefit (but for the provisions of this Chapter) for the assessee whether or not the party is a connected person in relation to any party to the arrangement.

I Co. [India] I Co. will be able to get back its own funds and can claim interest deduction on loan from C Co. Loan Equit y M Co. [Mauritius] Loan C Co. [Cyprus] 17 S97 - LACKS COMMERCIAL SUBSTANCE (1)(b)(iii) it involves or includes elements that have effect of offsetting or cancelling each other (1)(b)(iv) it involves or includes a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction

(1)(c) it involves the location of an asset or of a transaction or of the place of residence of any party which is without any substantial commercial purpose other than obtaining a tax benefit (but for the provisions of this Chapter) for a party; or (4) For the removal of doubts, it is hereby clarified that the following may be relevant but shall not be sufficient for determining whether an arrangement lacks commercial substance or not, namely: i. the period or time for which the arrangement (including operations therein) exists; ii. the fact of payment of taxes, directly or indirectly, under the arrangement; iii. the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement. 18 DETERMINING EXISTANCE OF TAX BENEFIT Sec. 99 i. the parties who are connected persons in relation to each other may be treated as one and the same person ii. any accommodating party may be disregarded iii. such accommodating party and any other party may be treated as one and the same person iv. the arrangement may be considered or looked through by disregarding any corporate structure

19 CLARIFICATIONS ISSUED BY CBDT Soon after the circular on POEM, on 27th January, 2017 the CBDT issued a circular containing clarifications in the form of answers to 16 Frequently Asked Questions on GAAR. The FAQs dealt with topics like: Tax Treaty v/s GAAR SAAR v/s GAAR Right of taxpayer to select an alternative Judicious implementation Grandfathering benefit GAAR as deterrent 20 CLARIFICATIONS ISSUED BY CBDT GAAR will not interplay with the right of the taxpayer to select or choose method of implementing a transaction For GAAR application, the issue as may be arising regarding the choice of entity, location, etc. has to be resolved on the basis of main purpose and other conditions provided under section 96

GAAR shall not be invoked merely on the ground that the entity is located in a tax efficient jurisdiction If the jurisdiction of FPI is finalised based on non-tax commercial considerations and the main purpose of the arrangement is not to obtain tax benefit, GAAR will not apply No GAAR if tax avoidance is sufficiently addressed by LOB clause in treaty 21 CLARIFICATIONS ISSUED BY CBDT De-minimis threshold of tax benefit > INR 3 crore is assessment year specific Two step approval procedure to ensure that GAAR is invoked only in deserving cases; and in a uniform, fair and rational manner 22

RECENT DEVELOPMENTS RECENT DEVELOPMENTS IN M & A All merger schemes are submitted to the Income-tax (IT) department for their comments. In most cases, IT department would not provide their comments on the scheme. In such cases, it was presumed that they do not have any objection to the Scheme. Recently, the IT department has been commenting on the scheme based on the applicability of GAAR. NCLT considers such comments and rejects the scheme. 24

MERGER THROUGH COURT ORDER AVM Capital (Bom) Ajanta Pharma / GABS (NCLT Mumbai) NIIT Technologies Limited (NCLT Delhi) Merger of 5 Promoter Cos. of Unichem Labs, listed Co. Merger of Gabs, Promoter Co. with Ajanta Pharma, listed co. Merger of PIPL BA and GSPL AS, Promoter Co. with NIIT, listed Co. Consolidation of holdings and enabling promoter to own shares directly in the listed company Enabling individual promoters to own shares directly in listed co Enabling promoters family trusts to own shares directly in listed co Objection Tax Avoidance

Taxable if sold in open market Scheme was propounded to avoid capital gains tax Objection Tax Avoidance Taxable if sold in open market Savings of DDT No tax implications Objection Tax Avoidance Sole purpose to transfer shares in a tax efficient manner Misusing benefit u/s 47 and 56 Appointed date fixed to beat deadline of change in law u/s 56 HC sanctioned the scheme Streamlining of shareholding a valid objective Shares controlled by same set of people both before and after merger Only 0.001% shareholders have objected to the scheme NCLT disapproved Scheme Against public interest Streamlining of shareholding NOT a valid objective

Savings of tax and DDT is a Tax Avoidance AVM Capital cited but brushed aside by NCLT NCLT sanctioned the scheme Taxpayer can arrange his affairs to reduce his tax burden in a lawful manner Key question is whether scheme is designed solely for avoiding tax or merely adopts a tax efficient way of undertaking the desired transaction Followed AVM Capital DEMERGER Uma Enterprises (Raj) Demerger of surplus land by an Oil Co. into 9 cos. Driven by Family Settlement amongst Promoters Scheme to facilitate focus on core competencies, proper management

HC rejected the Scheme on grounds of Tax Avoidance Since inception Co. only into oil mfg A/cs, Tax Audit Report, Segment reports, Directors report all showed only oil mfg as line of activity Real Estate was never a business undertaking Not a true demerger selected only to evade CGT & save SD 26 SET-OFF OF LOSS AND GAIN ON SALE OF SHARES Hede Consultancy (Bom) Wipro (Kar)

Shares sold at loss & subsequently in Shares sold at gains & subsequently in same year shares sold at gain same year shares sold at loss Set-off of loss & gain attacked as a Device Set-off of gain & loss attacked as a Device HC approved the setoff HC disallowed the set-off & held it was a device Sale of loss-making shares had Sale of gain shares had preceded the preceded the sale of profitable shares sale of loss shares Loss sale not influenced by gain Loss shares bought & sold in same year Valuation of both shares were genuine + sold to ex-employees Chronology of events also considered Genuineness of loss shares in doubt by High Court Chronology of events also considered by High Court SLP has been granted against HC order in 2015 27

SET OFF OF GAIN AND LOSS STILL VALID? Special Prints (Guj) / Pivet Finance (P&H) Sale of plant to group company at Gain + sale of preference shares to 2nd group company at Loss Sales based on Independent Valuation Report which considered various Valuation Methods Held, both transactions were genuine + proper Valn Reports Merely because one yielded a loss, cannot brand it as a device Loss set-off was upheld by the HC Q. Would these decisions be still valid under GAAR?

Q. What is the commercial rationale for selling loss shares within the Group even if done at a proper Valuation? But if justification for such Group sale then GAAR Not applicable 28 SALE OF BUSINESS Shiv Raj Gupta (Del) A Listed Co. sold its business for Rs. 55 lakhs MD / Promoter of Co. recd. Rs. 6 cr. as Non-compete Fees which was claimed to be a non-taxable Capital Receipt HC held bifurcation was a tax saving device Non-compete recd. by MD was astronomically high compared to sale consideration recd by Co.

Buyers rights by buying Co. were far valuable than non-compete clause since it included employees, contracts, plant Two Agreements were inter-related Re-characterised entire non-compete fee as sale consideration on account of sale of shares Approach similar to what GAAR allows u/s. 98(1)(a) + s.98(2)(ii) Dissecting approach by High Court SLP has been granted against HC order in 2017 29 SLUMP SALE Triune Energy Services (P.) Ltd. (Del)

Acquisition of Business on Slump Basis Depn. on Goodwill claimed by Buyer AO held Slump Sale a device to claim Depn. + save Tax HC set aside Objections: Buyer acquired business, contracts, employees + paid money Seller was a reputed co. with 350 employees Foreign Investors were interested in a JV with Seller and so business was hived-off to the JV

Wrong to say that the Slump Sale was sham / collusive Since sale genuine, all consequences, such as, Depreciation, follow and were allowed. A strong business proposition remains the best defence for an attack of GAAR! 30 S. 281 and GAAR Indian Seamless Ent (Bom) By a Scheme of Arrangement, a Co. wanted to gift shares held by it to its Shareholders & Dr. the Securities Premium Outstanding Tax Demand pending against Co. Dept contested the gift as being a device to evade tax since no application u/s. 281 was made by Co.

HC upheld Depts plea: Dividend in kind prohibited under Companies Act Gift when tax demand payable would be hit by s.281 Can arrange affairs to save tax but cannot dispose off assets to defeat s.281 Very few cases have extended tax avoidance to s.281 31 FIRMS AND TRANSFER OF IMMOVABLE PROPERTY Smt. Nayantara Agarwal (Bom) Dynamic Enterprises (Kar FB) Jamnalal Sons Ltd. (Bom)

Assessee entered into a partnership with her husbands Co for real estate development. Real Estate Firm reconstituted was reconstituted and got 5 partners. She introduced land as her capital contribution but the company did not introduce any capital. Nearly a year thereafter, erstwhile three partners took their share in partnership asset and went out of partnership Assessee company entered into a partnership firm in order to carry on business activity of dealing/trading in immovable

properties Within a short time, the firm was dissolved without carrying on any actual business - land was retained by Co Reval of assets and credited to old partners + paid cash to retiring partners no tax paid since no asset transfer Assessee got shares of the Co on dissolution. Firm continued to run business after reconstitution Dept. held it to be a transaction of transfer of land which would be subject to capital gains tax under section 45 Dept. sought to invoke s 45(4) device to trf land from old partners to new partners without Taxes Converted plots of land into stock

in trade and transferred immovable property and shares and securities into the partnership firm Dept. held transfer into partnership firm constituted transfer within meaning of s. 2(47), r.w. section 45 resulting in long-term capital gains 32 FIRMS AND TRANSFER OF IMMOVABLE PROPERTY Smt. Nayantara Agarwal (Bom) Dynamic Enterprises (Kar FB)

Jamnalal Sons Ltd. (Bom) HC held that this was a device to avoid paying CGT on transfer of the land from Assessee to Co HC Full Bench rejected Depts plea: HC Full Bench rejected Depts plea: Real nature of transaction was transfer of land. True nature and effect of the transaction to be considered And courts in such a case should not lay undue emphasis on the language Land never belonged to retiring partners it belonged to the firm On retirement, partners were not relinquishing their interest in land. They only relinquished share in the partnership. their No transfer of a capital asset and

no capital gains or profit arose. No partner had bought land as his capital contribution into the firm. There was no dissolution of the firm Firm was carried on regularly genuine and its business Capital contribution though constituted transfer of capital asset, yet it did not give rise to any capital gain as no determinable consideration at the relevant time Assessee company withdrew its capital 3 years after having introduced it 33 CASE STUDIES 34

CASE STUDY 1:- DIVIDEND V. BUYBACK LACKS COMMERCIAL SUBSTANCE [S.97(1)(C)] I Co. has 3 individual shareholders namely A, B & C. The company has share capital of Rs. 120 crores and accumulated reserves of Rs. 30 crores. The company has two options to distribute such reserves to the shareholders. Option 1 The company distributes the Rs. 30 Cr. by way of dividend. This will attract DDT @ 20.35765% on the dividend declared u/s 115-O of the ITA. Additionally, the shareholders (A, B & C) would be required to pay tax @ 10% on dividend income exceeding Rs.10 lakhs u/s 115BBDA. Option 2 The company makes an offer for buyback of part of the shares (assumed to be in compliance with requirements of Companies Act 2013). For the purpose of such buy-back, the company would be required to pay tax @ 23.072% u/s 115QA of the ITA on the amount distributed less the amount received for the issue of such shares. No further tax would be payable by the shareholders individually. The company chooses Option 2 to avoid additional

taxation of dividend u/s 115BBDA in the hands of the shareholders. Would GAAR apply to the companys decision? 35 CASE STUDY 2:- REVERSE MERGER NON-ARMS LENGTH RIGHTS AND OBLIGATIONS [SEC 96(1)(A)] The merger of a profit making company into a loss making one results in losses offsetting profits, a lower net profit and lower tax liability for the merged company. Would the losses be disallowed under GAAR? A Co. [Amalgamating Co.] Profit making Merges R Co. [Amalgamated Co.] Loss making The merger is covered by SAAR (NCLT approval) and the CBDT circular clarifies that GAAR would not be invoked if the NCLT has adequately and

explicitly considered the tax implication while sanctioning the arrangement. 36 CASE STUDY 2:- REVERSE MERGER The proceedings at NCLT u/s 230 of the Companies Act, 2013 require approval / presence of Income Tax Authority inviting their comments on a proposed arrangement and Circular No.1/2014 issued by the MCA dated 15 th January 2014 provides that when there is no response from the Income Tax Department, it may be presumed that the department has no objection to the proposed arrangement. Assuming that the tax authorities did not appear for the proceedings / provide any response to comments sought, the NCLT order has been permitting the merger with either of the following comments: Nobody appeared on behalf of the Income Tax, therefore no opinion has been provided on the tax implications of the merger. Nobody appeared on behalf of the Income Tax, therefore the tax implications of such merger have not been examined. Nobody appeared on behalf of the Income Tax, therefore it is presumed that tax department has no objection to the proposed merger. Department has recently started taking objections before NCLT. 37 CASE STUDY 3:- SALE OF LAND POST RESTRUCTURING Mr. A Partnershi p Firm

Other s Mr. A LLP Conversion New Co. Conversion Merger Loss Co. Merged Co. Sale Mr. A introduced land into partnership firm as his capital contribution The said partnership firm was converted into LLP within 2 months The LLP was converted into a company in the same year On conversion, land was recorded as stock-in-trade in New Co.s books. Loss Co. is a company in which 99% shares are held by Mr. A. and which has significant brought forward losses New Co. is merged with Loss Co. to form Merged Co. Merged Co. sells the land and earns significant profit which is set off against brought

forward losses 38 CASE STUDY 3:- SALE OF LAND POST RESTRUCTURING Mr. A Partnershi p Firm Other s Mr. A LLP Conversion New Co. Conversion Merger Loss Co. Merged Co.

Sale o Whether existence of multi-stepped structures by itself attracts GAAR provisions? o Whether the entire sequence of events would be considered impermissible avoidance arrangement or only a part thereof? o Which of the entities would be subject to GAAR all of them or Mr A only? o Assuming there was no synergy between the Part IX Company and Loss Co, can the merger itself be ignored by invoking GAAR provisions? o Does it matter if the merger is approved by the High Court in two states? 39 CASE STUDY 4:- EXIT FROM BUSINESS ABC family (comprising of A, B and C), A B C PP Option 2 wishes to divest business of ABC Co. DD family had insisted on slump sale of business by ABC Co (Option 1) PP family offers to purchase shares of ABC Co(Option 2)

ABC Co. DD Option 1 ABC family did not agree to dividend declaration by ABC Co prior to share transfer to PP family Contemporaneous discussions with tax Business advisors: Net of tax returns higher for share sale. Tax efficiency was one of the motivating factors for share sale option Option 1: DD family offer to buyEach of the sellers (A, B and C) invested RRL business the proceeds in residential house (s.54F) Option 2: PP family offer to buy 40 RRL shares CASE STUDY 4:- EXIT FROM BUSINESS Main purpose of implemented arrangement is tax benefit for RRL as there is avoidance of:

30% tax on STCG payable on itemised sale (or) 20% tax on LTCG payable on slump sale (or) Avoidance of applicability of s.50C (or) Consequential avoidance of DDT Facilitated s.54F exemption by promoters Substance of the transaction (i.e. acquisition of business) is different from the form [s.96(1)(c)] Transfer of business is by means and manner not ordinarily employed for bona fide purpose [s.96(1)(d)] Tax benefits ` 9 to 11 Cr. (being difference of tax incidence between Option 1 and Option 2) 41 CASE STUDY 5:- GIFT TAXATION U/S 56(2)(X) A Brother Bs Daughter in Law

B Exempt under proviso (I) to s.56(2) (x) Not exempt under s.56(2)(x) A and B are brothers; A is financially affluent Son of B, recently expired in an accident; the son is survived by his widow and children A, out of concern for Bs family and well being, gifts a sum of Rs 10 Cr. B, out of his own volition, gifts sum of Rs. 10 Cr. to his daughter-in-law (i.e. sons widow) 42 CASE STUDY 5:- GIFT TAXATION U/S 56(2)(X) A Brother Bs Daughter in Law B Exempt under proviso (I) to s.56(2) (x)

Not exempt under s.56(2)(x) Gift by A to B is exempt under proviso (I) to s.56(2)(x) as received from relative (brother) Gift by B to daughter-in-law is exempt under proviso (I) to s.56(2)(x) as received from relative (lineal ascendant of spouse i.e. husbands father) However, gift from A to Bs daughter-in-law is not protected under s.56(2) (x) Can GAAR be invoked to tax Bs daughter-in-law under s.56(2)(x)? 43 CASE STUDY 5:- GIFT TAXATION U/S 56(2)(X) CONSEQUENCES TAX IMPACT Disregarding B and concluding that Exemption under proviso (I) to Bs daughterinlaw has received section 56(2)(x) shall be denied as gift from A gift is not received from the relative of the Beneficiary

44 CASE STUDY 6:-SALARY STRUCTURING A Co. is a real estate developer. It builds residential complexes in Mumbai. Due to recession, many of its furnished flats are lying vacant. It has just recruited a young MBA graduate for sales and marketing. While fixing the salary structure of this employee, it decides to keep the basic salary at Rs. 20,000/- per month whereas giving rent free furnished accommodation of a premium flat worth Rs.10 crore (inclusive of Rs. 30 lakhs furniture) to this employee. Under Rule 3(1) of Income Tax Rules, 1962, perquisite of such rent free furnished accommodation is to be taken at 15% of the salary (salary as defined under Explanation to Rule 3) plus 10% of cost of owned furniture. Perquisite value of this rent free furnished accommodation as per Rule 3 comes to Rs. 3,36,000/- (15% of 2,40,000 + 10% of 30,00,000) whereas the market rent comes anywhere above Rs. 15,00,000/-. Ignore the threshold of 3 crores for this example. What if such salary structure is replicated across the board for 30 new employees thereby taking the total value of tax benefit above the threshold of Rs. 3 crore. How would the threshold be applied then qua A Co. and each employee separately or for A Co. and all employees taken together? 45 CASE STUDY 7:- SALE AND LEASE BACK Promoters (X,Y,Z) Promoters (X,Y)

PE Investors 44% 56% Sale of Shares (Rs. 100 crore) A Co. Lease B Co. Deposit (Rs. 50 crore) Sale of land (Rs. 8 crore) A Co.s shares are held by Promoters (X, Y and Z) and PE Investors A Co. owns a land and building in which it carries on its business PE Investors decided to exit by transferring their shareholding to B Co. (held by X and Y) for Rs. 100 crore B Co. was incorporated in 2015 but there has been no business activity in B Co A Co. sold land to B Co. at FMV of Rs. 8 crore The land was leased back by B Co. to A Co. for Rs. 1.5 lakh / month. 46 CASE STUDY 7:- SALE AND LEASE BACK Promoters

(X,Y,Z) Promoters (X,Y) PE Investors 44% 56% Sale of Shares (Rs. 100 crore) A Co. Lease B Co. Deposit (Rs. 50 crore) Sale of land (Rs. 8 crore) A Co. gave a lease deposit of Rs. 50 crore for such transaction The purchase of A Co.s shares by B Co. was funded from Rs. 50 crore received as lease deposit and Rs. 50 crore loan Lease deposit was funded from Rs. 8 crore sale of land, Rs. 10 crore internal accruals and Rs. 32 crore loan What will be the GAAR implications? 47

CASE STUDY 8:- TREATY BENEFIT US Co has 100% subsidiary Mau Co; that has 100% subsidiary I Co Mau Co issues equity to US Co; I Co issues CCDs to Mau Co US Co and Mau Co hold valid TRI Co pays interest on CCDs to Mau Co at ALP (say - 30 Cr.) I Co has withheld TDS @ 7.5% in terms of revised India Mauritius treaty US Co.

Equity 100% MAU Co. CCD 100% India Co 48 CASE STUDY 8:- TREATY BENEFIT US Co. Equity 100% How is tax reckoned? MAU Co. CCD 100% Deductibility of interest in hands of I Co is undisputed and is not subject to GAAR; GAAR is

invoked by regarding Mau Cos involvement as tainted benefit to be De-minimis threshold for invoking GAAR is 3 Cr. - Is it met? India Co If treaty benefit is denied fully? If treaty benefit of I-US available? 49 CASE STUDY 8:- TREATY BENEFIT CONSEQUENCES TAX IMPACT

Treating IAA as not entered Taxing US Co as if it had into or carried out [s.98(1)(b)] directly invested in I Co - WHT @ 15% Disregarding Mau Co as an accommodating party [s.98(1) (c)] ----------do---------- Treat Mau Co and US Co as one and same person [s.98(1) (d)] ----------do---------- Reallocate interest income from Mau CoInterest to US CoWHT [s.98(1) I-M (e)] I-US Interest WHT ----------do---------7.5% Domestic law WHT

15% 40% + SC 50 CASE STUDY 8:- TREATY BENEFIT CONSEQUENCES TAX IMPACT Treating the place of residence of Mau Co to be in USA by concluding that Mau Cos location of residence in Mauritius is without any substantial commercial purpose [s.98(1)(f)] Taxing Mau Co as if it is a company incorporated in USA and effective denial of treaty benefit in absence of TRC WHT @ 40% on a net basis (as s.115A does not apply to

CCD*) Disallowing treaty benefit to WHT @ 40% on a net basis (as Mau Co [s.98(1)] s.115A does not apply to CCD*) I-M Interest WHT 7.5% I-US Interest WHT 15% Domestic law WHT 40% + SC 51 CASE STUDY 9:- INTERMEDIATE HOLDING ENTITY X Ltd. [Old Co.] IHC Ltd. [Cyprus] A Ltd. [Operating Co.]

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. Should the beneficial owner of the dividends be considered and therefore, construe this as an abuse of the provisions of law to apply GAAR despite the fact that tax treaty contains no provision in this regard? 52 CASE STUDY 9:- INTERMEDIATE HOLDING ENTITY X Ltd. [Old Co.] IHC Ltd. [Cyprus] A Ltd. [Operating Co.] It is possible to take a view that tax benefit is likely to arise as a result of the interposition of the Cypriot IHC if the sole purpose of the IHC in Cyprus is to hold A Ltd. Therefore, could be an impermissible avoidance arrangement and hence, the tax authorities may proceed to re characterize the dividend as capital gain tax. 53

CASE STUDY 9:- INTERMEDIATE HOLDING ENTITY X Ltd. [Old Co.] IHC Ltd. [Cyprus] A Ltd. [Operating Co.] If 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? 54 CASE STUDY 9:- INTERMEDIATE HOLDING ENTITY X Ltd. [Old Co.] IHC Ltd. [Cyprus] A Ltd. [Operating Co.]

The right to declare dividend is a right protected and given by law the board has absolute discretion about when and how much dividend to declare. Should ideally be irrelevant from a GAAR perspective. Possible that Department takes a view that the timing of dividend was simply to reduce the capital gains liability and such dividend would not have been declared if the sale of shares was not to take place. Accordingly the Department would re-characterize the dividend as part of the sale consideration and tax the entire amount as capital gains. 55 CASE STUDY 10:- OVERSEAS PROJECT Option 1 A Ltd. (India) Option 2 A Ltd. branch B Ltd. (Country X) 25% 75% AOP / JV

(Country X) A Ltd, India has been awarded an EPC contract in Country X in 25% collaboration with a local EPC contractor, B Ltd. Initial investment of funds which will be in their respective share by A Ltd and B Ltd. The project would last for 3 years post which A Ltd does not expect to have further business in Country X. There are no taxes on dividends or capital gains in Country X and the rate of tax on corporate profits is 15%. A Ltd can directly undertake business in Country X (through a branch) in collaboration with B Ltd through an AOP or A Ltd can set up a JV entity in Country X in which it will hold 75% shares while B Ltd will hold 25% shares. Is there commercial justification to setting up an entity in Country X to undertake the EPC contract? 56 CASE STUDY 10:- OVERSEAS PROJECT Option 1 A Ltd. (India)

Results in the deferral in repatriation, and therefore taxation, of the income from the EPC contract. Option 2 A Ltd. branch Setting up of entity allows to ring fence the risk and is administratively easier to navigate local laws. B Ltd. (Country X) 25% 75% AOP / JV (Country X) At the end of the project period after repatriating all profits by way of dividend, A Ltd can simply sell the shares of the JV to B Ltd at the then book value (which will be roughly equal to investment value) and may probably record a capital loss. However, creating project specific entities,

especially for one-off overseas projects is a common practice. 57 CASE STUDY 10:- OVERSEAS PROJECT Option 1 A Ltd. (India) Transfer / lease of equipment Option 2 A Ltd. branch B Ltd. (Country X) 25% 75% AOP / JV (Country X) Certain specialized equipment will be supplied by A Ltd. This equipment has an approximate market value of almost 3 times its present

depreciated cost in the books of A Ltd. The equipment to be provided for the EPC project can either be provided on a lease or alternatively transferred. Since A Ltd has significant number of other assets and carrying amount in the same block of assets, the equipment could be sold to the project entity at the beginning of the project and re-acquired at the end of the project without any capital gains. Is there any implication under GAAR on transferring the equipment instead of leasing it? 58 CASE STUDY 10:- OVERSEAS PROJECT Option 1 A Ltd. (India) Transfer / lease of equipment Option 2 A Ltd. branch B Ltd. (Country X)

25% 75% AOP / JV (Country X) No capital gains implications at the time of sale since there are other assets and value in the block. Reacquisition will take place at market value which will significantly inflate the depreciable carrying value of the assets in the books of A Ltd. No taxation of lease rent as equipment transferred. Risk and liabilities would remain with A Ltd. along with ownership if equipment leased. Due to the transfer, it is receiving liquid funds exceeding cash inflow through lease. 59 CASE STUDY 11:- BENEFIT ARISING FROM DOMESTIC TAX LAW OF FOREIGN JURISDICTION India N Ltd. is company in India. It has a branch and

subsidiary, O Ltd., in Italy. The principle is that the country where a branch is located (Italy) allows the branch to act as the top entity in that countrys tax group, whereas India (the country of the head office) allows relief for the loss of the foreign branch against Indian profits. N Ltd. (Parent Co.) Italy Branc h Loans Country B Tax Group O Ltd. (Subsidiary ) Banks 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 the H.O. However, as per 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? 60 CASE STUDY 11:- BENEFIT ARISING FROM DOMESTIC TAX LAW OF FOREIGN JURISDICTION India The benefit that is arising to the entity is due to the difference in the taxation principles of each jurisdiction. N Ltd. (Parent Co.) There is no tax benefit to N Ltd in India or O Ltd in

Italy, they are being taxed in precisely the manner laid down in the domestic tax law. Italy Branc h Loans Country B Tax Group Banks Benefit is accruing at the group level without any detriment to either jurisdiction. In the event the Italian branch will make profits, the same will be chargeable to tax in India and will be consolidated with the profits of O Ltd and be subject to tax in Italy India will allow credit of taxes paid in Italy (only on the branchs income) O Ltd. (Subsidiary ) 61

CASE STUDY 12:- BUSINESS RESTRUCTURING Through conversion of an Indian entrepreneurial manufacturer (I Co) into a contract research and development (R&D) services provider cum contract manufacturer, by transfer of intellectual property (IP) in the form of technology and trade-mark; and also movement of strategic functions, from I Co to a global or regional principal company (P Co) set up in a tax friendly jurisdiction. Assuming that the transfer of such IP were at ALP; and further P Co has necessary substance at its level for assuming the role of a global or regional principal company; and that post-conversion remuneration policies of contract R&D and manufacturing services are determined to be at ALP, then no challenge would arise under the provisions of TP, even if the entire business conversion was triggered only for obtaining tax arbitrage with reference to the differential tax rates of India and the country of residence of P Co, as clarified by the OECD in Chapter IX of its TP guidelines. Thus, SAAR, in the form of TP gets complied with and satisfied. Would GAAR still be applicable in the instant case, absent any commercial rationale for undertaking the exercise of business restructuring, beyond mere obtaining of tax advantage? 62 TAX MITIGATION GAAR CANNOT BE INVOKED Setting-up of a unit in SEZ which results into a tax benefit, is a case of tax mitigation since the taxpayer is taking advantage of fiscal incentive offered to him by submitting to the conditions and economic consequences of the provisions in the legislation

A company chooses asset on lease over outright purchase and consequently claims higher deduction for lease rentals rather than depreciation. Being an investment decision of the company, GAAR provisions shall not apply An Indian Co. has raised fund from a foreign company incorporated in a low jurisdiction outside India through borrowings, when it could have issued equity. An evaluation of whether business should have raised funds through equity instead of debt should generally be left to the commercial judgement of a taxpayer. Further, the newly introduced thin capitalization provisions are enough to act as a safe harbour for the Revenue. 63 GAAR CONCERNS EXPRESSED BY VARIOUS BODIES 64 GAAR CONCERNS EXPRESSED BY VARIOUS BODIES The GAAR confers vast and discretionary powers to the tax authorities to disregard any business transactions including for instance, a tax neutral merger, or holding company structures, especially those which involve countries with which India has entered into favourable tax treaties. This would lead to significant uncertainty with

respect to conducting business in India. A tax treaty override (without any objective parameters) under GAAR could raise concerns about the sanctity of benefits conferred under treaties and affect Indias credibility as a reliable treaty partner. Structures that are currently in place could potentially be challenged under the new legislation causing significant hardship to existing investors. The application of GAAR to a specific structure by the tax authorities could change from year to year, resulting in significant fiscal uncertainty. Transactions/ structures that have been specifically upheld by Courts could also potentially be targeted under the GAAR. The GAAR could lead to cumbersome, time-consuming and costly litigation each time a transaction or structure is sought to be tested under the GAAR by the tax authorities. 65

ASSURANCES 66 ASSURANCES BY STANDING COMMITTEE It is not a revenue raising measure but is there to prevent loss of revenue [para 15.31] A mere tax benefit under DTA would not lead to application of GAAR unless other conditions prescribed are also fulfilled [para 15.31] Since GAAR would be operational under a set of guidelines framed by CBDT, there should be no cause for concern in this regard. [para 15.33] Further, the guidelines to be prescribed shall also be placed in the public domain before finalization [para 15.33] 67 67

ASSURANCES IN MEMORANDUM TO FINANCE BILL The basic criticism of statutory GAAR which is raised worldwide is that it provides a wide discretion and authority to the tax administration which at times is prone to be misused. This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime 68 68 TAX PLANNING IN THE REGIME OF GAAR 69 Only solution Is Substance Substance


Email: [email protected] Mobile:+91 90046 60107 Website: Disclaimer The information provided in this presentation is for informational purposes only, and should not be construed as legal advice on any subject matter. No recipients of this presentation, clients or otherwise, should act or refrain from acting on the basis of any content included in this presentation without seeking the appropriate legal or other professional advice on the particular facts and circumstances at issue. The content of this presentation contains general information and may not be accurate or reflect current legal developments, verdicts or settlements. The presenter and M/s. T. P. Ostwal & Associates LLP expressly disclaims all liability in respect to actions taken or not taken based on any or all the contents of this presentation.

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