The GAAR Guidelines

One of the major
changes implemented by the Finance
has been the introduction of the General Anti-Avoidance Rules (GAAR).
The Government has recently issued draft GAAR Guidelines in this connection,
which can be downloaded from

It is proposed
to introduce a monetary threshold for invocation of the GAAR provisions, and
time limits (such as time limits for making references to the Approving Panel)
have been introduced. Substantively, the Guidelines clarify that GAAR will
apply to income accruing or arising on or after 1.4.2013.

Further, it is
stated that (in para 1.1, Annexure D) the GAAR “is a codification of the proposition that while interpreting the
tax legislation, substance should be preferred over the legal form… These
propositions have otherwise been part of jurisprudence in direct tax laws as
reflected in various judicial decisions. The GAAR provisions codify this
substance over form ‘rule’…
”  Thus,
the Guidelines clarify that the purpose behind GAAR is not to change the
landscape, but to only codify the existing law. Thus, it is arguable that in a
situation where a Court (under current law) has upheld a type of transaction as
having commercial substance, the GAAR should (so far as possible) be
interpreted in line with that view. For example, in the Vodafone case, the Supreme Court did examine the factual matrix of
the transactions, and concluded that there was commercial substance: it is at
the very least arguable that the GAAR would not hit a similar transaction.
However, the Guideline then goes on to indicate that there is no mere
codification prescribed: the intent is to tackle avoidance, as distinct from
both evasion and mitigation.

It is further
clarified that the burden of proving the existence of an arrangement, the fact
of tax benefit, and the purpose behind the arrangement being to obtain that
benefit is on the Revenue.  The draft
guideline then gives a number of illustrations where the provisions of GAAR
could be invoked, and where the provisions would not be invoked. If one examines
these illustrations, it appears that in most cases where there is no DTAA
involved, GAAR would not really result in an outcome different from one which
could be expected under current law. The provisions would make a major
difference in cases where there is a DTAA. A few examples are seen below:

Example Number as per Guideline
Whether under current law this
arrangement would be disregarded?
Whether GAAR would be invoked under the
A business sets up an undertaking
in an under developed area by putting in substantial investment of capital,
carries out manufacturing activities therein and claims a tax deduction on
sale of such production/manufacturing
No – this is
to be treated as a case of tax mitigation. Taking advantage of a fiscal
incentive granted by statute would not amount to an impermissible tax
avoidance arrangement.
A business sets up a factory for
manufacturing in an under developed tax exempt area. It then diverts its
production from other connected manufacturing units and shows the same as
manufactured in the tax exempt unit (while doing only process of packaging
[It is not clear from the
illustration what ‘diverts its production means’]
Yes: if the
statutory condition is that the tax exempt unit must manufacture, and if
there is a diversion of production in the sense that production is carried on
in one unit but disclosed in the books of another, then it is open to examine
the true facts.

Yes [but see
the comments as to what is intended by ‘diverts its production’]

If ‘diversion’
means that production in one unit is stopped and production in the tax-exempt
unit is started, then there would not be any interference under current law.
Even under the GAAR, under example 1, this is arguably a case of tax
A foreign investor has invested in
India through a holding company situated in a low tax jurisdiction X. The
holding company is doing business in the country of incorporation, i.e. X,
has a Board of Directors that meets in that country and carries out business
with adequate manpower, capital and infrastructure of its own and therefore,
has substantial commercial substance in the said country X.
No: there is
commercial substance
The merger of a loss making company
into a profit making one results in losses off setting profits, a lower net
profit and lower tax liability for the merged company.
No – set off
would be allowed as per normal provisions, which have in-built measures to
check abuse
A choice made by a company between
leasing an asset and purchasing the same asset. The company would claim
deduction for leasing rentals rather than depreciation if it had their own
In the case of
leasing transactions, the Courts have been open to look into the “true
nature” of the transaction, to determine who gets the benefit of depreciation,
as recently discussed in
this post
If there is a
circular lease, the Revenue would invoke GAAR
A company has raised funds from an
unconnected party through borrowings, when it could have issued equity. Would
interest payments be denied as expenditure?
If the
borrowed funds are used for the purposes of business then deduction would be
allowed. Payments to connected parties may be disallowed to the extent
possible u/s 40A(2)(a)
Whether a business should have
raised funds through equity instead of as a loan should generally be left to
commercial judgment. GAAR would not typically be attracted.

GAAR may be attracted if this is a
case of connected party transaction.
[Arguably, here, disallowance if
any should be left to 40A, and there is no need for invoking GAAR
Y company, a non- resident, and Z
company, a resident of India, form a joint venture company X in India. Y incorporates
a 100%subsidiary A in country ABC of which Y is not a resident. The India-ABC
tax treaty provides for non-taxation of capital gains in the source country
and country ABC charges a minimal capital gains tax in its domestic law. A is
also designated as a “permitted transferee” of Y. “Permitted transferee”
means that though shares are held by A, all rights of voting, management,
right to sell etc., are vested in Y. As provided by the joint venture
agreement, 49% of X`s equity is allotted to company A (being 100% subsidiary
and “permitted transferee” of Y) and the remaining 51% is allotted to the Z
company. Thereafter, the shares of X held by A are sold by A to C (connected
to the Z group).
Arguably the
transaction could be disregarded: see Aditya
Birla Nuvo
’s case in the Bombay High Court
Company A, is incorporated in
country ABC as a wholly owned subsidiary of company B which is not a resident
of ABC or of India. The India-ABC tax treaty provides for non-taxation of
capital gains in the source country and country ABC charges a minimal capital
gains tax in its domestic law. Some shares of an Indian Company C were
acquired by A. The entire funding for investment by A in C was done by B. A
has not made any other transaction. These shares were subsequently disposed
of by A, thus resulting in capital gains which A claims as not being taxable
in India by virtue of the India- ABC tax treaty.

[Example 18 is similar]
Probably not,
under the ratio of Azadi Bachao Andolan
Yes: it appears that limitation of
benefits clauses would be read in to existing DTAAs if GAAR were to apply in
this manner.
An Indian Company A is a closely
held company and its major shareholders are connected companies B, C and D. A
was regularly distributing dividends but stopped distributing dividends from
1.4.2003, the date when Dividend Distribution Tax (DDT) was introduced in
India. A allowed its reserves to grow by not paying out dividends. As a
result no DDT was paid by the company. Subsequently, all its shareholders buyback
[sic] of shares was offered by the Indian Company A to its shareholder
company B based in country ABC and the other shareholders C and D who are not
resident of ABC. The India-ABC tax treaty provides for non-taxation of
capital gains in the source country and country ABC charges very low capital
gains tax in its domestic law. The buyback offer was only accepted by the
entity B. The accumulated reserves of A were used to buyback the shares from
the B entity.
The department
has already taken the ground in a few cases that this buyback amounts to a
payment of dividend. The department has also taken the contention that the
amounts can be considered as deemed dividend u/s 2(22)(d)
A foreign bank Fs branch
in India arranges loan for Indian borrower from F bank’s branch located in a
third country. The loan is later assigned to F bank’s branch in XYZ country
to take benefit of withholding provisions of India-XYZ treaty (India-XYZ
Treaty provides no source based withholding tax on interest to a bank
carrying out bona-fide business.)
Probably not,
unless the assignment is shown to be a sham
An Indian company is in the
business of import and export of certain goods. It purchases goods from
Country A and sells the same in country B. It sets up a subsidiary in Country
X – a zero/ low tax jurisdiction. The director of the Indian company
finalizes the contracts in India but shows the documentation of the purchase
and sale in Country X. The day to day management operations are carried out
in India. The goods move from A directly to B. The transactions are recorded
in the books of subsidiary in country X, where the profits are tax exempt.
It is arguable
that this is a case of sham transactions/entries under current law
A company had a disputed claim with
Z company. A transferred its actionable claims against Z for an amount which
was low, say, for example 10 % of the value of the actionable claim against Z
to a connected concern B by way of a transfer instrument. B transferred such
claim to C company and C further gifted it to D company, another connected
concern of A. Upon redemption of such actionable claims, D showed it as a
capital receipt and claimed exemption
Under current
law, even in a far less convoluted assignment of actionable claims, the
Department has taken the stance that the arrangement must be disregarded. It
appears that if there is some commercial substance behind the assignment then
the assignment will be upheld. As assignment inter-se group companies where
there is no possible commercial substance could arguable be disregarded even
under current law.
The manner of the transactions
indicates a lack of commercial substance: GAAR would be invoked

illustrations indicate that the GAAR provisions would in several cases not have
a drastic effect on the result of a tax-effective arrangement. Even under
current law, Courts in several cases have been willing to disregard
transactions which absolutely lack commercial substance. To an extent, due to
the decision in Azadi Bachao, a
greater amount of deference has been provided to the use of tax treaties; and
the GAAR intends to tackle what it sees as abuse of the treaties. The wisdom of
this policy is debatable; and once the policy has been decided on it is debatable
whether a GAAR is appropriate to achieve this end instead of incorporating
appropriate clauses in DTAAs. Furthermore, the guidelines (if finally
incorporated) into a relevant Rule or Circular would unquestionably be binding
on the Department. Thus, assuming that the examples above are incorporated in a
Circular, the Revenue would not be able to invoke GAAR where the example says
that there would be no recourse to GAAR. However, where the Circular provides
for the application of GAAR, it would still be open to assessees to challenge
this, if factually, commercial substance is shown. 

Unfortunately, several concerns raised relating to the
GAAR (including problems pertaining to excessive discretion, procedure for
approving panels etc) have not been clearly addressed in the Guidelines. The
attitude of the Department appears to be of looking at the arrangement and
determining the ‘substance’: an approach which is only likely to encourage
roving enquiries. Another view to approach the GAAR is to begin not with the
transaction/arrangement, but with the section conferring the relevant tax
benefits. After a purposive analysis of the section, the GAAR could be invoked
to defeat those transactions which obviously militate against the purpose of
the tax benefit. This is the approach adopted by the Supreme Court of Canada in
Trustco Mortgage
: “A transaction
may be considered to be ‘artificial’ or to ‘lack substance’ with respect to specific provisions of
the Income Tax Act, if
allowing a tax benefit would not be consistent with the object, spirit or
purpose of those provisions.  We should reject any analysis under s.
245(4) that depends entirely on ‘substance’ viewed in isolation from the
proper interpretation of specific provisions of the Income Tax Act or the relevant
factual context of a case.   However, abusive tax avoidance may be
found where the relationships and transactions as expressed in the relevant
documentation lack a proper basis relative to the object, spirit or purpose of
the provisions that are purported to confer the tax benefit, or where they are
wholly dissimilar to the relationships or transactions that are contemplated by
the provisions… The GAAR may be applied to deny a tax benefit only after it is
determined that it was not reasonable to consider the tax benefit to be within
the object, spirit or purpose of the provisions relied upon by the taxpayer…

For other approaches to GAAR, interested readers may also wish to refer to
this report
from the United Kingdom, prepared by Graham Aaronson QC.

About the author

Mihir Naniwadekar


  • Impromptu:

    On a first reading of the write-up, it is seen that the revised rules, rw the illustrations, aim at diluting the rigors of the dreaded GAAR in its original avatar; thereby, remove some of the obnoxious irritants it embodied.
    Nonetheless, it might be worthwhile for experts to delve into the details (for, as is said, the devil is in details), and not mind but spare more insightful thoughts, before reaching any incisive conclusion. For doing so, one has to necessarily carry out the exercise keeping in full view/focus the overriding provisions of the applicable comprehensive DTAAs ; so also the case law in abundance on the domestic law. For, as experience goes to demonstrate,besdies the DTAAs, it is the case law which is most likely to influence a decision based on any such conclusion. That is wrt the expected effect / outcome, desirable or otherwise, from the viewpoint of both the taxpayers and the Revenue.

    It may be adeded that, is the ideal situation would be if both sides co-operate and earnestly strive to take a pragmatic view on any of the inherent issues, real or imagined, with the common avowed goal of achieving the least complexity, resulting in the least litigation ; in other words,need of the times is to avoid fruitless and inconclusive battle (war!) of wits as has been the detestable fact of life all along.

    (to continue)

  • (contd.)
    Having underscored the utmost need to, especially in modern times, shun litigation, to recall for support: –
    "There is the lighter side to the law- mainly fed by the ignorance and foibles of men. There are few places where the amusing and exasperating sides of human nature can be watched so closely and so continually in a court of law. There is your opponent, who, though vanquished, can argue still. There is your client whose cupidity is sometimes matched only by his illiteracy."
    Can anyone honestly dispute, that was truly but wisely said by the renowned legal luminary, Palkhivala (in his speech broadcast over All India Radio- 'Professionally speaking' (year 1968)- "WE THE PEOPLKE").

  • Mihir, I'd have to disagree with you on the GAAR being a codification of existing law bit. We have always been a form over substance country, something you find confirmed even in cases as recent as the Bombay HC Vodafone case. While the Guidelines may state that the provs are a codification of existing law, the fact that they take a substance over form approach significantly widens and changes the Indian regime from form over substance to substance over form, enabling the tax guys to disregard arrangements even when there is no sham. I would anticipate there would be several situations therefore which may have held up under previous law, which may now be problematic on account of the GAAR – past jurisprudence notwithstanding. This view is consistent with the last line in that para where you mention that the Guideline itself clarifies that it isn't mere codification which is prescribed. Of course it can always be argued that past case law should apply blah blah but I would not imagine that position would carry a lot of weight.

    – Shreya

  • Also, while it is true that the examples listed in the table have come up before, and the taxpayer does have the right to challenge, the issue really is that they're trying to apply the Macaulay model of legislation to a tax context. This may not be right for India, a) because of the multiple variables that may exist in economic arrangements and b) because of the slowness of the justice delivery process and aggressiveness of Indian tax authorities who are likely to use the examples as cookie cutter examples of avoidance. People may set up holding companies as IP or finance pooling vehicles, to avoid the inflexibility of the Indian exchange control regime, or because the relevant jurisdiction is particularly conducive to headquarters etc. A 'low tax' jurisdiction is not just Mauritius but could potentially be a number of European countries, including Netherlands and the UK if they provide benefits in relation to capital gains / dividends which they often do to group structures. There is an absence of nuance here which would catch shady tax devices for sure but which is also likely to result in harassment in general. It doesn't work to equip the revenue officers with greater and greater powers until we are also ready to hold _them_ responsible for continuous wrongful initiation of claims, which may make them a little more discerning. Shreya

  • Shreya,

    Thanks for the comment: I will post a detailed response a bit later. Just one clarification: I don't think that the GAAR is a codification: but the Guideline says it is. I am just wondering whether (assuming the guideline makes its way into a circular), the Revenue can then take the stand that this is something other than a codification

  • "It doesn't work to equip the revenue officers with greater and greater powers until we are also ready to hold _them_ responsible for continuous wrongful initiation of claims, which may make them a little more discerning."

    Completely agree with this part, meanwhile.

  • I agree that it is likely to be argued, but I don't imagine it would carry a lot of weight.

    In a situation of conflict between the GAAR circular and previous case law, it is unlikely that courts will read down the GAAR provision merely on account of existing jurisprudence, particularly when it is fairly clear that the GAAR follows a substance over form approach (even though it contradicts itself in claiming to be a codification). This also raises an interesting interpretational issue about the primacy of a circular versus case law in applying the ITA – which should prevail? The Parliament has the power to clarify its intent by means of legislation, but does the executive have the power to prescribe an interpretation which effectively undoes decades of case law and does the enactment of the GAAR provision allow it to do so? To put it differently, is the term commercial substance sufficient to allow the circular to undo all the case law which may have approached the issue of commercial substance differently? I don't see why not.

    Of course there are several other potential challenges to the GAAR on account of which the courts may dilute it, as they have done in several other countries which have tried to apply it, but I'm not sure about this past jurisprudence bit. Still, tell detailed response 🙂

    – Shreya

  • (If the guidelines are introduced as a circular, I mean.)

    (Also, while the Guidelines do claim to be a codification in one spot, they also state that the intent isnt just to codify in another. So irrespective of whether the Guidelines are introduced as a circular, that language is likely to be of limited relevance… These guys need to get their act together.)

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