Sanpshot of Examples in GAAR implementation guidelines (1).pdf

8/13/2019 Sanpshot of Examples in GAAR implementation guidelines (1).pdf

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GAAR Analysisby CA. Arinjay Kumar Jain


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Tax Mitigation Setting up an Undertaking in an underdeveloped Area Exemption on Goods manufactured therein - Example 1 & 2 (1/2)

1

Business Entity

Undertaking inunder developed Area

FactsBusiness entity, sets up an undertaking through substantialinvestment in an underdeveloped Area, to carry out manufacturingactivities and claims a tax deduction on sale of production andmanufacturing from such undertaking

IssueWhether setting up of an undertaking can be classified as anarrangement , one of whose purpose is to obtain a tax benefit ?

Interpretation by Committee

Setting up production facilities in an under developed area to claimtax deduction on sale of such production is a case of Tax mitigation,wherein a tax payer is availing the benefit provided by Statute,subject to the specified condition, and hence GAAR cannot beinvoked in such a case.


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Tax Mitigation Setting up an Undertaking in an underdeveloped Area Exemption on Goods only Packaged therein - Example 1 & 2 (2/2)

2

Business Entity

FactsBusiness entity, sets up an undertaking through substantialinvestment in an underdeveloped Area, to carry outmanufacturing activities and claims a tax deduction on sale ofproduction and manufacturing from such undertaking

Such business also packages (without manufacturing) andSells goods purchased from other undertaking to Customer

IssueWhether profit earned by underdeveloped Area undertakingon sale of goods which are merely packaged, is entitled toobtain a tax benefit ?


Profits relating to goods which are not produced at thatlocation is a case of transaction, which lacks commercialsubstance, and tries to misuse tax provisions and henceshould be covered with GAAR.

Underdeveloped Area (Unit

II)

Developed Area

(Unit I)

Transfer ofunpackaged Goods

Customer

Sale to Customer

1

2

PackagesGoods


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Inbound Investment - Foreign Shareholder Company without substance -Example 18 -

4

Low tax jurisdiction - R

India

A

India Co.

B

Does not has commercialsubstance

FactsForeign Investor A has invested in India throughInvestment Co. B situated in a low tax jurisdiction RInvestment Co. does not have commercial substance

IssueCan GAAR be invoked or would the arrangement bepermissible ?


If A invests directly in India, it does not get benefit of treatyand has to pay capital gainstax in India.

Routing funds through B in country R results in avoidingpayment of capital gains tax

It is an impermissible avoidance arrangement and revenuewould invoke GAAR with regard to this arrangement.


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Dividend declared by Foreign operating subsidiary retained in Overseasand not repatriated to India - Example 4

5

Favorable tax jurisdiction - X

IndiaIndian Holding

Company

C OperatingSubsidiary

OverseasInvestment Co.

FactsIndian company has invested in overseas operatingsubsidiary C, through a Investment company in favorable

jurisdictionDividend declared by C are not repatriated back to India asthis would result in taxation of such dividend in India

IssueWould the deemed dividend be treated as income usingGAAR ?


Declaration/repatriation of dividend is a business choice ofthe companies and GAAR provisions would not apply.

Specific provision of CFC (when introduced) would alsoexclude application of GAAR to dividends retained in lowtax jurisdiction by Indian companies investing overseas.

Operatingsubsidiary

Jurisdiction


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Merger of Loss making company into Profit making entity - Example 5

6

Shareholders

FactsLoss making entity A is merged into another profitmaking entity BLosses of A would be offset against profit of B resulting inoverall lower net profit and lower tax liability for themerged company.

IssueWould the losses be disallowed under GAAR

IInterpretation by Committee

Wherever Specific Anti Avoidance provision (SAAR) are

available for particular transaction, GAAR would not beapplied. Since there are specific provisions restricting setoff of losses in case of merger and amalgamation, GAARwould not be invoked.

Profitmaking

entity - B

Lossmaking

entity - A

Merger of Lossmaking entity into

Profit making entity

Share issue


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Lease Vs Purchase of Asset Example 6

7

Option tocompany whichhas to acquire

Asset

Lease Asset, andclaim deduction

for lease rental

Purchase Asset,and claim

depreciation

Where the company leases an Asset and claims lease rentaldeduction, which is higher than depreciation, that wouldhave been allowed on owned Asset , can lease rental s beDisallowed ?

?

GAAR provisions, would not, prima facie, apply to adecision of leasing (as against purchase of an asset), unlessits a case of Circular leasing, wherein an asset purchased bytaxpayer, is taken back through various sub-leases to taketax benefit without an economic substance.

Interpretation


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Borrowing Vs Equity Thin capitalisation -Example 7

8

Option to raiseFunds

Raise Equity Notax deduction on

dividend

Raise Borrowings Tax deduction

for interest

Where the company borrows funds from unconnectedparty, while it could have raised equity, whether interestdeduction can be denied ?

?

Evaluation of loan Vs equity should be left to commercial judgment and GAAR would not apply

There are no specific thin capitalization rules under IT Act to disallow such interest

If payments are made to connected parties, Transferpricing provision would apply

In such a case, depending on Source of their

Funds & their location in low tax jurisdiction,GAAR provision may apply.

Interpretation


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Mark up on Cost recharge by service company covered under Transfer

Pricing provision Example 8

9

ServiceCompany

B

FactsService Company, handling non core operations ofgroup, charges group companies at Cost plus markup

IssueCan mark up be questioned using GAAR ?


Since there are specific anti avoidance provisions in

form of Transfer Pricing for transactions amongrelated parties, GAAR will not be invoked.

CA

Costrecharged atMark up


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Set off of losses in the stock market against gains which is aimed atbalancing the portfolio Example 9

10

Company

Capital gains Losses fromstock marketLower Overall

Taxes

Sale/purchase through stock market transactions where the buyer and seller are anonymous to each otherwould not come under GAAR provisions. However, where the parties are related, or are not anonymous, i.e,

they are brought together by an intermediary to enable adjustment of losses amongst themselves, GAAR wouldbe applicable.


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Inbound Investment through a Permitted Assignee Example 10

11

Non resident

Country ABC

India

Y

X

Z & Group

A

49%

51%

FactsY a non resident incorporated company A, in Country ABCto invest in Indian JV with Indian partner ZIndia - ABC Treaty provides for non-taxation of capital gainsin India and ABC charges a minimal capital gains tax in itsdomestic laws

All rights of voting, management, right to selletc., are vested in Y, who is a permitted assignee of A

Shares of X held by A are sold to a company connected to

Indian partner Zs group

IssueIs sale of shares by A taxable in India ?


Controlling rights of A are with Y A was only interposed with main purpose of taking

advantage of India and Country ABC Treaty. Such an arrangement results in misuse or abuse of tax

provisions and hence attract GAAR.


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Inbound Investment through Subsidiary where funds are provided byParent Example 11

12

Non resident

Country ABC

India

B

C

A

FactsCompany A, resident of Country ABC is a wholly ownedsubsidiary of company B,India-ABC tax treaty provides for non taxation of capitalgains in India and ABC charges a minimal capital gains taxin its domestic law.

A acquired shares of an Indian Company C wherein entirefunding was done by B.

A sells the shares and claim these as non taxable by virtueof the India- ABC tax treaty.

IssueIs sale of shares by A taxable in India applying GAAR ?


GAAR would be invoked in such a case since the beneficialowner of such shares was B , even though legal owner was

A, This was an arrangement which has been created with the

main purpose of avoiding capital gains tax in India.

Fundinfusion

Shareacquisition


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Selective Buy Back Example 12

13

Facts A is a closely held Indian company held by connected companiesB, C and D

A after regularly distributing dividends, stopped distributingdividends from 1.4.2003 after Dividend Distribution Tax wasintroducedSubsequently it made an offer to buyback shares from allshareholdersBuyback offer was only accepted by B, which came from country

ABC, which provides non taxation of such gains in India and lowtaxes in ABC.Other shareholders, who are not resident of ABC deny buyback

offer

IssueIs buyback of shares taxable in India applying GAAR ?


Non distribution of Dividend (which would have attracted Dividenddistribution tax ) was not for bonafide purpose. Since the company

did not perform buy back from other shareholders (as that wouldhave attracted capital gains tax), and passed this as an exemptcapital gains tax in the hands of B (and not other shareholders), thearrangement is a colourable device designed to avoid tax in India,and Revenue would invoke GAAR in this case

DB C

A

Low tax jurisdiction

Buy back shares

Other jurisdiction


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Sale of shares of an Indian asset owning company, by a foreign parent,situated in low tax jurisdiction Example 13

14

Country ABC

India

X

E

FactsX an Indian company held shares of V, an asset owningIndian companyX was liquidated and distributed shares of V to E and C,its parent companies, situated in country ABCIndia - ABC Treaty provides for non-taxation of capitalgains in India and ABC charges a minimal capital gainstax in its domestic lawsSubsequently E and C sold shares of V to claim capitalgains exemption in India

IssueIs sale of shares by E and C taxable in India ?


Facts indicate that liquidation of the Indian company, andresulting transfer of shares of V was an arrangement tomisuse or abuse the provision. of tax. Revenue wouldinvoke GAAR as regards this arrangement.

C

V

1. Liquidated

2. Distributedsharesto E and C


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Providing Bonus/ Salary due to an employee through issue andRedemption of Preferential shares - Example 19

19

Company AFacts

Employee of Company A is to receive bonus or salary.Employee subscribes for preferential shares of the employer.Preferential shares are purchased by a connected company ofA, or are redeemable at a premium thatreflects a portion of the employees annual salary or bonus,after a period of one year.In this manner, the employee receives the income as capital

gain.

IssueWhether GAAR can be invoked in such a case ?


Acquisition and transfer of such shares results inrecharacterisation of Salary income as Income from capitalgains, and is part of the arrangement to avoid income taxwhich would have been payable on salary. Hence , GAAR canbe invoked

Employee

Allotment ofPreference shares

Connected groupcompany

Sale to Connectedcompany

1

2(a)

Redemption bycompany

2(a)


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Assignment of Actionable claims and realisation Claim for Capital Receipt- Example 20

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Facts Company A had disputed claim with Z company.

Company A transferred its actionable claims for 10% ofamount to a connected concern B by way of a transferinstrument.

B transferred such claim to C company C gifted instrument to D company, Upon redemption D showed it as a capital receipt and

claimed exemption.

IssueWhether GAAR would be attracted ?


Transfer of Actionable claims, which are disputed, to

group companies at discounted value/gift, wherein therecipient redeems such claims, and treats gains therefrom as a capital receipt, is a colorable device, andlacks commercial substance. GAAR can be invoked.

BCompany A

Transfer of instrument

at low value

CGift

D

Transfer of instrument

1

3

2

Realizes such amountand claims as capital

receipt


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Purchase of shares of Subsidiary at High Price and sold at loss to claimcapital gains loss - Example 21

21

Facts Company A borrowed money from a Company `B`and used that to buy shares in three 100%subsidiaries above Fair Market Value (FMV)

Subsidiary companies transfer amount received toconnected companies of B.

A sells shares at below purchase price and claims ashort-term capital loss, which is proposed to be setoff against other long-term capital gains.

IssueWhether GAAR would be attracted ?


Its a case of creating rights and obligations, whichare not created between parties in ordinary course ofbusiness, and hence GAAR can be invoked.

Bsconnectedconcerns

Subsidiaries

BLends

A

Transfer back of

funds

1

PurchasesShares

2

3


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The Author is an International Tax and M&A Tax consultant with more than10 years of consulting experience. For any queries, the Author can bereached at [email protected]

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Sanpshot of Examples in GAAR implementation guidelines (1).pdf

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