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INDIAN GAAR: IS UNCERTAINTY CAUSING A SETBACK TO
FOREIGN INVESTMENTS?
Ameya Mithe & Rohan Shrivastava
Abstract
This paper discusses the historical view point of anti-avoidance in light of
Judicial Anti-Avoidance Rule in India and United Kingdom. It deals with
intricacies of treaty override and analyses its permissibility under the
Constitution. The paper focuses on the uncertainty impending around due to the
limited grandfathering of investments and clarifications made thereon. This paper
also addresses the uncertainty in application of SAAR and GAAR and the
possibility of their co-existence. The authors have elucidated the effects of GAAR
on Foreign Investments and have pin pointed the investors‘ concerns. At the end
the paper, the authors analyse the Indian GAAR in comparison with its
contemporary in the UK to show how certainty can be achieved in a statutory
GAAR. The paper aims to bring into light the uncertainty looming around the
current structure of GAAR in India and showing the repercussions of such
uncertainty on Foreign Investments.
1. INTRODUCTION
The Indian taxation system is at such a point of inflection, that it defies the wisdom of
great thinkers by making the word ‗certain‘ an inappropriate adjective to describe tax. The
advent of the much dreaded General Anti-Avoidance Rule (hereinafter ‗GAAR‘) in Chapter
X-A of the Income Tax Act, 1961 (hereinafter ‗the Act‘) has marked a threshold in the
process of tax planning, which brings in a very dense atmosphere of uncertainty among the
investors. This is not because of the introduction of a statutory GAAR itself, but because of
the confusion which the current structure of the GAAR as introduced in the Act has created at
so many levels. The Finance Act, 2013, although being an improvement to its predecessor in
Students of Law, Symbiosis Law School, Pune; E-mails: [email protected],
[email protected]. Authors would like to thank Mr. Sriram P. Govind, Associate Nishith Desai
Associates for his invaluable guidance and support. They would also like to thank Advocate Mihir C.
Naniwadekar, Bombay High Court, Mumbai for his valuable suggestions and discussions.
VOL. 1] INDIAN JOURNAL OF TAX LAW 56
terms of GAAR, has not done enough to clarify the position. It is much feared, and correctly
so, that GAAR as it exists in the Act gives wide powers to the Revenue to question each and
every arrangement, or a step in or a part thereof, of an investor, with a scope that these
powers may be abused to an extent that the ultimate onus of escaping the scrutiny falls on the
investor himself. The drafting of the GAAR provisions give a wide scope of discretion in
favour of the Income Tax Department (hereinafter ‗Department‘) to do so, and a very
negligible opportunity for an assessee to challenge the authority of the Department in this
regard. The clarifications by the Finance Ministry, followed by the recently notified GAAR
Rules1 have failed to adequately answer several questions, and the answers to the questions
they have answered have not been entirely satisfactory. Such an ambiguous situation has
cropped an atmosphere of uncertainty in the midst of investors.
The appetite of a country for tax being insatiable, and the ingenuity displayed by the
modern taxpayers of playing with the letter of the law has led to a change in approach of the
tax authorities and the courts for preventing the erosion of tax base, or rather, for maximising
the coffers of the government. A country which adopts a statutory GAAR appears to have
exercised its choice of prioritizing prevention of erosion of tax base over the principle of
certainty in taxation. Certainty in taxation is viewed as an inseparable principle to govern the
tax policy of an economy. Adam Smith, cited as the ―father of modern economics‖, has
premised four basic canons of taxation, of which ‗Certainty‘ is the second canon of taxation.2
The uncertainty in taxation encourages the insolence, and the favours of corruption, of an
order of men who are naturally unpopular, even where they are neither insolent nor corrupt.3
The effect of uncertainty can deter the investors from the economy or can lead to exploitation
of taxpayers. The need of certainty, at very basic level, can be understood with the aid of an
example. Suppose there is a ―standard‖ providing that motorists should ―drive carefully‖.
This can mean anything and can be interpreted to suit one‘s own convenience. On the other
hand, if there is a ―rule‖ stating that motorists should not exceed a speed limit of 60 kmph,
there is no scope for confusion and everyone knows what the rule means. Such certainty is
missing out from the present structure of GAAR.
1 Income Tax (17th Amendment) Rules, 2013, CBDT Notification dated 23/09/2013. The notification
inserted Rules 10U to 10UC in the Income Tax Rules, 1962.
2 ADAM SMITH, AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF NATIONS 676, (Unabridged ed., 1776).
3 Id., at 677; Certainty is also described as one of the ten principles envisaged by the American Institute of
Certified Public Accountants (AICPA) in one of its report of 2001. Certainty in addition to other
principles makes a structure more fair and workable.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 57
The present structure of GAAR needs many more clarifications with respect to various
aspects so that a certain degree of certainty is achieved. The Press release4 issued by Finance
Minister, on behalf of the government, accepted most of the recommendations of the Expert
committee set up to look into the grievances on GAAR. But even after such acceptance the
uncertainty looms upon. The authors are not of the view of opposing the introduction of
GAAR in India. The authors are trying to propose that the present structure of GAAR needs
much more certainty and it should also keep up the investor‘s legitimate interests.
2. INDIA’S JUDICIAL ANTI-AVOIDANCE RULE
Years of judicial interpretation have resulted in a settled position of distinguishing
between tax evasion and tax avoidance in terms of legal consequences. ―Avoidance of tax is
not tax evasion and it carries no ignominy with it, for it is sound law and, certainly, not bad
morality, for anybody to so arrange his affairs as to reduce the brunt of taxation to a
minimum.‖5 On the other hand tax evasion as an illegal means of preventing tax liability has
been accepted unanimously by the judiciary.6 Therefore, tax planning as distinguished from
tax evasion, has historically been an accepted right of a tax payer. This right was given
judicial protection in the famous case of IRC v. Duke of Westminster.7 In the words of Lord
Tomlin in this case-
―Every man is entitled if he can to order his affairs so that the tax attaching
under the appropriate Acts is less than it otherwise would be. If he succeeds in
ordering them so as to secure this result, then, however unappreciative the
Commissioners of Inland Revenue or his fellow tax gatherers may be of his
ingenuity, he cannot be compelled to pay an increased tax.‖
The supposed doctrine that in revenue cases ‗the substance of the matter‘ may be
regarded as discrete from the form or the strict legal position, was given its quietus by the
House of Lords in the Westminster case.8 This case settled the law that a taxpayer‘s
4 PRESS INFORMATION BUREAU, GOVERNMENT OF INDIA, Major Recommendations of Expert Committee on
GAAR accepted, (14 January 2013, New Delhi).
5 Aruna v. State of Madras, (1965) 55 ITR 642, 648 (Mad).
6 David F. Williams, Tax and Corporate Social Responsibility, available at
http://www.kpmg.co.uk/pubs/Tax_and_CSR_Final.pdf (June 07 2013, 10:50 AM).
7 IRC v. Duke of Westminster, [1935] All ER 259.
8 KANGA, PALKHIWALA AND VYAS, THE LAW AND PRACTICE OF INCOME TAX, (9th ed., 2004) (hereinafter
‗KANGA‘).
VOL. 1] INDIAN JOURNAL OF TAX LAW 58
transaction can be judged only under the letter of the law, and to give regard to the underlying
substance of the transaction seems to involve substituting ―the uncertain and crooked cord of
discretion‖ for ―the golden and straight mete wand of the law‖. In other words, this principle,
often known as the Westminster principle, allows for individuals and corporations to
structure their financial arrangements in such a way as to attract minimum tax liability, so
long as the structure is within the four corners of the law.9
There was a significant change in approach after the Second World War when the
House of Lords began to emphasize on purposive interpretation in tax law. The Ramsay
principle, which was established by the House of Lords in WT Ramsay v. IRC10
is often seen
as ―the New approach‖ to anti-avoidance.11
This principle is seen in contradistinction to the
Westminster principle as it authorizes the court to ascertain the legal nature of the transaction
in order to determine tax liability in light of the nature and purpose of the statute. This
judgement emerged as an antidote to a preordained series of self-cancelling transactions with
no business purpose other than avoidance of tax, designed to give a single composite result.12
The House of Lords stood to ignore the individual steps for the purpose of tax, and decided to
ascertain the true legal effect of the series as a whole.13
This decision was followed
subsequently in Burmah Oil14
and Dawson.15
This trilogy of cases was interpreted by the Inland Revenue to give rise to a new
judicial doctrine superseding the Westminster Principle, which empowers the Revenue to
question every single transaction lacking business purpose, and which is entered into with the
motive of minimising a taxpayer‘s burden.16
This misconception has been finally laid to rest
in the later decisions of Craven v. White17
and Macniven18
where the two seemingly distinct
9 Prateek Andharia, Azadi no more?, LETS TALK ABOUT THE LAW, available at
http://letstalkaboutthelaw.wordpress.com/2011/09/25/azadi-no-more/#comments (12 June 2013, 10:15
AM).
10 W.T. Ramsay v. IRC, [1981] 54 TC 101 (hereinafter ‗Ramsay‘).
11 MURRAY & PROSSER, TAX AVOIDANCE, 11 (2012).
12 THURONYI VICTOR, COMPARATIVE TAX LAW, 176 (2003).
13 Id.
14 IRC v.Burmah Oil Co. Ltd., [1982] STC 30 (hereinafter ‗Burmah Oil‘).
15 Furniss v. Dawson, [1984] STC 153 (hereinafter ‗Dowson‘).
16 Barclays Mercantile Business Finance Limited v. Mawson (Her Majesty‘s Inspector of Taxes), [2004]
UKHL 51.
17 Craven v. White, [1988] 3 All ER 495.
18 Macniven v. Westmoreland Investments, [2001] 1 All ER 865.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 59
doctrines of Westminster and Ramsay were reconciled. These decisions emphasized that in
Ramsay, both, Lord Fraser and Lord Wilberforce, were careful to stress that they were not
departing from the Westminster principle. The Ramsay principle, it has been held, does not
make it a judicial function to strike down every step which is taken to mitigate the burden of
tax, and it is still open to a taxpayer to choose the most tax efficient alternative out of the
multiple alternatives available to him.19
Thus, the Ramsay principle has been reinterpreted as
a parallel rule of statutory construction, and not anew judicial doctrine.20
Now, the Indian judicial system has been experimenting with anti-avoidance for quite
some time, and has referred to the Westminster principle on numerous occasions. The Indian
equivalent of the Westminster case is Raman & Co.21
wherein Shah J. legitimized the use of a
device ―to divert the income before it accrues or arises‖ to a taxpayer, and recognized that
the effectiveness of such device ―depends not on considerations of morality, but on operation
of the Income tax Act.‖
Indian judiciary for the first time, although temporarily, announced its complete
intolerance to tax avoidance in the form of a separate opinion of Chinnappa Reddy, J in
Mcdowells.22
This opinion was only meant to supplement the majority judgment delivered by
Ranganath Misra, J. who had legitimized tax planning not involving ‗colourable devices‘,
‗dubious methods‘ and ‗subterfuges‘ under the guise of tax planning.23
Chinnappa Reddy, J.,
in his controversial separate opinion, placed a radical position of law stating therein that ―the
ghost of Westminster has been exorcised in England‖ in light of Ramsay,24
Burma Oil,25
and
Dawson,26
and that any transaction aimed at avoiding tax must be disregarded.27
Mcdowell led to a lot of litigation since the Revenue saw in the case more than that was
justified by treating every instance of tax saving as intended avoidance, susceptible to the
19 Supra note 17.
20 Judith Freedman, Converging Tracks? Recent Developments in Canadian and UK Approaches to Tax
Avoidance, 53 CANADIAN TAX JOURNAL (2005).
21 CIT v. Raman & Co., (1968) 67 ITR 11, 17 (SC).
22 Mcdowell and Co. Ltd. v. Commercial Tax Officer, (1985) 154 ITR 148 (SC) (hereinafter ‗Mcdowell‘).
23 Id.
24 Ramsay, supra note 10.
25 Burma Oil, supra note 14.
26 Dawson, supra note 15.
27 McDowell, supra note 22.
VOL. 1] INDIAN JOURNAL OF TAX LAW 60
Mcdowell‘s rule.28
Then the Supreme Court later emerged as the tax planner‘s messiah in
Azadi29
and diluted the evil initiated by Mcdowell. It carefully examined Ramsay, and relying
on Craven v. White30
and Macniven,31
negatived the erroneous decision of Justice Reddy,
upheld the Westminster principle as being ―alive and kicking‖ in the country of its birth, and
hence the law of the land in India too.
In the recently decided Vodafone case32
the apex court has held that there is no conflict
between Azadiand and Mcdowell, since Azadi upholds the majority decision in Mcdowell and
only departs from it to the extent of the separate opinion of Reddy, J.33
However, K.S.
Radhakrishnan, J., while reiterating the right of a taxpayer to arrange his affairs in the most
tax efficient manner, has also stated that it is equally important for a transaction to have a
business or commercial substance. Moreover, he also emphasized on the necessity of an
―effective legislative measure‖ with respect to tax-avoidance ―what is inequitable and
undesirable.‖34
Thus, to say that the Courts have been tolerant to tax avoidance, and that the
very introduction of a legislative GAAR topples the existing position of taxation law in India
is counterfactual.
Since the landmark judgement in Vodafone, there have been some landmark decisions
which have upheld the stance of the Judiciary on anti-avoidance, which has not been
undermined by the government‘s recent efforts to stretch the arms of taxation even beyond its
own jurisdiction in the name of tax avoidance. The Andhra Pradesh High Court upheld the
28 IYENGAR SAMPATH, LAW OF INCOME TAX, 232 (11th ed., 2011).
29 Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706 (SC) (hereinafter ‘Azadi‘).
30 Craven v. White, supra note 17.
31 Macniven v. Westmoreland Investments, supra note 18.
32 Vodafone International Holdings BV v. Union of India, (2012) 341 ITR 1 (SC) (hereinafter ‗Vodafone‘).
33 In the Majority Judgement in Mcdowell, RanganathMisra, J., held in para 45 that ―tax planning may be
legitimate provided it is within the framework of the Law.‖ In the latter part of that para, he stated that
―colourable devices cannot form a part of tax planning‖ and that it is the duty of every taxpayer to pay
taxes without any subterfuges. This para is to be read with ¶ 46 where he states that "on this aspect one of
us, Chinnappa Reddy, J. has proposed a separate opinion with which we agree". This is the statement in
the majority opinion which had created the confusion that the majority agreed with the Justice Reddy‘s
separate opinion in its entirety. However the phrase ―this aspect‖ expresses the majority‘s agreement
with the separate opinion only with respect to tax avoidance with the use of colourable devices and
subterfuges. The Separate opinion makes repeated references to this aspect. Although, he makes a number of observations with regard to the need to depart from the Westminster principle, these must be
read as only in the context of artificial tax avoidance. Such a reading of the Mcdowellcase removes any
perceived conflict between the Mcdowell and Azadi. See, per S.H. Kapadia, C.J., Vodafone, Id., ¶ 64.
34 Macniven v. Westmoreland Investments, supra note 18, at ¶55.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 61
arrangement in Sanofi35
as being tax legitimate and rejected the application of the
retrospectively amended section 9 of the Act on the basis that the same cannot override a tax
treaty.
India‘s judicial anti-avoidance rule is restricted to sham transactions or colourable
devices.36
Thus, in general, the principle of form over substance has prevailed in India, with
the courts occasionally examining the substance of a transaction to determine its true legal
effect. GAAR, however, is a codification of the substance over form doctrine, empowering
the department to ascertain not only the legal substance, but also commercial or economic
substance, consequently superseding the Supreme Court decisions in Azadi and Vodafone.
3. TREATY OVERRIDE
With the introduction of Chapter X-A in the Act, GAAR was given an apparent
overriding effect over the DTAAs of India with various other countries. This effect is sought
to be achieved by the insertion of sub-section 2A in Section 90 of the Act, which makes
GAAR applicable whether its provisions are beneficial to the assessee or not. The
qualification of the provision with a non-obstante clause clearly eliminates the interference of
sub-section (2) of S.90 with the applicability of the provisions of GAAR.37
This makes
GAAR paramount Law in terms of international transactions, notwithstanding the existence
of an international treaty governing that transaction.
3.1 INTERNATIONAL LAW ON TREATY OVERRIDE
35 Sanofi Pasteur Holding v. The Department of Revenue, (2013) 213 Taxman 504 (AP); In this case,
Institut Merieux (IM) and Groupe Industriel Marcel Dassault (GIMD), both French companies, held 80 per cent and 20 per cent shares, respectively, in ShanH SAS (ShanH), another French company. ShanH,
in turn, held shares in Indian company Shantha Biotechnics Ltd. (SBL). In August 2009, IM and GIMD
sold its shareholding in ShanH to another French company, Sanofi Aventis. The transaction was carried
out in France. The bone of contention was similar to that in the Vodafone case, where the Revenue
Authorities contended that the transaction was a tax avoidance transaction, and that in reality the
controlling interest in SBL was sold, and therefore it should be taxed in India. Moreover, the authorities
also contended that the transaction was hit by the retrospective amendment to S. 9 of the Income tax Act,
which overruled the Supreme Court judgment in the Vodafone Case.
36 Killick Nixon v. DCIT, ITA No. 5518/2012, decided on 06/03/2012. The Hon‘ble Bombay High Court
relied on the Vodafone case and observed that ―where a transaction is sham and not genuine as in the
present case then it cannot be considered to be a part of tax planning or legitimate avoidance of tax liability.‖
37 S. 90A of the Income Tax Act, 1961 incorporates the DTAAs into the domestic law, and subsection (2)
thereof provides for the application of the Act over the DTAAs to the extent to which it is more
beneficial to the assessee concerned.
VOL. 1] INDIAN JOURNAL OF TAX LAW 62
Article 26 of the Vienna Convention on the Law of Treaties codifies the accepted
International law principle of pacta sunt servanda and states that ―treaties are binding on the
parties to it and must be performed by them in good faith.‖ Article 27 of the Convention acts
as a corollary to this principle by prohibiting parties to a treaty from ―invoking the provisions
of its internal law as a justification for its failure to perform a treaty.‖ Thus the Convention
places reciprocal obligations on the parties to a treaty, and all such parties are under the same
obligation to perform a treaty in good faith.38
Although India is not a party to the Convention,
the abovementioned principles are binding on India as part of customary international Law.39
The Convention is a law-making treaty40
on all the international treaties entered into by
its parties.41
However, the principle of pacta sunt servanda is subject to certain limitations,
and an international treaty is often not considered unconditionally sacrosanct. The OECD
commentary recognizes two conflicting approaches followed by different states as regards
cases which result in abuse of treaty provisions. As per the first approach, certain States
consider the right of taxation as emanating solely from the domestic law, which is narrowed
by the application of DTAAs. Therefore, an abuse of the provisions of a treaty is in effect
considered an abuse of the provisions of domestic law. Thus, to the extent that domestic anti
abuse rules are a part of the domestic tax law for determining which facts result in a tax
liability, they are not addressed by the tax treaties and are therefore not affected by them.42
The other States consider some abuses as being abuses of the provisions of the treaty
themselves rather than abuse of domestic law, and view to combat them by a more rational
construction of the treaty itself, especially in terms of those transactions which aim to claim
38 Edwards-Ker, Michael, Tax Treaty Interpretation, Ph.D Thesis, QUEEN MARY AND WESTFIELD
COLLEGE, UNIVERSITY OF LONDON (1994).
39 Vellore Citizens Welfare Forum v. Union of India, (1996) 5 SCC 647.
40 A law-making treaty is one which establishes general patterns of behaviour for the parties over a certain
period of time in certain areas. See, M. FITZMAURICE & A. QUAST, LAW OF TREATIES, Study Guide,
(UNIVERSITY OF LONDON, 2007), http://www.londoninternational.ac.uk/sites/default/files/law_treaties.pdf
(03 June 03 2014, 06.00 PM).
41 Interpretation of Human Rights Treaties, ICELANDIC HUMAN RIGHTS CENTRE
http://www.humanrights.is/en/human-rights-education-project/human-rights-concepts-ideas-and-
fora/part-i-the-concept-of-human-rights/interpretation-of-human-rights-treaties, (09 June 2014, 06:42
PM); European Court of Human Rights in Wemhoff v. Federal Republic of Germany, 2122/64 [1964]
ECHR 4, the court has noted that because the Convention is a ‗law-making treaty, it is [...] necessary to
seek the interpretation that is most appropriate in order to realise the aim and achieve the object of the treaty‘.
42 OECD (2012), Model Tax Convention on Income and on Capital 2010 (updated 2010), Commentary on
Article 1 concerning the persons covered by the convention, ¶ 9.2, OECD PUBLISHING available at
http://dx.doi.org/10.1787/978926417517-en (09 June 2014, 07:00 PM).
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 63
benefits which a treaty does not intend to confer. This approach attempts to uphold the
principle of good faith in respect of interpretation of treaties, as enshrined in Article 26 of the
Vienna Convention.43
Both these approaches nonetheless recognize the rights of States to
prevent the conferment of benefits under a treaty when arrangements constituting an abuse of
treaties have been entered into.44
3.2 LEGAL POSITION IN INDIA
The issue can be narrowed down to the legal position in India regarding interface
between an international treaty and a subsequent legislative enactment.45
Although this issue
has not been directly dealt by the Constitution, a harmonious reading of some of the
constitutional provisions can be a helpful guide in determining the same. The Indian
Constitution directs the State to endeavour to foster respect for international law and treaty
obligations.46
From a combined reading of Article 246 of the Constitution along with the
relevant entries in List I of the 7th Schedule, particularly entries 13 and 14, it can be
concluded that treaty making power is primarily a parliamentary function. In addition, the
Parliament is also authorized to ―make any law for the whole or any part of India for
implementing any treaty with any country or countries or any decision made in any
international conference, association, or other bodies.‖47
This power is not fettered by the
legislative competence of the states under Lists II and III of the 7th Schedule, and has an
overriding effect over the same.
The Executive power under the Constitution extends to matters in respect of which the
Parliament is empowered to make laws, in the absence of a parliamentary legislation and
subject to constitutional limitations.48
Thus, it is only in the absence of such Parliamentary
legislation regarding procedure for entering into treaties that it is left upon the Executive to
43 Id., ¶ 9.3.
44 Id., ¶ 9.4.
45 Amit M. Sachdeva, Can the Proposed Tax Code Override Indian Tax Treaties?, TAX NOTES
INTERNATIONAL, available at
http://www.vaishlaw.com/article/Indian%20DTC%20and%20Tax%20Treaties-Amit%20Sachdeva.pdf (14 June 2013, 06:40 PM).
46 The Constitution of India, 1950, Article 51.
47 Id., Article 253.
48 Id., Article 73.
VOL. 1] INDIAN JOURNAL OF TAX LAW 64
do the same.49
The bottom line however remains that so far as implementation of
international treaties is concerned, the constitutional mandate is clear that it is only the
Parliament which has exclusive power to make laws for implementation of treaties and
international agreements.50
As stated above, that unlike other jurisdictions, the treaty making power under the
Indian Constitution is not conferred on the executive, but is placed squarely within the
domain of the Parliament.51
Articles 246(1)52
and 253 are merely enabling provisions, and do
not place an obligation on the Parliament to implement treaties through enactment.53
The
Parliament being so empowered is equally competent to choose not to legislate in order to
give effect to such treaty. The scheme of international taxation in India is such that all the
DTAAs are entered into by India under S.90 of the Act. Thus they are essentially delegated
legislation.54
They are considered to be mini legislations containing in them all the relevant
aspects or features which are at variance with the general taxation laws of the respective
countries.55
They hold an important position in the scheme of Indian income-tax legislation,
inasmuch as they lay down an alternate scheme of taxation.56
In ABN Amro Bank N V v.
JCIT,57
the Tribunal observed that in case of any conflict between a tax treaty and a domestic
law, the former must yield to the law passed independently by the parliament. This decision
is based on the principle laid down by the Supreme Court in the case of Gramophone
49 Treaty Making Power under Our Constitution, NATIONAL COMMISSION TO REVIEW THE WORKING OF
THE CONSTITUTION, (January 8, 2001) available at http://lawmin.nic.in/ncrwc/finalreport/v2b2-3.htm.
(25 June 2014, 05.00 PM).
50 BIMAL N. PATEL, II INDIA AND INTERNATIONAL LAW, 17 (2008).
51 ―If the national executive, the government of the day, decide to incur the obligations of a treaty which involve alteration of law, they have to run the risk of obtaining the assent of Parliament to the necessary
statute or statutes.‖ See, Per Lord Atkin, Attorney General for Canada v. Attorney General of Ontario,
[1937] AC 326, 347. Also see, Gujarat v. VoraFiddali, AIR 1964 SC 1043, where the Supreme Court
held that in India Treaties occupy the same status, and adopt the same treaty practice as in United
Kingdom; Shiva Kant Jha, Treaty Making Power: The Context, SHIVAKANTJHA.ORG,
http://www.shivakantjha.org/openfile.php?filename=articles/3_treaty-making.htm#_ftn4 (06 July 2013,
3:33 PM).
52 Read with entries 13 and 14 of List I, The Constitution of India, 1950, supra note 46.
53 Id., Article 253 reads ―Parliament has power to make any law...for implementing any treaty‖, and does
not read as ―Parliament shall make a law...‖
54 Azadi, supra note 29.
55 DCIT v. Boston Consulting Group Pvt. Ltd., (2005) 93 TTJ 293 (Mum).
56 Kotak Mahindra Primus Ltd. v. DDIT, (2006) 105 TTJ 293 (Mum); Western Union Financial Services
Inc.v. ADIT, (2006) 101 TTJ 56 (Del).
57 ABN Amro Bank N V v. JCIT, (2005) 96 TTJ 1041(Kol).
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 65
Company58
that in the event of a conflict between a municipal law and an international law,
―the sovereignty and integrity of the Republic and the supremacy of the constituted
Legislature in making the laws may not be subjected to external rules….‖ However, there are
few decisions in India which deal with the issue of tax treaty override in light of S. 90 of the
Act. The Apex Court in Azadi59
ventured into this sphere to some extent but the conclusion of
the Court is of little significance in the context of GAAR because the court declared the
overriding effect of a treaty over the provisions of the Act where a notification regarding
implementation of a treaty is issued pursuant to S. 90 of the Act. This is hardly the issue in
question today. Moreover, the Court has quoted the findings of a Report60
with respect to
anti-abuse provisions to be incorporated either in the treaty or in the domestic legislation, but
has refused to opine on the same. However, the Court in Vodafone61
has recognized that lack
of clarity and appropriate provisions in the statute or treaty regarding circumstances when
Judicial Anti-Avoidance Rule would apply has generated litigation in India,62
thus
recognizing the importance of a statutory law on the same.
Since all the DTAAs are in the form of delegated legislation under S. 90 of the Act,
under the scheme of Indian taxation law and Constitutional Law, there seems to be no
restriction on the power of the Parliament to legislate in a manner so as to override a treaty,
just as the Parliament can amend or overturn an earlier enacted law.63
4. GRANDFATHERING OF INVESTMENTS
The Finance Bill, 2012 brought in an environment of uncertainty and fear among
investors who were cynical about the lack of protection to existing structures and
arrangements. This resulted in a major withdrawal of investments from the economy and loss
of confidence in the Government as such a major change in tax law was undertaken without
58 Gramophone company of India Ltd. v. Birendra Bahadur Pandey, AIR 1984 SC 667.
59 Azadi, supra note 29.
60 Report of Working Group on Non Resident Taxation, MINISTRY OF FINANCE AND COMPANY AFFAIRS,
GOVERNMENT OF INDIA (January 2003), available at http://finmin.nic.in/reports/NonResTax.pdf. (25
June 2014, 05.00 PM).
61 Vodafone, supra note 32.
62 Id., per Kapadia, C.J., ¶ 68.
63 Sohrab E. Dastur (Senior Advocate), Principles of Interpretation of issues in Double Taxation Avoidance
Treaties,TAXATION, http://itaxation.wordpress.com/2008/08/31/principles-of-interpretation-of-issues-in-
double-taxation-avoidance-treaties/, (02 June 2013, 4:10 PM).
VOL. 1] INDIAN JOURNAL OF TAX LAW 66
any consultation from investors.64
Moreover, the legitimate expectations of the investors were
denied as they had set up their structures and planned investments under the umbrella of
Azadi65
as the law of the land. The newly introduced GAAR, over and above giving
unconditional power to the department, also seemed to target these investors who believed
the department to be capable of sending Show Cause Notices under the law even for existing
structures in the absence of any grandfathering clause.66
The Parliamentary Standing Committee on Finance, with respect to the Direct Taxes
Code Bill, 2010 (hereinafter ‗DTC Bill‘), had recommended the grandfathering of all existing
structures against application of GAAR provisions contained therein.67
The Shome
Committee report68
which was prepared to give recommendations to the Finance Ministry
after consulting various investors corrected the same as this ―would allow an impermissible
arrangement to exist in perpetuity if created before commencement of GAAR and
grandfathered under GAAR provisions.‖69
In addition, it gave an example similar to the
instant case where if the recommendations of the Standing Committee70
are to be followed,
then a conduit company incorporated in a favourable jurisdiction in 2008 will enjoy tax
exemption indefinitely for all the future investments made by it.71
Thus, it was recommended
that ―investments (though not arrangements)‖ should be grandfathered.72
This
recommendation sought to extend the grandfathering provision to the date of applicability of
GAAR.
64 Since the announcement of Budget 2012 on March 16 (2012), net FII inflows have slowed dramatically,
showing an effective daily average drop of 95% since March 16. See, Nicolas De Boursac, FIIs will quit
Indian markets if swords of GAAR, indirect transfer rules hang over their heads, THE ECONOMIC TIMES,
(May 6, 2012) http://articles.economictimes.indiatimes.com/2012-05-06/news/31588238_1_net-fii-
inflows-gaar-global-funds, (10 July 2013, 06:53 PM).
65 Azadi, supra note 29.
66 A grandfathering clause is a provision which states that the old law will continue to apply in some
existing situations, whereas the new law will apply to all future cases.
67 49TH REPORT OF STANDING COMMITTEE ON FINANCE (2011-12), MINISTRY OF FINANCE (DEPARTMENT OF
REVENUE), The Direct taxes Code Bill, 2010 (hereinafter ‗STANDING COMMITTEE‘).
68 EXPERT COMMITTEE 2012, Report on General Anti-Avoidance Rules (GAAR) in Income Tax act, 1961,
(September 2012) (hereinafter ‗SHOME‘).
69 Id., at 40.
70 STANDING COMMITTEE, supra note 68.
71 SHOME, supra note 68, at 40.
72 Id., at 41.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 67
The press release73
issued by the Finance Ministry later in the financial year accepted
the major recommendations, but only partially accepted the recommendation with respect to
grandfathering of investments. Although investments were grandfathered, the exemption was
provided only to those undertaken before the date of August 30, 2010, which was the date on
which the DTC Bill was tabled in the Lok Sabha. Thus, though the relief of deferment of
GAAR to April 1, 2016 was provided to the investors, investments made after August 2010
and before April 2016 were left totally unprotected. The press release has been crystallized in
the form of the recently notified GAAR Rules.74
The authors are of the view that the restriction of relief of grandfathering only to
investments made before a date in the past (August 30, 2010) selected on arbitrary
considerations (hereinafter ‗limited grandfathering‘) smacks of an intention of the
Government to keep the ambit of GAAR as wide as possible.
There are two major reservations which the authors have regarding the reasonability of
the limited grandfathering as introduced through the GAAR Rules.
a) Whether the limited grandfathering in the GAAR Rules can be challenged as
unconstitutional?
There is no doubt about the fact that GAAR shall be applied prospectively as regards
income and is not intended to target income received or accrued before its date of
enforcement.75
However, the limited grandfathering of investments only till August 2010
may trigger challenge on grounds of retrospectivity.
A retrospective law has been defined by the Supreme Court, using the definition given
in ‗Words and Phrases, Permanent Edition, Volume 37A‘ as ―one which takes away or
impairs vested or accrued rights acquired under existing laws, or creates a new obligation,
imposes a new duty, or attaches a new disability, in respect of transactions or considerations
already past.‖76
The investors, who have undertaken investments, have done so in light of the
73 Supra note 4.
74 Supra note 1.
75 Speech of Finance Minister whilst moving amendments to Finance Bill, 2012, May 7, 2012; Draft
guidelines regarding implementation of General Anti Avoidance Rules (GAAR) in terms of §101 of the
Income Tax Act, 1961; SHOME, supra note 69; Explanatory memorandum to Finance Bill, 2013.
76 Virender Singh Hooda and Ors. v. State of Haryana and Anr., AIR 2005 SC 137.
VOL. 1] INDIAN JOURNAL OF TAX LAW 68
conclusive position of law as declared by the Supreme Court in Azadi77
as regards the
precedence of form over substance. This position has been followed in effect in subsequent
cases including the recent decision of Dynamic India Fund I.78
This decision has also been
approved by the Supreme Court in the recent landmark judgement of Vodafone BV.79
With
the law so clearly in place, they have acquired a vested right under it, and imposing GAAR
on these investments ―imposes a new duty, or attaches a new disability, in respect to
transactions or considerations already past.‖80
Therefore, it may be argued that such an
application of GAAR makes it a retrospective law under the aforementioned definition.
It is a cardinal principle of construction that every statute is considered to be prima
facie prospective, unless it is made to have retrospective application either expressly or by
necessary implication.81
As explained above, GAAR has been given a retrospective effect
through the Income Tax Rules. However, it is a well settled principle of Administrative Law
that a retrospective law can even be introduced through a delegated legislation, if the parent
statute so authorizes.82
An administrative body has power to give retrospective effect to a rule
only to the extent to which the parent statute so permits it. The Supreme Court in Yadav83
has
held in addition to the above, that the rule making authority must show that there was
sufficient, reasonable and rational justification to apply the rules retrospectively.
The Income-Tax Rules are made by the Central Board of Direct Taxes (―CBDT‖) under
Section 295 of the Act. Sub-section (4) of this section expressly authorizes the CBDT to give
retrospective effect to the rules. However, retrospective effect cannot be so given if it
prejudicially affects the interests of the assesse, unless the contrary is permitted by the section
of the statute for the purpose of which the rule is made.84
Whether the limited grandfathering
provision prejudicially affects the interests of the assessee or not is again a moot point. If the
rule is challenged on the ground of retrospectivity in light of the limited grandfathering
77 Azadi, supra note 29.
78 In re, Dynamic India Fund I, AAR No. 1016/2010.
79 Vodafone, supra note 32.
80 Supra note 76.
81 Zile Singh v. State of Haryana, (2004) 8 SCC 1; Keshvan v. State of Bombay, AIR 1951 SC 124; Gem
Granites v. Commr.of Income Tax, (2005) 1 SCC 171.
82 The State of Madhya Pradesh v. Tikamadas, AIR 1975 SC 1429; Income Tax Officer, Alleppey v. M.C.
Ponnoose, AIR 1970 SC 385.
83 B.S. Yadav and Ors. v. State of Haryana, AIR 1981 SC 561.
84 Union of India v. Dr. S. Krishna Murthy, (1989) 4 SCC 689.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 69
provision, then the court may look it from two angles. It may be argued that the GAAR as
originally introduced does not impliedly grandfather past investments, and therefore a
grandfathering provision, even if limited, provides a relief to the assessees, and is in fact not
prejudicial to their interests. On the other hand it may even be argued that the GAAR has an
implied grandfathering, and a limited grandfathering provision introduced through the rules
limits the relief to the investors, and attempts to apply GAAR to past investments. To this
extent the rule may be struck down for being prejudicial to the interests of the assessees since
chapter X-A does not permit (either expressly or impliedly) making of a retrospective rule for
its purpose. Moreover, even if so authorized, the board has to give a reasonable and rational
justification to such retrospective application of GAAR provisions in light of the Yadav
ruling.
Assuming that the board has an implied authority to apply GAAR retrospectively (in
terms of investments and not income), then the constitutional validity of the limited
grandfathering needs to be determined. It has been upheld on several occasions that a
retrospective law legitimately passed cannot be challenged except on the grounds of violation
of fundamental rights.85
The authors are of the opinion that if GAAR is applied to all past
investments after the date of August 30, 2010, even if through an express law validly passed,
it is open to challenge on the ground of violation of Article 14 and 19 (1) (g) of the
Constitution.
Article 14 permits the Legislature (including the delegate) to make reasonable
classification of persons, objects and transactions for the purpose of achieving specific ends.86
However, such a classification must be founded on an intelligible differentia and this
differentia must have a rational relation to the object sought to be achieved by the statute.87
Also, it is a well- established Constitutional law principle, recognized by the Supreme Court,
85 State of Gujarat and Anr. v. Raman Lal Keshav Lal Soni, AIR 1984 SC 161; This follows from the
general constitutional mandate that no law, whether prospective or retrospective, can be made which
contravenes fundamental rights; The Constitution of India, Article 13, supra note 47.
86 Western U.P. Electric Power and supply Co. Ltd. v. State of Uttar Pradesh, AIR 1970 SC 21; R.K. Garg v. Union of India, AIR 1981 SC 2138.
87 State of West Bengal v. Anwar Ali Sarkar, AIR 1952 SC 75; Budhan v. State of Bihar, AIR 1955 SC
191; Harakchand v. Union of India, AIR 1970 SC 1453; State of Bombay v. F.N. Balsara, AIR 1951 SC
318.
VOL. 1] INDIAN JOURNAL OF TAX LAW 70
that Article 14 is violated not only when equals are treated unlike, but also when unequals are
treated alike, i.e., if there is similar treatment of groups situated in dissimilar circumstances.88
The limited grandfathering provision satisfies both sides of the aforementioned
inequalities. Firstly, it treats the similarly placed investments before and after the date of
August 30, 2010 differently by imposing retrospective burden on the latter while exempting
the former. The basis of classification is that since the DTC Bill was tabled on August 30,
2010, investors undertaking investments after this date are aware of the possibility of GAAR
provisions contained therein to have effect in the near future. However, the tabling of a bill is
just the first step in the process of enactment. The fact that the DTC Bill has not yet been
enacted further goes against the government‘s reasoning. Therefore the classification of
investments on the basis of their timing with respect to such arbitrary date does not qualify as
―intelligible differentia‖ having a ―rational nexus with the object sought to be achieved‖.
Secondly, the limited grandfathering provision also affords similar treatment to investments
made before and after the date of applicability of GAAR, consequently treating unequals
equally. Thus, it is argued that the provision violates every facet of equality guaranteed under
Article 14.
Article 19(1)(g), in granting the right to practice any profession, or to carry on any
occupation, trade or business, carries with it a further safeguard against imposition of an
unreasonable tax burden.89
In determining whether the retrospectivity of a law is so arbitrary
and burdensome as to violate Article 19(1)(g),90
the criteria declared by the Supreme Court
include the period of retrospectivity and the degree of any unforeseen financial burden
imposed for the past period.91
The investors having acquired a vested right to invest, in light
88 Chiranjit Lal v. Union of India, AIR 1951 SC 41; Om Narain v. Nagar Palika, Shahjahanpur, (1993) 2
SCC 242.
89 Prateek Andharia, The Validity of Retrospective Amendments to the Income Tax Act: Section 9 of the Act
and the Ishikwajma Harima Case, 4 NUJS L.REV. 269 (2011).
90 The Constitution of India, supra note 47; the freedoms under Article 19 are available only to ―citizens‖.
Since many of the investors affected by GAAR will be corporations, their locus standi for a challenge
under Article 19 is questionable, i.e., even if the corporation is Indian in every sense, e.g., it is registered
in India, has Indian capital and all of its shareholders and directors are Indian, it can claim no right under
Art. 19; State Trading Corporation of India v. The Commercial Tax Officer, AIR 1963 SC 1811; Tata
Engineering v. State of Bihar, AIR 1965 SC 40. However, in the course of time, the rigours of the above
pronouncements have been diluted by resorting to the strategy of joining a natural person along with a
company in the writ petition challenging violation of Art. 19(1)(g). See, M.P. JAIN, INDIAN
CONSTITUTIONAL LAW, 801 (5th ed., 2008); Sakal Papers v. Union of India, AIR 1962 SC 305; R.C.
Cooper v. Union of India, AIR 1970 SC 564; Bennett Coleman & Co. v. Union of India, AIR 1973 SC
106.
91 Ujagar Prints v. Union of India, (1989) 3 SCC 488.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 71
of various judgements of the Supreme Court as discussed above, the retrospective burden of
scrutiny for the purposes of GAAR under Section 144BA of the Act will be imposed on
them. This burden is completely unforeseen as the DTC Bill tabled in the Lok Sabha on
August 30, 2010 is far from a conclusive Law capable of directing the investors on their
proposed investments. An unforeseen retrospective burden of taxation denies the taxpayer the
rightful opportunity of carrying out cost-benefit analysis of the proposed transaction and to
decide whether or not to enter into such a transaction.92
b) The protection of grandfathering should have been afforded not only to the
transfer of existing investments, but also to returns accruing or arising from
these investments.
The Shome Committee report has recommended the grandfathering of investments to
cover exit of such investments even after the date of commencement of GAAR (the date of
grandfathering being the same as the date of commencement of GAAR).93
This is because
most of the foreign investment in India being made from Mauritius and Singapore, the same
is made on the condition of availing of treaty benefits, which include non-taxation of capital
gains in India on exit or sale of such investments.94
This scope of grandfathering has been
accepted and followed in the GAAR Rules which limits the protection of grandfathering only
to the transfer of investments. Thus, the tax benefit on sale of grandfathered investments even
after the date of commencement of GAAR would not attract the provisions of GAAR.
In the opinion of the authors, the grandfathering provision must be broad enough even
to cover returns from investments such as dividends, interests etc. Thus, in light of the limited
grandfathering provision, if an investment made before August 30, 2010 is grandfathered,
and if such investment otherwise qualifies as an impermissible avoidance arrangement, then
the consequences of GAAR should not apply to the returns accruing or arising from such
investments even after this date.
92 Pradip R. Shah, Retrospective Amendments – High-time for Introspection by India, CA CLUB INDIA,
(April 1, 2010) http://www.caclubindia.com/articles/retrospective-amendments-hightimefor-
introspection-by-india-5144.asp (07 May 2014, 4:35 PM).
93 SHOME, supra note 68, at 41.
94 Id., at 40.
VOL. 1] INDIAN JOURNAL OF TAX LAW 72
5. GAAR AND ITS COUNTER PRODUCTIVITY TO FOREIGN
INVESTMENTS
5.1 TAX AS A VARIABLE OF FOREIGN INVESTMENT
―India needs investment for employment generation and advancement of its economy
and everyone needs to keep that in mind.‖95
The ex-chief justice of India implanted the
comment, aftermath of Vodafone96
judgement, with the intention of reminding the
government‘s rough neck policies of tax collection which were driving away the foreign
investments from the country. The ex-chief justice, from his own personal experience,
reiterated the importance of a sensible tax strategy to attract foreign investors. Globalisation
is a fact which cannot go unnoticed. Globalisation and taxation are two faces of the same
coin. Modern International taxation practice also views taxation as a means for directing and
regulating the flow of investments.97
In this era, scope of taxation is a factor which makes or
breaks the foreign investment in any country. ―A country which is as yet developing, both in
its global economic confidence and in its taxation regime, needs the encouragement and
support of its contemporaries.‖98
Justice Swatanter Kumar, a party to the Vodafone judgment,
reinstituted the need of framing the law and policies in consonance with the current economic
scenario of the country. Another significant concern pointed out by the Hon‘ble judge was
the administration of tax laws in a complex and unfriendly manner. He prioritized the need
from simplification of tax laws to simplified and friendly administration of tax laws.
The policy makers introducing or revising its FDI Policy may rely on one or more
economic models or frameworks to examine the possible channel of influence. The Policy
Framework for investment99
primarily focuses on developing and transition economies. Tax,
one of the issues influencing FDI, has to be studied keeping in mind various factors which
may affect FDI in such countries. In setting the tax burden on inbound investment, policy
95 Spare Vodafone – Save Thousands of Job: Ex Chief Justice Kapadia, (May 17, 2013), available at
http://www.itatonline.org/articles_new/index.php/spare-vodafone-save-thousands-of-jobs-ex-chief-
justice-kapadia/ (27 July 2014, 01:13 PM).
96 Vodafone, supra note 32.
97 Justice Swatanter Kumar, Complex Tax Laws & Hostile Tax Dept Are Responsible For Tax Avoidance,
(January 26, 2013) available at http://www.itatonline.org/articles_new/index.php/complex-tax-laws-hostile-tax-dept-are-responsible-for-tax-avoidance/ (27 July 2014, 1:07 PM).
98 Id.
99 OECD (2007), Tax Effects on Foreign Direct Investments- No.17, OECD PUBLISHING available at
http://www.oecd.org/tax/tax-policy/39866155.pdf (05 July 2014, 4:15 PM).
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 73
makers are encouraged to assess whether their host country offers attractive risk/return
opportunities, taking into account framework conditions, (e.g. political/monetary/fiscal
stability; legal protection; public governance) market characteristics and the prevalence of
location-specific profits.100
The authors are of the view that the impediment created by the tax
authorities/governments by imposing taxes with discretionary powers and uncertainty, deter
the foreign investors to make the location specific decision in favour of the host countries.101
Therefore, this issue can be mooted on two facets i.e. first on the scheme of discretionary
power and second on the scheme of legal uncertainty.102
On the point of discretionary power, it can be contended that the present structure of
statutory GAAR, introduced by the government, overlay a gigantic scope of exercising
discretion at the lowest level by the Assessing Officer. Difficulty to administer discretionary
regime results in delays and uncertainty for investors. This can even increase the overall cost
of making an investment in some countries.103
If the overall cost of the investment will
increase, then why would an investor look forward to such investment?
On the question of legal uncertainty, ―legal certainty‖ would imply dynamic and
efficient substantive laws clearly stating the rights, obligations, and liabilities of all business
parties, rule-based business transactions, and procedural law providing prompt and
inexpensive means to the courts, an institutional framework that supports business
development and sustainability, strict adherence to the principles of ‗rule of law‘ and
‗supremacy of the law‘, and an efficient and independent judiciary. Legal uncertainty on the
other hands always occurs when individual actors are uncertain of the effects of the
100 Id.
101 ―The sudden and unprecedented move in the [Budgetary] bill has undermined confidence in the policies
of the government of India toward foreign investment and taxation and has called into question the very
rule of law.‖ Rahul Bedi, George Osborne says Indian tax plans could harm investment, THE
TELEGRAPH, (April 2, 2012), available at
http://www.telegraph.co.uk/finance/newsbysector/industry/9179558/George-Osborne-says-Indian-tax-
plans-could-harm-investment.html (07 July 2014, 7:30 PM).
102 The tax uncertainty now anticipated creates significant risk that these global funds will choose to avoid
the Indian capital markets altogether and redirect their resources to other opportunities. Nicholas de
Boursac, FIIs will quit Indian markets if swords of GAAR, indirect transfer rules hang over their heads,
THE ECONOMIC TIMES, (May 6, 2012) available at http://articles.economictimes.indiatimes.com/2012-05-06/news/31588238_1_net-fii-inflows-gaar-global-funds (07 July 2014, 7:50 PM).
103 Jacques Morisset & Neda Pirnia, How Tax Policy and Incentives affect the Foreign Direct Investment: A
Review, THE WORLD BANK AND INTERNATIONAL FINANCE CORPORATION FOREIGN INVESTMENT
ADVISORY SERVICE, Policy Research Working Paper No. 2509, 22, (December 2000).
VOL. 1] INDIAN JOURNAL OF TAX LAW 74
provisions of the dominant legal system on the results of their actions.104
The objective legal
uncertainty, which does not form a reliable and sure basis for decisions, always affects the
investment decisions. This uncertainty can be best explained with an example mentioned in
the first section of this paper wherein the uncertainty is created by the standard laid down for
driving speed. If there is a legal uncertainty in the minds of the investors for decision making,
then how would a foreign investor make such an investment? The foreign investors will be
more deterred, as the cost of international legal disputes is much greater than domestic
disputes.105
Therefore the discretionary power entrusted in Chapter X-A in favour of tax authorities
and uncertainty looming in the minds of foreign investors, will result in loss of foreign
investor‘s confidence in the economy and tax structure.106
This loss may defeat the purpose
of revising the FDI Policy. Moreover, cases like Vodafone give a reason to foreign investors
to ponder over their investment decisions.107
The controversy over introduction of GAAR has haunted not only the foreign investors
but also raised concerns in the minds of countries from where the investments are brought in
India. Mauritius, top investing country through FDI with 38%,108
is also concerned over the
effects of Indian GAAR on their role as a preferred investment route to India.109
Not only
Mauritius, this concern is raised from every corner of the world to maintain the balance
between the reform measures in the form of FDI and introduction of GAAR.110
The
104 Martin Zaglar & Cristiana Zanzottera, Corporate Income Taxation Uncertainty and Foreign Direct
Investment, WU International Taxation Research Paper Series No. 2012-07, 3, (2012).
105 Hanno von Freyhold, Volkmar Gessner, Enzo L. Vial & Helmut Wagner, Cost of Judicial Barriers for Consumers in the single Market, A REPORT FOR THE EUROPEAN COMMISSION, BRUSSELS, 117, (Oct.-
Nov.,1995).
106 Supra note 101.
107 Investors into India rely on good governance, a predictable regulatory regime and a hassle-free, rules-
based business environment because they are making major long-term commitments, large sums of
money, long gestation and long operation periods, needing as much predictability and consistency as
possible. See, Singapore PM Lee Hsien Loong says business environment in India 'complicated', THE
INDIAN EXPRESS, (July 11, 2012).
108 Fact Sheet on Foreign Direct Investment From April, 2000 to April, 2013, (April, 2013)
http://dipp.nic.in/English/Publications/FDI_Statistics/2013/india_FDI_April2013.pdf (20 June 2014,
06.00 PM).
109 Mauritius is looking to balance India‘s concerns over misuse of a tax treaty between the two countries,
with its desire to remain a preferred investment route into India, according to a Mauritius delegation
comprising officials from the investment promotion board and financial sector regulators. See, Remya
Nair, Mauritius to address India‘s concerns over tax treaty, THE ECONOMIC TIMES, 9 (July 11, 2013).
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 75
government unleashed huge FDI reforms in order to attract foreign investments in the country
in light of the harsh economic environment;111
but how far these reforms will prove to be
adequate enough to regain the investor‘s confidence, keeping in mind the upcoming GAAR
in two years, is still a pending question to be answered.
It is an economic reality, as mentioned in detail above, that FDI flows towards a
location with a strong governance infrastructure which includes enactment of laws and a
well-oiled legal system. Certainty is integral to rule of law. Certainty and stability form the
basic foundation of any fiscal system. Certainty in tax policy is crucial for taxpayers
(including foreign investors) to make rational economic choices in the most efficient manner.
In the opinion of the authors, it is for the government of the day to have certainty
incorporated in the Treaties and in the laws so as to avoid conflicting views. Investors should
know where they stand. It also helps the tax administration in enforcing the provisions of the
taxing laws. This would serve the purpose of having an anti-avoidance rule as well as the
investors will not lose confidence in the economy.
5.2 GOVERNMENT EFFORTS TO ATTRACT FOREIGN INVESTMENT
Foreign Direct Investment (―FDI‖) is an investment involving a long term relationship
and reflecting a lasting interest and control of a resident entity in one economy in an
enterprise resident in an economy other than that of the foreign direct investors.112
The initiation of new economic policy in 1991 is remarked as the stepping stone of
Indian foreign investment regime. The removal of restrictive and regulated trade practices, by
the policymakers, was welcomed by the foreign investors then. Subsequently, with the
process of reforms, India has witnessed a change in the flow of FDI in the country. The
whole reform process has turned the investors‘ faces towards India making it a preferred
investment destination.113
110 With the introduction of General Anti-Avoidance Rules (GAAR) which were intended to plug taxation
loopholes and the announcement on retrospective amendments to income tax law have affected business
sentiments and investors‘ confidence globally. See, Follow Obama order on FDI, reforms: CII, THE
INDIAN EXPRESS, (17 July, 2013).
111 To lure foreign money, boost growth, India eases FDI curbs, THE HINDUSTAN TIMES, (17 July, 2013).
112 UN Conference on Trade and Development, World Investment Report, Foreign Direct Investment and
the Challenge of Development, (1999).
113 Id.
VOL. 1] INDIAN JOURNAL OF TAX LAW 76
The table and chart below show the total FDI inflows from the financial year 2000-01
to 2012-13.
Figure 1: FDI Inflow Table
(Amount in US $ Million)
Financial Year Total FDI Inflows
2000-01 4,029
2001-02 6,130
2002-03 5,035
2003-04 4,322
2004-05 6,051
2005-06 8,961
2006-07 22,826
2007-08 34,843
2008-09 41,873
2009-10 (P) 37,745
2010-11 (P) 34,847
2011-12 (P) 46,556
2012-13 (P) 36,860
Source: Based on DIPP, ―Fact Sheet on Foreign
Direct Investment‖, April 2013.
(P): All figures are provisional. Financial Year is
April-March.
Total FDI Inflow comprises of Equity inflows
(FIPB/SIA, Automatic Route & Acquisition route,
Equity capital of unincorporated bodies and Re-
invested earnings.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 77
Source: Based on DIPP, ―Fact Sheet on Foreign Direct Investment‖, April
2013.
(P): All figures are provisional. Financial Year is April-March.
Total FDI Inflow comprises of Equity inflows (FIPB/SIA, Automatic
Route & Acquisition route, Equity capital of unincorporated bodies and
Re-invested earnings.
The era before 2005 shows a mixed development of FDI in India. The quantum of FDI
inflows fluctuated till 2005. After 2005 there seems to be a significant development in the
figures. The increase in the year 2005 was a result of many policy initiatives framed by the
government in order to attract FDI inter alia enactment of Special Economic Zones Act and
the decision of allowing upto 100% FDI under the automatic route for townships, housing,
built-up infrastructure and construction development projects.114
The opening up of the
automatic route for specific sectors for investment rather than FIPB route by the government
yielded in opening up of the market and thus the foreign investors enjoyed freedom in
decision making.115
The acquisition of shares of the domestic enterprise by the foreign
114 K.S. CHALAPATI RAO & BISWAJIT DHAR, INDIA‘S FDI INFLOWS TRENDS AND CONCEPTS, RESEARCH AND
INFORMATION SYSTEM FOR DEVELOPING COUNTRIES & INSTITUTES FOR STUDIES IN INDUSTRIAL
DEVELOPMENT (2011), available at http://ris.org.in/images/RIS_images/pdf/FDI_Book-Final.pdf (20
June 2014, 07.00 PM).
115 Id.
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
50,000
2000
-01
2001
-02
2002
-03
2003
-04
2004
-05
2005
-06
2006
-07
2007
-08
2008
-09
20
09-
10
20
10-
11
20
11-
12
20
12-
13
Figure 2: Total FDI Inflows Chart
Total FDI Inflows
VOL. 1] INDIAN JOURNAL OF TAX LAW 78
investors was also one of the prominent reasons behind the increase in FDI inflow after
2005.116
The increase in inflow of FDI since 2005 is a result of policy initiatives taken by the
government. Emergence of service sector over the manufacturing sector was also responsible
for the rise in FDI.117
Increase in inflow of foreign capital from tax haven countries also
contributed towards rise in FDI in India.118
The relationship between growth and FDI in a
country is positive i.e. higher the growth rate leads to more FDI.119
The authors propose to draw a comparative analysis between the FDI during the time of
Azadi120
and that during the time when the Finance Bill, 2012 was introduced. The decision
in Azadi was given in October 2003, i.e., in the Financial Year 2003-04. As is evident from
the table and the graph shown hereinabove, the FDI inflows in that Finance Year were below
the 5000 mark, which is 10 times lesser than its peak in 2011-12, which is the Financial Year
when GAAR was first introduced. The Supreme Court had upheld the Circular 789,121
thereby validating treaty shopping. It had emerged as the tax planner‘s messiah by upholding
the Westminster principle as being applicable even today, and is viewed as a watershed in the
Indian Jurisprudence on international taxation.122
The Supreme Court had adapted a
favourable attitude towards foreign investors at a time when the government was not too
committed towards attracting foreign investment. This was a time even before the major
reforms took place in 2005 as mentioned above.
Ironically, the controversial Finance Bill, 2012 which increased uncertainty and
discretionary power (both of which are deterrents to foreign investment), was introduced at
the time when FDI inflows were at their peak because of committed measures being taken by
the Government. The Finance Act, 2012 proved to be a nightmare for the foreign investors in
India. Apart from introducing the much dreaded GAAR, it also brought in a retrospective
amendment to S. 9 of the Act by broadening the definition of capital asset being a share or
116 Id.
117 Id.
118 Id; Singapore replacing US at number 2 after Mauritius and in top 10 investing countries, Cyprus and
UEA were also added as they are tax havens.
119 Chandana Chakraborty & Peter Nunnenkamp, Economic Reforms, FDI, and Economic Growth in India:
A Sector Level Analysis, 36 WORLD DEVELOPMENT 1192 (2008), available at
http://58.194.176.234/gjtzx/uploadfile/200904/20090401152836328.pdf.
120 Azadi, supra note 29.
121 CBDT Circular No.789, 13-4-2000. The Circular clarifies that a Certificate of residence issued by the
Mauritian authorities will constitute sufficient evidence for accepting status of residence as well as
beneficial ownership for the purpose of availing benefits under the India-Mauritius double tax treaty.
122 KANGA, supra note 8.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 79
interest in a company incorporated outside so as to include underlying Indian assets of that
company within the definition. This was specifically done to overrule the Supreme Court
Judgment in Vodafone123
which had held otherwise. The enactment also disturbed the settled
position of law declared by Azadi by overriding the Circular 789.124
The enactment shook the
confidence of foreign investors, and was predicted, in India as well as abroad, to have adverse
impact on inflow of foreign investment.125
Thus, in the opinion of the Authors, the current structure of GAAR is counterproductive
to the Governments efforts at increasing inflow of foreign investment. This argument is
supported by figures showing that the annual FDI flow fell by 38% in India in the financial
year 2012-13126
despite all the Government efforts in the nature of reforms, targeted at
attracting foreign investments to India.127
The FDI attracted in November 2012 was a two-
year low.128
Even after an improvement in GAAR through the Finance Act, 2013, and the GAAR
Rules, many of the recommendations of the Shome Committee report which aim at greater
certainty have not been included. The government is introducing new and heavy FDI reforms,
but it is doubtful whether this is going to help the foreign investors in fading out the
123 Vodafone, supra 32.
124 Finance Bill, 2012 introduced sub-section (4) to S. 90 of the Act which required the assessee, being a
foreign resident, to have a ―certificate, containing such particulars as may be prescribed‖ in order to avail
the benefits of the tax treaty.‖ This disturbed the settled position of a Tax Residency Certificate being a
sufficient proof of residence.
125 Senior Advocate Harish Salve comments in Finance Act 2012. Mr. Slave also said that GAAR will affect
foreign investments. See, Proposed Change to Finance Bill to impact Foreign Investment, THE
ECONOMIC TIMES, (28 April, 2012) http://articles.economictimes.indiatimes.com/2012-04-
28/news/31453430_1_impact-foreign-investment-tax-case-income-tax-act (26 July 2014, 11:00 PM).
Italy Trade commissioner raises concern. See, Retrospective Amendment to I-T Act may FDI in India,
THE BUSINESS STANDARD, (20 May, 2012) http://taxmantra.com/inflow-fdi-impacted-retrospective-
amendment-laws.html (26 July 2013, 10:00 PM).
126 Annual FDI flow dips 38%, THE TELEGRAPH, (03 June, 2013) available at
http://www.telegraphindia.com/1130603/jsp/business/story_16965052.jsp#.UfEO99Kotf8 (23 July 2014,
04:30 PM).
127 The government had taken several policy decisions in the past few months to attract foreign investments.
Important among these include, allowing FDI in multi-brand retail and civil aviation sectors and seeking
legislative approval for increasing FDI cap in insurance and pension sectors. See, FDI dips by 38% to $ 22.4 billion in 2012-13, THE TIMES OF INDIA, (03 June, 2013) available at
http://timesofindia.indiatimes.com/business/india-business/FDI-dips-by-38-to-22-4-billion-in-2012-
13/articleshow/20392486.cms (26 July 2014, 1:30 PM).
128 Supra note 126.
VOL. 1] INDIAN JOURNAL OF TAX LAW 80
ambiguity around or the effect of the retrospective amendments on indirect transfers or non-
acceptance of certain key recommendations of the Shome Committee on GAAR.129
The government is still continuously making efforts in order to attract FDI in India in a
desperate attempt to spur the economy and to stem the rupee‘s slide. Recently on July 16,
2013 the government raised caps in a range of sectors such as telecom, asset reconstruction
firm, credit information services, defence etc.130
The Government has also been taking
measures to attract other forms of foreign investment. The Qualified Foreign Investor (QFI)
scheme was introduced in 2011-12 by allowing foreign investors to invest in Mutual Funds,
which was further expanded on 1st January, 2012 to allow them to invest directly in the
Indian Equity Market. FII investments in debt securities have also been progressively
enhanced and debt limit allocation mechanism for FII has been rationalised by allowing
reinvestment to FII, and adopting First Come First Serve (FCFS) method of allocating limits
in case of the long term infra bonds. Rationalisation has also taken place in the terms and
conditions for FII investment scheme in infrastructure debt and non-resident investment
scheme in terms of the lock-in period and residual maturity criterion.131
Furthermore, the
Chandrasekhar Committee132
formed by the SEBI published its report on June 12, 2013,
wherein it recommended the merging of existing FIIs, Sub-accounts, and QFIs into a single
investor class to be termed as Foreign Portfolio Investor (FPI) with the aggregate limit as
24%. As regards Foreign Venture Capital Investor (FVCI), the committee recommended the
considerable expansion of the present list of 9 sectors. Consequently, the Government is
expected to prepare a negative list so that the rest of the sectors are open to Venture Capital
Fund (VCF) activity.133
These efforts of the government are expected to be received stoically by foreign
investors since a lot of other key issues in India still linger in a cloud of uncertainty, and these
129 Indian Budget & its Impact for Foreign Investors, 5(33) SKP Tax Alert, (March 2013), available at
http://www.skpgroup.com/newsletters/tax-alerts/skp-tax-alert-V-33-Indian-Budget-and-its-impact-for-
foreign-investors.html (25 June 2014, 05.00 PM).
130 Supra note 111.
131 PRESS INFORMATION BUREAU, GOVERNMENT OF INDIA, Government takes several initiatives to attract
foreign investment, (December 6, 2012) available at http://pib.nic.in/newsite/erelease.aspx?relid=90127 (12 June 2014).
132 Report of the Committee on Rationalization of Investment Routes and Monitoring of Foreign Portfolio
Investments, SECURITIES AND EXCHANGE BOARD OF INDIA (June 12, 2013).
133 Id.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 81
issues include the current tax structure.134
The authors being concerned only with GAAR, the
government efforts to attract foreign investments will go in vain unless the uncertainty in
GAAR is addressed.
6. CONCLUSION: CONTEMPORARY SETTING AN EXAMPLE
The Authors would like to reiterate their position that they are not opposed to the
concept of a statutory GAAR, but are critics of the form in which the Indian GAAR has been
drafted, and is expected to be implemented. A statutory GAAR in itself is not characterized
by uncertainty and unfettered power which is a major deterrence to the inflow of foreign
investment. These are characteristics which are unique to the Indian GAAR and should not
lead to a prejudicial generalisation against the concept of a statutory GAAR. This can be
evidently seen from the GAAR introduced in the UK, which became effective recently on
July 17, 2013 when the Finance Bill, 2013 received the royal assent.135
Although the two GAARs are contemporaries, the approaches followed by the two are
completely different. Philip Baker QC,136
while comparing the Indian GAAR as introduced in
the Finance Bill, 2012 and the draft UK GAAR in the Aaronson Report,137
states that ―The
Aaronson GAAR seems to have bent over backwards in trying to achieve as much certainty as
possible. One wonders whether the draftsman of the Indian GAAR has not tried to bend over
backwards in the opposite direction.‖138
The Aaronson Report advocated a moderate and focussed Anti-Avoidance Rule for the
UK, which aims at targeting abusive and contrived arrangements without disturbing
reasonable tax planning. The Report rejected the idea of a broad spectrum GAAR as being
unnecessary to the UK tax system, and a GAAR along the lines of the Report was accepted
134 Reforms Fail to enthuse Foreign Investors, EQUITY MASTER‘S-THE 5 MINUTE WRAP UP, available at
http://www.equitymaster.com/5MinWrapUp/detail.asp?date=07/22/2013&story=2&title=Reforms-fail-
to-enthuse-foreign-investors (27 July 2014, 8:46 PM).
135 Christopher Groves et al, United Kingdom: UK Finance Act 2013-Royal Assent on 17 July 2013,
WITHERS WORLDWIDE, (July 27, 2013) available at
http://www.mondaq.com/x/254390/Income+Tax/UK+Finance+Act+2013+Royal+Assent+on+17+July+2
013 (27 June 2014, 08:50 PM).
136 Philip Baker, Tax Barrister and Queens Counsel, United Kingdom.
137 REPORT BY GRAHAM AARONSON QC, GAAR Study, November 11, 2011(hereinafter ‗AARONSON‘).
138 Philip Baker, The UK GAAR and the Indian GAAR, available at
http://www.taxmann.com/taxmannflashes/flashst13-6-12_DTL_3-UKGAAR.pdf (23 July 2013, 3:42
PM) (hereinafter ‗Baker‘).
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by the Government in the Budget of 2012.139
Thus, the GAAR which has recently come into
force in the UK is along the lines of the GAAR suggested by the Aaronson Report, with some
material differences reflecting the formal consultation process.140
One of the major causes of uncertainty in the Indian GAAR is that it is extremely broad
and targets an ―impermissible avoidance arrangement‖, the main purpose of which is to
obtain a tax benefit, and this condition must be qualified with any of the stipulated conditions
which include misuse or abuse of the legislation and deemed lack of commercial
substance.141
The GAAR therefore threatens to undermine legitimate tax planning. Senior
Tax Advocate Sohrab E. Dastur while commenting on the Finance Bill, 2012 states certain
situations where the Assessing Officer may deny tax benefit for the reason that the main
purpose therein is to obtain a tax benefit, such as, dividend stripping; a situation where shares
are sold under private arrangement rather than on stock exchange only to be able to book a
loss because a loss on stock exchange is not allowed; Sale and lease bank transactions, etc.142
In contrast to the Indian GAAR, its British counterpart is a General Anti-Abuse Rule
which targets only ―abusive‖ tax arrangements, whose classification as such will depend
upon circumstances which, inter alia, include exploitation of any shortcoming in the
provisions and use of abnormal steps to achieve the substantive results of the arrangement.143
The UK GAAR is expressly designed to exclude reasonable tax planning.144
The HMRC has also provided an official GAAR Guidance on how it is to be operated,
and also provides elaborate examples of situations when GAAR will or will not be
attracted.145
This Guidance is expressly recognized by the legislation for its aid to the
interpretation and application of GAAR.146
In India, the Shome Committee Report147
does set
139 FULL TRANSCRIPT, UK Budget speech 2012, George Osborne, (March 21, 2012) available at
http://www.newstatesman.com/economy/2012/03/tax-rate-today-britain-billion (27 June 2014, 08:00
PM).
140 Antony Seely, Bussiness and Transportation Section, TAX AVOIDANCE: A GENERAL ANTI-ABUSE RULE ,
NO. SN6265 (2013- Library of House of Commons).
141 Baker, supra note 138.
142 Soli Dastur on Finance Bill, 2012, LET‘S TALK ABOUT THE LAW, (March 23, 2012) available at
http://letstalkaboutlaw.wordpress.com/2012/03/21/soli-dastur-on-finance-bill-2012/ (23 June 2014, 4:27
PM).
143 UK Finance Bill, 2013, cl. 204(2).
144 HM REVENUE AND CUSTOMS, HMRC‘s GAAR Guidance, B4.1, available at
http://www.hmrc.gov.uk/avoidance/gaar.htm (23 June 2014, 6:57 PM).
145 Id., C.
146 Id., A4.
2014 Indian GAAR: Is Uncertainty Causing a Setback to Foreign Investments? 83
out examples of situations which GAAR should or should not cover, but this report does not
form a part of the legislation like the HMRC Guidance, and the degree to which its
recommendations have been accepted is unclear.
The HMRC Guidance provides for an independent Advisory Panel whose function is to
provide its opinion on cases referred to it in order to bring in an independent and non HMRC
perspective to the application of GAAR.148
This goes a long way in ensuring certainty and
keeping discretionary power at check. In the Indian GAAR, the Approving Panel is to be
chaired by a sitting or a retired High Court Judge, and one out of the two remaining members
is an independent academic or a scholar.149
Although a positive composition, the Approving
panel is involved at a later stage when the assessee objects to the Shown Cause Notice sent
by the Commissioner,150
unlike UK where the independent Advisory Panel is involved before
any action is taken under GAAR.151
Moreover, the Indian GAAR is to be applied ―in
accordance with such guidelines and subject to such conditions and the manner as may be
prescribed‖.152
The investors and taxpayers are still awaiting such guidelines or conditions
from the Government.
Under the Indian GAAR, once an arrangement is characterized as an impermissible
avoidance arrangement, the Assessing Officer is empowered to disregard or recharacterise the
whole transaction, look through the arrangement by disregarding any corporate structure,
change the place of residence of a party or situs of an asset for tax purposes, treat equity as
debt or vice-versa etc.153
Thus such wide powers have been conferred at a an extremely low
level. The UK GAAR on the other hand provides for a designated HMRC officer who alone
can send a show cause notice to the taxpayer for the purposes of GAAR.154
Such a safeguard
is absent in the Indian GAAR, which is likely to go a long way in shaking investor
confidence, more so with foreign investors.
147 SHOME, supra note 68.
148 GAAR Guidance, supra note 144, E4.
149 Income Tax Act, 1961, S. 144BA (16).
150 Id., S. 144BA (4).
151 GAAR Guidance, supra note 145, E3.2
152 Income Tax Act, 1961, S. 101
153 Id., S. 98.
154 UK Finance Bill, 2013, Schd. 41, Cl. 3.
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It is pertinent to point out a few positive steps which have been taken by the
government since the Finance Act, 2012. Section 90(4) has been amended by the Finance
Act, 2013 to provide that a person resident in a foreign country which has a DTAA with India
must mandatorily have a ―certificate of his being a resident‖. This substituted the previously
amended section where the foreign resident was required to have a ―certificate, containing
such particulars which may be prescribed.‖ This had created a lot of ruckus among investors
from low tax jurisdictions such as Mauritius and Cyprus who had a valid tax residency
certificate which was granted immunity by the Supreme Court in Azadi155
where it had
upheld the Circular 789.156
The Finance Act 2013 provided the required respite by restoring
the existing position of a valid Tax Residency Certificate as an accepted proof of residence.
However, such Certificate is a necessary but not a sufficient proof by virtue of the newly
introduced sub-section (5) to section 90, wherein the assessee may be required to produce
such further documentation as may be prescribed. The implication of this provision on
Circular 789 and Azadi is yet to be seen.
The GAAR Rules157
provide for a monetary threshold of Rs. 3 crores of tax for the
invocation of GAAR provisions, which provides the much required relief to the investors
since it reduces the possibility of every tax planning being questioned. Furthermore, the FIIs
which choose not to take any tax treaty benefit have been proposed to be left out of GAAR,
and so have the foreign investors in FIIs. This is expected to reduce the repulsion of foreign
investors from investing through FIIs.
Even after these positive steps taken by the Government, the current structure of GAAR
leaves much to be desired. How far this is going to be addressed before GAAR becomes
effective is yet to be seen. However, the time for procrastination is running out.
155 Azadi, supra note 29.
156 Supra note 121.
157 Supra note 1.