The Need for GAAR

By Saachi Kanjani & Isha Maniar

Editor’s Note: There has been extensive debate about the implementation of General Anti-Avoidance Rules (GAAR) across different jurisdictions. The need for GAAR is felt because it is believed that such provisions will improve the integrity of the taxation system and legitimise the interests of taxpayers as well. This research paper discusses what are avoidance provisions, their origin, and how they are different from evasion and planning. It analyses the taxation regime in different nations, particularly India. The Vodafone case has been studied in detail and the recommendations of the Shome Committee have been scrutinised to suggest an effective way for the implementation of GAAR.”


The government of every country recognizes the need to introduce General Anti Avoidance Rule, hereinafter referred to as GAAR, for several reasons. The need for a GAAR is usually justified by a concern that the integrity of the tax system needs to be strengthened. This, in turn, usually reflects a judgment by the Government and Parliament that existing laws, judicial practice and tax administration are not considered adequate to address current challenges and the anticipated requirements of future generations.

As a consequence, such a judgment or statement is deemed controversial because of the different interests and opinions that are to be balanced between the community as represented by the Government and the Revenue on the one hand and on the other, specific elements of the tax base, such as citizens and more particularly business, residents and non-residents.

Discussions about the need for a GAAR usually focus on competing policy interests such as the need for integrity of the tax system as against the legitimate interests of taxpayers to organize their affairs in a normal commercial or family way and the community benefits of economic growth resulting from business investment.

However, such discussions also need to focus on the precise form of the GAAR for a given nation so that it is targeted to address effectively only the mischief that it should and to do so fairly so as to strengthen the confidence of all stakeholders in the system. Such debates and discussions are very important and require informed and balanced contributions from all stakeholders.

One may distil some of the key challenges in the design of the GAAR – achieving consensus on what the GAAR should focus on and how the rules work fairly and efficiently to effectively apply in those cases in a way that is subject to judicial review and administered based on evidence of all relevant facts.

Further the central concern of a GAAR should be whether the design intent of the GAAR truly translates into the legislation and administration. Future generations live with the benefits and the burdens. For example, Tax administrators may become frustrated by judicial interpretations that depart from their own. Taxpayers may also be bewildered by expectations of the GAAR having a limited impact only to find it becomes a risk to be faced far more broadly. Absolute transparency and consensus about design intent might not anticipate and avoid all problems but without it there is no hope whatsoever.

Distinction between Avoidance and Evasion

Justice Murphy said it best in Federal Commissioner of Taxation v. Hancock[i], “The resource of ingenious minds to avoid revenue laws has always proved inexhaustible and for that reason it is neither possible nor safe to say in advance what must be found….”

There has been an ongoing debate and subsequent controversy regarding the difference between tax avoidance and tax evasion. The distinction lies in the meaning of the two concepts itself – Avoidance is to be within the purview of the law, whereas evasion is illegal.

However, the cause of the controversy is that tax avoidance is done in a convoluted manner, and even though each individual action is by itself not illegal, but the transaction in it’s entirety amounts to a tax benefit that was never intended by the tax law. In other words, what is not to be done directly is done indirectly.

Therefore, several judicial decisions have called such activities as illegal, although there isn’t unanimity in this context.

The distinction between the two concepts is highlighted by the appreciation of facts in each case. The taxpayer’s argument is that the legal form in which the transactions take place is more crucial than the substance. So the crux of the controversy is the relative importance of each of the two – substance and form. To elaborate further on the same, the doctrine of substance v/s form[ii] states that, “The prevalence of economic or social reality over the literal wording of legal provisions”. Judicial pronouncements exist for both sides but none of them support evasion specifically and openly.

It was this controversy that led to the birth of GAAR in India.

Finance Minister Pranab Mukherjee wanted to end the controversy over this issue by introducing a General Anti-Avoidance Rule (GAAR) in the income tax law of the country, which would clearly specify on what occasions were the tax authorities to prove certain aspects, and on what occasions were the tax payers to prove certain other aspects.

It is important to highlight the distinction between Tax Evasion and Tax Avoidance. Tax evasion has been defined by The Organisation for Economic Co- operation and Development (OECD)[iii] as “A term that is difficult to define but which is generally used to mean illegal arrangements where liability to tax is hidden or ignored i.e. the tax payer pays less tax than he is legally obligated to pay by hiding income or information from tax authorities’’. In case of tax evasion deliberate steps are taken by the taxpayer in order to reduce the tax liability by illegal or fraudulent means. Tax avoidance[iv], on the other hand is defined by the OECD, as “term used to describe an arrangement of a tax payer’s affairs that is intended to reduce his liability and that although the arrangement could be strictly legal it is usually in contradiction with the intent of the law it purports to follow”.

The key points of distinction being that in tax avoidance the key facts or details are not hidden by the tax payer, but are on record.

Another term, which is sometimes used while analysing the difference between tax evasion and tax avoidance, is tax planning[v]. The OECD defines tax planning as “arrangement of a person’s business and /or private affairs in order to minimize tax liability”. However, in practice, in some cases, the dividing line between tax planning and tax avoidance, or between permissible tax avoidance and impermissible tax avoidance, may not be clear. It may be noted that the GAAR is not an antidote for ‘tax evasion’, but for ‘tax avoidance’. The GAAR cannot deal with tax evasion since it cannot deal with what is not reported. The Government has recognized the fact that the GAAR is meant for tackling tax avoidance. Tax evasion and tax avoidance involve similar taxpayer behaviour and are each undertaken in pursuit of the same broad aim: to minimise or to eliminate tax liability. They are factually similar, but legally distinct.

Tax evasion is illegal. It consists in the willful violation or circumvention of applicable tax laws in order to minimize tax liability. Tax evasion generally involves either deliberate under-reporting or non-reporting of receipts, or false claims to deductions. This conduct is legally straightforward to identify; a taxpayer has committed tax evasion only if he or she has breached a relevant law. Indeed, evasion ordinarily involves criminal fraud. Tax avoidance, on the other hand, is not illegal. Rather, it is the act of taking advantage of legal opportunities to minimize one’s tax liability.

Background and Origin

The scope of the proposed GAAR provisions is exceptionally wide. The introduction of the GAAR in the present form is likely to create uncertainty about the tax implications of various business and non-business transactions / arrangements. This would not only create practical difficulty for the taxpayers, in the current economic scenario, such provisions could create a negative environment against the efforts of increasing domestic as well as foreign inward investments. The Supreme Court has in Vodafone’s case[vi] also observed that Foreign Direct Investment (FDI) “flows towards location with a strong governance infrastructure which includes enactment of laws and how well the legal system works. Certainty is integral to rule of law. Certainty and stability form the basic foundation of any fiscal system. Tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner. Investors should know where they stand. It also helps the tax administration in enforcing the provisions of the taxing laws.” A holistic view, therefore, needs to be taken in the matter.

Therefore, the proposal on GAAR provisions needs to be considered in this context and viewed from this larger angle. The moot question arises is whether, at this stage, the approach of introducing the GAAR in the Indian Tax Law is correct or whether it is better to adopt a targeted approach and expand the scope of SAARs. If it is felt necessary to introduce GAAR provisions, a further question, which needs consideration is, whether it is wise to introduce these in the present form in the Indian tax scenario. The recommendations given in this paper should also be viewed against this background.

What is GAAR ?

General Anti-avoidance Rule (GAAR) is a concept which generally empowers the Revenue Authorities in a country to deny the tax benefits of transactions or arrangements which do not have any commercial substance or consideration other than achieving the tax benefit. Denial of tax benefits by the Revenue Authorities in different countries, often by disregarding the form of the transaction, has been a matter of conflict between the Revenue Authorities and the taxpayers. Traditionally, the principles regarding what constitutes an impermissible tax avoiding mechanism have been laid down by the Courts in different countries, with a series of decisions of the English Courts starting from the Duke of Westminster’s[vii] case. In India also, the ruling of the Supreme Court in McDowell’s case[viii] was a watershed. This ruling itself has been interpreted by different courts including the Supreme Court in various subsequent decisions. In its recent ruling in the famous Vodafone case, the Supreme Court has stated that GAAR is not a new concept in India as the country already has a judicial anti-avoidance history.

With the increasing globalisation of economies and growth in cross border transactions, some countries have introduced legislation which has empowered the Revenue Authorities to question transactions and arrangements and disregard their form to deny tax benefit unless the taxpayer can establish the commercial legitimacy of the transaction. However, different countries have taken different approaches in this regard. Australia was in the forefront of introducing a GAAR as early as 1981. Mature economies like Canada, New Zealand, Germany, France and South Africa have also introduced a GAAR. Emerging economies have also started introducing GAAR with the phenomenal growth of their economies. However, some of the leading nations like USA and UK have taken a cautious approach.

It is common for taxpayers to arrange their affairs in a way that will give them tax benefits, which are through genuine and legitimate actions. Over the past few years it has been noticed that the Revenue Authorities have attempted to deny tax benefits, whether under the tax treaty or domestic law, by disregarding the form and looking through the transactions. However, genuine transactions consummated in a tax efficient manner need to be distinguished from sham transactions or colourable devices used for evading tax. The approach of Revenue Authorities has resulted in protracted litigation and uncertainty. The Revenue Authorities’ attempts in this regard have not succeeded in most cases, especially in the Supreme Court, the most recent being in the Vodafone case[ix].

In India, there are specific anti-avoidance provisions in the domestic tax laws as well as ‘limitation of benefits’ clauses in some tax treaties. Additionally, the Government proposes to introduce GAAR provisions through the Direct Taxes Code. The proposed GAAR provisions would override the provisions of the tax treaties signed by India. The Direct Taxes Code Bill, 2010 (the Code), after its introduction in Parliament, was referred to a Standing Committee of Parliament. The Standing Committee has obtained the views and recommendations of various stakeholders. Currently the Standing Committee is examining the Bill. The Code, which was planned to be effective from 1 April, 2012 is expected to be delayed. However, given the importance of the GAAR provisions from the Government’s perspective and the developments by way of the judicial outcomes of some important matters over some time, one would not be surprised if GAAR provisions are introduced in the current laws.

The purpose of this Research Paper is to provide an analysis of the proposed GAAR provisions contained in the Code and recommendations vis-à-vis the proposed introduction of the GAAR. Revenue collection is one of the most important rights of the Government and associated with it is the introduction of measures to restrict taxpayers from entering into arrangements resulting in tax avoidance. However, as observed by the Supreme Court in the Vodafone ruling[x], strategic tax planning is permissible and one has to take a holistic view considering the entire scenario. Further, India is a preferred investment destination for multinational corporations. It is extremely important for investors that the investment destination has certainty in its tax policy and legislation. The GAAR is a measure that requires substantial discussion amongst the stakeholders before its introduction. Experience shows that countries in which a GAAR has been introduced in legislation have taken considerable time in its stabilization. Based on experience, one can say that stakeholders need awareness on the subject so that one does not lose sight of the entire scenario resulting in unintended consequences.

International Perspective on GAAR


A taxpayer in Canada is entitled to structure affairs so as to minimize tax within the confines of the law. However, tax planning (or tax minimisation) must be contrasted with tax evasion, which may render the taxpayer liable to fines or imprisonment. Some forms of tax planning are restricted through the use of specific anti-avoidance provisions, more generally abusive planning, is checked through a statutory GAAR.

Background of legislation

Canadian tax laws contain GAAR provisions since 1988. Canadian Supreme Court had, in the case of Copthorne ruling[xi], observed that the general anti-avoidance rule scheme is set out in the Act and requires that three questions be decided: (1) was there a tax benefit; (2) was the transaction giving rise to the tax benefit an avoidance transaction; and (3) was the avoidance transaction giving rise to the tax benefit abusive.

The Court further observed that “in order to determine whether a transaction is an abuse or misuse of the Act, a court must first determine the object, spirit or purpose of the provisions that are relied on for the tax benefit, having regard to the scheme of the Act, the relevant provisions and permissible extrinsic aids.”

Procedural requirements

In Canada Trustco[xii], the Canadian Supreme Court laid down the following procedural principles: The onus is on the taxpayer to refute the following (on a balance-of-probabilities basis): the assertion that a tax benefit results from the 
transaction. It is not permissible, however, for the Canada Revenue Agency (hereinafter referred to as the CRA) to take the position that more tax would have been paid if the taxpayer had engaged in some other transaction or that the amount of tax paid is less than some notional amount that the CRA believes should have been paid; and the assertion that the transaction was an avoidance transaction. The taxpayer might be able to refute this assertion by showing a bonafide and primary non-tax purpose for the transaction.

If there is a tax benefit and an avoidance transaction, the burden then falls on the CRA to establish that there is abusive tax avoidance.


Australia’s GAAR was introduced in 1981 and is contained in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936).

The Australian GAAR is a provision of last resort, i.e. it should not apply unless the taxpayer’s claim is otherwise allowable. It, therefore, counters schemes that strictly satisfy the technical requirements of the tax law, including the ordinary provisions and SAAPs, but when objectively viewed, are considered to be conducted or carried out with the sole or dominant purpose of obtaining a tax benefit. If certain conditions are met, the provisions allow the Commissioner to cancel all or part of any tax benefits which a taxpayer derives from the scheme.

On 18 November 2010, the Australian Government released for public comment a Discussion Paper that deals with the review of the existing anti-avoidance rules. The paper deals with possible improvements to both the general and specific anti-avoidance provisions with a view to simplify as well as improve the operation of these provisions.

Foreign tax credit schemes

Schemes entered into after 13 August 1998 to acquire or generate foreign tax credits that can be used to shelter low-taxed foreign-sourced income from Australian tax. A specific power is provided to the Commissioner to amend a foreign tax credit determination.

Dividend stripping

Dividend stripping is not defined in the legislation. The essence of dividend stripping is that value is taken out of a company in the form of a dividend, normally an abnormally large dividend, which clears all the current and accumulated profits out of the company, in order to achieve a tax benefit.

In case of dividend stripping arrangement, the Commissioner is allowed to cancel the tax benefits derived by shareholders who sell their shares before
a dividend is declared. The share-dealing company in such a situation is also denied a rebate in respect of the dividend. A rebate is also denied where the purchaser of the shares is not a share-dealing company but seeks to claim the loss on the shares as a capital loss[xiii].


The new EITL[xiv], which came into effect on 1 January 2008, includes a general anti-avoidance provision[xv].

Article 47 of the EITL provides: “If an enterprise engages in a business arrangement without bonafide commercial purposes that results in reducing its taxable revenue or taxable income, the tax bureau has the right to make adjustments based on reasonable methods.” 
The tax authorities may initiate a GAAR audit of enterprises that enter into the following arrangements:

  • abuse of tax incentives;
  • abuse of treaties;
  • abuse of the corporate structure;
  • use of tax havens for the avoidance of taxes; and
  • other business arrangements without bonafide 
commercial purposes.

Tax authorities identifies potential cases for investigation based on the information submitted by taxpayers or gathered through their own channels.

GAAR audits and adjustments must be reported level by level up to the State Administration of Taxation for approval.

South Africa

GAAR operates as one of the measures to counter tax avoidance, and is generally considered as a residual measure, which may apply in addition to or as an alternative to any other or specific anti-avoidance provision.

Background of legislation

During 2006, the Income Tax Act 50 of 1962 was amended to enable the South African Revenue Service (SARS) to more effectively combat tax avoidance in South Africa. Section 103(1), the general anti-avoidance provision, was repealed and the GAAR was introduced. The GAAR is contained in Part IIA of Chapter III of the Income Tax Act and specifically applies to impermissible avoidance arrangements as defined.

Tax consequences- 
If the above requirements are met, South African revenue authorities may:

  • disregard, combine or re-characterize the 
arrangement or any step thereof;
  • disregard any accommodating or tax-indifferent 
party or treat this party and any other party as one 
and the same person;
  • deem the parties who are connected persons in 
respect of each other as one and the same person;
  • re-allocate any income, receipt or accrual of a capital 
nature or expenditure;
  • re-characterize any income of a capital nature as 
income of a revenue nature;
  • treat the transaction as if it has not been carried out, 
or in any other manner that in ‘revenue authorities’ view is adequate for the prevention or diminution of the tax benefit.


Taxpayer is free to arrange affairs but broad limitations are placed under the GAAR. However, tax avoidance must be main or only motive of taxpayer arrangements and strict burden of proof on tax authorities; it is considered irrelevant that arrangements are “unusual”.


In the Stubart ruling[xvi], the Supreme Court expressly rejected the business purpose test and reaffirmed the Duke of Westminster[xvii] doctrine. Enacted a GAAR in 1988; specific criteria for applying GAAR set out by the Courts and benefit of doubt given to taxpayer.


Contains GAAR in tax code (AO). Legal structures can be disregarded under “abuse of form and legal structures” provision. Courts apply substance over form; use the principle of analogy and teleological reduction in their decisions. Advance rulings are given.Germany has one of the highest numbers of anti-avoidance related cases.


India does not have GAAR yet. Domestic law has SAAR provisions[xviii]. Underlying principles implemented through judicial and administrative decisions. Courts have favoured taxpayer historically and taken literal view[xix].Azadi Bachao Andolan[xx] was a landmark case which accepted that every man was entitled to arrange his own affairs as not to attract taxes[xxi]. 

United Kingdom

The UK does not have statutory GAAR.[xxii] In principle, tax avoidance is legal and tax evasion illegal; transaction must not be unlawful and specific anti-avoidance provisions must not affect purpose/motive. U.K. Courts traditionally follow literal approach rather than purposive. U.K. Courts have also taken a purposive approach in several legal decisions: Ramsay case[xxiii].Government primarily relies on SAAR and judicial decisions. No GAAR was enacted though in 1988 the Revenue published a consultative document but it was decided subsequently not to implement any GAAR.

United States

Does not have statutory GAAR. The Courts have evolved several judicial anti-avoidance doctrines. Gregory v. Helvering [xxiv] (1935) held that any one may arrange their affairs that his taxes shall be as low as possible. Courts tend to apply substance over form Aiken Industries and Johansson v. USA). Similarly, transactions or series of transactions without a business purpose may be ignored.

Morality of Tax Avoidance

Lord Denning famously remarked that tax avoidance “may be lawful, but it is not yet a virtue”[xxv].

In Duke of Westminster v. Commissioners of Inland Revenue,45 the taxpayer had a number of employees, such as servants and gardeners, who were all on fixed wages or salaries. The taxpayer covenanted to make weekly payments to them of the same amounts they would otherwise have received as salary. The deed did not prevent the employees from collecting their ordinary salaries in addition to the covenanted payments. However, the employees wrote letters to the taxpayer in which they agreed that in practice they would forego their wage rights in consideration for the payments under the deed.

This arrangement qualified the taxpayer for a surtax deduction in respect of the payments made by deed. He would not have received a deduction if he had paid the employees’ salaries in the usual way because the expenditure related to his personal needs. The arrangement was within the letter of the law but clearly was outside of its spirit. The policy behind the relevant legislation was that if part of a taxpayer’s income never actually belongs to him because, as an annuity, it belongs to someone else, though paid through the taxpayer, then he should not pay tax on it. However, in this case the annuities effectively functioned as salaries.

The House of Lords, however, upheld the taxpayer’s scheme because there was no GAAR and because their Lordships adopted a strict approach to statutory construction, favouring the arrangement’s form over its substance.

It is morally wrong not only because it is illegal but also because, within our legal and societal context, our broad moral obligation to contribute to the collective has taken the specific shape of a duty to pay our taxes. Tax evasion is thus a wrong in a deep sense. Considering that tax evasion is morally wrong in virtue of its content as well as its legal status, it is not convincing to suggest that the mere fact   that tax avoidance is not illegal means that it is also not immoral. From this perspective, the factual similarity between avoidance and evasion and the fineness of the legal line between them suggest the opposite conclusion from the one drawn by judges. If tax avoidance is factually almost indistinguishable from tax evasion, and if despite being a legal construct tax evasion is in a deep sense immoral, then tax avoidance is similarly immoral.

Economically speaking, there is no distinction between tax avoidance and tax evasion. They are motivated by the same desire to minimize tax liability and have the same economic consequences. It is very difficult to gauge the amount of revenue lost to tax avoidance schemes. Tax avoidance is harmful in that it results in a misallocation of resources. Taxpayers spend time and money devising tax avoidance schemes. This expenditure of effort may be profitable for the taxpayer but only because that taxpayer manages to extract an unintended tax benefit.

Tax avoidance therefore represents a deadweight loss to the economy, as the taxpayer in achieving the tax benefit undertakes no actually beneficial activity. The activity is demonstrably non-beneficial according to the following thought experiment: imagine that everyone, rather than just a subset of taxpayers, actively and aggressively pursued tax avoidance schemes wherever there was an opportunity to do so and there was little chance of being found out. The effect would be that tax rates would have to be raised and no one would achieve any gain. In fact, everyone would be worse off because tax avoidance is itself a deadweight cost. In practice, it has substantially negative distributional consequences. Not all taxpayers are able or willing to devise or to take advantage of tax avoidance schemes. Generally it is wealthy taxpayers or those with more sophisticated knowledge of tax law who are in the position to take advantage of tax avoidance opportunities.

Both avoidance and evasion risk undermining public confidence in the tax system. This can give rise to a vicious circle: as confidence falls, members of the public become less likely voluntarily to comply with tax laws.

As a generalization, tax evasion is more likely to be carried out on a smaller scale than tax avoidance. For instance an individual taxpayer who engages in evasion by not declaring under the table income from that individual’s second job might thereby deprive the revenue of a few hundred dollars over a year. However, a company that structures a series of artificial transactions may generate legal tax deductions worth millions of dollars.

Tax avoidance also undermines governments’ revenues and governments’ progressivity policies.

Judges and commentators have made much of the legal difference between evasion and avoidance. Many judges have considered that while evasion is immoral because it is in breach of the law, legal avoidance involves no such moral misstep. But to draw moral conclusions from legal observations constitutes logical confusion. The fact that conduct is not illegal does not necessarily mean that it is also moral. It is legal to sell cigarettes, but this observation does not tell us whether selling cigarettes is moral. It is true that conduct that is legal cannot be immoral in one special sense: that is, since it is not illegal, it cannot be immoral for the reason of illegality. But conduct can be immoral for many reasons other than that it breaches the law. Evasion is immoral for more than legal reasons alone.

The difference between evasion and avoidance is a matter of law, not of relevant fact. This difference cannot tell us anything about the differences or similarities between evasion and avoidance in moral terms, except for the special case that evasion is immoral anyway to the extent it is illegal. Judges overlook the considerable factual similarity between avoidance and evasion: both aim to minimize tax liability and both have similar economic effects. Judges are correct when they note that there is a legal dissimilarity between the evasion and avoidance, but the factual similarities between the two are of much greater moral significance than the legal difference; from the perspective of morality we should look at the two phenomena as being just one phenomenon.

Philosophical view on tax avoidance

Payment of taxes is the crux of the matter at hand, even though in several cases working citizens seem to think that the government is stealing their hard-earned money, which is being wasted on politicians and their luxuries. However, this is far from the truth.

Revenue generated through taxes help to strengthen the country’s economy and create resources that help to provide various facilities and services to citizens, such as railways, roadways, water supply, education facilities, and other such basic requirements of average working individuals and their families. Generally, all citizens are bound to pay the various taxes such an income tax, sales tax, excise tax, social security, recreation tax, among others, however, in some countries, persons earning very low or no income are not bound to pay taxes. Even among persons who do pay taxes, there exist varying percentages of taxes to be paid by individuals, depending on their level of income, higher the level of income, higher the percentage of tax charged on the same, and vice versa.

The necessity to pay tax can be clearly explained with the help of certain simple but significant examples, such as, if we were to make use of clean water from our house taps without having to actually pay for the filtration pipe leading to the nearby reservoir, it makes it more than worth it to pay taxes, as we cannot afford to do the latter, and neither is it practical. Similarly, if we were to travel from city A to city B within the same country, if would not be possible to bear the cost of construction of roads that connect the two cities. Therefore, paying taxes is the wiser option, as it provides a number of benefits and services in return.

The government provides a several categories of services, such as 1) infrastructure projects, which includes building of roads, bridges, dams, canals and other such projects, 2) public security, which includes funds to maintain fire and police departments, and also defence forces such as air-force, army and navy, and also to purchase arms for the same, 3) general services such as keeping streets clean, trash removal, water treatment, street lights, 4) health services: most governments provide free or subsidized health services to it’s citizens, especially those who are not able to afford the same. Preventive immunization and vaccines are some of the health services made available to citizens at subsidized rates.

There is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor, and all do right; for nobody owes any public duty to pay more than the law demands. Taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere hypocrisy.

Case Laws

Justice Holmes, “Taxes are what we pay for civilized society. I like to pay taxes. With them, I buy civilization”.

In 1985, a five-judge bench of the Supreme Court cleared the air in the judgment of McDowell and Co.[xxvi] where Justice Mishra writing for four judges observed: “Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belied that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.”

Justice Reddy, after referring to several English cases, was of the view that the Westminster principle has been given a decent burial in the very country of its origin, and that Courts have adopted a much more concerned attitude regarding tax avoidance. They are now concerned with the intended effect of a transaction for fiscal purposes along with the genuineness of the same. In his opinion, no one can get away with a tax avoidance project with the mere statement that there is nothing illegal about it. He was very clear that India needs to part with the principle of Westminster and the alluring logic of tax avoidance.

In the Wood Polymer case[xxvii], a hint of this approach is found where the learned Justice Desai refused to sanction amalgamation of companies as it would lead to avoidance of tax.

The Vodafone case[xxviii]


Vodafone International Holdings BV (“Vodafone“) entered into a Share Purchase Agreement (“SPA”) with Hutchison Telecommunications International Limited (“HTIL”), Cayman Islands for purchasing the singular equity share of CGP Investment (Holdings) Ltd (“CGP”), a Cayman based wholly owned subsidiary of HTIL. CGP in turn, directly and indirectly, owned approximately 67 percent of the share capital of Vodafone Essar Limited (“VEL”), an Indian entity. The acquisition resulted in Vodafone acquiring control over CGP and its subsidiaries, including VEL. The Revenue authorities issued a notice to Vodafone, treating it as an assessee-in-default for failure to withhold taxes on gains arising to HTIL on the transfer of shares of CGP. The Revenue authorities held that the gains were taxable in India as there was transfer of a controlling stake / business situated in India.

The assessee challenged the said Show Cause Notice on the ground that the transaction in issue was a simple transfer of shares between two foreign companies and not transfer of any capital asset in India and as such, said transaction did not attract the provisions of Income Tax Act.

Question of law 

Whether the transfer of shares between two foreign companies, resulting in extinguishment of controlling interest in the Indian Company held by a foreign company to another foreign company, amounted to transfer of capital assets in India and as such chargeable to tax in India.

Ratio Decidendi

Transaction amounting to transfer of capital assets in India, by divestment of controlling stake in an Indian Company held by a foreign company to another foreign company resulting in extinguishment of right, would attract provisions of Indian Income Tax Act. Any profit or gain which arose from the transfer of a group company in India has to be regarded as a profit and gains of the entity or the company which actually controls its, particularly when on facts, the flow of income or gain can be established to such controlling company and as such is taxable in India. When the dominant purpose of entering into agreements between the two foreigners is to acquire the controlling interest which one foreign company held in the Indian company, by other foreign company, the transaction would certainly be subject to municipal laws of India, including the Indian Income Tax Act as per Effects Doctrine. 
Where a right or liability is created by a statute, which gives a special remedy for enforcing it, the remedy provided by that statute only must be availed of. 
Even if the burden of proof does not lie on a party, the Court may draw an adverse inference if he withholds important documents in his possession, which can throw light on the facts at issue. 

The potential investors would need to be therefore extra careful while structuring their cross-border mergers and acquisitions transactions lest they are slapped with unwarranted and unexpected tax liability from strange quarters which they have not factored in their negotiations and to minimise the chances of litigation.

 Need for GAAR in India

General Anti-avoidance Rule (GAAR), as a concept, generally empowers the Revenue Authorities in a country to deny tax benefits of transactions, which do not have any commercial substance or consideration other than achieving tax benefit. Denial of tax benefits by the Revenue Authorities in different countries, very often by entirely disregarding the form of the transaction, has been a matter of conflict between the Revenue Authorities and the taxpayers. Traditionally, the principles regarding what constitutes an impermissible tax avoiding mechanism have been laid down by the courts in different countries, with a series of decisions of the English Courts starting from the Duke of Westminster’s case. In India too, the ruling of the Supreme Court in McDowell’s case was a watershed. This ruling itself has been interpreted by different courts including the Supreme Court in various subsequent decisions. In its recent ruling in the very well-known Vodafone case, the Supreme Court has stated that GAAR is not a new concept in India as the country already has a judicial anti-avoidance history.

The need for a GAAR is usually justified by a concern that the integrity of the tax system of a country needs to be stabilized strengthened. This in turn usually reflects a judgment by the Government and Parliament that existing laws, judicial practice and tax administration are not considered adequate to address current challenges and the anticipated requirements of future generations. Inevitably such a judgment is controversial because of the different interests and opinions that are to be balanced between the community as represented by the Government and the Revenue on the one hand and on the other, specific elements of the tax base, such as citizens and more particularly business, residents and non-residents.

Legislatures in various countries are moving towards promulgating General Anti-Avoidance Rules. Courts in India have examined the issue of tax avoidance and laid down the principles as to what constitutes tax avoidance. In light of the various judicial precedents, the tax authorities in India tend to raise the issue of tax avoidance and deny relief to the taxpayer. Given the uncertainties involved in such application, it is imperative for the proposed GAAR to be successful; it should not impact genuine business transactions or promote uncertainty. One of the key objectives for introducing the Direct Tax Code, which GAAR is a part of, is to simplify the language to enable better comprehension and remove ambiguity to foster voluntary compliance, thus reducing litigation.

Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner. Sectors that provide a greater opportunity for tax avoidance tend to cause distortions in the allocation of resources. Since the better-off sections are more endowed to resort to such practices, tax avoidance also leads to cross-subsidization of the rich. In the past, the response to tax avoidance has been the introduction of legislative amendments to deal with specific instances of tax avoidance. Since the liberalization of the Indian economy, increasingly sophisticated forms of tax avoidance are being adopted by the taxpayers and their advisers.

In view of the above, it is necessary and desirable to introduce a general anti-avoidance rule, which will serve as a deterrent against such practices. This is also consistent with the international trend.

Suggestions and Recommendations

An expert panel set up by former Prime Minister Manmohan Singh to review the provisions of the GAAR — or rules to prevent tax evasion — has recommended that they be put off by three years, a move that’s expected to soothe the nerves of jittery foreign investors and help boost sentiment.

The panel, headed by tax expert Parthasarathi Shome director and chief executive, Indian Council for Research on International Economic Relation, which submitted its report to the finance ministry on Saturday, also said that GAAR provisions should not apply to examine the genuineness of the residency of an entity set up in Mauritius. Experts say this clause is expected to calm foreign investors who route their investments through Mauritius, with whom India has a double-tax avoidance treaty.

The Shome committee also suggested that GAAR should only cover arrangements where the main purpose is to obtain a tax benefit, not those in which this is merely one of the purposes. It has also recommended a monetary threshold of Rs. 3 crore of tax benefit (tax only, not interest, etc.) to a taxpayer in a year for applying GAAR provisions.

The panel recommended abolition of the tax on gains arising from transfer of listed securities, whether capital gains or business income, to both residents as well as non-residents.

Explaining why it wanted GAAR deferred, the committee said, “GAAR is an extremely advanced instrument of tax administration — one of deterrence, rather than for revenue generation — for which intensive training of tax officers who would specialize in the finer aspects of international taxation is needed.”

GAAR has been a matter of investor anxiety as it was feared that the proposed rules would be used to open up investigations into the source of incoming investments. Recognizing the potential damage that this could do to investment inflows, the government has been trying to undo the damage caused by some of the taxation proposals in the 2012-13 Budget.

GAAR and retrospective changes to tax laws have attracted criticism globally, in the wake of which the Prime Minister had set up the Shome committee in July to consult stakeholders, study the provisions of GAAR and make its recommendations for necessary changes in the rules.

The Shome panel said the application of modified GAAR from 2016-17 should be announced now. “In effect, GAAR would apply from the assessment year 2017-18. Pre-announcement is a common practice internationally in today’s global environment of freely flowing capital,” the report said.

“It would be perspicacious, as indicated above, for the government to postpone the implementation of GAAR for three years with an immediate pre-announcement of the date to remove any uncertainty from the minds of stakeholders,” it said.

The panel felt that a longer period of preparation should enable taxpayers to plan for a change in the anti-avoidance regime that would allow legitimate tax planning reflecting a proper understanding of the new legislation and guidelines, while doing away with dubious tax avoidance arrangements.

Experts cheered the move saying the panel report would go a long way in assuring investors about the predictability of tax policies.

Experts also lauded the Shome committee’s recommendation of broad-basing the approving panel for GAAR by including two independent members. The committee said the approving panel should consist of five members, including a chairman. The chairman should be a retired judge of the high court, two members should be from outside government (persons of eminence drawn from the fields of accountancy, economics or business with knowledge of income tax issues) and two members should be chief commissioners of income tax or one chief commissioner and one commissioner.

“The approving panel should be a permanent body with a secretariat. It should have a two-year term. A decision of the approving panel should occur by a majority of members,” the panel said.

It also said that GAAR provisions should be subject to an overarching principle that tax mitigations should be distinguished from tax avoidance before invoking GAAR. It added that an assessing officer should not invoke GAAR where the tax payer submits a satisfactory undertaking to pay tax along with interest in case it is found that GAAR provisions are applicable in relation to the remittance during assessment proceedings. An assessing officer may invoke GAAR with the prior approval of the commissioner in case the tax payer does not submit any satisfactory undertakings.

The Shome committee said that training programmes should be started for all assessing officers in the area of international taxation to minimize the deficiency of trust between the tax administration and taxpayers.

“The recommendations of the committee clearly indicates the responsiveness on the business concern. If implemented, it could go a long way to help the business climate and establish the credibility that is needed most at this time,” said Rahul Garg, leader, direct tax, at PwC, India.

Parthasarathi Shome, head of the expert committee on General Anti Avoidance Rules (GAAR) that recommended deferring the controversial tax provision by three years and abolition of capital gains tax on transfer of securities, spoke to Economic Times Now shortly after submitting the report on Saturday, 1st September 2012. Excerpts[xxix]:

  1. Investors were concerned about the timelines to implement GAAR. Did you keep jittery FIIs in mind while recommending that it be postponed by three years?
  2. I think GAAR is a very incisive deterrent instrument; it’s not a revenue-generating instrument. Overall, international taxation requires knowledge and application skills for which we have to develop a band of brilliant tax officers. Taxpayers with the habit of concocting tax avoidance schemes that are egregious should also be allowed to adjust to the newly emerging environment of anti-tax avoidance.

They have certain investments that are reflective of avoidance so they will get time to get rid of these. Also, the three-year postponement should be announced now for the benefit of all. All members including Mr (N) Rangachary, who is a former CBDT chairman, have agreed to this. We have had very exhaustive exchanges with all stakeholders and most have pleaded for this time. Though some stakeholders like Assocham said GAAR should not be implemented at all, others suggested a five or seven-year abeyance.

But three years will be an appropriate span to prepare for GAAR. This adjustment time is required by all stakeholders, the tax department, the tax advisory firms and industry. They all should be given some time to mature.

  1. GAAR is an integral part of the Direct Tax Code which has a deadline of 1st April 2013 for implementation. Can DTC be implemented without the provisions of GAAR?
  2. DTC is so comprehensive that it can be implemented. It’s an over-arching code of taxation while GAAR is a precise and incisive tax deterrent. So in that way DTC and GAAR are on the opposite sides of a pole. It is very true that DTC should be revisited.
  3. How do you ensure that the provisions of GAAR to declare a business structure as “non-permissible” will not be misused by the authorities?
  4. It is very important to precisely define the different criteria for invoking GAAR. We as a committee have studied various GAAR models from various countries. We have looked at other international instances; we have also taken suggestions from all the stakeholders involved. We have tried to categorically define the various provisions of GAAR without killing the golden goose of investors. We are looking forward to the comments that we get on our draft.


The GAAR provisions are similar to a double-edged sword and need to be judicially invoked by the revenue authorities.

The Courts in India have examined the issue of tax avoidance and laid down the principles relating to what exactly constitutes tax avoidance. In light of the various judicial precedents, the tax authorities in India tend to raise the issue of tax avoidance and deny relief to the taxpayer. Given the uncertainties involved in such application, it is imperative for the proposed GAAR to be successful; it must not impact genuine business transactions or promote uncertainty among the same. One of the main objectives for introducing the Direct Tax Code in India is to simplify the language to enable better understanding and remove ambiguity to foster voluntary compliance and prevent avoidance.

In this context, we may refer to what Chris Evans, has written in his Article “Containing Tax Avoidance: Anti- Avoidance Strategies (2008)” –

“It may be too cynical to assume ‘the existence of tax avoidance as a constant and perpetual motivation 
for every taxpayer[xxx]’, but there is no doubt that tax avoidance is widespread and that it presents a major problem for those concerned with public finance issues. There is some evidence that the aggressive retail marketing of tax avoidance products and schemes may have been constrained in recent years, but avoidance activity is by its nature opportunistic and ad hoc. Simply raising the price of avoidance (through successful containment, increased regulation and constrained supply) will not choke off demand.

Indeed, no single response or approach – whether administrative, legislative or judicial – can adequately or effectively contain avoidance activity. Such containment only begins to occur where strategies drawn from all three spheres complement each other by operating in combination. As Sir Ivor Richardson astutely pointed out some years ago, current requirements for a comprehensive and integrated approach go beyond a more traditional analysis where “the legislature … exerts control of tax avoidance through special and general anti-avoidance provisions; the revenue administration contributes in administering those provisions and exercising discretions; and the judiciary is expected to strike the right balance between acceptable and unacceptable tax planning through its interpretation and application of tax legislation[xxxi].”

However, ultimately, corporate as well as personal taxpayers themselves have to take responsibility for the level
 of avoidance and the degree of acceptance of such behaviour that exists at any point of time in any society. The revenue authority, the judiciary and the legislature can play a role in shaping the demand for, and supply of, tax avoidance activity in the country, but such issues belong, in the ultimate analysis, in the realms of moral and ethical behaviour of the taxpayers themselves. Corporate as well as personal social responsibility – and the reputational damage that excessive avoidance activity can attract – remains the ultimate deterrent, notwithstanding the impressive arsenal that can be available to those who seek to counter avoidance.

Beyond that we should also perhaps be mindful
that two of the traditional goals of public finance – simplicity and equity – have critical roles to play in determining social responses to avoidance activity. In recent years, these two goals may have been less prominent in tax reform than the efficiency goal that lends itself to easier economic measurement and evaluation.

It is paradoxical that the more complex that the
tax regime becomes (often in attempts to contain avoidance activity), the more likely it will be that opportunities for avoidance will arise. Avoidance activity thrives in complexity and uncertainty. And where that complexity exacerbates the natural interaction (sometimes mediated by intermediaries) between the taxpayer and the revenue authority such that it becomes frictional rather than cooperative, there will almost inevitably be a higher probability of avoidance activity.

It may be necessary for taxpayers to examine the transactions/arrangements entered into, so that 
they do not fall within the boundary of being considered as impermissible avoidable transactions entered into with the object of obtaining a tax benefit.

Somewhat inevitably, GAARs have significant consequences when applied. It must follow that GAARs should be enacted carefully so that they are designed to address real mischief only and go no further than that. To ensure the tax system does not fall into disrepute, GAARs must be administered transparently and with abundant due process; keeping in mind it’s consequences.

Concluding with some experiences from Australia after 30 years with the current GAAR, which replaced a GAAR considered then by the Government and Parliament of the day to be inadequate. The GAAR continues to be the most complex and controversial tax legislation for all stakeholders, not only in Australia or India, but also all over the world. Its operation requires close attention, evidence of fact and circumstance is necessary as well, as it is critical to ensure that it only applies where and how it should. The Commissioner of Taxation has publicly raised the possibility that it should be strengthened given the trend of recent court cases on top of an existing review to update the current GAAR. There is, however, a concern that sometimes the GAAR is applied in cases that it should not be.

One may distil some of the key challenges in the design of the GAAR – achieving consensus on what the GAAR should focus on and how the rules work fairly, quickly and efficiently to effectively apply in those cases in a way that is certain, subject to judicial review and administered based on evidence of all relevant facts.

Further everyone should be skeptical as to whether the design intent of the GAAR truly translates into the legislation and administration. Future generations live with the benefits and the burdens. For example, Tax administrators may become frustrated by judicial interpretations that depart from their own. Taxpayers may also be bewildered by expectations of the GAAR having a limited impact only to find it becomes a risk to be faced far more broadly. Upfront transparency and consensus about design intent will not anticipate and avoid all problems but without it there is absolutely no hope.

It would be unwise to suggest that any country has found all the answers pertaining to tax avoidance, tax evasion and rules relating to the same. This research paper is, however, a significant and unique resource, which will hopefully help to ensure that the GAAR debate in India will find the right way to the best outcomes in this extremely difficult and complex area.

Edited by Kudrat Agrawal

[i] Federal Commissioner of Taxation v. Hancock, (1961) 8 ATR 328, 333.

[ii] Economic and Political Weekly, June 2, 2012, Vol XLVII No. 22.

[iii] Glossary of Tax Terms, http:/,3343,en_2649_34897_33933853_1_1_1_1,00&&en-USS_01DBC.html

[iv] OECD, Glossary of Tax Terms.

[v] OECD, Glossary of Tax Terms.

[vi] Vodafone International Holdings v. Union of India, [2009] 311 ITR 46 (High Court of Bombay).

[vii] Duke of Westminster v. Inland Revenue, 19 T.C. 490 (H.L.) (U.K.).

[viii] McDowell & Co. Ltd. v. Commercial Tax Officer, AIR 1986 SC 649 (Supreme Court of India).

[ix] Supra note vi.

[x] Id.

[xi] Copthorne Holdings Ltd. v. Canada, 2011 SCC 63

[xii] Canada Trustco Mortgage Co. [2005] SCC 54.

[xiii] PS LA 2005/24 ‘Application of General Anti-avoidance Rule’.

[xiv] Enterprise Income Tax Law.

[xv] Article 47 of the Enterprise Income Tax Law (EITL).

[xvi] Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R 536.

[xvii] Supra note vii.

[xviii] Examples- sections 37(1) and 40A(2), Income Tax Act, 1961.

[xix] Kulandagan Chettiar, R.M.Muthaiah and S.R.M Firm cases

[xx] Union of India v. Azadi Bachao Andolan, [2003] 263 ITR 706 (Supreme Court of India).

[xxi] Reaffirming Duke of Westminster principle and distinguishing McDowell case.

[xxii] Chapman v. Honig [1963] 2 QB 502.

[xxiii] W. T. Ramsay Ltd. v. Inland Revenue Commissioner, (1981) 54 T.C. 101 (H.L.) (U.K.).

[xxiv] Helvering v. Gregory, 69 F.2nd 809 (2nd Cir. 1934).

[xxv] Weston’s Settlements Trusts [1969] 1 Ch 223; [1968] 3 All ER338.

[xxvi] Supra note viii.

[xxvii] Wood Polymer Ltd. and Bengal Hotels Limited (1977) 47 Com Cas 597 (Guj).

[xxviii] Supra note vi.

[xxix] Suchetana Ray, ‘Three Years Enough To Prepare For GAAR: Parathasarathi Shome’, 2nd September, 2012 available at

[xxx] C.H. Gustafson, “The Politics and Practicalities of Checking Tax Avoidance in the United States” in G.S. Cooper, Tax Avoidance and the Rule of Law, (Amsterdam: IBFD, 1997), at p 376.

[xxxi] I. Richardson, “Reducing Tax Avoidance by Changing Structures, Process and Drafting” in G.S. Cooper, Tax Avoidance and the Rule of Law, (Amsterdam: IBFD, 1997), at p 327.

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