Cos Seek Clarity on GAAR Provisions for Local Deals

Firms worried that proposal to check aggressive tax planning could hurt them as well

Companies that plan to restructure business or set up operations in zones that allows tax benefits have rushed to experts, worried that the rules proposed in the budget to check aggressive tax planning, though targeted at foreign companies, could hurt Indian companies equally hard. The General Anti-Avoidance Rules, or GAAR, proposed in the budget give powers to the income-tax officials to deny tax benefit to a business arrangement if they feel the purpose is primarily to save taxes. Domestic transactions entered into with sole objective of deriving tax benefits face risk under the GAAR, said Sudhir Kapadia, partner and national tax leader at Ernst & Young adding that many companies had approached them for clarity on the provisions. Income-tax officials confirm that they will not distinguish between foreign and Indian transactions when they invoke GAAR provisions to deny tax benefits claimed by companies. GAAR provisions will apply on all tax planning transactions irrespective of whether domestic or overseas, "said an income tax official. Companies acquiring a loss making entity to save taxes could be particularly vulnerable, if they are unable to provide an economic rationale for their purchase. Under the income tax rules, business losses can be adjusted against profits and also allowed to be carried forward for eight years, a provision many companies have used to save taxes by acquiring businesses with high accumulated losses. There is a high chance that under the GAAR rules proposed by finance minister Pranab Mukherjee in the budget, such acquisition of losses could be seen as aggressive tax avoidance schemes by the tax authorities and flagged impermissible avoidance arrangement that will not get any tax benefit. The other arrangements that risk attracting GAAR provisions could include borrowing funds from a related party as interest cost can be claimed as a deduction, decision to lease an asset against an outright purchase, debt write off and in an extreme situation, even a decision to set up a new unit in a tax-free zone could be questioned. Companies are worried that the far reaching tax proposals could pose risk to all kinds of tax restructuring undertaken to lower liability. "Questions can be asked with regard to even seemingly legitimate arrangements, said Kapadia. For example, there could be questions as to why have you borrowed funds from a related party instead of taking an equity infusion or set up a unit in a tax-free zone. "Pranay Bhatia, Associate Partner at Economic Laws Practice says even a tax deferral can be treated as tax avoidance and the GAAR provisions could be invoked. "There is a need for a clear guidance on situations in which GAAR will be invoked, "Bhatia said adding that most of the firms clients had approached them seeking clarity. Rahul Garg, direct tax leader at PwC, warns that companies should be prepared to prove economic substance of any transaction and need to document the purpose of every layer and special purpose vehicle used in a transaction. "If I were to issue whole host of convertible debentures and the interest on that debenture is sought to be allowed and claimed as interest, I would be cautious to ensure that there is sufficient documentation to show that there is a commercial purpose and that it was not another form of equity, "he says. Despite this documentation, if the tax department is not convinced with the taxpayers reasons for using a particular structure, part or whole of the transaction can be disregarded, combined or re-characterized. There is a need to have an extensive framework of rules and a threshold below which transactions will not be touched to give some certainty, Garg said.

Financial Express, New Delhi, 12-04-2012