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Tax planning vs tax evasion: The debate continues
February, 08th 2010

Last fortnight, the Authority for Advance Rulings (AAR) delivered an important ruling on tax neutrality in relation to cross border mergers. The significance of ruling in the present context is attributable to tax administrations ongoing stance that business restructuring is motivated for tax avoidance purposes and hence tax neutrality should be denied. The AAR reiterated well established judicial principle that as long as a transaction is commercially justifiable, the availability of a tax exemption cannot make it illegal or a design to avoid tax. The ruling is a welcome development and will provide guidance to evaluate acceptable tax planning in domestic and international business restructuring.

Key judicial principles
Indian courts have generally considered a deliberate attempt to subvert the law to obtain tax benefit as an illegal act and impermissible. On the contrary, arranging transactions within the permissible framework of law to secure a tax advantage is acceptable in line with international principles.

With an endeavor to meet fiscal targets, Indian tax administration typically seek to consider transactions that result in tax savings as colourable devices and attempt to raise high pitched assessments, which have become a subject matter of long drawn court battle. The administration has been placing reliance on McDowells case, wherein the Supreme Court had held that any colourable device used with an intention to evade tax is impermissible.

The McDowell decision rendered in mid 80s has in essence served as a bible for the administration. Tax payers on the other hand, argue that tax planning cannot be treated as illegal merely on a revenue perception that there is an underlying motive causing loss to the treasury. Tax payers place reliance on principles upheld by English Courts in the cases of Westminster and Fisher which have consistently held that an business enterprise is entitled to arrange his affairs as not to attract taxes, sofaras it acts within the framework of law. The English court principles have upheld by the Supreme Court over several decades including the landmark Azadi Bachao Andolan case in 2004.

Advance ruling of Star Television Group
In the Star TV case, a group of companies comprising owners of Indian language channels, Star Plus, Star Gold, Star One and Star Utsav, are proposed to be merged with an Indian group company. The merger, organised as a scheme of amalgamation is presently awaiting approval of the Bombay High Court under the Companies Act. Star argued that the said merger met all the specified conditions for tax neutral merger under the Indian tax laws. The Revenue, however, contended that the merger is a make-believe scheme having no legitimate purpose apart from tax evasion and avoidance of tax in India.

The merger sought to achieve synergies of operation and enhanced operational flexibility and the AAR found merit in its commercial justification. Further, the AAR held that contracting parties are free to enter into a legitimate transaction, notwithstanding tax benefits. The judgement is well reasoned and brings a level of stability to the ongoing debate on tax avoidance.

Increasing legislative drive on tax avoidance
An anti-avoidance provision in the tax law is a measure to check convoluted transactions devised exclusively for the purpose of evading taxes. Such provisions attempt to strike down unacceptable tax avoidance practices and have been in vogue in matured tax jurisdictions such as Australia, Canada.

The present law contains specific anti-avoidance provisions as opposed to general provisions. Transfer pricing regulations are an example, which seek to ensure adequate arms length payments between related parties and curb profit shifting in cross-border scenarios. More importantly, the Direct Tax Code proposes to introduce a general Anti-Avoidance Rule (GAAR) law. GAAR will empower a Commissioner of Income Tax to declare any transaction as an impermissible avoidance arrangement if it results in certain tax benefits or it creates rights or obligations which would not normally be created between persons dealing at arms length or it results in abuse of the provisions of the DTC, lacks commercial substance or bona fide business purpose, etc.,

Amongst DTC provisions, the GAAR proposal has resulted in higher levels of anxiety amongst business who fear that the judicially accepted distinctions between permissible tax planning and tax evasion will disappear due to its wide coverage and vague drafting.

Path ahead
While the proposed GAAR may address tax administrations concerns on Revenue leakage, the law makers need to reflect on challenges of implementing GAAR such to spare legitimate tax planning transactions. Given our record on tax controversies, one fears that the policy makers may seek to overstretch the concept of tax evasion. As our present Finance Minister acknowledged: one of the insignia of a mature fiscal policy is stability and I feel we ought to focus on administrative & judicial reforms to create a more stable tax dispute resolution mechanism before embarking in unchartered territory. GAAR needs greater debate consensus attempts to rush into an important legislation of such nature could have long term ramifications.

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