Western India Regional Council The Institute Of Chartered Accountants Of India

1. Western India Regional Council The Institute Of Chartered Accountants Of India Tax Planning – Dead or Alive in India after GAAR CA T.P. Ostwal 30th December, 2018

3. TRADITIONAL TERMS 3

4. ANTI-AVOIDANCE PROVISIONS 4

6. FRAMEWORK OF GAAR

7. PRE-CONDITIONS FOR INVOCATION OF GAAR 7

8. MANDATE OF GAAR • The assessee is bound to not to get into IAA • Entering into IAA is not barred by law • It is only at the instance of AO, can an arrangement be declared as IAA • Unlike Sec. 92, which make a suo motu mandate, here the assessee is not bound to suo motu declare his arrangement as IAA • It resembles the concept in Sec. 14A read with Rule 8D which can be invoked only at the instance of revenue : Holcim India P Ltd [Delhi HC 2014-TIOL-1586-HC-DEL] • Section 90(2A) and 90A(2A) of the ITA provides for GAAR overriding the treaty 8

9. APPLICABILITY OF GAAR • As per Rule 10U, GAAR does NOT applies to: • an arrangement where the tax benefit in the relevant assessment year arising, in aggregate, to all the parties to the arrangement does not exceed a sum ofRs. 3 crore; • aForeign Institutional Investor,— • (i) who is an assessee under the Act; • (ii) who has not taken benefit of an agreement referred to in section 90 or section 90A as the case may be; and • (iii) who has invested in listed securities, or unlisted securities, with the prior permission of the competent authority, in accordance with the Securities and Exchange Board of India (Foreign Institutional Investor) Regulations, 1995 and such other regulations as may be applicable, in relation to such investments; • a person, being a non-resident, in relation to investment made by him by way ofoffshore derivative instrumentsor otherwise, directly or indirectly, in a Foreign Institutional Investor; 9

10. GRAND FATHERING • “Any income accruing or arising to, or deemed to accrue or arise to, or received or deemed to be received by, any person from transfer ofinvestmentsmadebefore 1st April 2017by such person” – Rule 10U(1)(d) • Except • “Without prejudice to the provisions of clause (d) of sub-rule (1), the provisions of Chapter X-A shall apply to anyarrangement, irrespective of the date on which it has been entered into, in respect of thetax benefit obtained from the arrangement on or after 1st April 2017.” – Rule 10U(2) 10

11. IMPERMISSIBLE AVOIDANCE AGREEMENT – S 96 Essential two conditions: The Main Purpose + Obtain Tax Benefit (part or whole or in any step of such arrangement) “Either of the given four conditions”: Not at Arm’s Length Represents Misuse or Abuse of the provisions of the Act “Lacks Commercial Substance” Entered or carried on in a manner not normally employed for “Bona-fide Purposes”. "arrangement" means any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding; 11

12. PRESUMPTION OF PURPOSE [96(2)] Burden of proof to prove that ‘main purpose’ of arrangement is not to obtain tax benefit is on taxpayer. it seems that section 96 casts a presumption of purpose only for primary condition of tax benefit being main purpose Section 96(2) does not refer to tax benefit being ‘one of the main purpose’ Burden of proof to establish satisfaction of 1 of the 4 tests of tainted element on tax authority Arrangement presumed to have been entered into for main purpose of obtaining tax benefit even if: Main purpose of whole arrangement is not to obtain tax benefit but Main purpose of step in, or a part of, the arrangement is to obtain tax benefit 12

13. ARRANGEMENT [SEC 102(1)]; STEP [SEC 102(9)] “Arrangement”means any step in, or part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding. “Step”includes a measure or an action, particularly one of series taken in order to deal with or achieve a particular thing or object in the arrangement. Canada Ruling- OFSC Holdings: interpreting– “series of transaction” Held that related transaction is completed in contemplation of a series where the parties “knew of” the series and “took it into account” 13

14. TAX BENEFIT [SEC 102(10)] a b c d e f 14

15. LACKS COMMERCIAL SUBSTANCE [S 97] • (a) the substance or effect of the arrangement as a whole, is inconsistent with, or differs significantly from, the form of its individual steps or a part; or • This condition is essentially an articulation of the internationally known “substance over form doctrine”, where the legislative intent is to prevent transactions entered merely to avail the tax benefit with no legal substance thereby resulting into abuse of provision of the law. • (d) it does not have a significant effect upon the business risks or net cash flows of any party to the arrangement apart from any effect attributable to the tax benefit that would be obtained (but for the provisions of this Chapter). • It is unclear as to what is the meaning of the word ‘significant’ as it is used in connection with effect on the business risk or net cash flow. The overall concept of the aforesaid provision is to cover within its scope the arrangements or transactions which are internationally known as sham transactions and is essentially an articulation of the “economic substance doctrine”. 15

16. S97 - LACKS COMMERCIAL SUBSTANCE (b)(i) it involves or includesround trip financing; S.97(2): Round trip financing includes any arrangement in which, through a series of transactions— (a)funds are transferred among theparties to the arrangement; and (b) such transactions do not haveany substantial commercial purposeother than obtaining the tax benefit(but for the provisions of this Chapter), without having any regard to— (A) whether or not the funds involved in the round trip financing can be traced to any funds transferred to, or received by, any party in connection with the arrangement; (B) the time, or sequence, in which the funds involved in the round trip financing are transferred or received; or (C) the means by, or manner in, or mode through, which funds involved in the round trip financing are transferred or received. F. Co. FDI ODI I. Co. 16

17. S97 - LACKS COMMERCIAL SUBSTANCE (b)(ii) it involves or includesan accommodating party S.97(3): A party to an arrangement shall be an accommodating party, if themain purposeof the direct or indirectparticipation of that party in the arrangement, in whole or in part, is to obtain, directly or indirectly, atax benefit(but for the provisions of this Chapter) for the assesseewhether or not the party is a connected personinrelation to any party to the arrangement. I Co. will be able to get back its own funds and can claim interest deduction on loan from C Co. I Co. [India] Loan Equity M Co. [Mauritius] C Co. [Cyprus] Loan 17

18. S97 - LACKS COMMERCIAL SUBSTANCE (1)(b)(iii) it involves or includes elements that have effect of offsetting or cancelling each other (1)(b)(iv) it involves or includes a transaction which is conducted through one or more persons and disguises the value, location, source, ownership or control of funds which is the subject matter of such transaction (1)(c) it involves the location of an asset or of a transaction or of the place of residence of any party which is without any substantial commercial purpose other than obtaining a tax benefit (but for the provisions of this Chapter) for a party; or (4) For the removal of doubts, it is hereby clarified that the following may be relevant but shall not be sufficient for determining whether an arrangement lacks commercial substance or not, namely:— the period or time for which the arrangement (including operations therein) exists; the fact of payment of taxes, directly or indirectly, under the arrangement; the fact that an exit route (including transfer of any activity or business or operations) is provided by the arrangement. 18

19. DETERMINING EXISTANCE OF TAX BENEFIT Sec. 99 the parties who are connected persons in relation to each other may be treated as one and the same person any accommodating party may be disregarded such accommodating party and any other party may be treated as one and the same person the arrangement may be considered or looked through by disregarding any corporate structure 19

20. CLARIFICATIONS ISSUED BY CBDT • Soon after the circular on POEM, on 27th January, 2017 the CBDT issued a circular containing clarifications in the form of answers to 16 “Frequently Asked Questions” on GAAR. • The FAQs dealt with topics like: • Tax Treaty v/s GAAR • SAAR v/s GAAR • Right of taxpayer to select an alternative • Judicious implementation • Grandfathering benefit • GAAR – as deterrent 20

21. CLARIFICATIONS ISSUED BY CBDT • GAAR will not interplay with the right of the taxpayer to select or choose method of implementing a transaction • For GAAR application, the issue as may be arising regarding the choice of entity, location, etc. has to be resolved on the basis of main purpose and other conditions provided under section 96 • GAAR shall not be invoked merely on the ground that the entity is located in a tax efficient jurisdiction • If the jurisdiction of FPI is finalised based on non-tax commercial considerations and the main purpose of the arrangement is not to obtain tax benefit, GAAR will not apply • No GAAR if tax avoidance is sufficiently addressed by LOB clause in treaty 21

22. CLARIFICATIONS ISSUED BY CBDT • De-minimis threshold of tax benefit > INR 3 crore is assessment year specific • Two step approval procedure to ensure that GAAR is invoked only in deserving cases; and in a uniform, fair and rational manner 22

23. RECENT DEVELOPMENTS

24. RECENT DEVELOPMENTS IN M & A • All merger schemes are submitted to the Income-tax (IT) department for their comments. • In most cases, IT department would not provide their comments on the scheme. • In such cases, it was presumed that they do not have any objection to the Scheme. • Recently, the IT department has been commenting on the scheme based on the applicability of GAAR. • NCLT considers such comments and rejects the scheme. 24

25. MERGER THROUGH COURT ORDER

26. DEMERGER Uma Enterprises (Raj) • Demerger of surplus land by an Oil Co. into 9 cos. • Driven by Family Settlement amongst Promoters • Scheme to facilitate focus on core competencies, proper management • HC rejected the Scheme on grounds of Tax Avoidance • Since inception Co. only into oil mfg • A/cs, Tax Audit Report, Segment reports, Directors report all showed only oil mfg as line of activity • Real Estate was never a business undertaking • Not a true demerger – selected only to evade CGT & save SD 26

27. SET-OFF OF LOSS AND GAIN ON SALE OF SHARES 27

28. SET OFF OF GAIN AND LOSS – STILL VALID? Special Prints (Guj) / Pivet Finance (P&H) • Sale of plant to group company at Gain + sale of preference shares to 2nd group company at Loss • Sales based on Independent Valuation Report which considered various Valuation Methods • Held, both transactions were genuine + proper Valn Reports • Merely because one yielded a loss, cannot brand it as a device • Loss set-off was upheld by the HC • Q. Would these decisions be still valid under GAAR? • Q. What is the commercial rationale for selling loss shares within the Group even if done at a proper Valuation? • But if justification for such Group sale then GAAR Not applicable 28

29. SALE OF BUSINESS Shiv Raj Gupta (Del) • A Listed Co. sold its business for Rs. 55 lakhs • MD / Promoter of Co. recd. Rs. 6 cr. as Non-compete Fees which was claimed to be a non-taxable Capital Receipt • HC held bifurcation was a tax saving device • Non-compete recd. by MD was astronomically high compared to sale consideration recd by Co. • Buyer’s rights by buying Co. were far valuable than non-compete clause since it included employees, contracts, plant • Two Agreements were inter-related • Re-characterised entire non-compete fee as sale consideration on account of sale of shares • Approach similar to what GAAR allows u/s. 98(1)(a) + s.98(2)(ii) • Dissecting approach by High Court • SLP has been granted against HC order in 2017 29

30. SLUMP SALE Triune Energy Services (P.) Ltd. (Del) • Acquisition of Business on Slump Basis • Depn. on Goodwill claimed by Buyer • AO held Slump Sale a device to claim Depn. + save Tax • HC set aside Objections: • Buyer acquired business, contracts, employees + paid money • Seller was a reputed co. with 350 employees • Foreign Investors were interested in a JV with Seller and so business was hived-off to the JV • Wrong to say that the Slump Sale was sham / collusive • Since sale genuine, all consequences, such as, Depreciation, follow and were allowed. • A strong business proposition remains the best defence for an attack of GAAR! 30

31. S. 281 and GAAR Indian Seamless Ent (Bom) • By a Scheme of Arrangement, a Co. wanted to gift shares held by it to its Shareholders & Dr.the Securities Premium • Outstanding Tax Demand pending against Co. • Deptcontested the gift as being a device to evade tax since no application u/s. 281 was made by Co. • HC upheld Dept’s plea: • Dividend in kind prohibited under Companies Act • Gift when tax demand payable would be hit by s.281 • Can arrange affairs to save tax but cannot dispose off assets to defeat s.281 • Very few cases have extended tax avoidance to s.281 31

32. FIRMS AND TRANSFER OF IMMOVABLE PROPERTY 32

33. FIRMS AND TRANSFER OF IMMOVABLE PROPERTY 33

34. CASE STUDIES 34

35. Case Study 1:- Dividend v. Buyback Lacks commercial substance [s.97(1)(c)] • I Co. has 3 individual shareholders namely A, B & C. The company has share capital of Rs. 120 crores and accumulated reserves of Rs. 30 crores. The company has two options to distribute such reserves to the shareholders. Option 2 The company makes an offer for buy-back of part of the shares (assumed to be in compliance with requirements of Companies Act 2013). For the purpose of such buy-back, the company would be required to pay tax @ 23.072% u/s 115QA of the ITA on the amount distributed less the amount received for the issue of such shares. No further tax would be payable by the shareholders individually. Option 1 The company distributes the Rs. 30 Cr. by way of dividend. This will attract DDT @ 20.35765% on the dividend declared u/s 115-O of the ITA. Additionally, the shareholders (A, B & C) would be required to pay tax @ 10% on dividend income exceeding Rs.10 lakhs u/s 115BBDA. The company chooses Option 2 to avoid additional taxation of dividend u/s 115BBDA in the hands of the shareholders. Would GAAR apply to the company’s decision? 35

36. Case Study 2:- Reverse Merger Non-arm’s Length Rights and Obligations [sec 96(1)(a)] The merger of a profit making company into a loss making one results in losses offsetting profits, a lower net profit and lower tax liability for the merged company. Would the losses be disallowed under GAAR? A Co. [Amalgamating Co.] R Co. [Amalgamated Co.] Merges Loss making Profit making The merger is covered by SAAR (NCLT approval) and the CBDT circular clarifies that GAAR would not be invoked if the NCLT has adequately and explicitly considered the tax implication while sanctioning the arrangement. 36

37. Case Study 2:- Reverse Merger • The proceedings at NCLT u/s 230 of the Companies Act, 2013 require approval / presence of Income Tax Authority inviting their comments on a proposed arrangement and Circular No.1/2014 issued by the MCA dated 15th January 2014 provides that when there is no response from the Income Tax Department, it may be presumed that the department has no objection to the proposed arrangement. • Assuming that the tax authorities did not appear for the proceedings / provide any response to comments sought, the NCLT order has been permitting the merger with either of the following comments: • Department has recently started taking objections before NCLT. Nobody appeared on behalf of the Income Tax, therefore no opinion has been provided on the tax implications of the merger. Nobody appeared on behalf of the Income Tax, therefore the tax implications of such merger have not been examined. Nobody appeared on behalf of the Income Tax, therefore it is presumed that tax department has no objection to the proposed merger. 37

38. Case Study 3:- Sale of Land Post Restructuring Mr. A Others Mr. A Merger Partnership Firm LLP New Co. Loss Co. Merged Co. Conversion Conversion Sale • Mr. A introduced land into partnership firm as his capital contribution • The said partnership firm was converted into LLP within 2 months • The LLP was converted into a company in the same year • On conversion, land was recorded as stock-in-trade in New Co.’s books. • Loss Co. is a company in which 99% shares are held by Mr. A. and which has significant brought forward losses • New Co. is merged with Loss Co. to form Merged Co. • Merged Co. sells the land and earns significant profit which is set off against brought forward losses 38

39. Case Study 3:- Sale of Land Post Restructuring Mr. A Others Mr. A Merger Partnership Firm LLP New Co. Loss Co. Merged Co. Conversion Conversion Sale • Whether existence of multi-stepped structures by itself attracts GAAR provisions? • Whether the entire sequence of events would be considered impermissible avoidance arrangement or only a part thereof? • Which of the entities would be subject to GAAR – all of them or Mr A only? • Assuming there was no synergy between the Part IX Company and Loss Co, can the merger itself be ignored by invoking GAAR provisions? • Does it matter if the merger is approved by the High Court in two states? 39

40. Case Study 4:- EXIT FROM BUSINESS PP • ABC family (comprising of A, B and C), wishes to divest business of ABC Co. • DD family had insisted on slump sale of business by ABC Co (Option 1) • PP family offers to purchase shares of ABC Co(Option 2) • ABC family did not agree to dividend declaration by ABC Co prior to share transfer to PP family • Contemporaneous discussions with tax advisors: Net of tax returns higher for share sale. Tax efficiency was one of the motivating factors for share sale option • Each of the sellers (A, B and C) invested the proceeds in residential house (s.54F) A B C Option 2 ABC Co. DD Option 1 Business Option 1: DD family offer to buy RRL business Option 2: PP family offer to buy RRL shares 40

41. Case Study 4:- EXIT FROM BUSINESS • Main purpose of implemented arrangement is tax benefit for RRL as there is avoidance of: • 30% tax on STCG payable on itemised sale (or) • 20% tax on LTCG payable on slump sale (or) • Avoidance of applicability of s.50C (or) • Consequential avoidance of DDT • Facilitated s.54F exemption by promoters • Substance of the transaction (i.e. acquisition of business) is different from the form [s.96(1)(c)] • Transfer of business is by means and manner not ordinarily employed for bona fide purpose [s.96(1)(d)] • Tax benefits `9 to 11 Cr. (being difference of tax incidence between Option 1 and Option 2) 41

42. Case Study 5:- GIFT TAXATION U/S 56(2)(X) Brother A B’s Daughter in Law B Exempt under proviso (I) to s.56(2)(x) • A and B are brothers; A is financially affluent • Son of B, recently expired in an accident; the son is survived by his widow and children • A, out of concern for B’s family and well being, gifts a sum of Rs 10 Cr. • B, out of his own volition, gifts sum of Rs. 10 Cr. to his daughter-in-law (i.e. son’s widow) Not exempt under s.56(2)(x) 42

43. Case Study 5:- GIFT TAXATION U/S 56(2)(X) Brother A B’s Daughter in Law B Exempt under proviso (I) to s.56(2)(x) • Gift by A to B is exempt under proviso (I) to s.56(2)(x) as received from relative (brother) • Gift by B to daughter-in-law is exempt under proviso (I) to s.56(2)(x) as received from relative (lineal ascendant of spouse i.e. husband’s father) • However, gift from A to B’s daughter-in-law is not protected under s.56(2)(x) Can GAAR be invoked to tax B’s daughter-in-law under s.56(2)(x)? Not exempt under s.56(2)(x) 43

44. Case Study 5:- GIFT TAXATION U/S 56(2)(X) 44

45. Case Study 6:-Salary Structuring • A Co. is a real estate developer. It builds residential complexes in Mumbai. Due to recession, many of its furnished flats are lying vacant. • It has just recruited a young MBA graduate for sales and marketing. While fixing the salary structure of this employee, it decides to keep the basic salary at Rs. 20,000/- per month whereas giving rent free furnished accommodation of a premium flat worth Rs.10 crore (inclusive of Rs. 30 lakhs furniture) to this employee. • Under Rule 3(1) of Income Tax Rules, 1962, perquisite of such rent free furnished accommodation is to be taken at 15% of the salary (salary as defined under Explanation to Rule 3) plus 10% of cost of owned furniture. • Perquisite value of this rent free furnished accommodation as per Rule 3 comes to Rs. 3,36,000/- (15% of 2,40,000 + 10% of 30,00,000) whereas the market rent comes anywhere above Rs. 15,00,000/-. Ignore the threshold of 3 crores for this example. • What if such salary structure is replicated across the board for 30 new employees thereby taking the total value of tax benefit above the threshold of Rs. 3 crore. How would the threshold be applied then – qua A Co. and each employee separately or for A Co. and all employees taken together? 45

46. Case Study 7:- Sale and Lease Back Promoters (X,Y) PE Investors Promoters (X,Y,Z) 44% 56% Sale of Shares (Rs. 100 crore) Lease A Co. B Co. Deposit (Rs. 50 crore) Sale of land (Rs. 8 crore) • A Co.’s shares are held by Promoters (X, Y and Z) and PE Investors • A Co. owns a land and building in which it carries on its business • PE Investors decided to exit by transferring their shareholding to B Co. (held by X and Y) for Rs. 100 crore • B Co. was incorporated in 2015 but there has been no business activity in B Co • A Co. sold land to B Co. at FMV of Rs. 8 crore • The land was leased back by B Co. to A Co. for Rs. 1.5 lakh / month. 46

47. Case Study 7:- Sale and Lease Back Promoters (X,Y) PE Investors Promoters (X,Y,Z) 44% 56% Sale of Shares (Rs. 100 crore) Lease A Co. B Co. Deposit (Rs. 50 crore) Sale of land (Rs. 8 crore) • A Co. gave a lease deposit of Rs. 50 crore for such transaction • The purchase of A Co.’s shares by B Co. was funded from Rs. 50 crore received as lease deposit and Rs. 50 crore loan • Lease deposit was funded from Rs. 8 crore sale of land, Rs. 10 crore internal accruals and Rs. 32 crore loan What will be the GAAR implications? 47

48. Case Study 8:- Treaty Benefit US Co. • US Co has 100% subsidiary Mau Co; that has 100% subsidiary I Co • Mau Co issues equity to US Co; I Co issues CCDs to Mau Co • US Co and Mau Co hold valid TRI • Co pays interest on CCDs to Mau Co at ALP (say - 30 Cr.) • I Co has withheld TDS @ 7.5% in terms of revised India Mauritius treaty Equity 100% MAU Co. CCD 100% India Co 48

49. Case Study 8:- Treaty Benefit US Co. • Deductibility of interest in hands of I Co is undisputed and is not subject to GAAR; GAAR is invoked by regarding Mau Co’s involvement as tainted How is tax benefit to be reckoned? De-minimis threshold for invoking GAAR is 3 Cr. - Is it met? • If treaty benefit is denied fully? • If treaty benefit of I-US available? Equity 100% MAU Co. CCD 100% India Co 49

50. Case Study 8:- Treaty Benefit 50