Direct Tax Code 2009 and GAAR

Although it is fairly well settled under the Indian tax jurisprudence that tax avoidance is legal but tax evasion is not, the dividing line between the two has always been extremely thin and blurred. In Mcdowell v. Commercial Tax officer [AIR 1986 SC 649], Justice Chinappa Reddy while delivering a minority opinion had further blurred the distinction between tax avoidance and tax evasion. However, a smaller bench of the Supreme court in Azadi Bachao Andolan [(2003) 263 ITR 706] correctly did not endorse the minority view in Mcdowell, holding clearly that a man has every right to structure his business in a manner that would reduce his tax liability. Having said that in my humble view Azadi may be per incuriam as in Mcdowell, interestingly the majority might have concurred with some of the findings of Justice Chinnappa Reddy (para. 26&27 of the Mcdowell Judgement is relevant) making the latter a binding precedent.


It is widely believed that both the decisions would be rendered inconsequential if the provisions relating to the General Anti Avoidance Rules (GAAR) as incorporated in the Direct Tax Code Bill, 2009 are brought into force. In this post I shall discuss some of the provisions relating to GAAR in the Direct Tax Code and in some later posts I shall also look into the provisions of GAAR as it exists in some matured jurisdictions such as Canada, Britain, France etc.

The intent of incorporating the GAAR can be best explained by the relying on the discussion paper released by the department last year. The following remarks from the paper may be relevant:

24.1 Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance objective of collecting revenues in an efficient, equitable and effective manner…………………….there is a strong general presumption in the literature on tax policy that all tax avoidance, like tax evasion, is economically undesirable and inequitable. On considerations of economic efficiency and fiscal justice, a taxpayer should not be allowed to use legal constructions or transactions to violate horizontal equity.



The intent echoes the sentiment of Justice Chinappa Reddy in Mcdowells and is in line with the aggressive tax policy undertaken by the department in recent times [See Generally: Geoffrey T. Loomer, The Vodafone Essar Dispute: Inadequate Tax Principles Create Difficult Choices For India, 21(1) NLSI. Rev. 89 (2009)] . Although the intent may be questionable or noble, the actual provisions relating to GAAR seems to be untenable.



S. 112(1) stipulates that the revenue may declare “any arrangement as an impermissible avoidance arrangement”. At first blush this clause seems to be very wide and gives blatant discretionary powers to the revenue. S. 112 not only empowers the revenue to declare “any” arrangement as impermissible but also gives it the power to disregard the arrangement, treat the parties who are connected to each other as one and the same person, re-characterising any equity into debt or vice versa and so on. Further, S. 113 (14) defines impermissible avoidance arrangement as under:


“impermissible avoidance arrangement means a step in, or a part or whole of, an arrangement, whose main purpose is to obtain a tax benefit and it,-

(a) creates rights, or obligations, which would not normally be created between persons dealing at arm's length;

(b) results, directly or indirectly, in the misuse, or abuse, of the provisions of this Code;

(c) lacks commercial substance, in whole or in part; or

(d) is entered into, or carried out, by means, or in a manner, which would not

normally be employed for bonafide purposes;

Conventional wisdom would suggest that S. 113 (14) imposes a limitation on the word “any” in S. 112 i.e. to say that the GAAR only gets triggered when the ingredients of S. 113 (14) are satisfied in a given case. But the interpretation can also be that S. 113 (14) is not exhaustive and the revenue may treat “any” other transaction as an impermissible avoidance arrangement even though it might not expressly fall within the ambit of S. 113(14). The discussion paper supports the former interpretation i.e. S. 113(14) imposes a restriction on the word “any” in S. 112. This interpretation is however rendered meaningless if one refers to S. 114 (1) which stipulates that an arrangement shall be presumed to have been entered for the main purpose of obtaining a tax benefit unless the contrary is shown by the person obtaining such a benefit. The effect of S. 114 (1) is fairly simple; the revenue might deem “any” arrangement to be for the main purpose of obtaining a tax benefit and if the assesse is unable to prove anything to the contrary the revenue would then be free to undertake the consequences as laid down in S. 112 even if the ingredients of S. 113 (14) are not expressly met.

Readers may also refer to a post written by Mihir here.