General Anti Avoidance Rules are a set of rules that countries have framed in order to minimize tax avoidance. Tax avoidance are a set of strategies where companies evade taxes by doing offshore transactions in tax havens i.e. countries where taxes are negligible, and thus save taxes.
So to prevent the loss of taxation these rules are framed.
In India GAAR shall be introduced from 1st April 2017.
Examples to Understand Application GAAR provisions : (Source GAAR Committee)
Example 1:
Facts:
A business sets up an undertaking in an under developed area by putting in substantial investment of capital, carries out manufacturing activities therein and claims a tax deduction on sale of such production/manufacturing. Is GAAR applicable in such a case ?
Interpretation:
There is an arrangement and one of the main purposes is a tax benefit. However, this is a case of tax mitigation where the tax payer is taking advantage of a fiscal incentive offered to him by submitting to the conditions and economic consequences of the provisions in the legislation e.g., setting up the business only in the under developed area. Revenue would not invoke GAAR as regards this arrangement.
Example 2:
Facts:
A business sets up a factory for manufacturing in an under developed tax exempt area. It then diverts its production from other connected manufacturing units and shows the same as manufactured in the tax exempt unit (while doing only process of packaging there). Is GAAR applicable in such a case ?
Interpretation:
There is an arrangement and there is a tax benefit, the main purpose or one of the main purposes of this arrangement is to obtain a tax benefit. The transaction lacks commercial substance and there is misuse of the tax provisions. Revenue would invoke GAAR as regards this arrangement.
The provision of GAAR are such that it shall be at the discretion of the Revenue Authorities to decide whether the purpose of a certain business decision taken shall be eligible for tax benefits or not.
The sweeping powers given to tax authorities might increase harassment or litigation.
The uncertain tax environment is not conducive for investments and so G.A.A.R should be applied sparingly and IT officials need to be sensitized.
One of the measures suggested is that GAAR should not be applied if amount under investigation is below a threshold, thus small industries can be free from harassment.
Finance Minister Arun Jaitley had in his Budget speech in 2015, deferred GAAR implementation by two years and also said that the investments made up to March 31, 2017 shall not be subjected to GAAR, which was to be applied on those claiming tax benefit of over Rs 3 crore.
The old rule shall apply to situations till a notified time period and then a new set of rules shall apply to situations after a certain time period.
Thus old rules of tax avoidance shall apply to transactions made till March 31st, 2017 and then after that all transactions shall be subject to the new GAAR rules.
India currently has DTAA with 84 different countries and so the terms and conditions are different in each agreement. But DTAA is a bilateral agreement i.e. an agreement between two countries to prevent taxation on the same income twice.
So suppose a person who is an Indian citizen but resides in a foreign country doesn't need to pay tax on the same income twice if that country has signed a DTAA with India. DTAA is with reciprocal basis i.e. a person of a different country and staying in India also is protected from double taxation.
DTAA can be source based or residence based.
Under source based, if a Indian residing in a foreign country gets income from some source in India either by selling land or shares or any other business then he has to pay tax in India. But the country where he resides won't ask him to pay tax on the same income.
Under residence based taxation, he won't have to pay tax in India even though he has earned money from that country, but he shall pay tax in his country of residence.
India has signed a modified DTAA with Mauritius, Cyprus and Singapore for converting the Residence based taxation into source based taxation but only for income arising out of selling of shares i.e. stock market investment.
Since no capital gains tax or limited capital gains tax was imposed in Mauritius and Cyprus, Singapore the foreign investors made gains by routing investments in India's stock market from these countries.