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Forensic Accounting 16

The document discusses forensic accounting and curbing tax avoidance. It summarizes key aspects of India's Direct Taxes Code (DTC) including the presumption of purpose clause and how it shifts the burden of proof to taxpayers. It also discusses how the DTC's General Anti-Avoidance Rule (GAAR) expands the scope of transactions subject to scrutiny and connects GAAR to the doctrine of piercing the corporate veil. Suggestions are made to provide more clarity and safeguards in the application of GAAR to avoid impacting legitimate tax planning.

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67 views

Forensic Accounting 16

The document discusses forensic accounting and curbing tax avoidance. It summarizes key aspects of India's Direct Taxes Code (DTC) including the presumption of purpose clause and how it shifts the burden of proof to taxpayers. It also discusses how the DTC's General Anti-Avoidance Rule (GAAR) expands the scope of transactions subject to scrutiny and connects GAAR to the doctrine of piercing the corporate veil. Suggestions are made to provide more clarity and safeguards in the application of GAAR to avoid impacting legitimate tax planning.

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silvernitrate1953
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© © All Rights Reserved
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Download as DOCX, PDF, TXT or read online on Scribd
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FORENSIC ACCOUNTING

LIFTING THE VEIL TO CURB AVOIDANCE

Presumption of purpose
Under the DTC, an arrangement shall be presumed to have been
entered into or carried out for the main purpose of obtaining a tax
benefit unless the person obtaining the tax benefit proves that
obtaining the tax benefit was not the main purpose of the
arrangement. Similarly, an arrangement shall be presumed to
have been entered into, or carried out for the main purpose of
obtaining a tax benefit, if the main purpose of a step in, or part of
the arrangement is to obtain a tax benefit, regardless of the fact
that the main purpose of the whole arrangement may not be to
obtain a tax benefit. This provision is certainly inspired from the
experience under the Income Tax Act regime where the tax
authorities are severely disadvantaged in terms of establishing
sham transactions. Moreover, the RDP is quick to defend the
GAAR on grounds of there being no significant additional
information and disclosure requirements for taxpayers.75

DTC Regime and Piercing the


Corporate Veil
Before we conclude our discussion on the DTC, it would be
prudent for the purpose of clarity, to highlight the connection
between the GAAR and the doctrine of piercing the corporate
veil. The doctrine emerged from the judiciary as a means of
unearthing sham transactions and ensuring that proceeds from
such transactions were charged to tax. The judicial doctrine
came to acquire certain standards on the basis of which
transactions would be classified as colourable transactions but
the judicial doctrine despite all its developments could not
fathom all the possible devices employed to avoid tax. The GAAR
emerged in this context as a widely worded statutory rule that
could be used to potentially bring any transaction under its
scanner. More importantly, the GAAR shifts the standard from
‘transaction’ to ‘arrangement’ thereby increasing the scope of its
own coverage. The definitions of “impermissible avoidance
arrangement”, “tax benefit” and “lacks commercial substance”
etc. were discussed with a view to demonstrate the proposed
functioning of the GAAR regime when it comes into effect. Our
preliminary analysis is that the GAAR regime along with its treaty
override clause and presumption of purpose clause will serve the
Government’s objective of ensuring compliance as well as
checking tax avoidance well.

VII. Law in Other Jurisdictions


Before we part with this discussion, it might be well to consider
the position of law in other jurisdictions. The debate about
whether a transaction or arrangement should be analyzed for tax
purposes on the basis of its legal form or, alternatively, its
economic substance has raged across jurisdictions. One would
remember our discussion on the development of the position in
UK in an earlier section. Most jurisdictions have settled this
debate in favour of substance over form.

Australia
Australia has incorporated both general and specific anti-
avoidance rules in its income tax legislations. These rules have
been designed to prevent inappropriate fiscal outcomes arising
where tax payers have deliberately altered the form of their
transactions in order to obtain a fiscal advantage. The general
anti-avoidance provisions under Part IVA of Australian Income
Tax law (the Income Tax Assessment Act, 1936), to some degree
provides scope for the authorities to adopt a ‘substance over
form’ approach in relation to arrangements entered into by
taxpayers with the dominant purpose of reducing their income
tax obligations. An Australian Tax Office Draft Determination (TD
2009/17 – Income tax: treaty shopping) that was issued following
the case of Federal Commissioner of Taxation vs. The Myer
Emporium Ltd.76 is indicative of the manner in which the
Australian authorities have adopted the substance over form
approach.

United States
The US has several rules in its legislation which have codified
the substance over form concept. The Internal Revenue Service
(IRS) is permitted to re-characterize cross-border conduit
financing transactions. Specifically, the IRS is authorized to
disregard an intermediate company in a multiparty financing
agreement if the company is used as part of tax avoidance plan.
The US courts have consistently taken the view that transactions
are to be taxed according to their economic substance rather
than their legal form. Furthermore, in Burger King v State Tax
Commission, the Court overlooking the form of the transaction,
rejected the contention of the Tax Commission that Burger King
could not claim exemption from sales tax because it did not
charge a line item on the receipt for packaging and hence the
packaging was not being resold. Most importantly, the Supreme
Court, in Helvering v F & R Lazarus & Co, summarized the
doctrine of the substance over form by stating that
administrators of the law and the courts are concerned with
substance and realities. The Court further stated that formal
written documents are not rigidly binding.

Germany
German law recognizes the substance over form approach in
those instances where an inappropriate legal structure resulting
in tax advantage is utilized and where the taxpayer is unable to
provide significant non-tax reasons for using such a structure. A
legal structure is considered inappropriate if the taxpayer or a
third party generates a tax benefit that is not intended by the
law.82 Here, it is interesting to note that the onus on establishing
the bona fide of a legal structure resulting in tax advantage lies
with the taxpayer. In this way, there is a similarity between
German law and the presumption of purpose clause u/s. 125 of
the DTC.

Switzerland
Switzerland does not have many written or specific anti-
avoidance rules. Under such circumstances, the general
principles of abuse of law or tax evasion apply. Swiss law does
not look unfavourably upon aggressive tax planning efforts
provided such efforts do not result in abuse of law or tax evasion.
However, Swiss law does recognize the substance over form
approach. Swiss tax authorities are empowered to disregard a
structure or transaction and assess tax liability on the basis of
economic realities underlying the transaction in circumstances
where the form chosen by the taxpayer is unusual, where the
form has been chosen only for tax saving purposes and where the
taxpayer would make significant tax savings if the hypothesis in
which the structure was recognized by the tax authorities.

VIII. Suggestions
This portion of the paper will focus on two questions viz. whether
the law requires to be reformed and what reforms can be
suggested? In dealing with these questions, we are in the
unenviable position of having to balance the interests of the
taxpayer and the Revenue. The Direct Taxes Code is expected to
take effect in April 2012 and accordingly, this section will focus
on the principles relating to ‘piercing the corporate veil’ that have
been enshrined in the DTC. We answer the first question by
affirming that the law requires to be reformed in the interests of
clarity. The Government has undoubtedly made an ideological
choice in revising the tax regime in favour of the Revenue and we
intend to confine our suggestions within the framework of this
choice. The following paragraphs answer the second question.
Safeguards in the application of
GAAR
The RDP states that the CBDT will issue guidelines for the
circumstances in which the GAAR may be invoked. At the time of
the Bill being introduced in Parliament, no additional guidelines
have been introduced. The apprehension was that legitimate tax
planning efforts may be undermined.84 The Revenue may evolve
a strategy wherein it targets a particular pattern of business
structures that results in high losses to the Exchequer. In other
words, the CBDT which has the power to issue guidelines can
outline particular avoidance models or arrangements which will
be targeted by the GAAR so as to ensure greater clarity for the
tax authorities and the taxpayer.

Tax Benefits and Impermissible


Avoidance Arrangements
The premise of an ‘impermissible avoidance arrangement’ is that
there is an arrangement which in whole or part, or any step
therein, has as its main purpose the obtaining of a tax benefit.
Similarly, a tax benefit refers to a reduction, avoidance or
deferral of tax payable. It is difficult to fathom any arrangement
which is established for even bona fide purposes which may not
have the effect of resulting in tax avoidance or reduction. In
other words, the DTC which was designed to target tax
avoidance can potentially target legitimate arrangements. This is
a genuine concern and demands that the language of GAAR
regime be reconsidered.

Focus on ‘impermissible
arrangement’
Greater clarity is achieved if the statute is seen in terms of tax
avoidance being an incidence of an impermissible avoidance
arrangement. Ideally, the tax authorities should probe
arrangements that fall under any one of the four grounds under s.
124(15) of the DTC and then ascertain whether such an
arrangement has resulted in any tax benefit. No harm is caused
where an impermissible arrangement does not result in loss to
the exchequer. An impermissible arrangement in itself is not a
bona fide arrangement under the DTC. Consequently, a resulting
tax benefit should trigger the GAAR regardless of whether or not
such tax benefit was the main purpose behind the arrangement.
Accordingly, we suggest that the words “whose main purpose is
to obtain” in s. 124(15) of the DTC be replaced by the words
“resulting in”.

IX. Concluding Remarks


There are no two ways about assessing the doctrine of piercing
the corporate veil. It has proved to be an effective instrument in
unearthing sham transactions and recovering losses to the
exchequer. The legislature was spot on in measuring the utility of
the doctrine and giving it statutory recognition in the Direct
Taxes Code in the form of the anti-avoidance rule. The doctrine
has witnessed phenomenal transformation from the time when
Indian courts first applied it to taxation matters to the time when
the DTC was introduced in the Parliament. Following the decision
in Azadi, it came to be accepted that the Indian tax regime
allowed taxpayers to arrange their finances in a manner that
would result in least tax liability provided such arrangement was
legal. The decisions in Vodafone  and Richer Holding have
demonstrated how the doctrine was applied to bring seemingly
immune transactions within the tax ambit.

THE FULL PAPER OF Adhitya Srinivasan & Vipul Agrawal-can be


read at- itataonline.org

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